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

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FORM 10-K

|ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|------------------------------------------------------------------------------------
|For the fiscal year ended December 31, 2003                                         

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
|------------------------------------------------- |  | -----------------------------------------
|67/8% Quarterly Interest Bond Securities Due 2101 |  | New York Stock Exchange, Inc.            
|6.25% Notes Due November 1, 2102                  |  | New York Stock Exchange, Inc.            
|5.60% Notes Due July 15, 2103                     |  | New York Stock Exchange, Inc.            

Securities
registered pursuant to Section 12(g) of the Act: None

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

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

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

The
aggregate market value of common equity, excluding treasury shares, held by non-affiliates of the registrant at June 30, 2003 was $41,172,860. 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, 2003.

At
March 25, 2004, 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).



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TABLE OF CONTENTS

|         |  |                                                                                        |  | Page
|-------- |  | -------------------------------------------------------------------------------------- |  | ----
|PART I   |  |                                                                                        |  |     
|Item 1.  |  | Business.                                                                              |  | 3   
|Item 2.  |  | Properties.                                                                            |  | 41  
|Item 3.  |  | Legal Proceedings.                                                                     |  | 41  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                    |  | 41  
|PART II  |  |                                                                                        |  |     
|Item 5.  |  | Market for Registrant's Common Equity and Related Stockholder Matters                  |  | 42  
|Item 6.  |  | Selected Financial Data.                                                               |  | 43  
|Item 7.  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations. |  | 43  
|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk.                            |  | 61  
|Item 8.  |  | Financial Statements and Supplementary Data                                            |  | 62  
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.  |  | 100 
|Item 9A. |  | Controls and Procedures.                                                               |  | 100 
|PART III |  |                                                                                        |  |     
|Item 10. |  | Directors and Executive Officers of the Registrant.                                    |  | 101 
|Item 11. |  | Executive Compensation                                                                 |  | 105 
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management.                        |  | 109 
|Item 13. |  | Certain Relationships and Related Transactions                                         |  | 112 
|Item 14. |  | Principal Accountant Fees and Services.                                                |  | 113 
|PART IV  |  |                                                                                        |  |     
|Item 15. |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K.                      |  | 114 

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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 financial strength 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
non-municipal obligations and has been a major insurer of asset-backed and other non-municipal obligations since its inception in 1985. FSA expanded the focus of its business
in 1990 to include financial guaranty insurance of municipal obligations and has since become a major insurer of municipal obligations. For the year ended December 31, 2003, the Company had
gross premiums written of $895.8 million, of which 34% related to insurance of asset-backed and other non-municipal obligations and 66% related to insurance of municipal
obligations. At December 31, 2003, the Company had net par outstanding of $289.5 billion, of which 41% represented insurance of asset-backed and other non-municipal
obligations and 59% 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 subsidiary, FSA Capital
Management Services LLC ("FSACMS"). The amounts stated above exclude the intercompany 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. In the third quarter of 2003, the Company consolidated
FSA Global for the first time as a result of the Company's adoption of Financial Accounting Standards Board ("FASB") Interpretation No. 46, "Consolidation of Variable Interest Entities, an
interpretation of ARB No. 51" (FIN 46). The Company also consolidated Premier International Funding Co. (Premier) in the third quarter as a result of FSA obtaining control rights. FSA Global is
engaged in the issuance of FSA-insured medium term notes and invests the proceeds from the sale of its notes in FSA-insured obligations with a view towards realizing the yield
difference between the notes issued and the obligations purchased with the note proceeds. Premier is principally engaged in debt defeasance for lease transactions. The Company's management believes
that the assets held by FSA Global and Premier, including those that are eliminated in consolidation, are beyond the reach of the Company and its creditors, even in bankruptcy or other receivership.
At December 31, 2003, FSA Global had $2.3 billion principal amount of outstanding notes, after elimination of intercompany transactions.

FSACMS
and FSA Capital Markets Services LLC (collectively, the "GIC Subsidiaries") are wholly owned subsidiaries of the Company. Until April 2003, both companies issued GICs.
FSACMS has conducted all GIC business since April 2003, following receipt of an exemption from the requirements of the Investment Company Act of 1940. Proceeds from the sale of GICs are lent to
FSA Asset Management LLC ("FSAM"). FSAM generally invests in obligations that would qualify for FSA

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insurance
with a view towards realizing a yield difference between its investments and its obligations. At December 31, 2003, the Company had $4.2 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 made 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.

The
Company is a subsidiary of Dexia Holdings, Inc. ("Dexia Holdings"), which, in turn, is owned 90% by Dexia Crédit Local SA 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, as well as in the U.S. 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 the chairman of White Mountains became non-executive chairman of the Company.    White
Mountains is an insurance holding company.

In
1998, the Company and XL entered into a joint venture, establishing two Bermuda domiciled financial guaranty insurance companiesFSA International and XL Financial
Assurance Ltd ("XLFA"). 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. At the merger date, each outstanding share of the Company's
common stock was converted into the right to receive $76.00 in cash. At December 31, 2003, approximately 99% of the Company's common stock was held by Dexia Holdings, and the only other holders
were an affiliate of 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 debt securities issued by the Company are listed on the NYSE.

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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 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 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. Municipal obligations insured by FSA include project finance obligations, consisting
primarily of obligations of special purpose issuers backed by the cash flow from lease or other revenues from projects serving a substantial public purpose, including government office buildings, toll
roads, healthcare facilities and utilities.

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 four trends: (i) expansion of asset securitization; (ii) growth of project finance in Europe through expansion of
private finance for funding of
infrastructure projects; (iii) 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 continued demand for credit enhancement by individuals who purchase municipal bonds; and (iv) growing use of financial guaranty insurance in non-U.S.
markets. The Company also anticipates continued demand over the long term for its GIC business and other financial products programs that employ financial guaranty insurance provided by FSA. The
Company believes that short term trends for financial guaranty insurance remain uncertain due, among other things, to (i) potential decline in municipal financings and refundings should
interest rates rise; and (ii) increased competition among financial guarantors and other alternative providers of credit enhancement.

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 Risk
Management Officer and Chief Financial Officer as full-time members, and the heads of FSA's Municipal Finance, Corporate Finance, International Finance and Financial Products groups, as
part-time members. Bruno Deletre, a director of the Company, was named anex officiomember of the Management Committee in 2003. FSA is

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primarily
engaged in the business of writing financial guaranty insurance on asset-backed and municipal obligations. In 2001, FSA commenced insuring GICs issued by the GIC Subsidiaries.

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. The great majority of asset-backed obligations are secured by or
represent interests in diverse pools of assets, such as residential mortgage loans, auto loans, credit card receivables, other consumer receivables, corporate loans or bonds, government debt and small
business loans. 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 (CDS) 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.

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, some corporations have found securitization of their assets to be a less costly funding alternative to traditional forms of
borrowing or otherwise important in diversifying funding sources. Also, some finance companies fund consumer finance and home equity lending through securitization.

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.

According
to industry sources, the par volume of funded U.S. public asset-backed securities, including securities distributed under Rule 144A, since 1999, were as follows:

Year

New Issues of Funded U.S. Public
Asset-Backed Securities(1)(in billions)1999

$
254.72000


272.82001


324.62002


411.52003


510.3


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According
to industry sources, par volumes in certain other asset-backed markets from 2000 through 2003 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(2)(in billions)2000

$
65.8

$
85.6

$
78.52001


143.1


115.2


79.62002


214.0


117.3


87.72003


296.2


180.6


79.5


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The
data in the tables above exclude synthetic transactions and therefore does not reflect the substantial growth in the use of CDS. According to survey data published on the website of
the International Swaps and Derivatives Association, Inc., www.isda.org, the notional principal amount of CDS outstanding in world markets at the dates indicated were as follows:

Date

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

$
918.9December 31, 2002


2,191.6June 30, 2003


2,687.9


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According
to the Association of Financial Guaranty Insurers ("AFGI"), the annual totals of funded and synthetic asset-backed par insured of financial guaranty insurance originated by
monoline guarantors since 1999 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)1999

$
117.9

$
24.22000


116.1


55.22001


167.1


51.42002


165.5


63.22003


N/A(2
)

N/A(2
)


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In
general, since the 1990s, the asset-backed financial guaranty business has grown because of a variety of factors, including expansion of U.S. and international asset-backed securities
and CDS markets, the related opportunities for guarantors to insure high-quality business and diversify their insured portfolios, high demand for credit enhancement on complex asset-backed
issues and attractive returns available in the asset-backed market.    Although the asset-backed market is now mature in the U.S., the Company expects it to continue to be a significant
market for financial guarantors and to provide substantial growth opportunities outside the U.S.

In
recent years, there has been substantial consolidation and contraction among finance companies that originate securitizations, particularly in the subprime mortgage and auto loan
finance sectors in which FSA operates. This consolidation appears to have been largely completed, and the surviving companies generally have stronger operating profiles than before the period of
consolidation. In addition, narrowing spreads between the yields on Triple-A and lesser rated obligations generally reduced the number of appropriately priced opportunities for guarantors
during 2003. In the CDO market, investor appetite and corresponding volumes are also dependent on the credit cycle and credit spreads, with narrower spreads generally slowing both the overall and
insured volume of CDOs.

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. Municipal obligations include project finance obligations, consisting of obligations backed by the cash flow from leases or other revenues
from projects serving a substantial public purpose, including government office buildings, toll roads, healthcare facilities and utilities.

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Until
1999, insurance of municipal obligations (primarily in the U.S.) represented the largest portion of the financial guaranty insurance business. In 1999, rising interest rates were
responsible for much of the decline in total issuance that year and caused a steep decline in refundings. 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 in
2002 and 2003 as low interest rates, diminished tax revenues and continuing needs for infrastructure investment drove municipalities to borrow on an unprecedented scale.

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

Insured U.S. Municipal Obligations(1)

Year

New Total Volume

New Insured Volume

New Insured Volume as Percent of New Total Volume(dollars in billions)1999

$
227.6

$
105.6

46.4
%2000


200.7


79.3

39.52001


288.2


134.3

46.62002


358.8


178.9

49.92003


384.8


191.3

49.7


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

According
to AFGI, the annual totals of non-U.S. municipal par insured of financial guaranty insurance originated by monoline guarantors since 1999 were as follows:

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

Year

Amount(in billions)1999

$
2.62000


4.12001


6.02002


8.12003


N/A(2
)


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GICs/Variable Interest Entity (VIE) Debt

The Company's GIC business provides GICs to municipalities and other market participants. All such GICs are insured by FSA. Municipal GICs are primarily used by
holders to invest bond proceeds required to be maintained in debt service reserve funds or construction funds for bond issues. Non-municipal GICs insured by FSA include GICs acquired by
issuers of credit linked notes and GICs acquired by FSA Global. GICs provide for the return of principal and the payment of interest at specified rates. Amounts raised by the GIC Subsidiaries 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 GIC-related obligations) 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 unexpected withdrawals of principal from 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, which fund the payment of project expenses in accordance with the underlying bond documents,
may be drawn more quickly or more slowly than anticipated to pay such expenses. In addition, most FSA-insured GICs allow for withdrawal of GIC funds in the event of a downgrade of FSA,
typically below AA- by 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.

FSA
Global is 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 that are U.S. dollar denominated or converted into U.S. dollars at LIBOR-based floating borrowing rates, and invests its funds in U.S. dollar denominated
LIBOR-based floating rate 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.

Types of Products

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

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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 control rights of FSA in the event of default are generally more limited and 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.

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The
following table indicates the Company's percentages of par amount (net of reinsurance) outstanding at December 31, 2003 and 2002 with respect to each type of asset-backed and
municipal program:

Net Par Amount and Percentage Outstanding by Program Type

|                 |  | December 31, 2003 |        
|---------------- |  | ----------------- | -------
|
|
|
|New Issue        |  | $                 | 110,429
|Secondary Market |  |                   | 6,941  
|                 |  |                   |        
|Total            |  | $                 | 117,370
|                 |  |                   |        

|                 |  | December 31, 2002 |        
|---------------- |  | ----------------- | -------
|
|
|
|New Issue        |  | $                 | 118,332
|Secondary Market |  |                   | 6,590  
|                 |  |                   |        
|Total            |  | $                 | 124,922
|                 |  |                   |        

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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 CDS and
credit-linked notes structured to have risks similar to those of more traditional 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. FSA has 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. In recent years, FSA has reinsured a modest amount of business from other financial guaranty insurers.

A
summary of the Company's par outstanding at December 31, 2003 is as follows:

|                |  | Direct |         | Assumed |   | Total Gross |  | Ceded |         | Net
|--------------- |  | ------ | ------- | ------- | - | ----------- |  | ----- | ------- | ---
|
|Asset-backed(1) |  | $      | 142,545 |         | $ | 1,183       |  | $     | 143,728 |    
|Municipal       |  |        | 241,810 |         |   | 752         |  |       | 242,562 |    
|                |  |        |         |         |   |             |  |       |         |    
|Total           |  | $      | 384,355 |         | $ | 1,935       |  | $     | 386,290 |    
|                |  |        |         |         |   |             |  |       |         |    

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At
December 31, 2003, the weighted average life of the direct par insured on these policies was approximately 3 and 13 years for asset-backed and municipal obligations,
respectively.

Asset-Backed and Other Non-Municipal Obligations

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



13

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14

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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 in an amount
sufficient 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 bonds of state and local municipal authorities issued
on a conduit basis on behalf of not-for-profit hospitals and hospital systems for refinancings and capital acquisitions and construction, payable from amounts derived under
loan agreements and notes of such health care providers with such authorities.

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 state 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

15

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other
obligations having international aspects but otherwise within the municipal categories described above.

A
summary of FSA's insured portfolio at December 31, 2003 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.

Insured Portfolio

Summary of Insured Portfolio at December 31, 2003(1)

|                         |                                              | Number of
Issues In
Force      |       | Net Par
Amount
Outstanding |       | Net
Par and
Interest |         | Percent
of Net
Par and
Interest |       
|------------------------ | -------------------------------------------- | ------------------------------ | ----- | -------------------------- | ----- | -------------------- | ------- | ------------------------------- | ------
|
|Asset-backed obligations |                                              |                                |       |                            |       |                      |         |                                 |       
|                         | Residential mortgages                        |                                | 297   |                            | $     | 14,816               |         | $                               | 16,669
|                         | Consumer receivables                         |                                | 64    |                            |       | 13,484               |         |                                 | 14,327
|                         | Pooled corporate obligations                 |                                | 211   |                            |       | 48,919               |         |                                 | 52,309
|                         | Other domestic asset-backed obligations      |                                | 84    |                            |       | 3,761                |         |                                 | 5,098 
|                         | International obligations                    |                                | 128   |                            |       | 37,548               |         |                                 | 39,214
|                         |                                              |                                |       |                            |       |                      |         |                                 |       
|                         |                                              | Total asset-backed obligations |       | 784                        |       |                      | 118,528 |                                 |       
|                         |                                              |                                |       |                            |       |                      |         |                                 |       
|Municipal obligations    |                                              |                                |       |                            |       |                      |         |                                 |       
|                         | General obligation bonds                     |                                | 5,188 |                            |       | 65,222               |         |                                 | 98,248
|                         | Housing revenue bonds                        |                                | 196   |                            |       | 7,597                |         |                                 | 14,000
|                         | Municipal utility revenue bonds              |                                | 969   |                            |       | 30,025               |         |                                 | 48,827
|                         | Health care revenue bonds                    |                                | 176   |                            |       | 7,051                |         |                                 | 12,668
|                         | Tax-supported (non-general obligation) bonds |                                | 980   |                            |       | 33,835               |         |                                 | 52,685
|                         | Transportation revenue bonds                 |                                | 119   |                            |       | 10,744               |         |                                 | 19,486
|                         | Other domestic municipal bonds               |                                | 654   |                            |       | 10,319               |         |                                 | 15,758
|                         | International obligations                    |                                | 70    |                            |       | 6,145                |         |                                 | 14,064
|                         |                                              |                                |       |                            |       |                      |         |                                 |       
|                         |                                              | Total municipal obligations    |       | 8,352                      |       |                      | 170,938 |                                 |       
|                         |                                              |                                |       |                            |       |                      |         |                                 |       
|                         |                                              |                                | Total |                            | 9,136 |                      | $       | 289,466                         |       
|                         |                                              |                                |       |                            |       |                      |         |                                 |       

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16

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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                          |                                | 7    
|                                                 | Consumer receivables                           |                                | 6    
|                                                 | Pooled corporate obligations                   |                                | 5    
|                                                 | Other domestic non-municipal obligations(1)(2) |                                | 2    
|                                                 | International obligations                      |                                | 11   
|                                                 |                                                |                                |      
|                                                 |                                                | Total asset-backed obligations |      
|                                                 |                                                |                                |      
|Municipal obligations                            |                                                |                                |      
|                                                 | General obligations bonds                      |                                | 27   
|                                                 | Housing revenue bonds                          |                                | 3    
|                                                 | Municipal utility revenue bonds                |                                | 12   
|                                                 | Health care revenue bonds                      |                                | 2    
|                                                 | Tax-supported (non-general obligation) bonds   |                                | 14   
|                                                 | Transportation revenue bonds                   |                                | 5    
|                                                 | Other domestic municipal bonds                 |                                | 4    
|                                                 | International obligations(1)                   |                                | 2    
|                                                 |                                                |                                |      
|                                                 |                                                | Total municipal obligations    |      
|                                                 |                                                |                                |      
|                                                 |                                                |                                | Total
|                                                 |                                                |                                |      

---

17

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Terms to Maturity

The table below sets forth the contractual terms to maturity of FSA's policies at December 31, 2003 and 2002:

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

|                   |       | December 31, 2003 |        | December 31, 2002
|------------------ | ----- | ----------------- | ------ | -----------------
|
|
|0 to 5 years       |       | $                 | 58,500 |                  
|5 to 10 years      |       |                   | 33,063 |                  
|10 to 15 years     |       |                   | 6,806  |                  
|15 to 20 years     |       |                   | 1,450  |                  
|20 years and above |       |                   | 18,709 |                  
|                   |       |                   |        |                  
|                   | Total |                   | $      | 118,528          
|                   |       |                   |        |                  

---

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, 2003:

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

|Original Net Par Amount     |       | Number of
Policies |       | Net Par Amount
Outstanding
|--------------------------- | ----- | ------------------ | ----- | --------------------------
|
|Less than $10 million       |       | 699                |       | $                         
|$10 to $50 million          |       | 543                |       |                           
|$50 million to $100 million |       | 382                |       |                           
|$100 million or greater     |       | 833                |       |                           
|                            |       |                    |       |                           
|                            | Total |                    | 2,457 |                           
|                            |       |                    |       |                           

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MunicipalOriginal Net Par Amount Per Issue(1)

|Original
Net Par Amount     |       | Number
of Policies |        | Net Par
Amount
Outstanding
|--------------------------- | ----- | ------------------ | ------ | --------------------------
|
|Less than $10 million       |       | 12,820             |        | $                         
|$10 to $50 million          |       | 4,121              |        |                           
|$50 million to $100 million |       | 658                |        |                           
|$100 million or greater     |       | 590                |        |                           
|                            |       |                    |        |                           
|                            | Total |                    | 18,189 |                           
|                            |       |                    |        |                           

---

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

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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, 2003

|Jurisdiction                 |       | Number
of Issues |       | Net Par
Amount
Outstanding |        | Percent of Total
Municipal Net
Par Amount
Outstanding |     
|---------------------------- | ----- | ---------------- | ----- | -------------------------- | ------ | ----------------------------------------------------- | ----
|
|California                   |       | 895              |       | $                          | 24,789 |                                                       | 14.5
|New York                     |       | 575              |       |                            | 15,727 |                                                       | 9.2 
|Texas                        |       | 669              |       |                            | 12,128 |                                                       | 7.1 
|Pennsylvania                 |       | 643              |       |                            | 10,550 |                                                       | 6.2 
|Florida                      |       | 259              |       |                            | 10,007 |                                                       | 5.9 
|New Jersey                   |       | 524              |       |                            | 8,673  |                                                       | 5.1 
|Illinois                     |       | 622              |       |                            | 7,774  |                                                       | 4.5 
|Washington                   |       | 267              |       |                            | 6,140  |                                                       | 3.6 
|Michigan                     |       | 359              |       |                            | 5,134  |                                                       | 3.0 
|Massachusetts                |       | 185              |       |                            | 5,016  |                                                       | 2.9 
|Wisconsin                    |       | 412              |       |                            | 4,038  |                                                       | 2.4 
|Ohio                         |       | 212              |       |                            | 3,732  |                                                       | 2.2 
|Indiana                      |       | 210              |       |                            | 3,581  |                                                       | 2.1 
|All other U.S. jurisdictions |       | 2,450            |       |                            | 47,504 |                                                       | 27.8
|International                |       | 70               |       |                            | 6,145  |                                                       | 3.5 
|                             |       |                  |       |                            |        |                                                       |     
|                             | Total |                  | 8,352 |                            | $      | 170,938                                               |     
|                             |       |                  |       |                            |        |                                                       |     

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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 31,2003

2002

2001(in thousands)U.S.

$
599,410

$
386,808

$
364,817International


32,926


33,290


13,837Total revenues

$
632,336

$
420,098

$
378,654


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

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, 2003, FSA's ten largest net insured asset-backed transactions represented $17.4 billion, or 6.0%, of the Company's total net par amount outstanding, and FSA's ten largest
net insured municipal credits represented $9.0 billion, or 3.1%, of the Company's total net par amount outstanding. For purposes of the foregoing, different issues of asset-backed securities by
the same sponsor have not been aggregated. FSA has, however, adopted underwriting policies establishing single risk guidelines applicable to asset-backed securities of the same sponsor. In addition,
individual corporate names may appear in more than one FSA-insured CDO transaction, but such exposures are not aggregated for purposes of identifying 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 reviews, generally on a quarterly
basis, 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 CDS, a deductible) or third-party protection (such as bank
letters of credit, guarantees, net worth maintenance agreements, indemnity agreements or reinsurance agreements). This

21

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overcollateralization
or third-party protection need not protect 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.
Asset-backed obligations insured by FSA may also benefit from third party protection such as letters of credit, mortgage guaranty insurance or financial guaranty insurance provided by other financial
institutions. 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 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. Asset-backed obligations insured by FSA are reviewed prior to issuance by both S&P and Moody's to evaluate
the risk proposed to be insured. In the case of municipal obligations, prior rating agency review is a function of the type of insured obligation and the risk elements involved. The independent review
of FSA's underwriting practices performed by the rating agencies further strengthens the underwriting process.

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

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

Each
underwriting group in the Financial Guaranty Department 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 municipal international project finance 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 Risk Management Officer, Chief Domestic Underwriting Officer, Chief International Underwriting Officer,

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General
Counsel and Associate General Counsel for Asset-Backed Transactions. 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, Municipal Underwriting Officer, Managing Director of
Public Finance and Associate General Counsels for Municipal Transactions. The MUNC approval process generally requires approval by at least the Chief Executive Officer or President; the Chief
Municipal Underwriting Officer or Municipal Underwriting Officer; and an Associate General Counsel for Municipal Transactions. Following approval, minor transaction modifications may be approved by
the Chair of the applicable underwriting committee. Major changes require the concurrence of the applicable underwriting committee. Subject to applicable limits, guaranties of secondary market issues
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 Committee and the head of the department
involved, with a third signature required from a member of the Risk Management Committee for larger transactions. Subject to applicable limits, municipal transactions that meet certain credit and
return criteria may be approved by a committee (the "Demi-MUNC") comprised of the Chief Municipal Underwriting Officer, Municipal Underwriting Officer or Managing Director for Municipal
Operations; an Associate General Counsel for Municipal Transactions; and any one of certain managing directors and directors designated by the MUNC. The Demi-MUNC approval process
generally requires approval by at least two voting members, with approval by the Chief Municipal Underwriting Officer or Municipal Underwriting Officer required for transactions exceeding a certain
size.

Corporate Research

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

23

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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 reserve for the unpaid losses and loss adjustment expenses for the 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. For CDOs, a case reserve is recorded to the extent that the overcollateralization
ratio (non-defaulted collateral at par divided by the debt insured) has fallen below 100% and there is a projected loss when calculating the present value of cash flows.

The
Company also maintains a non-specific general reserve, which is available to be applied against future additions or accretions to existing case reserves or to new case
reserves to be established in the future. The general reserve is derived from two separate steps. The first step is to multiply loss factors by the Company's total net par underwritten and to discount
the result at the then current risk-free rates. The loss factors used for this purpose are obtained from an independent rating agency study of bond defaults and have been adjusted by the
Company's portfolio characteristics and history. The second step pertains to the Company's insured CDOs, where a present value "deterministic" approach, discussed below, is utilized to calculate the
general reserve for the Company's insured CDOs.

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.

24

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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                          |                        | $                       | 223,618
|Less reinsurance recoverable                  |                        |                         | 75,950 
|                                              |                        |                         |        
|Net balance at January 1                      |                        |                         | 147,668
|Incurred losses and loss adjustment expenses: |                        |                         |        
|                                              | Current year           |                         |        
|                                              | Prior years            |                         |        
|Restructured transaction                      |                        |                         | (2,231 
|Paid losses and loss adjustment expenses:     |                        |                         |        
|                                              | Prior years            |                         |        
|                                              |                        |                         |        
|Net balance December 31                       |                        |                         | 174,173
|Plus reinsurance recoverable                  |                        |                         | 59,235 
|                                              |                        |                         |        
|                                              | Balance at December 31 |                         | $      
|                                              |                        |                         |        

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.

In
the second quarter of 2002, as part of the Company's ongoing credit review process, management identified certain transactions not performing as expected in its portfolio of insured
CDOs. As a result, management undertook a quantitative analysis of all CDO transactions in its insured portfolio that breached senior overcollateralization triggers, which were included in such
transactions as one measure of adverse performance. A present value deterministic approach was utilized as a basis to estimate the loss inherent in this portfolio. The deterministic model takes the
average cumulative default rate produced by a Monte Carlo simulation and applies those default rates to a cash flow model using (i) a timing sequence dependent on the portfolio's rating and
maturity composition, (ii) an estimate of collateral recovery values for severity and (iii) the LIBOR forward curve as a predictor of interest rates. Management assumed that current
default rates on CDO collateral would improve in a manner consistent with an economic recovery following a period of significant credit deterioration similar to that experienced in 1991/1992 and, as a
result, management utilized the Moody's idealized default curve, adjusted by a factor consistent with the relationship between the 1992 cohort experience and the Moody's 30-year average
default rate. The per-period default rate was calculated based on 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 reserves ($11.3 million).
The $31.0 million increase in the Company's general reserve resulted in a corresponding increase to losses

25

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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. 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 for several years, 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 in 2002 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, 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
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. 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.

During
2003, the Company charged $34.5 million to loss expense, comprised of $9.2 million related to the CDO portfolio discussed above, $22.4 million for
originations of new business and $2.9 million for the accretion of the discount on prior years' reserves. The general reserve increased by $21.8 million in 2003, consisting of the loss
expense, a transfer to the general reserve of $1.4 million representing recoveries received on prior-year transactions and a transfer of $14.1 million from the general
reserve to case basis reserves. In addition, the Company reclassified $2.2 million of case reserves relating to a restructured transaction to securitized loans on the balance sheet. Giving
effect to these transfers, the general reserve totaled $111.5 million at December 31, 2003.

Reserves
for losses and loss adjustment expenses are discounted at the then current risk-free rates, which ranged between 4.94% and 6.1% for case basis reserves and 1.2% to
7.953% for the general reserve. The cumulative amount of discount taken was approximately $65.9 million, $44.7 million and $29.6 million at December 31, 2003, 2002 and
2001, respectively.

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

26

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to
underwriting certain categories of municipal risks, FGIC was sold in December 2003 and its new management has indicated that FGIC will compete more broadly in asset-backed and municipal
sectors not previously serviced by FGIC. Likewise, XLCA and CIFG, as relative 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. In addition, DEPFA Bank, plc, has announced its intentions to establish a monoline financial guaranty insurer to compete in the U.S. public finance market. DEPFA
Bank, plc, an Irish bank, is a provider of financial services to public sector clients. The Company understands that other parties are also considering establishing new financial guaranty insurers
that may compete with the Company.

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 U.S. 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 capital ratio (represented by the ratio of its net insurance in force to qualified statutory capital) and the average industry capital ratio at the dates
indicated. Net insurance data does not distinguish between quota share reinsurance and first-loss reinsurance. In light of FSA's substantial use of first-loss

27

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reinsurance
in the asset-backed sector, the data below tends to overstate FSA's risk leverage in comparison with its industry counterparts.

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

---

Reinsurance

Reinsurance is the commitment by one insurance company, the "reinsurer," to reimburse another insurance company, the "ceding company," for a specified portion of
the insurance risks underwritten by the ceding company in consideration for a portion of the premiums received. The ceding company typically but not always receives 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 internal, rating agency and state
insurance regulatory limits; to diversify risks; to reduce the need for additional capital; and to strengthen financial ratios. At December 31, 2003, FSA had reinsured approximately 25.0% 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

28

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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, 2003 were ACE Capital Re International Ltd., ACE Guaranty
Corp., Radian Reinsurance Inc. (formerly Enhance Reinsurance Company), RAM Reinsurance Co. Ltd., Swiss Reinsurance America Corporation, Tokio Marine and XLFA.

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

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 2003.

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 financial strength 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

29

---

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") and other
state insurance regulatory authorities. The last completed examination was conducted in 2000 for the three-year period ended December 31, 1999. FSA's accounts are currently under
examination for the three-year period ended December 31, 2002.

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.

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

30

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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 on 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.

31

---

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

Dividend Restrictions

FSA's ability to pay dividends is dependent on FSA's financial condition, results of operations, cash requirements, rating agency confirmation of
non-impairment of FSA's ratings and other related factors, and is also subject to restrictions contained in the 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 on FSA's statutory statements for the year ended December 31, 2003, the maximum amount available for payment of dividends by FSA without
regulatory approval over the following 12 months is approximately $112.6 million. In 2003 and 2002, FSA International paid a preferred dividend of $3.3 million and
$8.7 million, respectively, to XL, 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 Belgium, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Norway, 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. FSA is in the process of seeking branch licenses in Canada (and its respective provinces) and Japan.

U.S. Bank Holding Company Act

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

32

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a
U.S. banking office, and each of its non-U.S. bank subsidiaries with a U.S. banking office, must be both (i) "well-capitalized," which requires Tier 1 and total
capital to risk-based asset ratios of at least 6% and 10%, respectively, as calculated under home country standards, and (ii) "well-managed," which requires a composite
U.S. banking office examination rating by the relevant U.S. bank regulator of at least "satisfactory." Dexia holds its investment in, and operates, the Company and its subsidiaries under, the
"financial activities" authorization permitted to "financial holding companies."

Investments

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

Investment Portfolio

Management's primary objective in managing FSA's investment portfolio is generation of an optimal level of after-tax investment income while
preserving capital and maintaining adequate liquidity. FSA's investment 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 Risk
Management 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-backed 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) TheDebtCenter, L.L.C., which operates TheMuniCenter, L.L.C., 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 at December 31, 2003 was approximately 7.5 years. The Company's current investment strategy is to invest
in quality, readily marketable instruments of intermediate average duration so as to generate stable investment earnings with minimal market value or credit risk.

33

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

Investment Portfolio by Rating
at December 31, 2003 (1)

Rating

Percent of
Investment
PortfolioAAA(2)

76.9
%AA

20.2A

2.9100.0
%


---

|                          |                             | Summary of Investments
December 31, |        
|------------------------- | --------------------------- | ----------------------------------- | -------
|
|
|
|Long term investments:    |                             |                                     |        
|                          | Taxable bonds               |                                     | $      
|                          | Tax-exempt bonds            |                                     |        
|                          |                             |                                     |        
|                          | Total long-term investments |                                     |        
|Short-term investments(2) |                             |                                     | 172,806
|                          |                             |                                     |        
|                          | Total investments(3)        |                                     | $      
|                          |                             |                                     |        

---

34

---

|                                      |                        | Investment Portfolio by Security Type
December 31, |          
|------------------------------------- | ---------------------- | -------------------------------------------------- | ---------
|
|
|
|U.S. government and agency securities |                        | $                                                  | 97,964   
|Mortgage-backed securities            |                        |                                                    | 220,031  
|Municipal bonds                       |                        |                                                    | 2,506,380
|Asset-backed securities               |                        |                                                    | 83,584   
|Corporate securities                  |                        |                                                    | 259,102  
|Foreign securities                    |                        |                                                    | 108,249  
|                                      |                        |                                                    |          
|                                      | Total fixed maturities |                                                    |          
|Short-term investments(2)             |                        |                                                    | 172,806  
|                                      |                        |                                                    |          
|                                      | Total investments(3)   |                                                    | $        
|                                      |                        |                                                    |          

---

35

---

|                                       |                      | 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, 2003
|---------------------------------------------- | -------------------------------- | -----------------
|
|
|Pass-through securitiesU.S. Government agency |                                  | $                
|CMOsU.S. Government agency                    |                                  |                  
|CMOsnon-agency                                |                                  |                  
|                                               |                                  |                  
|                                               | Total mortgage-backed securities |                  
|                                               |                                  |                  

The
Company's investments in mortgage-backed securities consisted of pass-through certificates and collateralized mortgage obligations ("CMOs"), which are backed by mortgage
loans guaranteed or insured by agencies of, or sponsored by, the federal government. These securities are highly liquid with readily determinable market prices. The Company also held, at
December 31, 2003, Triple-A rated CMOs which are not guaranteed by government agencies. Secondary market quotations are available for these securities, although they are not as
liquid as government agency-backed securities.

The
CMOs held at December 31, 2003 have stated maturities ranging from 3 to 41 years and expected average lives ranging from 3 to 11 years based on anticipated
prepayments of principal. None of the Company's holdings of CMOs is subject to extraordinary interest rate sensitivity. At December 31, 2003, 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 mortgage interest rates, with prepayments increasing when prevailing interest rates are lower than the rates on
the underlying

36

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mortgages.
When prepayments occur, the proceeds must be reinvested at then current market rates, which may be below the yield on the prepaid securities.

VIE Portfolio

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

All
bonds in the VIE Portfolio are insured by FSA. The credit quality of the VIE Portfolio, without the benefit of FSA's insurance, at December 31, 2003 was as follows:

VIE Portfolio by Rating
at December 31, 2003(1)

Rating

Percent of BondsAAA

3.7
%AA

4.3A

72.0BBB

20.0100.0
%


---

37

---



The amortized cost and estimated fair value of bonds in the VIE Portfolio were as follows at December 31, 2003:

|                                                      |       | Amortized
Cost |           | Gross
Unrealized
Losses |   | Fair Value
|----------------------------------------------------- | ----- | -------------- | --------- | ----------------------- | - | ----------
|
|Obligations of U.S. states and political subdivisions |       | $              | 16,200    |                         | $ |           
|Corporate securities                                  |       |                | 181,163   |                         |   | (846      
|Foreign                                               |       |                | 211,952   |                         |   | (335      
|Asset-backed securities                               |       |                | 1,102,427 |                         |   |           
|                                                      |       |                |           |                         |   |           
|                                                      | Total |                | $         | 1,511,742               |   | $         
|                                                      |       |                |           |                         |   |           

GIC Portfolio

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

GIC Portfolio by Rating
at December 31, 2003(1)

Rating

Percent of
Investment
PortfolioAAA

98.1
%AA

0.7A

0.3Other

0.9100.0
%


---

Summary of GIC Portfolio

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

---

38

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Investment Portfolio by Security Type

|                                      |                        | December 31, |          
|------------------------------------- | ---------------------- | ------------ | ---------
|
|
|
|Mortgage-backed securities            |                        | $            | 209,284  
|Municipal bonds                       |                        |              | 181,640  
|U.S. government and agency securities |                        |              | 162,912  
|Asset-backed securities               |                        |              | 3,531,672
|Corporate securities                  |                        |              | 18,829   
|                                      |                        |              |          
|                                      | Total fixed maturities |              |          
|Short-term investments(2)             |                        |              |          
|                                      |                        |              |          
|                                      | Total investments      |              | $        
|                                      |                        |              |          

---

Distribution of Investments by Maturity

December 31, 2003Investment Category

Amortized
Cost

Fair
Value(in thousands)Due in one year or less(1)

$
9,964

$
10,017Due after one year through five years


8,864


8,919Due after ten years


344,553


340,685Mortgage-backed securities


209,284


206,108Asset-backed securities


3,531,672


3,531,957Total investments

$
4,104,337

$
4,097,686


---

At
December 31, 2003, the mortgage-backed securities included in the GIC Portfolio consisted of pass-through certificates of $209.3 million and
$206.1 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, 2003, the Company and its subsidiaries had 326 employees. None of its employees are covered by collective bargaining agreements. The
Company considers its employee relations to be satisfactory.

39

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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 them to, the Securities and Exchange Commission.

Forward-Looking Statements

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

In
its filings with the SEC, reports to shareholders, press releases and other written and oral communications, the Company from time to time makes forward-looking statements. Such
forward-looking statements include, but are not limited to, (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 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 losses and loss adjustment 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) prepayment speeds on FSA-insured asset-backed securities and other factors that may influence the amount of
installment premiums paid to FSA; (xiv) changes in the value or performance of strategic investments made by the Company; 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.

40

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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 is not subject to any material
pending legal proceedings.

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 2003.

41

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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. 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 2004, 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 six 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 paid a dividend on its common stock of $0.17625 per share for each of the first two quarters of 2002, totaling $11.7 million in aggregate for 2002. During the third
quarter of 2002, the Company determined that it would suspend payment of dividends 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.

42

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Item 6.    Selected Financial Data

The following Selected Consolidated Financial Data at, or for the years ended, December 31, should be read in conjunction with the Consolidated Financial
Statements and accompanying notes included elsewhere herein.

|                                                 |  | 2003 |           | 2002 |   | 2001      |  | 2000 |           | 1999
|------------------------------------------------ |  | ---- | --------- | ---- | - | --------- |  | ---- | --------- | ----
|
|SUMMARY OF OPERATIONS(a)                         |  |      |           |      |   |           |  |      |           |     
|Gross premiums written                           |  | $    | 895.8     |      | $ | 803.7     |  | $    | 485.6     |     
|Net premiums written                             |  |      | 614.3     |      |   | 532.7     |  |      | 319.6     |     
|Net premiums earned                              |  |      | 356.4     |      |   | 314.9     |  |      | 231.0     |     
|Net investment income                            |  |      | 154.0     |      |   | 139.1     |  |      | 128.9     |     
|Net income                                       |  |      | 290.6     |      |   | 181.1     |  |      | 209.5     |     
|BALANCE SHEET DATA(a)                            |  |      |           |      |   |           |  |      |           |     
|Total investments(b)                             |  | $    | 9,581.2   |      | $ | 5,037.4   |  | $    | 3,214.1   |     
|Total assets(b)                                  |  |      | 12,304.5  |      |   | 7,027.5   |  |      | 4,306.9   |     
|Deferred premium revenue, net                    |  |      | 1,166.6   |      |   | 892.6     |  |      | 669.5     |     
|Losses and loss adjustment expense reserve, net  |  |      | 174.2     |      |   | 147.7     |  |      | 85.5      |     
|Notes payable                                    |  |      | 430.0     |      |   | 430.0     |  |      | 330.0     |     
|Guaranteed investment contracts                  |  |      | 4,198.9   |      |   | 2,449.0   |  |      | 600.0     |     
|Variable interest entities' debt                 |  |      | 2,537.5   |      |   |           |  |      |           |     
|Preferred stock                                  |  |      |           |      |   |           |  |      |           |     
|Common shareholders' equity                      |  |      | 2,168.4   |      |   | 1,868.4   |  |      | 1,636.0   |     
|ADDITIONAL DATA                                  |  |      |           |      |   |           |  |      |           |     
|Qualified statutory capital(c)                   |  | $    | 2,104.3   |      | $ | 1,876.1   |  | $    | 1,593.6   |     
|Total claims-paying resources(c)(d)              |  | $    | 4,657.7   |      | $ | 3,819.1   |  | $    | 3,217.3   |     
|Net par outstanding(c)                           |  | $    | 294,389.6 |      | $ | 265,700.4 |  | $    | 217,110.8 |     
|Net insurance in force (principal + interest)(c) |  | $    | 409,476.3 |      | $ | 365,256.1 |  | $    | 300,637.1 |     
|Total dividends                                  |  | $    |           |      | $ | 11.7      |  | $    | 31.1      |     

---

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

Overview

Management's principal objective is to increase the intrinsic value of the Company over the long term. To this end, it seeks to accumulate a book of
conservatively underwritten financial guaranty insurance business to generate premiums that create a reliable, predictable earnings stream.

43

---

Strategically,
the Company seeks to maintain balanced capabilities across domestic and international asset-backed and municipal markets in order to have the flexibility to pursue the most attractive
opportunities available at any point in the business cycle.

To
accurately reflect how management evaluates the Company's operations and progress toward long-term goals, this discussion employs both measures promulgated in accordance
with accounting principles generally accepted in the United States of America (GAAP measures) and measures not so promulgated (non-GAAP measures). Although the measures identified as
non-GAAP in this discussion should not be considered substitutes for GAAP
measures, management and investors consider them important because of characteristics specific to the financial guaranty business.

Results of Operations

The GAAP measuregross premiums writtencaptures premiums collected in a given period, whether collected up front
for business originated in the period, or in installments for business originated in prior periods. Because a significant portion of the Company's premiums are collected in installments, management
uses a non-GAAP measure,gross present value originations (PV originations), to reflect the business originatedin a given period. PV originations has two
components. The first,gross present value of premiums written (PV
premiums), reflects estimated 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. To calculate PV premiums, management estimates the life of each transaction that has installment premiums and
discounts the future installment premium payments. The second component of PV originations is thepresent value of future net interest margin (PVNIM).
PVNIM represents the present value of the difference between the estimated interest to be received on the investments of the Company's financial products segment and the estimated interest to be paid
on guaranteed investment contracts (GICs) issued by subsidiaries of the Company (the GIC Subsidiaries) over the estimated life of each transaction. PVNIM is calculated after giving effect to swaps and
other derivatives that convert fixed-rate assets and liabilities to floating rates. 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 2003, 2002 and 2001 were 5.91%, 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.

Premiums

The following tables reconcile gross premiums written to PV originations and summarize net earned and written premiums.

Reconciliation of Gross Premiums Written to Non-GAAP PV Originations

|                                        |  | Year Ended December 31, |       
|--------------------------------------- |  | ----------------------- | ------
|
|
|Gross premiums written                  |  | $                       | 895.8 
|Gross installment premiums received     |  |                         | (355.4
|PV estimated future premiums originated |  |                         | 310.1 
|PVNIM originated                        |  |                         | 44.1  
|                                        |  |                         |       
|Gross PV originations                   |  | $                       | 894.6 
|                                        |  |                         |       

44

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Net Earned and Written Premiums

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

In
2003 and 2002, net premiums earned increased 13.2% and 36.3%, respectively, from each prior year's result. Excluding the effects of refundings and prepayments, net premiums earned
increased 13.2% in 2003 and 29.3% in 2002. Refundings and prepayments result from interest-rate movements and other factors outside the Company's control, and no assurance can be given
that refundings and prepayments will continue at the recent level. The recent slower growth rate in earned premiums is a function of the relatively higher contribution from U.S. municipal
originations, which generally have longer maturities and therefore a slower earnings process.

Originations

Financial Security Assurance Inc. (FSA) and the financial products operations generated PV originations of $894.6 million, $881.8 million and
$696.5 million for the years ended December 31, 2003, 2002 and 2001, respectively. The tables below show the components of PV originations and the related insured par amounts.

U.S. Municipal New Originations

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

New-issue
volume in the U.S. municipal bond market reached record levels of $384.8 billion and $358.8 billion in 2003 and 2002, respectively, as low interest
rates, diminished tax revenues and continuing needs for infrastructure investment drove municipalities to borrow on an unprecedented scale. Estimated insurance penetration approached 50% in each of
those years, up from 47% in 2001, when $288.2 billion of bonds were issued. In each of the three years, FSA guaranteed approximately 27% of the insured par amount of bonds sold. The recent
trend toward higher market volumes may not continue. Rising interest rates would be expected to result in a general decline in market volume.

Including
both primary and secondary U.S. municipal obligations with closing dates in 2003, the annual par amount insured by FSA increased 6.3%, and PV premiums increased 14.8%, compared
with 2002 results. Premium rates were strong throughout 2003 due to wider credit spreads than in prior periods. In 2002, the comparable par amount FSA insured increased 41.6%, and the related PV
premiums increased 89.2%, compared with 2001 results. PV premiums rose more rapidly than par insured in 2002 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.

45

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U.S. Asset-Backed New Originations

Year Ended December 31,2003

2002

2001Gross par insured (in billions)

$
15.6

$
35.6

$
56.1Gross PV premiums (in millions)


177.6


196.1


350.1


In
2003, PV premiums from the Company's U.S. asset-backed business approached that of the previous year, off 9.4%, even though par originated declined 56.2%. Compared with the previous
year, the Company's asset-backed business was more diversified, with a shift away from large Super Triple-A credit default swaps (CDS), Triple-A tranches of residential
mortgage-backed securities and auto loan transactions and toward higher premium types of transactions, including Triple-A collateralized loan obligations (CLOs), certain residential
mortgage obligations and consumer finance issues, such as credit card receivable transactions. In 2002, par value of U.S. asset-backed issues insured by FSA declined 36.4% to $35.6 billion,
reflecting the Company's decision to refrain from insuring collateralized debt obligations (CDOs) at mid-year 2002 pending a reevaluation of its underwriting standards, as well as the
Company'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 in 2002 comparable
to two transactions that together contributed $90 million of PV premiums in 2001.

International New Originations

Year Ended December 31,2003

2002

2001Gross par insured (in billions)

$
10.3

$
19.8

$
21.1Gross PV premiums (in millions)


189.8


199.3


120.3


International
par insured by the Company in 2003 declined 48.0% from the previous year's result, while PV premiums declined only 4.8%. PV premiums declined less than par insured, largely
because of a shift from Super Triple-A pooled corporate CDS to a broader range of transactions, including CLOs, synthetic residential mortgage securitizations and other structured
financings. Infrastructure financings contributed the largest share of international premium production in 2003, driven by major transactions in the United Kingdom. In 2002, the Company's
international par insured declined 6.3%, while its international PV premiums rose 65.6%, because Triple-A and Double-A shadow-rated CDO transactions, which tend to have low
premiums relative to par, represented a smaller percentage of the business mix in 2002 than in 2001.

Financial Products New Originations

Year Ended December 31,2003

2002

2001Gross present value of future net interest margin (in millions)

$
44.1

$
65.7

$
3.8


PVNIM
for 2003 was 32.9% below PVNIM for 2002. The Company constrained its GIC activity during the first four months of 2003 as it approached a regulatory limit of 100
non-qualified holders. This limit was lifted when the Company received an exemption from the Investment Company Act in April 2003. In addition, the low interest-rate
environment in 2003 tended to suppress demand for long-term GICs. The Company entered the business of providing GICs in the fourth quarter of 2001.

46

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Net Investment Income and Realized Gains

Net investment income increased 11.4% in 2003 from that of the prior year, primarily due to higher invested balances arising from new business writings, partially
offset by lower reinvestment rates stemming from the low interest-rate environment during the year. Net investment income increased 7.9% in 2002 from that of the prior year, primarily due
to higher invested balances arising from new business writings. For further discussion, see "Liquidity and Capital Resources" below.

Income from Investments

Year Ended December 31,2003

2002

2001(dollars in millions)Net investment income

$
154.0

$
139.1

$
128.9Net realized gains


5.1


29.2


7.2After-tax net realized gains


3.8


21.2


4.7Effective tax rate on investment income excluding effects of realized gains and losses and variable interest entities


9.2
%

10.4
%

11.0
%


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

Losses and Loss Adjustment Expenses

The provision for losses and loss adjustment expenses was $34.5 million, $65.6 million and $12.5 million in 2003, 2002 and 2001,
respectively.

In
the second quarter of 2002, as part of the Company's ongoing credit review process, management identified certain transactions not performing as expected in its portfolio of insured
CDOs. As a result, management undertook a quantitative analysis of all CDO transactions in its insured portfolio that breached senior overcollateralization triggers, which were included in such
transactions as one measure of adverse performance. A present value "deterministic" approach was utilized to estimate the loss inherent in this portfolio. The deterministic model takes the average
cumulative default rate produced by a Monte Carlo simulation and applies those defaults to a cash flow model using (i) a timing sequence dependent on the portfolio's rating and maturity
composition, (ii) an estimate of collateral recovery values for severity and (iii) the LIBOR forward curve as a predictor of interest rates. Management assumed that current default rates
on CDO collateral would improve in a manner consistent with an economic recovery following a period of significant credit deterioration similar to that experienced in 1991/1992 and, as a result,
management utilized the Moody's idealized default curve, adjusted by a factor consistent with the relationship between the 1992 cohort experience and the Moody's 30-year average default
rate. The per-period default rate was calculated based on the Moody's weighted-average rating factor for each piece of surviving collateral. Recovery rates were judgmentally established by
the Company. In considering the recovery rates to be utilized, management adjusted Moody's average recovery rates (observed since 1982) downward to reflect more recent adverse observations. At
June 30, 2002, this analysis produced a present value of expected losses of $51.5 million, net of reinsurance recoveries and net of unearned premiums and future ceding commissions.
Management addressed this net present value of expected loss ($51.5 million) through (i) an increase in the Company's general reserve ($31.0 million) and (ii) amounts
already existing in its general reserve ($20.5 million), including general reserve amounts reallocated to case 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 expenses 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 established a methodology

47

---

of
recording case reserves on CDO transactions based on the extent to which the overcollateralization ratio (non-defaulted collateral at par value divided by the debt insured) has fallen
below 100%, since management believes that claims on such transactions are probable and that the amount of the undercollateralization is a reasonable estimate of such claims. Such transactions may
benefit from excess cash flow attributable in part to higher interest rates on the underlying collateral than on the insured securities. In addition, such transactions generally require insured
payments of principal only at the ultimate maturity of such transactions. As a result, the Company does not expect to be required to pay claims on these transactions for several years, but may elect
to do so at an earlier date at its discretion. Over time, management expects to reallocate amounts in its general reserve (including accretions thereto) to case reserves as specific losses on its
insured CDO portfolio become probable and estimable in accordance with the undercollateralization methodology described above.

Beginning
in the second quarter of 2002, management refined the loss factor it applies to its net par underwritten when calculating the Company's 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.

During
2003, the Company charged $34.5 million to loss expense, comprised of $9.2 million related to the CDO portfolio discussed above, $22.4 million for origination
of new business and $2.9 million for the accretion of the discount on prior years' reserves. The general reserve increased by $21.8 million in 2003, consisting of the loss expense, a
transfer to the general reserve of $1.4 million representing recoveries received on prior-year transactions and a transfer of $14.1 million from the general reserve to case
reserves. In addition, the Company reclassified $2.2 million of case reserves, relating to a restructured transaction, to securitized loans on the balance sheet. Giving effect to these
transfers, the general reserve totaled $111.5 million at December 31, 2003.

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

In
2003 and 2002, FSA exercised certain rights available under its financial guaranty policies and indentures relating to certain loan-backed notes issued by 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, the GIC Subsidiaries). 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 (such as removal of servicer, sale of assets and liquidation of the entity), the trusts
and refinancing vehicles 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.

48

---

At
December 31, 2003, the reinsurance recoverable on unpaid losses from reinsurers and ceded par outstanding, by Standard & Poor's Ratings Services (S&P) rating levels, are
as follows:

Reinsurer's S&P Rating

Reinsurance
Recoverable

Ceded Par
Outstanding(in millions)AAA

$
13.6

$
38,748.4AA


15.7


47,572.2A


26.1


9,011.6Not currently rated


3.8


1,492.2Total

$
59.2

$
96,824.4


Interest Expense

Interest expense in 2003, 2002 and 2001 was $33.0 million, $28.1 million and $16.9 million, respectively. For further discussion, see
"Liquidity and Capital Resources" below.

Other Operating Expenses

Other operating expenses for 2003 increased 14.9% from that of the previous year. The increase relates primarily to increased personnel, occupancy and consulting
costs. The corresponding 43% increase in other operating expenses for 2002 is primarily related to higher personnel costs (see Note 10 to the Consolidated Financial Statements).

Guaranteed Investment Contract Net Interest Margin

In the fourth quarter of 2001, the Company's GIC Subsidiaries began issuing FSA-insured GICs. These transactions resulted in a net interest margin of
$11.2 million, $7.8 million and $(0.2) million for the years ended December 31, 2003, 2002 and 2001, respectively.

Net Realized and Unrealized Gains (Losses) on Derivatives

FSA's business includes insurance of CDS referencing diversified pools of corporate obligations. The Company had net par outstanding of $63.8 billion
relating to these deals at December 31, 2003. Many of these transactions require periodic accounting adjustments to reflect an estimate of fair value under Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended (SFAS No. 133). These transactions have generally been underwritten with
Triple-A or higher levels of credit protection provided by significant deductibles that must be exhausted prior to claims under FSA's guarantees. Adjustments required by SFAS
No. 133 resulted in pre-tax income of $34.8 million and a charge to income of $50.2 million for the years ended December 31, 2003 and 2002, respectively. The
benefit for 2003 resulted primarily from tightening credit spreads in the CDS market, while the charge for 2002 resulted primarily from widening credit spreads in that market. Neither of these
adjustments indicate any material improvement or deterioration in the underlying credit quality of FSA's insured CDS portfolio. The gain or loss created by estimated fair-value adjustments
will rise or fall each quarter based on estimated market pricing of highly rated swap guarantees and is not expected to be an indication of potential claims under FSA's guaranty. Fair value is defined
as the price at which an asset or a liability could be bought or sold in a current transaction between willing parties. The fair value is determined based on quoted market prices, if available. If
quoted market prices are not available, as is the case primarily with CDS on pools of assets, then the determination of fair value is based on internally developed estimates. Management applies
judgment when developing these estimates and considers factors such as current prices charged for similar agreements, performance of underlying assets, changes in internal shadow ratings, the level at
which the deductible has been set and FSA's ability to obtain reinsurance for its

49

---

insured
obligations. Due to changes in these factors, the gain or loss from derivative instruments may vary substantially from period to period. Absent any claims under FSA's guaranty, any "losses"
recorded in marking a guaranty to fair value will be reversed by an equivalent "gain" at or prior to the expiration of the guaranty. Given the very high credit quality of FSA's insured CDS portfolio
and the Company's intent to hold to maturity, management believes that "losses" or "gains" attributable to marking these exposures to fair value do not reflect on the profitability of the Company in a
meaningful way.

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

Equity Earnings in Unconsolidated Affiliates

Total equity in earnings of unconsolidated affiliates was $5.5 million, $29.3 million and $11.7 million for 2003, 2002 and 2001,
respectively. The decrease from 2002 to 2003 relates primarily to the equity in earnings from Fairbanks Capital Holding Corp., the parent company of Fairbanks Capital Corp. (collectively with its
parent, "Fairbanks"). Fairbanks is owned 56.8% by The PMI Group Inc. and 29.8% by the Company, with the remainder owned by certain founders of Fairbanks. Fairbanks is a servicer of
single-family residential mortgage loans originated by unaffiliated third parties. Most of the mortgage loans serviced by Fairbanks are considered "sub-prime," reflecting the lower than
"prime" credit quality of the borrower/homeowner. At December 31, 2003, the Company's interest in Fairbanks had a book value of $46.4 million, of which $7.6 million represented
goodwill. The Company's equity in earnings from Fairbanks for 2003, 2002 and 2001 was a loss of $13.5 million, income of $13.8 million and income of $4.5 million, respectively.

Fairbanks'
business is subject to regulation, supervision and licensing by various federal, state and local authorities, which have increased their focus on lending and servicing
practices in the sub-prime lending industry. In October 2002, the Federal Trade Commission (FTC) informed Fairbanks that it was investigating whether Fairbanks' loan servicing or
other practices violated the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, Section 5 of the Federal Trade Commission Act or other laws enforced by the FTC. The Company
understands that, in March 2003, the U.S. Department of Housing and Urban Development (HUD) initiated a criminal investigation into Fairbanks' servicing practices. Certain of Fairbanks'
shareholders, including the Company, received civil investigative demands from the FTC relating to their investments in Fairbanks and their knowledge of Fairbanks' servicing operations.

Fairbanks
is also subject to private litigation, including a number of putative class action suits, alleging violations of federal and/or state laws. The publicity surrounding
sub-prime lending and servicing practices may result in the filing of other putative class action suits against Fairbanks.

Fairbanks
is highly leveraged and dependent on credit facilities to make servicing and delinquency advances in the regular course of its business, to finance the acquisition of mortgage
servicing rights and for other business purposes. In May 2003, Moody's Investors Service, Inc. (Moody's) and Standard & Poor's Ratings Services (S&P) downgraded their loan
servicer rankings for Fairbanks from strong to
below average. These actions constituted potential events of default under Fairbanks' credit facilities, which led to a restructuring of and amendments to the credit facilities in June 2003.

In
order to address alleged violations of various federal and state laws, Fairbanks is reimbursing certain fees allegedly collected improperly and is changing certain of its loan
servicing practices,

50

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including
the types and amounts of fees collected, without admitting any violations. Due to these developments, future income from Fairbanks' operations is expected to be reduced. While the impairment
analysis performed by the Company did not result in a write-down of the investment, the Company continues to monitor the value of its investment in Fairbanks.

On
November 12, 2003, the FTC announced a settlement with Fairbanks, resolving the FTC's and HUD's civil allegations against Fairbanks. The settlement requires Fairbanks to pay
$40.0 million to the FTC to compensate consumers who suffered harm, enjoins Fairbanks from future law violations and imposes new restrictions on Fairbanks' business practices. The settlement is
contingent on approval by a federal district court in Massachusetts and is expected to be coordinated with a related settlement in a class action lawsuit. The settlement amount and other costs,
aggregating $55.0 million, have been reflected in Fairbanks', and hence the Company's, results for 2003.

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. Specifically, as issuer of a financial guaranty insurance policy insuring the VIE's obligations, FSA bears the risk of asset
performance (typically, but not always, after a significant depletion of overcollateralization, excess spread, a deductible or other credit protection). FSA's underwriting policy is to insure only
obligations that are otherwise investment grade. In addition, the VIE typically pays a periodic premium to FSA in consideration of the issuance by FSA of its insurance policy, with the VIE's assets
typically serving as the source of such premium, thus providing some of the "rewards" of the VIE's assets to FSA. VIEs are also employed by FSA in connection with "repackaging" of outstanding
securities into new securities insured by FSA and with refinancing underperforming, non-investment grade transactions insured by FSA. The degree of influence exercised by FSA over these
VIEs varies from transaction to transaction, as does the degree to which "risks and rewards" associated with asset performance are assumed by FSA. While all transactions insured by FSA are included in
the Company's outstanding exposure, and losses under
these obligations are reflected in the Notes to Consolidated Financial Statements for the year ended December 31, 2003, the assets and liabilities of these VIEs, except for refinanced
transactions discussed in Note 22 to the Consolidated Financial Statements and as discussed below, have not been consolidated with those of the Company for financial reporting purposes as the
Company is not the primary beneficiary.

In
January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB
No. 51" (FIN 46). FIN 46 addresses consolidation of VIEs that have one or both of the following characteristics: (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. In December 2003, the FASB issued FASB Interpretation
No. 46 (revised December 2003), "Consolidation of Variable Interest Entities, an interpretation of ARB 51" (FIN 46R). FIN 46R replaced FIN 46 and is effective for public companies for
periods after December 15, 2003.

51

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The
Company applied FIN 46 and consolidated for financial reporting purposes, effective July 1, 2003, FSA Global Funding Limited (FSA Global) and Canadian Global Funding
Corporation (Canadian Global). In addition, as a result of the Company obtaining control rights of another VIE, Premier International Funding Co. (Premier), on July 1, 2003, the Company
consolidated Premier beginning July 1, 2003. FIN 46 requires that, upon consolidation, the Company initially measure the VIE's assets, liabilities and minority interest at their carrying
amounts under existing GAAP as if the entity had been consolidated from the time the Company was considered its primary beneficiary (or parent). The aggregate increase in the balance sheet related to
the consolidation of these three entities was $2.0 billion. Any differences upon consolidation were reflected as a cumulative effect of a change in accounting principle. The cumulative effect
of a change in accounting principle for Canadian Global resulted in additional income of $4.8 million, net of income tax. There were no cumulative income statement effects from consolidating
FSA Global and Premier. FSA Global is managed as a "matched funding vehicle," in which the proceeds from the issuance of FSA-guaranteed notes are invested in obligations having cash flows
substantially matched to those of, and maturing prior to, such notes. In certain cases, investments of FSA Global consist of GICs issued by the GIC Subsidiaries. Similarly, Canadian Global and Premier
have GICs issued by the GIC Subsidiaries in their investment portfolios. In each such case, the Company's GIC liability and GIC asset are eliminated in consolidation. At December 31, 2003,
$559.9 million was eliminated as a result of such consolidation. In the cases of FSA Global and Canadian Global, permitted activities are limited by charter and do not involve active
management; the legal documents that establish the VIEs do not permit the sale or other disposal of the financial assets they hold, except in automatic response to the terms of such financial assets;
and the VIEs are structured as bankruptcy-remote entities. The Company's management believes that the assets held by the VIEs, including those that are eliminated in consolidation, are beyond the
reach of the Company and its creditors, even in bankruptcy or other receivership. All intercompany insured amounts between FSA and FSA Global or Canadian Global previously included
in the Company's outstanding exposure are excluded from the Notes to the Consolidated Financial Statements for the year ended December 31, 2003.

Taxes

In the third quarter of 2002, the Company changed its method of taxing its equity in earnings from 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 in earnings from Fairbanks, based on management's expectation that it would
realize its gain on such investment through dividend distributions rather than through sale of its investment. In 2002, the Company recorded a cumulative-to-date benefit of
$4.0 million.

In
2003 and 2002, the effective tax rates of 24% and 16%, respectively, differ from the statutory rate of 35% due primarily to tax-exempt interest income and income from
Financial Security Assurance International Ltd. (FSA International) and, for 2002, the change in taxing the Company's equity in earnings from Fairbanks. 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.

Earnings

Net income for 2003 was $290.6 million, a 60% increase over that of 2002. In addition to net income, management views operating earnings (a
non-GAAP measure) as an important measure of operating results. The Company definesoperating earningsas net income before the effects of
fair-value adjustments for FSA-insured CDS that have investment-grade underlying credit quality and are

52

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required
to be marked to fair value under SFAS No. 133. Management views insured CDS risks as comparable to other insured risks and enters into such non-cancelable contracts fully
intending to hold them to maturity. Management expects that the SFAS No. 133 adjustments for each guaranteed CDS will sum to zero over the life of the transaction, as explained above under "Net
Realized and Unrealized Gains (Losses) on Derivatives." Management therefore considers operating earnings a key measure of normal operating results. The following table is a reconciliation of net
income to operating earnings for 2003, 2002 and 2001.

Net Income and Reconciliation to Non-GAAP Operating Earnings

Year Ended December 31,2003

2002

2001(in millions)Net income

$
290.6

$
181.1

$
209.5Less fair-value adjustments of insured CDS, net of taxes


23.4


(34.1
)

4.4Operating earnings(1)

$
267.2

$
215.2

$
205.1


---

Shareholders' Equity and Adjusted Book Value

Shareholders' equity (book value) grew 16.1% during 2003 and 14.2% during 2002. Management believes that the intrinsic value of the Company comprises not only
book value and franchise value but also the estimated present value of future income from business it has already originated. Such future income is substantial because premiums are earned over the
life of each insured transaction. It includes revenues from premiums that have been collected but have not yet been earned (deferred premium revenue), the estimated net present value (PV) of future
premiums that will be collected in installments and, for GIC transactions, the estimated present value of future net interest margin. For this reason, management considers non-GAAP
adjusted book value (ABV), which captures these forms of deferred income, to be a reasonable proxy for the intrinsic value of the Company, exclusive of franchise value. The Company uses ABV to
calculate a portion of compensation paid to its employees, as described in Note 10 to the Consolidated Financial Statements. The following table is a reconciliation of book value to adjusted
book value.

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Book Value and Reconciliation to Non-GAAP Adjusted Book Value

December 31,2003

2002(in millions)Shareholders' equity (book value)(1)

$
2,168.4

$
1,868.4After-tax value of:Net deferred premium revenue, net of deferred acquisition costs and goodwill


572.8


407.6Present value of future installment premiums and present value of future net interest margin


424.1


411.3Adjusted book value

$
3,165.3

$
2,687.3


---

54

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Market Risk

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

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

FSA
Asset Management LLC (FSAM) manages the investments in the GIC Portfolio and the VIE Portfolio. The primary objectives in managing the GIC Portfolio are to generate stable net
interest margin, to maintain liquidity and to optimize risk-adjusted returns. FSAM arranges for the acquisition of the VIE Portfolio investments, which are generally held until maturity.

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 95% was invested in long-term fixed-income securities at December 31, 2003. 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 2003, this hypothetical increase in interest rates of 1.0% across the entire yield
curve would result in an after-tax decrease of $133.0 million in the net fair value of the Company's fixed-income portfolio. For the GIC Portfolio, this hypothetical increase in
interest rates would result in an after-tax decrease of $51.1 million, partially offset by a gain of $47.0 million relating to futures and interest-rate swaps
used to hedge the interest-rate risks on the GIC 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. Under the above scenario, reported income and cash flows would be expected to increase due to
higher yields on newly invested funds generated
from earnings and run-off of the outstanding investment portfolio. The VIE Portfolio is hedged against interest-rate risk.

The
Company's investment portfolio holdings are primarily U.S. dollar-denominated fixed-income securities, including municipal bonds, U.S. government and agency bonds, and
mortgage-backed, asset-backed, corporate and foreign securities. In calculating the sensitivity to interest rates for the taxable securities, U.S. Treasury rates are changed instantaneously by 1.0%,
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 Portfolio consists primarily of U.S. dollar-denominated asset-backed securities, U.S. agency and government securities and mortgage-backed securities. FSAM generally converts all
fixed-rate assets and liabilities to floating rates using hedging instruments. As interest rates change, and assuming a highly effective fair-value hedging arrangement has been
designated, 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.

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

Losses and Loss Adjustment Expenses

The Company's losses and loss adjustment expenses comprise case reserves and a non-specific general reserve. FSA establishes a case 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. A case 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 reserve is recorded based on the extent to which the overcollateralization ratio
(non-defaulted collateral at par divided by the debt insured) has fallen below 100% and there is a projected loss when calculating the present value of cash flows. The
non-specific general reserve is available to be applied against future additions or accretions to existing case reserves or to new case reserves. The general reserve is calculated by
applying a loss factor to the total net par amount underwritten 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 reflect the Company's insured obligations. Management's judgments may
also consider macroeconomic factors, political developments and changes in underwriting standards or mix of business.

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 values in the
early 1990s and the deterioration in 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 "Results of OperationsLosses and Loss Adjustment Expenses,"
above, for a discussion of the refinanced transactions.

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 applied this approach consistently from period to period. Since the reserves are based on estimates,
there can be no assurance that the ultimate liability will not differ from such estimates.

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Investments

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 financial products business and FSA Global is determined based on 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 on 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.

Revenue Recognition

Premiums are received either up front 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. When the Company, through its ongoing credit review process, identifies transactions where certain triggers have been breached, the Company ceases to earn
premiums on such transactions. The amount of any case reserves established for these transactions will be net of the unearned premiums for such transactions.

Deferred Acquisition Costs

Deferred acquisition costs comprise 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 general costs are incurred, they are allocated to individual cost centers, and a percentage of those costs is 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 the GIC Subsidiaries, except for GIC commissions. GIC commissions are paid only upon execution of a transaction and represent third-party finder fees
that are amortized over the life of the GIC. Deferred general 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 installment classification, as well as by underwriting year, and are amortized over the
period in which the related premiums are earned. Recoverability of deferred acquisition costs is determined by considering anticipated losses and loss adjustment expenses.

57

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Liquidity and Capital Resources

The Company's consolidated invested assets at December 31, 2003, net of unsettled security transactions, were $9,464.7 million, compared with the
December 31, 2002 balance of $5,027.2 million. These balances include the change in the market value of the investment portfolio, which had an unrealized gain position of
$225.5 million at December 31, 2003, compared with an unrealized gain position of $201.0 million at December 31, 2002. In addition to the increase in unrealized gains, the
increase in invested assets was largely attributable to the growth of the Company's financial products segment and the consolidation of VIEs, as discussed above under "Results of
OperationsVariable Interest Entities." Although included in total invested assets, the Company's management believes that the assets held by the VIEs, including those that are eliminated
in consolidation, are beyond the reach of the Company and its creditors, even in bankruptcy or other receivership. At December 31, 2003, the Company had, at the holding company level, an
investment portfolio of $22.8 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 on its receipt of dividends from, or payment on surplus notes by, FSA.

FSA's
ability to pay dividends depends on FSA's financial condition, results of operations, cash requirements, determination that FSA's ratings will not be adversely affected and other
related factors,
and is also subject to restrictions contained in the insurance laws and related regulations of New York and other states. Under the insurance laws of the State of New York, FSA may pay dividends out
of earned surplus, provided that, together with all dividends declared or distributed by FSA during the preceding 12 months, the dividends do not exceed the lesser of (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 2003 and 2002. Based on FSA's statutory statements for the year ended December 31, 2003, 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 $112.6 million. In 2003 and 2002, FSA
International paid preferred dividends of $3.3 million and $8.7 million, respectively, to XL Capital Ltd, its minority interest owner.

At
December 31, 2002, the Company held $212.9 million of surplus notes of FSA. During 2003, FSA repaid $60.0 million of those surplus notes. At December 31,
2003, the Company held $152.9 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.

The
Company paid no dividends to its shareholders in 2003. Dividends paid by the Company to its shareholders were $11.7 million and $31.1 million in 2002 and 2001,
respectively.

On
July 31, 2003, the Company issued $100.0 million principal amount of 5.60% Notes due July 15, 2103, which are callable without premium or penalty in whole or in
part at any time on or after July 31, 2008. Debt issuance costs of $3.3 million will be amortized over the life of the Notes. In September 2003, the Company called for redemption,
on November 1, 2003, its 6.950% Senior Quarterly Income Debt Securities (6.950% Senior QUIDS) due November 1, 2098 and delivered to the trustee sufficient collateral to legally defease
the 6.950% Senior QUIDS. The unamortized debt issuance costs of $3.2 million for the 6.950% Senior QUIDS were charged to interest expense for 2003. Subsequently, the trustee used the defeasance
collateral to redeem all of the 6.950% Senior QUIDS. The Company had two other debt issues outstanding at December 31, 2003: $230.0 million of 6.25% Notes due November 1, 2102,
which are callable without premium or penalty in whole or in part at any time on or after November 26, 2007, and $100.0 million of 67/8% Quarterly Income Bond Securities
due December 15, 2101, which are callable without premium or penalty on or after December 19, 2006.

58

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Following
is a summary of the Company's long-term obligations at December 31, 2003:

Long-Term Obligations

|                            |  | Less than 1 Year |       | 1-3 Years |   | 3-5 Years |  | Greater than
5 years |     | Total
|--------------------------- |  | ---------------- | ----- | --------- | - | --------- |  | -------------------- | --- | -----
|
|Long-term debt obligations  |  | $                | 1,575 |           | $ | 1,522     |  | $                    | 823 |      
|Operating lease obligations |  |                  | 5     |           |   | 7         |  |                      |     |      
|                            |  |                  |       |           |   |           |  |                      |     |      
|Total                       |  | $                | 1,580 |           | $ | 1,529     |  | $                    | 823 |      
|                            |  |                  |       |           |   |           |  |                      |     |      

In
2003, 2002 and 2001, the Company made additional equity investments of $0, $13.4 million and $15.0 million, respectively, to Fairbanks. At December 31, 2003, 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 financial products segment, liquidity lines of credit with banks, and capital market transactions.

FSA
has a credit arrangement aggregating $150.0 million, which is provided by commercial banks and intended for general application to transactions insured by its subsidiaries. At
December 31, 2003, there were no borrowings under this arrangement, which expires on April 23, 2004, if not extended.

FSA
has a standby line of credit in the amount of $325.0 million with a group of international banks to provide loans to FSA after it has incurred, during the term of the
facility, cumulative municipal losses (net of any recoveries) in excess of the greater of $325.0 million or the average annual debt service of the covered portfolio multiplied by 5.00%, which
amounted to $865.6 million at December 31, 2003. 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, 2010 and contains an annual renewal provision subject to approval by the banks. No amounts have been utilized under this commitment as of December 31, 2003.

In
June 2003, $200.0 million of money market committed preferred trust securities (the CPS Securities) were issued by trusts created for the primary purpose of issuing the
CPS Securities, investing the proceeds in high-quality commercial paper and providing FSA with put options for issuing to the trusts non-cumulative redeemable perpetual
preferred stock (the Preferred Stock) of FSA. If a put

59

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option
were to be exercised by FSA, the applicable trust would use the portion of the proceeds attributable to principal received upon maturity of its assets, net of expenses, and transfer such
proceeds to FSA in exchange for Preferred Stock of FSA. FSA pays a floating put premium to the trusts. The cost of the structure was $3.6 million for 2003 and was recorded in equity. The trusts
are vehicles for providing FSA access to new capital at its sole discretion through the exercise of the put options. The Company does not consider itself to be the primary beneficiary of the trusts
under FIN 46 because it does not retain the majority of the residual benefits or expected losses.

The
Company's asset management group has a $100.0 million line of credit with UBS Loan Finance LLC, which expires December 10, 2004, unless extended. This line of credit
provides an additional source of liquidity should there be unexpected draws on GICs issued by the GIC Subsidiaries. There were no borrowings under this arrangement at December 31, 2003.

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

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

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

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

60

---

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.

As
of December 31, 2003, the Company had no material commitments for capital expenditures. The Company is considering relocating its corporate headquarters to another location in
New York City. In the event that the Company relocates, it will enter into commitments for capital expenditures relating to the new space.

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Market Risk".

61

---



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 Auditors                                                                                                                                            |  | 63  
|Consolidated Balance Sheets as of December 31, 2003 and 2002                                                                                                              |  | 64  
|Consolidated Statements of Operations and Comprehensive Income for the Years Ended December 31, 2003, 2002 and 2001                                                       |  | 65  
|Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2003, 2002 and 2001                                                           |  | 66  
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001                                                                                |  | 67  
|Notes to Consolidated Financial Statements                                                                                                                                |  | 69  
|Schedule:                                                                                                                                                                 |  |     
|II Condensed Financial Statements of Financial Security Assurance Holdings Ltd. as of December 31, 2003 and 2002 and for the Years Ended December 31, 2003, 2002 and 2001 |  | 119 

62

---

REPORT OF INDEPENDENT AUDITORS

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, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31,
2003 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 accounting 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.

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

/s/
PricewaterhouseCoopers LLP

PricewaterhouseCoopers
LLP
New York, New York
February 5, 2004

63

---

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)

|                                                                                                              |                            | December 31,
2003                                                |           | December 31,
2002 |           
|------------------------------------------------------------------------------------------------------------- | -------------------------- | ---------------------------------------------------------------- | --------- | ----------------- | ----------
|ASSETS                                                                                                        |                            |                                                                  |           |                   |           
|Bonds at fair value (amortized cost of $3,275,310 and $2,615,173)                                             |                            | $                                                                | 3,508,649 |                   | $         
|Short-term investments                                                                                        |                            |                                                                  | 224,429   |                   |           
|Variable interest entities' bonds at fair value (amortized cost of $1,511,742)                                |                            |                                                                  | 1,510,561 |                   |           
|Variable interest entities' short-term investment portfolio                                                   |                            |                                                                  | 11,102    |                   |           
|Guaranteed investment contract bond portfolio at fair value (amortized cost of $4,033,979 and $1,840,949)     |                            |                                                                  | 4,031,263 |                   |           
|Guaranteed investment contract bond portfolio pledged as collateral at fair value (amortized cost of $70,358) |                            |                                                                  | 66,423    |                   |           
|Guaranteed investment contract short-term investment portfolio                                                |                            |                                                                  | 228,812   |                   |           
|                                                                                                              |                            |                                                                  |           |                   |           
|                                                                                                              | Total investment portfolio |                                                                  |           | 9,581,239         |           
|Cash                                                                                                          |                            |                                                                  | 19,460    |                   |           
|Securitized loans                                                                                             |                            |                                                                  | 440,611   |                   |           
|Deferred acquisition costs                                                                                    |                            |                                                                  | 273,646   |                   |           
|Prepaid reinsurance premiums                                                                                  |                            |                                                                  | 695,398   |                   |           
|Investment in unconsolidated affiliates                                                                       |                            |                                                                  | 110,863   |                   |           
|Reinsurance recoverable on unpaid losses                                                                      |                            |                                                                  | 59,235    |                   |           
|Other assets                                                                                                  |                            |                                                                  | 1,124,063 |                   |           
|                                                                                                              |                            |                                                                  |           |                   |           
|                                                                                                              |                            | TOTAL ASSETS                                                     |           | $                 | 12,304,515
|                                                                                                              |                            |                                                                  |           |                   |           
|LIABILITIES AND MINORITY INTEREST AND SHAREHOLDERS' EQUITY                                                    |                           
|Deferred premium revenue                                                                                      |                            | $                                                                | 1,861,960 |                   | $         
|Losses and loss adjustment expenses                                                                           |                            |                                                                  | 233,408   |                   |           
|Guaranteed investment contracts                                                                               |                            |                                                                  | 4,198,915 |                   |           
|Variable interest entities' debt                                                                              |                            |                                                                  | 2,537,466 |                   |           
|Deferred federal income taxes                                                                                 |                            |                                                                  | 152,646   |                   |           
|Notes payable                                                                                                 |                            |                                                                  | 430,000   |                   |           
|Accrued expenses and other liabilities                                                                        |                            |                                                                  | 721,684   |                   |           
|                                                                                                              |                            |                                                                  |           |                   |           
|                                                                                                              |                            | TOTAL LIABILITIES AND MINORITY INTEREST                          |           |                   | 10,136,079
|                                                                                                              |                            |                                                                  |           |                   |           
|COMMITMENTS AND CONTINGENCIES                                                                                 |                            |                                                                  |           |                   |           
|Common stock (200,000,000 shares authorized; 33,517,995 issued; par value of $.01 per share)                  |                            |                                                                  | 335       |                   |           
|Additional paid-in capitalcommon                                                                             |                            |                                                                  | 900,224   |                   |           
|Accumulated other comprehensive income (net of deferred income taxes of $76,041 and $66,270)                  |                            |                                                                  | 147,433   |                   |           
|Accumulated earnings                                                                                          |                            |                                                                  | 1,120,444 |                   |           
|Deferred equity compensation                                                                                  |                            |                                                                  | 23,445    |                   |           
|Less treasury stock at cost (297,658 shares held)                                                             |                            |                                                                  | (23,445   | )                 |           
|                                                                                                              |                            |                                                                  |           |                   |           
|                                                                                                              | TOTAL SHAREHOLDERS' EQUITY |                                                                  |           | 2,168,436         |           
|                                                                                                              |                            |                                                                  |           |                   |           
|                                                                                                              |                            | TOTAL LIABILITIES AND MINORITY INTEREST AND SHAREHOLDERS' EQUITY |           | $                 | 12,304,515
|                                                                                                              |                            |                                                                  |           |                   |           

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

64

---

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands)

|                                                                      |                                                                                                                                        | Year Ended December 31, |        
|--------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------- | ----------------------- | -------
|
|REVENUES:                                                             |                                                                                                                                        |                         |        
|                                                                      | Net premiums written                                                                                                                   |                         | $      
|                                                                      |                                                                                                                                        |                         |        
|                                                                      | Net premiums earned                                                                                                                    |                         | $      
|                                                                      | Net investment income                                                                                                                  |                         |        
|                                                                      | Net realized gains                                                                                                                     |                         |        
|                                                                      | Financial products net interest income                                                                                                 |                         |        
|                                                                      | Financial products net realized losses                                                                                                 |                         |        
|                                                                      | Variable interest entities' net interest income                                                                                        |                         |        
|                                                                      | Net realized and unrealized gains (losses) on derivative instruments                                                                   |                         |        
|                                                                      | Other income                                                                                                                           |                         |        
|                                                                      |                                                                                                                                        |                         |        
|TOTAL REVENUES                                                        |                                                                                                                                        |                         | 632,336
|EXPENSES:                                                             |                                                                                                                                        |                         |        
|                                                                      | Losses and loss adjustment expenses                                                                                                    |                         |        
|                                                                      | Interest expense                                                                                                                       |                         |        
|                                                                      | Policy acquisition costs                                                                                                               |                         |        
|                                                                      | Financial products net interest expense                                                                                                |                         |        
|                                                                      | Variable interest entities' net interest expense                                                                                       |                         |        
|                                                                      | Other operating expenses                                                                                                               |                         |        
|                                                                      |                                                                                                                                        |                         |        
|TOTAL EXPENSES                                                        |                                                                                                                                        |                         | 251,880
|                                                                      |                                                                                                                                        |                         |        
|Minority interest                                                     |                                                                                                                                        |                         | (9,612 
|Equity in earnings of unconsolidated affiliates                       |                                                                                                                                        |                         | 5,529  
|                                                                      |                                                                                                                                        |                         |        
|INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE |                                                                                                                                        |                         | 376,373
|Provision (benefit) for income taxes:                                 |                                                                                                                                        |                         |        
|                                                                      | Current                                                                                                                                |                         |        
|                                                                      | Deferred                                                                                                                               |                         |        
|                                                                      |                                                                                                                                        |                         |        
|                                                                      | Total provision                                                                                                                        |                         |        
|                                                                      |                                                                                                                                        |                         |        
|INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE                  |                                                                                                                                        |                         | 285,786
|Cumulative effect of accounting change, net of income taxes of $2,598 |                                                                                                                                        |                         | 4,800  
|                                                                      |                                                                                                                                        |                         |        
|NET INCOME                                                            |                                                                                                                                        |                         | 290,586
|OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:                        |                                                                                                                                        |                         |        
|                                                                      | Unrealized gains (losses) arising during period [net of deferred income tax provision (benefit) of $11,049, $44,750 and $(3,291)]      |                         |        
|                                                                      | Less: reclassification adjustment for gains included in net income [net of deferred income tax provision of $1,278, $7,874 and $2,133] |                         |        
|                                                                      |                                                                                                                                        |                         |        
|                                                                      | Other comprehensive income (loss)                                                                                                      |                         |        
|                                                                      |                                                                                                                                        |                         |        
|COMPREHENSIVE INCOME                                                  |                                                                                                                                        | $                       | 303,336
|                                                                      |                                                                                                                                        |                         |        

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

65

---

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands)

|                                                                                               |  | Common
Stock |     | Additional
Paid-In
Capital-
Common |   | Unrealized
Gain
(Loss) on
Investments |   | Accumulated
Earnings |         | Deferred
Equity
Compensation |   | Treasury
Stock |   | Total |       
|---------------------------------------------------------------------------------------------- |  | ------------ | --- | ---------------------------------- | - | ------------------------------------- | - | -------------------- | ------- | ---------------------------- | - | -------------- | - | ----- | ------
|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 expense of $36,876) |  |              |     |                                    |   |                                       |   |                      | 71,717  |                              |   |                |   |       |       
|Dividends paid on common stock                                                                 |  |              |     |                                    |   |                                       |   |                      |         |                              |   | (20,380        | ) |       |       
|Deferred equity payout                                                                         |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       | (271  
|                                                                                               |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       |       
|BALANCE, December 31, 2002                                                                     |  |              | 335 |                                    |   | 903,494                               |   |                      | 134,683 |                              |   | 829,858        |   |       | 23,445
|Net income for the year                                                                        |  |              |     |                                    |   |                                       |   |                      |         |                              |   | 290,586        |   |       |       
|Net change in accumulated comprehensive income (net of deferred income tax expense of $9,771)  |  |              |     |                                    |   |                                       |   |                      | 12,750  |                              |   |                |   |       |       
|Capital issuance costs                                                                         |  |              |     |                                    |   | (3,605                                | ) |                      |         |                              |   |                |   |       |       
|Capital contribution                                                                           |  |              |     |                                    |   | 335                                   |   |                      |         |                              |   |                |   |       |       
|                                                                                               |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       |       
|BALANCE, December 31, 2003                                                                     |  | $            | 335 |                                    | $ | 900,224                               |   | $                    | 147,433 |                              | $ | 1,120,444      |   | $     | 23,445
|                                                                                               |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       |       

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

66

---

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

|                                       |                                                                                  | 2003                                      |            | 2002       |           | 2001       |           
|-------------------------------------- | -------------------------------------------------------------------------------- | ----------------------------------------- | ---------- | ---------- | --------- | ---------- | ----------
|Cash flows from operating activities:  |                                                                                  |                                           |            |            |           |            |           
|                                       | Premiums received, net                                                           |                                           | $          | 591,030    |           | $          | 575,889   
|                                       | Policy acquisition and other operating expenses paid, net                        |                                           |            | (102,543   | )         |            | (101,954  
|                                       | Termination fee on derivatives                                                   |                                           |            |            |           |            | (43,000   
|                                       | Recoverable advances recovered (paid)                                            |                                           |            | (959       | )         |            | 5,010     
|                                       | Losses and loss adjustment expenses paid, net                                    |                                           |            | (5,972     | )         |            | (2,403    
|                                       | Net investment income received                                                   |                                           |            | 186,619    |           |            | 170,828   
|                                       | Federal income taxes paid                                                        |                                           |            | (83,972    | )         |            | (81,349   
|                                       | Interest paid on notes                                                           |                                           |            | (28,687    | )         |            | (22,710   
|                                       | Interest paid on guaranteed investment contracts                                 |                                           |            | (19,824    | )         |            | (13,793   
|                                       | Variable interest entities' interest paid                                        |                                           |            | (13,629    | )         |            |           
|                                       | Variable interest entities' net interest income received                         |                                           |            | 12,096     |           |            |           
|                                       | Other                                                                            |                                           |            | 55,460     |           |            | 6,027     
|                                       |                                                                                  |                                           |            |            |           |            |           
|                                       |                                                                                  | Net cash provided by operating activities |            |            | 589,619   |            |           
|                                       |                                                                                  |                                           |            |            |           |            |           
|Cash flows from investing activities:  |                                                                                  |                                           |            |            |           |            |           
|                                       | Proceeds from sales of bonds                                                     |                                           |            | 948,365    |           |            | 785,929   
|                                       | Purchases of bonds                                                               |                                           |            | (1,598,396 | )         |            | (1,188,115
|                                       | Net decrease (increase) in short-term investments                                |                                           |            | 151,988    |           |            | (155,871  
|                                       | Proceeds from sale of guaranteed investment contract bonds                       |                                           |            | 1,222,708  |           |            | 850,399   
|                                       | Purchases of guaranteed investment contract bonds                                |                                           |            | (3,385,041 | )         |            | (2,745,130
|                                       | Securities purchased under agreements to resell                                  |                                           |            | (85,000    | )         |            | (90,000   
|                                       | Net decrease (increase) in guaranteed investment contract short-term investments |                                           |            | (224,180   | )         |            | 313,404   
|                                       | Purchases of variable interest entities' bonds                                   |                                           |            | (16,200    | )         |            |           
|                                       | Net decrease in variable interest entities' short-term investments               |                                           |            | 13,048     |           |            |           
|                                       | Purchases of property, plant and equipment                                       |                                           |            | (1,202     | )         |            | (6,126    
|                                       | Other investments                                                                |                                           |            | 28,137     |           |            | (94,046   
|                                       |                                                                                  |                                           |            |            |           |            |           
|Net cash used for investing activities |                                                                                  |                                           | (2,945,773 | )          |           | (2,329,556 | )         
|                                       |                                                                                  |                                           |            |            |           |            |           
|Cash flows from financing activities:  |                                                                                  |                                           |            |            |           |            |           
|                                       | Issuance of notes payable                                                        |                                           |            | 96,673     |           |            | 222,605   
|                                       | Repayment of notes payable                                                       |                                           |            | (100,000   | )         |            | (130,000  
|                                       | Dividends paid                                                                   |                                           |            | (3,290     | )         |            | (20,380   
|                                       | Securities sold under repurchase agreements                                      |                                           |            | 63,965     |           |            |           
|                                       | Proceeds from issuance of guaranteed investment contracts                        |                                           |            | 3,328,487  |           |            | 2,273,815 
|                                       | Proceeds from issuance of variable interest entities' debt                       |                                           |            | 101,189    |           |            |           
|                                       | Repayment of guaranteed investment contracts                                     |                                           |            | (1,139,173 | )         |            | (485,445  
|                                       | Capital issuance costs                                                           |                                           |            | (3,605     | )         |            |           
|                                       |                                                                                  |                                           |            |            |           |            |           
|                                       |                                                                                  | Net cash provided by financing activities |            |            | 2,344,246 |            |           
|Net increase (decrease) in cash        |                                                                                  |                                           | (11,908    | )          |           | 23,584     |           
|Cash at beginning of year              |                                                                                  |                                           | 31,368     |            |           | 7,784      |           
|                                       |                                                                                  |                                           |            |            |           |            |           
|Cash at end of year                    |                                                                                  | $                                         | 19,460     |            | $         | 31,368     |           
|                                       |                                                                                  |                                           |            |            |           |            |           

On July 1, 2003, the Company consolidated $1.9 billion in assets and $1.9 billion in liabilities relating to variable
interest entities with no corresponding cash movement. In 2003, the Company received tax benefits of $0.3 million from its parent company, which was recorded as a capital contribution. In 2002
and 2001, restricted treasury stock of $0.3 million and $0.3 million, respectively, was distributed to a director as deferred compensation plan payouts.

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

67

---

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(in thousands)

|                                                                                                  |  | Year Ended December 31, |        
|------------------------------------------------------------------------------------------------- |  | ----------------------- | -------
|
|Reconciliation of net income to net cash flows from operating activities:                         |  |                         |        
|Net income                                                                                        |  | $                       | 290,586
|Increase in accrued investment income                                                             |  |                         | (5,535 
|Increase in deferred premium revenue and related foreign exchange adjustment                      |  |                         | 274,010
|Increase in deferred acquisition costs                                                            |  |                         | (19,869
|Increase (decrease) in current federal income taxes payable                                       |  |                         | 8,696  
|Increase (decrease) in unpaid losses and loss adjustment expenses, net of reinsurance recoverable |  |                         | 28,736 
|Increase (decrease) in amounts withheld for others                                                |  |                         | (18    
|Provision (benefit) for deferred income taxes                                                     |  |                         | 18,565 
|Net realized losses (gains) on investments                                                        |  |                         | (5,126 
|Deferred equity compensation                                                                      |  |                         |        
|Depreciation and accretion of discount                                                            |  |                         | 29,511 
|Minority interest and equity in earnings of unconsolidated affiliates                             |  |                         | 4,083  
|Change in other assets and liabilities                                                            |  |                         | (34,020
|                                                                                                  |  |                         |        
|Cash provided by operating activities                                                             |  | $                       | 589,619
|                                                                                                  |  |                         |        

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

68

---

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001

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 receivables, securities or other assets having an ascertainable cash flow or market value.
The Company also insures synthetic asset-backed obligations that generally take the form of credit default swap (CDS) obligations or credit-linked notes that reference pools of securities or loans,
with a defined deductible to cover credit risks associated with the referenced securities or loans. The municipal obligations insured by the Company consist primarily of general obligation bonds that
are supported by the issuers' taxing power and of special revenue bonds and other special obligations of states and local governments that are supported by the issuers' ability to impose and collect
fees and charges for public services or specific projects. Municipal obligations include obligations backed by the cash flow from leases or other revenues from projects serving a substantial public
purpose, including government office buildings, toll roads, healthcare facilities and utilities. Financial guaranty insurance written by the Company guarantees scheduled payments on an issuer's
obligation. In the case of a payment default on an insured obligation, the Company is generally required to pay the principal, interest or other amounts due in accordance with the obligation's
original payment schedule or, at its option, to pay such amounts on an accelerated basis.

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

In
the third quarter of 2003, the Company consolidated two variable interest entities (VIEs), FSA Global Funding Limited (FSA Global) and Canadian Global Funding Corporation (Canadian
Global), as a result of Financial Accounting Standards Board (FASB) Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" (FIN 46). The
Company also consolidated another VIE, Premier International Funding Co. (Premier), in the third quarter as a result of obtaining control rights (see Note 25). The Company's management believes
that the assets held by FSA Global, Canadian Global and Premier, including those that are eliminated in consolidation, are beyond the reach of the Company and its creditors, even in bankruptcy or
other receivership.

The
Company offered guaranteed investment contracts (GICs) through two of its wholly owned subsidiaries, FSA Capital Markets Services LLC and FSA Capital Management Services LLC
(collectively, the GIC Subsidiaries) through April 2003. FSA Capital Management Services LLC has conducted all GIC business since April 2003, following receipt of an exemption from the
requirements of the Investment Company Act of 1940. 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 pre-specified rate.

69

---

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. At December 31, 2003, Dexia Holdings, Inc. owned approximately 99% of the Company's outstanding shares; the only other holders of the Company's common stock were an
affiliate of White Mountains Insurance Group, Ltd. and certain current and former directors of the Company who owned shares of the Company's common stock or economic interests therein under the
Director Share Purchase Program (see Note 10).

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying 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, 2003 and 2002 and the reported amounts of revenues and expenses in the consolidated statements of
operations and comprehensive income during the years ended December 31, 2003, 2002 and 2001. Such estimates and assumptions include, but are not limited to,
losses and loss adjustment expenses, fair value of financial instruments and the deferral and amortization of policy acquisition costs. Actual results may differ from those estimates. Significant
accounting policies under GAAP are as follows:



The consolidated financial statements include the accounts of the Company and its direct and indirect subsidiaries, 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) Inc. (collectively, the Subsidiaries). The consolidated financial statements also include the accounts of FSA Global, Canadian Global and Premier, beginning July 1, 2003. All
intercompany accounts and transactions have been eliminated. Certain prior-year balances have been reclassified to conform to the 2003 presentation.



Investments in debt securities designated as available for sale are carried at fair value. The unrealized gain or loss on the investments that are not hedged is
reflected as a separate component of 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 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 fair value, which
approximates cost. Cash equivalents are amounts deposited in money market funds and investments with a maturity at time of

70

---

purchase
of three months or less and are included in short-term investments. Realized gains or losses on sale of investments are determined on the basis of specific identification.
Investment income is recorded as earned. Other-than-temporary impairments are reflected in earnings as a realized loss.

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



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

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

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



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



Gross and ceded premiums received in upfront payouts are earned in proportion to the amount of risk outstanding over the expected period of coverage. The amount
of risk outstanding is equal to the sum of the par amount of debt insured over the expected period of coverage. Deferred premium

71

---

revenue
and prepaid reinsurance premiums represent the portion of premium that is applicable to coverage of risk to be provided in the future on policies in force. When an insured issue is retired or
defeased prior to the end of the expected period of coverage, the remaining deferred premium revenue and prepaid reinsurance premium, less any amount credited to a refunding issue insured by the
Company, are recognized. For premiums received on an installment basis, the Company earns the premium over each installment period, typically less than one year, throughout the period of coverage.
When the Company, through its ongoing credit review process, identifies transactions where certain triggers have been breached, the Company ceases to earn premiums on such transactions. The amount of
any case reserves established for these transactions will be net of the unearned premiums for such transactions.



The Company establishes a case reserve for unpaid losses and loss adjustment expenses for the present value of the estimated loss, net of subrogation recoveries,
when, in management's opinion, the likelihood of a future loss on a particular insured obligation is probable and determinable at the balance sheet date. The estimated loss on a transaction is
discounted using the then current risk-free rates, which ranged from 4.94% to 6.1%. For insured collateralized debt obligations (CDOs), a case 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% and there is a projected loss when calculating the present value of
cash flows.

The
Company also maintains a non-specific general reserve, which is available to be applied against future additions or accretions to existing case reserves or to new case
reserves to be established on particular insured obligations in the future. The general reserve is derived from two separate steps. The first step is to multiply loss factors by the Company's total
net par underwritten and to discount the result at the then current risk-free rates, which ranged from 1.2% to 7.953% at December 31, 2003. The loss factors used for this purpose
are obtained from an independent rating agency study of bond defaults and have been adjusted by the Company's portfolio characteristics and history. The second step pertains to the Company's insured
CDOs, where a present value "deterministic" approach (described in Note 16) is utilized to calculate the general reserve for the Company's insured CDOs.

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. However, because of the uncertainty involved in developing these estimates, the ultimate liability may differ from current estimates.



Deferred acquisition costs comprise 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 the GIC Subsidiaries, except for GIC commissions paid to third parties. Deferred acquisition
costs are amortized over the period in which the related premiums are earned. When an insured issue is retired or defeased prior to the end of the expected period of coverage, the remaining deferred
acquisition cost is recognized. Recoverability of deferred acquisition costs is determined by considering deferred premium revenue and estimated installment premiums and the present value of
anticipated losses and loss adjustment expenses.

72

---



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



Assets and liabilities denominated in foreign currencies are translated at the spot rate. Revenues and expenses denominated in foreign currencies are translated
at average rates prevailing during the year. Unrealized gains and losses, net of deferred taxes, resulting from translating investments denominated in foreign currencies are recorded in shareholders'
equity. Gains and losses from transactions in foreign currencies are recorded in income.



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

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

3.     INVESTMENTS

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

Bonds
at amortized cost of $8.9 million and $8.5 million at December 31, 2003 and 2002, respectively, were on deposit with state regulatory authorities as required
by insurance regulations.

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

Year Ended December 31,2003

2002

2001Bonds

$
153,544

$
138,095

$
126,750Equity investments





336


504Short-term investments


3,185


3,092


3,874Investment expenses


(2,681
)

(2,403
)

(2,207
)Net investment income

$
154,048

$
139,120

$
128,921


73

---

The
credit quality of bonds in the investment portfolio at December 31, 2003 was as follows:

Rating (1)

Percent of BondsAAA

76.9
%AA

20.2A

2.9100.0
%


---

Of
the bonds included in the investment portfolio, 11.4% were AAA by virtue of insurance provided by FSA. Without giving effect to the FSA guaranty, the weighted-average rating of the
FSA-insured investments was in the Double-A range, and all of these investments were investment grade.

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

December 31, 2003

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

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

$
97,964

$
3,391

$
(335
)
$
101,020Obligations of states and political subdivisions


2,506,380


218,930


(1,287
)

2,724,023Mortgage-backed securities


220,031


4,439


(1,409
)

223,061Corporate securities


259,102


10,668


(593
)

269,177Foreign securities


108,249


69


(2,368
)

105,950Asset-backed securities


83,584


1,860


(26
)

85,418Total

$
3,275,310

$
239,357

$
(6,018
)
$
3,508,649


December 31, 2002

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

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

$
68,429

$
7,178

$
(29
)
$
75,578Obligations of states and political subdivisions


2,034,691


186,352


(174
)

2,220,869Mortgage-backed securities


252,970


8,203


(140
)

261,033Corporate securities


184,302


10,992


(36
)

195,258Asset-backed securities


74,781


2,244





77,025Total

$
2,615,173

$
214,969

$
(379
)
$
2,829,763


74

---

The
following table shows the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized
loss position, at December 31, 2003 (in thousands):

Less than 12 months

12 months or more

TotalFair Value

Unrealized Losses

Fair Value

Unrealized Losses

Fair Value

Unrealized LossesU.S. Treasury securities and obligations of U.S. government corporations and agencies

$
15,536

$
297

$
6,953

$
38

$
22,489

$
335Obligations of states and political subdivisions


129,931


1,231


2,964


56


132,895


1,287Mortgage-backed securities


66,899


1,332


1,824


77


68,723


1,409Corporate securities


25,263


593








25,263


593Foreign securities


98,074


2,368








98,074


2,368Asset-backed securities


3,036


26








3,036


26Total

$
338,739

$
5,847

$
11,741

$
171

$
350,480

$
6,018


The
Company periodically monitors its investment portfolio for individual investments in an unrealized loss position in order to assess whether that investment is considered
other-than-temporarily impaired. In each case, the Company determines the nature and cause of the decline and whether the Company maintains the ability and intent to hold the
security until the unrealized loss may reverse or until maturity. At December 31, 2003, the Company determined that no investments were considered other-than-temporarily
impaired.

75

---

The change in net unrealized gains (losses) for the investment portfolio consisted of (in thousands):

Year Ended December 31,2003

2002

2001Bonds

$
18,749

$
122,300

$
(12,883
)Equity investments





(70
)

329Change in net unrealized gains (losses)

$
18,749

$
122,230

$
(12,554
)


The
amortized cost and fair value of bonds in the investment portfolio at December 31, 2003, by contractual maturity, are shown below (in thousands). Actual maturities could
differ from contractual maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.

Amortized
Cost

Fair ValueDue in one year or less

$
18,820

$
19,128Due after one year through five years


427,201


433,678Due after five years through ten years


492,998


528,991Due after ten years


2,032,676


2,218,373Mortgage-backed securities (stated maturities of 3 to 41 years)


220,031


223,061Asset-backed securities (stated maturities of 2 to 15 years)


83,584


85,418Total

$
3,275,310

$
3,508,649


Proceeds
from sales of bonds for the investment portfolio during 2003, 2002 and 2001 were $948.3 million, $772.0 million and $537.1 million, respectively. Gross
gains of $12.6 million, $30.3 million and $9.1 million and gross losses of $7.3 million, $1.3 million and $1.8 million were realized on sales in 2003, 2002
and 2001, respectively.

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

GIC Portfolio

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

2003

2002Bonds

$
65,518

$
42,803Short-term investments


562


1,015Net investment income

$
66,080

$
43,818


76

---

The
credit quality of bonds held in the GIC Portfolio at December 31, 2003 was as follows:

Rating

Percent of BondsAAA

98.1
%AA

0.7A

0.3Other

0.9100.0
%


---

Of
the bonds included in the GIC Portfolio, 11.3% were AAA by virtue of insurance provided by FSA. Without giving effect to the FSA guaranty, the weighted-average rating of the
FSA-insured investments was in the Double-A range, and all of these investments were investment grade.

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

December 31, 2003

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair ValueObligations of U.S. states and political subdivisions

$
344,552

$
190

$
(4,057
)
$
340,685Mortgage-backed securities


209,284


829


(4,005
)

206,108Corporate securities


18,829


110


(3
)

18,936Asset-backed securities


3,531,672


4,257


(3,972
)

3,531,957Total

$
4,104,337

$
5,386

$
(12,037
)
$
4,097,686


December 31, 2002

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair ValueObligations of U.S. states and political subdivisions

$
116,315

$


$
(1,824
)
$
114,491Mortgage-backed securities


582,743


786


(10,424
)

573,105Corporate securities


46,647


253


(45
)

46,855Asset-backed securities


1,095,244


1,452


(3,835
)

1,092,861Total

$
1,840,949

$
2,491

$
(16,128
)
$
1,827,312


77

---

The
following table shows the gross unrealized losses and fair value for the GIC Portfolio, aggregated by investment category and length of time that individual securities have been in a
continuous unrealized loss position, at December 31, 2003 (in thousands):

Less than 12 months

12 months or more

TotalFair Value

Unrealized Losses

Fair Value

Unrealized Losses

Fair Value

Unrealized LossesObligations of U.S. states and political subdivisions

$
212,264

$
2,258

$
61,751

$
1,799

$
274,015

$
4,057Mortgage-backed securities


49,709


71


66,423


3,934


116,132


4,005Corporate securities








4,997


3


4,997


3Asset-backed securities


1,299,896


2,655


24,342


1,317


1,324,238


3,972Total

$
1,561,869

$
4,984

$
157,513

$
7,053

$
1,719,382

$
12,037


The
Company periodically monitors the GIC Portfolio for individual investments in an unrealized loss position in order to assess whether that investment is considered
other-than-temporarily impaired. In each case, the Company determines the nature and cause of the decline and whether the Company maintains the ability and intent to hold the
security until the unrealized loss may reverse or until maturity. At December 31, 2003, there were nine securities that were in an unrealized loss position for a continuous 12-month
period or longer. None of the nine securities had an unrealized loss that exceeded book value by 20% or greater at December 31, 2003. At December 31, 2003, the Company determined that no
investments were considered other-than-temporarily impaired.

The
amortized cost and fair value of the GIC Portfolio, at December 31, 2003, by contractual maturity, are shown below (in thousands). Actual maturities could differ from
contractual maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.

Amortized
Cost

Fair ValueDue in one year or less

$
9,964

$
10,017Due after one year through five years


8,864


8,919Due after ten years


344,553


340,685Mortgage-backed securities (stated maturities of 1 to 30 years)


209,284


206,108Asset-backed securities (stated maturities of 3 to 40 years)


3,531,672


3,531,957Total

$
4,104,337

$
4,097,686


Proceeds
from sales of bonds held in the GIC Portfolio during 2003, 2002 and 2001 were $190.7 million, $274.1 million and $174.2 million, respectively. Gross gains
of $10.5 million were realized on sales in 2003, offset by $11.5 million of unrealized losses on derivatives used to hedge the securities that were sold. Gross losses of
$0 million, $0.2 million and $0.3 million were realized on sales in 2003, 2002 and 2001, respectively.

78

---

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 31,2003

2002

2001Balance, beginning of period

$
253,777

$
240,492

$
201,136Costs deferred during the period:Ceding commission income


(73,943
)

(68,464
)

(41,935
)Premium taxes


16,773


13,401


9,653Compensation and other acquisition costs


135,430


122,441


113,013Total


78,260


67,378


80,731Costs amortized during the period


(58,391
)

(54,093
)

(41,375
)Balance, end of period

$
273,646

$
253,777

$
240,492


5.     STATUTORY ACCOUNTING PRACTICES

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



79

---



A
reconciliation of net income for the calendar years 2003, 2002 and 2001 and shareholders' equity at December 31, 2003 and 2002, reported by the Company on a GAAP basis, to the
amounts reported by the insurance company subsidiaries on a statutory basis, is as follows (in thousands):

Net Income:

2003

2002

2001GAAP BASIS

$
290,586

$
181,075

$
209,496Non-insurance companies net loss


30,354


1,704


3,083Premium revenue recognition


(27,867
)

(19,624
)

(23,113
)Losses and loss adjustment expenses incurred


21,813


20,585


3,867Deferred acquisition costs


(19,868
)

(13,285
)

(39,356
)Deferred income tax provision (benefit)


17,303


(23,888
)

15,949Current income tax


(18,049
)

(8,162
)

(6,239
)Change in fair value of derivatives


(34,796
)

48,788VIE consolidation


(5,120
)Other


8,588


7,895


9,383STATUTORY BASIS

$
262,944

$
195,088

$
173,070


December 31Shareholders' Equity:2003

2002GAAP BASIS

$
2,168,436

$
1,868,370Non-insurance companies liabilities, net


139,209


102,954Premium revenue recognition


(189,823
)

(162,788
)Loss and loss adjustment expense reserves


109,237


89,656Deferred acquisition costs


(273,646
)

(253,777
)Contingency reserve


(936,761
)

(691,955
)Unrealized gain on investments


(232,877
)

(214,148
)Deferred income taxes


199,346


168,452Surplus notes


154,761


214,865Other


29,615


62,533STATUTORY BASIS SURPLUS

$
1,167,497

$
1,184,162SURPLUS PLUS CONTINGENCY RESERVE

$
2,104,258

$
1,876,117


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 expense was controlled by a tax-sharing agreement that based the allocation of such benefit or expense on 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.

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 $86.7 million, $57.1 million and $41.9 million at December 31, 2003, 2002
and 2001, respectively.

80

---

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

December 31,2003

2002Deferred acquisition costs

$
85,441

$
80,815Deferred premium revenue adjustments


16,520


17,663Unrealized capital gains


76,886


67,116Contingency reserves


96,481


78,433Undistributed earnings


4,513


3,552Other


2,008Total deferred federal income tax liabilities


281,849


247,579Loss and loss adjustment expense reserves


(34,304
)

(27,526
)Deferred compensation


(89,182
)

(80,446
)Derivative fair-value adjustments


(5,717
)

(15,288
)Other





(9
)Total deferred federal income tax assets


(129,203
)

(123,269
)Total deferred federal income taxes

$
152,646

$
124,310


No
valuation allowance was necessary at December 31, 2003 or 2002.

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

Year Ended December 31,2003

2002

2001Tax at statutory rate

35.0
%
35.0
%
35.0
%Tax-exempt investments

(8.4
)
(16.4
)
(9.8
)Income of foreign subsidiary

(2.8
)
(2.5
)
(3.0
)Other

0.3

0.1

0.1Provision for income taxes

24.1
%
16.2
%
22.3
%


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 18). 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 on management's expectation that it would realize its gain on such investment through dividend distributions rather than through sale of its investment. In 2002, the Company recorded
a cumulative-to-date benefit of $4.0 million, included in tax-exempt investments in the above reconciliation, relating to this change.

7.     DIVIDENDS AND CAPITAL REQUIREMENTS

Under the insurance laws of the State of New York, FSA may pay a dividend to the Company without the prior approval of the Superintendent of Insurance of the
State of New York (the New York Superintendent) only from earned surplus subject to the maintenance of a minimum capital requirement. In addition, the dividend, together with all dividends declared or
distributed by FSA during the preceding 12 months, may not exceed the lesser of 10% of its policyholders' surplus shown

81

---

on
FSA's last filed statement, or adjusted net investment income, as defined, for such 12-month period. As of December 31, 2003, FSA had $112.6 million available for the
payment of dividends over the next 12 months. In addition, at December 31, 2003, the Company held $152.9 million 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 2003, with the approval of the New York Superintendent, FSA repaid $60.0 million of principal on such notes. In 2002, FSA
repaid $28.0 million and subsequently issued an additional $96.9 million of surplus notes to the Company.

8.     CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES

FSA has a credit arrangement aggregating $150.0 million, which is provided by commercial banks and intended for general application to transactions insured
by the Subsidiaries. At December 31, 2003, there were no borrowings under this arrangement, which expires on April 23, 2004, if not extended.

FSA
has a standby line of credit commitment in the amount of $325.0 million with a group of international banks to provide loans to FSA after it has incurred, during the term of
the facility, cumulative municipal losses (net of any recoveries) in excess of the greater of $325.0 million or the average annual debt service of the covered portfolio multiplied by 5.00%,
which amounted to $865.6 million at December 31, 2003. 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, 2010 and contains an annual renewal provision subject to approval by the banks. No amounts have been utilized under this commitment as of December 31, 2003.

FSAM
has a $100.0 million line of credit with UBS Loan Finance LLC, which expires December 10, 2004, unless extended. There were no borrowings under this agreement at
December 31, 2003.

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

9.     LONG-TERM DEBT

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

82

---

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

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

10.   EMPLOYEE BENEFIT PLANS

The Company and its Subsidiaries maintain both qualified and non-qualified non-contributory defined contribution pension plans for the
benefit of eligible employees. The Company and its Subsidiaries' contributions are based on a fixed percentage of employee compensation. Pension expense, which is funded annually, amounted to
$4.9 million, $5.1 million and $3.6 million for the years ended December 31, 2003, 2002 and 2001, respectively.

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

Performance
shares are awarded under the Company's 1993 Equity Participation Plan. The 1993 Equity Participation Plan authorizes the discretionary grant of performance shares by the
Human Resources Committee to key employees of the Company and its Subsidiaries. The amount earned for each performance share depends on 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
|---- |  | -------------------------------- |  | ----------------------- |  | ---------------------- |  | ------------------------- |  | -------------------------- |  | -----------------------------
|2001 |  | 1,094,834                        |  | 310,200                 |  | 261,034                |  | 12,250                    |  | 1,131,750                  |  | $                            
|2002 |  | 1,131,750                        |  | 372,775                 |  | 380,279                |  | 13,901                    |  | 1,110,345                  |  |                              
|2003 |  | 1,110,345                        |  | 342,845                 |  | 464,778                |  | 13,261                    |  | 975,151                    |  |                              

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 expense for the performance shares was $63.1 million, $58.9 million and $48.2 million for the years ended December 31, 2003, 2002 and 2001,
respectively.

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

83

---

In
the fourth quarter of 2000, the Company purchased 304,757 shares of its common stock from Dexia Holdings, Inc. for $24.0 million. This purchase was intended to fund
obligations relating to the Company's Director Share Purchase Program (DSPP), which enables its participants to make deemed investments in the Company's common stock under the DCP and SERP. Under the
DSPP, the deemed investments in the Company's stock are irrevocable, settlement of the deemed investments must be in stock and, after receipt, the participants must generally hold the stock for at
least six months. In 2003, 2002 and 2001, $0, $0.3 million and $0.3 million, respectively, of restricted treasury stock was distributed to a director as a DSPP 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.

11.   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 31,2004

$
5,3972005


4,3492006


1,4602007


841Total

$
12,047


Rent
expense for the years ended December 31, 2003, 2002 and 2001 was $7.3 million, $6.2 million and $6.2 million, respectively.

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

12.   REINSURANCE

The 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 affiliated (see Note 14) and unaffiliated reinsurers under quota share, first-loss and excess-of-loss treaties and on a facultative basis.

In
the event that any or all of the reinsuring companies are unable to meet their obligations 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.

84

---

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

|                                                    |  | Year Ended December 31, |        
|--------------------------------------------------- |  | ----------------------- | -------
|
|Written premiums ceded                              |  | $                       | 281,541
|Written premiums assumed                            |  |                         | 3,294  
|Earned premiums ceded                               |  |                         | 159,350
|Earned premiums assumed                             |  |                         | 3,832  
|Losses and loss adjustment expense payments ceded   |  |                         | 16,993 
|Losses and loss adjustment expense payments assumed |  |                         |       

|                                                    |  | December 31,
|--------------------------------------------------- |  | ------------
|
|Principal outstanding ceded                         |  | $           
|Principal outstanding assumed                       |  |             
|Deferred premium revenue ceded                      |  |             
|Deferred premium revenue assumed                    |  |             
|Losses and loss adjustment expense reserves ceded   |  |             
|Losses and loss adjustment expense reserves assumed |  |             

13.   OUTSTANDING EXPOSURE AND COLLATERAL

The Company's policies insure the scheduled payments of principal and interest on asset-backed (including FSA-insured CDS) and municipal obligations.
The net par outstanding as of December 31, 2003 and 2002 and the contractual terms to maturity are as follows (in millions):

|                   |       | December 31, 2003 |        | December 31, 2002
|------------------ | ----- | ----------------- | ------ | -----------------
|
|
|0 to 5 years       |       | $                 | 58,500 |                  
|5 to 10 years      |       |                   | 33,063 |                  
|10 to 15 years     |       |                   | 6,806  |                  
|15 to 20 years     |       |                   | 1,450  |                  
|20 years and above |       |                   | 18,709 |                  
|                   |       |                   |        |                  
|                   | Total |                   | $      | 118,528          
|                   |       |                   |        |                  

---

85

---

The
par amount ceded as of December 31, 2003 and 2002 and the terms to maturity are as follows (in millions):

|                   |       | December 31, 2003 |       | December 31, 2002
|------------------ | ----- | ----------------- | ----- | -----------------
|
|
|0 to 5 years       |       | $                 | 9,372 |                  
|5 to 10 years      |       |                   | 7,585 |                  
|10 to 15 years     |       |                   | 2,682 |                  
|15 to 20 years     |       |                   | 1,971 |                  
|20 years and above |       |                   | 3,590 |                  
|                   |       |                   |       |                  
|                   | Total |                   | $     | 25,200           
|                   |       |                   |       |                  

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

|                               |                                | Net of Amounts Ceded(1)
December 31, |        | Ceded
December 31,
|------------------------------ | ------------------------------ | ------------------------------------ | ------ | ------------------
|
|
|Residential mortgages          |                                | $                                    | 20,682 |                   
|Consumer receivables           |                                |                                      | 14,039 |                   
|Pooled corporate obligations   |                                |                                      | 78,147 |                   
|Other asset-backed obligations |                                |                                      | 5,660  |                   
|                               |                                |                                      |        |                   
|                               | Total asset-backed obligations |                                      | $      | 118,528           
|                               |                                |                                      |        |                   

---

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

|                                           |                             | Net Par Outstanding
December 31, |        | Ceded
December 31,
|------------------------------------------ | --------------------------- | -------------------------------- | ------ | ------------------
|
|
|General obligation bonds                   |                             | $                                | 67,212 |                   
|Housing revenue bonds                      |                             |                                  | 7,597  |                   
|Municipal utility revenue bonds            |                             |                                  | 30,024 |                   
|Health care revenue bonds                  |                             |                                  | 7,051  |                   
|Tax-supported non-general obligation bonds |                             |                                  | 33,835 |                   
|Transportation revenue bonds               |                             |                                  | 10,744 |                   
|Other municipal bonds                      |                             |                                  | 14,475 |                   
|                                           |                             |                                  |        |                   
|                                           | Total municipal obligations |                                  | $      | 170,938           
|                                           |                             |                                  |        |                   

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

86

---

by
the Company to be significant, given other more relevant measures of diversification, such as issuer or industry diversification.

The
Company seeks to maintain a diversified portfolio of insured municipal obligations designed to spread its risk across a number of geographic areas. The following table sets forth
those states in which municipalities located therein issued an aggregate of 2% or more of the Company's net par amount outstanding (in millions) of insured municipal securities as of
December 31, 2003:

|State                        |       | Number of
Issues |       | Net Par Amount Outstanding |        | Percent of Total Municipal Net Par Amount Outstanding |      | Ceded Par Amount Outstanding
|---------------------------- | ----- | ---------------- | ----- | -------------------------- | ------ | ----------------------------------------------------- | ---- | ----------------------------
|California                   |       | 895              |       | $                          | 24,789 |                                                       | 14.5 | %                           
|New York                     |       | 575              |       |                            | 15,727 |                                                       | 9.2  |                             
|Texas                        |       | 669              |       |                            | 12,128 |                                                       | 7.1  |                             
|Pennsylvania                 |       | 643              |       |                            | 10,550 |                                                       | 6.2  |                             
|Florida                      |       | 259              |       |                            | 10,007 |                                                       | 5.9  |                             
|New Jersey                   |       | 524              |       |                            | 8,673  |                                                       | 5.1  |                             
|Illinois                     |       | 622              |       |                            | 7,774  |                                                       | 4.5  |                             
|Washington                   |       | 267              |       |                            | 6,140  |                                                       | 3.6  |                             
|Michigan                     |       | 359              |       |                            | 5,134  |                                                       | 3.0  |                             
|Massachusetts                |       | 185              |       |                            | 5,016  |                                                       | 2.9  |                             
|Wisconsin                    |       | 412              |       |                            | 4,038  |                                                       | 2.4  |                             
|Ohio                         |       | 212              |       |                            | 3,732  |                                                       | 2.2  |                             
|Indiana                      |       | 210              |       |                            | 3,581  |                                                       | 2.1  |                             
|All other U.S. jurisdictions |       | 2,450            |       |                            | 47,504 |                                                       | 27.8 |                             
|International                |       | 70               |       |                            | 6,145  |                                                       | 3.5  |                             
|                             |       |                  |       |                            |        |                                                       |      |                             
|                             | Total |                  | 8,352 |                            | $      | 170,938                                               |      | 100.0                       
|                             |       |                  |       |                            |        |                                                       |      |                             

14.   RELATED PARTY TRANSACTIONS

The Subsidiaries ceded premiums of $48.8 million, $23.4 million and $12.8 million to subsidiaries of XL Capital Ltd (XL), which owns
an interest in FSA International, for the years ended December 31, 2003, 2002 and 2001, respectively. The amounts included in prepaid reinsurance premiums at December 31, 2003 and 2002
for reinsurance ceded to subsidiaries of XL were $60.8 million and $32.0 million, respectively. The amounts included in reinsurance recoverable for unpaid losses at December 31,
2003 and 2002 for reinsurance ceded to subsidiaries of XL were $10.9 million and $7.4 million, respectively.

The
Subsidiaries had premiums earned of $2.5 million, $5.0 million and $4.4 million in the first half of 2003 and the years ended 2002 and 2001, respectively,
relating to the guarantees of debt issued or assets purchased by FSA Global. Intercompany premiums earned relating to FSA Global have been eliminated in consolidation for periods subsequent to
July 1, 2003.

The
Subsidiaries had premiums earned of $20.5 million, $17.3 million and $7.2 million for the years ended December 31, 2003, 2002 and 2001, respectively,
relating to business with affiliates of Dexia. Deferred premium revenue relating to those transactions was $6.9 million and $7.7 million at
December 31, 2003 and 2002, respectively. Gross par outstanding relating to those transactions was $16,824.9 million and $16,166.0 million at December 31, 2003 and 2002,
respectively. The Company also paid Dexia a fee of $0.7 million and $3.3 million in 2003 and 2002, respectively, relating to business in which both Dexia and the Company are involved.
For the years ended December 31, 2003, 2002 and 2001, the Company recorded net revenues of $52.9 million, net expenses of $3.7 million and net revenues of $0.5 million,
respectively, relating to swaps where Dexia was the counterparty. At December 31, 2003 and 2002, the Company recorded other assets of $233.3 million and other liabilities of
$3.1 million, respectively, primarily relating to swaps where Dexia was the counterparty. In addition, the Company had $154.3 million in VIE debt at December 31, 2003, relating to
debt issued to Dexia. During 2003, the Company recorded $3.3 million in VIE net interest expense relating to such debt.

87

---

15.    DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

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

Bonds,
GIC bond portfolio, GIC bond portfolio pledged as collateral and VIE bond portfolioThe carrying amount represents fair value. The fair value is based on quoted market
price.

Short-term
investments, including the GIC short-term investment portfolio and VIE short-term investments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 on 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 the treatment of deferred premium revenue, the fair value of installment premiums is the estimated present value of the future contractual premium
revenues that would be received under a reinsurance agreement with a third party to transfer the Company's financial guaranty risk, net of that portion of the premium retained by the Company to
compensate it for originating and servicing the insurance contract.

GICs
and VIE debtThe fair value 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.

Fair-value
adjustments on derivativesThe carrying amount represents fair value. The Company uses quoted market prices, when available, to determine fair value.
If quoted market prices are not available, management uses internally developed estimates.

88

---

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

|                               |                                                                                      | December 31, 2003 |   | December 31, 2002
|------------------------------ | ------------------------------------------------------------------------------------ | ----------------- | - | -----------------
|
|Assets:                        |                                                                                      |                   |   |                  
|                               | Bonds                                                                                |                   | $ | 3,508,649        
|                               | Short-term investments                                                               |                   |   | 224,429          
|                               | GIC bond portfolio                                                                   |                   |   | 4,031,263        
|                               | GIC short-term investment portfolio                                                  |                   |   | 228,812          
|                               | GIC bond portfolio pledged as collateral                                             |                   |   | 66,423           
|                               | VIE bonds                                                                            |                   |   | 1,510,561        
|                               | VIE short-term investments                                                           |                   |   | 11,102           
|                               | Cash                                                                                 |                   |   | 19,460           
|                               | Securitized loans                                                                    |                   |   | 440,611          
|                               | Fair-value adjustments on derivatives                                                |                   |   | 407,742          
|                               | Receivable for investments sold                                                      |                   |   | 389              
|Liabilities:                   |                                                                                      |                   |   |                  
|                               | Deferred premium revenue, net of prepaid reinsurance premiums                        |                   |   | 1,166,562        
|                               | Losses and loss adjustment expenses, net of reinsurance recoverable on unpaid losses |                   |   | 174,173          
|                               | GICs                                                                                 |                   |   | 4,198,915        
|                               | VIE debt                                                                             |                   |   | 2,537,466        
|                               | Notes payable                                                                        |                   |   | 430,000          
|                               | Fair-value adjustments on derivatives                                                |                   |   | 25,405           
|                               | Payable for investments purchased                                                    |                   |   | 116,878          
|Off-balance-sheet instruments: |                                                                                      |                   |   |                  
|                               | Installment premiums                                                                 |                   |   |                 

16.    LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

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

|                                               |                        | 2003 |         | 2002    |   | 2001    |        
|---------------------------------------------- | ---------------------- | ---- | ------- | ------- | - | ------- | -------
|Balance at January 1                           |                        | $    | 223,618 |         | $ | 114,428 |        
|Less reinsurance recoverable                   |                        |      | 75,950  |         |   | 28,880  |        
|                                               |                        |      |         |         |   |         |        
|Net balance at January 1                       |                        |      | 147,668 |         |   | 85,548  |        
|Incurred losses and loss adjustment expenses:  |                        |      |         |         |   |         |        
|                                               | Current year           |      |         | 22,375  |   |         | 21,133 
|                                               | Prior years            |      |         | 12,111  |   |         | 44,480 
|Restructured transaction                       |                        |      | (2,231  | )       |   |         |        
|Paid losses and loss adjustment expenses, net: |                        |      |         |         |   |         |        
|                                               | Prior years            |      |         | (5,750  | ) |         | (3,493 
|                                               |                        |      |         |         |   |         |        
|Net balance December 31                        |                        |      | 174,173 |         |   | 147,668 |        
|Plus reinsurance recoverable                   |                        |      | 59,235  |         |   | 75,950  |        
|                                               |                        |      |         |         |   |         |        
|                                               | Balance at December 31 |      | $       | 233,408 |   | $       | 223,618
|                                               |                        |      |         |         |   |         |        

89

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During
2001, the Company increased its general reserve by $12.5 million, of which $8.2 million was for origination 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 reserves. Giving effect to these transfers, the general reserve totaled $69.1 million 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
CDOs. As a result, management undertook a quantitative analysis of all CDO transactions in its insured portfolio that breached senior overcollateralization triggers, which were included in such
transactions as one measure of adverse performance. A present value "deterministic" approach was utilized to estimate the loss inherent in this portfolio. The deterministic model takes the average
cumulative default rate produced by a Monte Carlo simulation and applies those defaults to a cash flow model using (i) a timing sequence dependent on the portfolio's rating and maturity
composition, (ii) an estimate of collateral recovery values for severity and (iii) the LIBOR forward curve as a predictor of interest rates. Management assumed that current default rates
on CDO collateral would improve in a manner consistent with an economic recovery following a period of significant credit deterioration similar to that experienced in 1991/1992 and, as a result,
management utilized the Moody's idealized default curve, adjusted by a factor consistent with the relationship between the 1992 cohort experience and the Moody's 30-year average default
rate. The per-period default rate was calculated based on the Moody's weighted-average rating factor for each piece of surviving collateral. Recovery rates were judgmentally established by
the Company. In considering the recovery rates to be utilized, management adjusted Moody's average recovery rates (observed since 1982) downward to reflect more recent adverse observations. At
June 30, 2002, this analysis produced a present value of expected losses of $51.5 million, net of reinsurance recoveries and net of unearned premiums and future ceding commissions.
Management addressed this net present value of expected loss ($51.5 million) through (i) an increase in the Company's general reserve ($31.0 million) and (ii) amounts
already existing in its general reserve ($20.5 million), including general reserve amounts reallocated to case 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 expenses 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 established a methodology of recording case reserves on CDO transactions based on the
extent to which the overcollateralization ratio (non-defaulted collateral at par value divided by the debt insured) has fallen below 100%, since management believes that claims on such
transactions are probable and that the amount of the undercollateralization is a reasonable estimate of such claims. Such transactions may benefit from excess cash flow attributable in part to higher
interest rates on the underlying collateral than on the insured securities. In addition, such transactions generally require insured payments of principal only at the ultimate maturity of such
transactions. As a result, the Company does not expect to be required to pay claims on these
transactions for several years, but may elect to do so at an earlier date at its discretion. Application of this methodology resulted in recording $68.8 million in gross case reserves and
$29.8 million in reinsurance recoverable on unpaid losses, resulting in a $39.0 million increase in net case reserves in 2002. Management, beginning in the second quarter of 2002, has
refined the loss factor it applies to its net par underwritten when calculating the 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 approximately $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
origination of new business and $3.4 million was for accretion of the discount on prior years' reserves. Also during 2002, the Company

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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
reserves. Giving effect to these transfers, the general reserve totaled $89.7 million at December 31, 2002.

During
2003, the Company charged $34.5 million to loss expense, comprised of $9.2 million related to the CDO portfolio discussed above, $22.4 million for origination
of new business and $2.9 million for the accretion of the discount on prior years' reserves. The general reserve increased by $21.8 million in 2003, consisting of the loss expense, a
transfer to the general reserve of $1.4 million representing recoveries received on prior-year transactions and a transfer of $14.1 million from the general reserve to case
reserves. In addition, the Company reclassified $2.2 million of case reserves relating to a restructured transaction to securitized loans on the balance sheet (see Note 22). Giving
effect to these transfers, the general reserve totaled $111.5 million at December 31, 2003.

The
cumulative amount of discount taken was approximately $65.9 million, $44.7 million and $29.6 million at December 31, 2003, 2002 and 2001, respectively.

17.    QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

|     |                                                                       | First |   | Second  |   | Third |         | Fourth |   | Full Year |  
|---- | --------------------------------------------------------------------- | ----- | - | ------- | - | ----- | ------- | ------ | - | --------- | -
|
|2003 |                                                                       |       |   |         |   |       |         |        |   |           |  
|     | Gross premiums written                                                |       | $ | 129,554 |   | $     | 294,832 |        | $ | 262,127   |  
|     | Net premiums written                                                  |       |   | 92,185  |   |       | 187,884 |        |   | 182,946   |  
|     | Net premiums earned                                                   |       |   | 80,090  |   |       | 88,158  |        |   | 95,460    |  
|     | Net investment income                                                 |       |   | 36,533  |   |       | 37,776  |        |   | 38,991    |  
|     | Losses and loss adjustment expenses                                   |       |   | 6,300   |   |       | 6,595   |        |   | 14,638    |  
|     | Net realized and unrealized gains (losses) on derivative instruments  |       |   | (225    | ) |       | 2,365   |        |   | 8,259     |  
|     | Income before income taxes and cumulative effect of accounting change |       |   | 83,760  |   |       | 88,763  |        |   | 81,851    |  
|     | Cumulative effect of accounting change, net of taxes                  |       |   |         |   |       |         |        |   | 4,800     |  
|     | Net income                                                            |       |   | 65,825  |   |       | 68,089  |        |   | 66,081    |  
|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     |  
|     | Net realized and unrealized gains (losses) on derivative instruments  |       |   | (8,228  | ) |       | (16,470 | )      |   | (54,296   | )
|     | Income before taxes                                                   |       |   | 70,033  |   |       | 56,252  |        |   | 33,437    |  
|     | Net income                                                            |       |   | 54,120  |   |       | 45,405  |        |   | 34,396    |  

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

18.    INVESTMENTS IN UNCONSOLIDATED AFFILIATES

The Company made equity investments in Fairbanks of $0, $13.4 million and $15.0 million in 2003, 2002 and 2001, respectively. At December 31,
2003, the Company had a 29.8% interest in Fairbanks. The Company's investment in Fairbanks is accounted for using the equity method of accounting.

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Amounts
recorded by the Company in connection with Fairbanks at December 31, 2003, 2002 and 2001 were as follows (in thousands):

|                                                                          |  | 2003 |         | 2002 |   | 2001  
|------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | ------
|Investment in Fairbanks, including $7.6 million of goodwill               |  | $    | 46,423  |      | $ | 59,971
|Equity in earnings from Fairbanks, net of goodwill amortization (in 2001) |  |      | (13,548 | )    |   | 13,795

At
December 31, 2003 and 2002, the Company's retained earnings included $3.5 million and $17.0 million, respectively, of accumulated undistributed earnings of
Fairbanks.

Fairbanks
is a servicer of single-family residential mortgage loans originated by unaffiliated third parties. Most of the mortgage loans serviced by Fairbanks are considered
"sub-prime," reflecting the lower than "prime" credit quality of the borrower/homeowner. Fairbanks is owned 56.8% by The PMI Group Inc. and 29.8% by the Company, with the remainder
owned by certain founders of Fairbanks.

Fairbanks'
business is subject to regulation, supervision and licensing by various federal, state and local authorities, which have increased their focus on lending and servicing
practices in the sub-prime lending industry. In October 2002, the Federal Trade Commission (FTC) informed Fairbanks that it was investigating whether Fairbanks' loan servicing or
other practices violated the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, Section 5 of the Federal Trade Commission Act or other laws enforced by the FTC. The Company
understands that, in March 2003, the U.S. Department of Housing and Urban Development (HUD) initiated a criminal investigation into Fairbanks' servicing practices. Certain of Fairbanks'
shareholders, including the Company, received civil investigative demands from the FTC relating to their investments in Fairbanks and their knowledge of Fairbanks' servicing operations.

Fairbanks
is also subject to private litigation, including a number of putative class action suits, alleging violations of federal and/or state laws. The publicity surrounding
sub-prime lending and servicing practices may result in the filing of other putative class action suits against Fairbanks.

Fairbanks
is highly leveraged and dependent on credit facilities to make servicing and delinquency advances in the regular course of its business, to finance the acquisition of mortgage
servicing rights and for other business purposes. In May 2003, Moody's and S&P downgraded their loan servicer rankings for Fairbanks from strong to below average. These actions constituted
potential events of default under Fairbanks' credit facilities, which led to a restructuring of and amendments to the credit facilities in June 2003.

In
order to address alleged violations of various federal and state laws, Fairbanks is reimbursing certain fees allegedly collected improperly and is changing certain of its loan
servicing practices, including the types and amounts of fees collected without admitting any violations. Due to these developments, future income from Fairbanks' operations is expected to be reduced.
While the impairment analysis performed by the Company did not result in a write-down of the investment, the Company continues to monitor the value of its investment in Fairbanks.

On
November 12, 2003, the FTC announced a settlement with Fairbanks, resolving the FTC's and HUD's civil allegations against Fairbanks. The settlement requires Fairbanks to pay
$40.0 million to the FTC to compensate consumers who suffered harm, enjoins Fairbanks from future law violations and imposes new restrictions on Fairbanks' business practices. The settlement is
contingent on approval by a federal district court in Massachusetts and is expected to be coordinated with a related settlement in a class action lawsuit. The Company guaranteed 34.4% of Fairbanks'
obligations under a $30.7 million letter of credit that may be drawn upon by the FTC as security for a portion of the $40.0 million payment required under the terms of the FTC's
settlement agreement with Fairbanks. Any payment by the Company under this agreement would be recorded as an additional equity investment in Fairbanks. The settlement amount and other costs,
aggregating $55.0 million, have been reflected in Fairbanks', and hence the Company's, results for 2003.

92

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The Company has a 15% interest in XL Financial Assurance Ltd, a financial guaranty insurance subsidiary of XL. 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, 2003, 2002 and 2001 are as
follows (in thousands):

|                             |  | 2003 |        | 2002 |   | 2001  
|---------------------------- |  | ---- | ------ | ---- | - | ------
|Investment in XLFA           |  | $    | 64,440 |      | $ | 52,206
|Equity in earnings from XLFA |  |      | 19,077 |      |   | 9,145 
|Dividends received from XLFA |  |      | 6,640  |      |   | 6,665 

At
December 31, 2003 and 2002, the Company's retained earnings included $25.7 million and $13.2 million, respectively, of accumulated undistributed earnings of XLFA.

19.   MINORITY INTEREST IN SUBSIDIARY

In November 1998, FSA International sold to XL $20.0 million of preferred shares representing a minority interest in FSA International, which is a
Bermuda-based financial guaranty subsidiary of FSA. In December 1999, FSA International sold to XL an additional $10.0 million of preferred shares to maintain its minority ownership
percentage. The preferred shares are Cumulative Participating Voting Preferred Shares, which in total have a minimum fixed dividend of $1.5 million per annum. In 2003 and 2002, FSA
International paid preferred dividends of $3.3 million and $8.7 million, respectively, to XL. For the years ended December 31, 2003, 2002 and 2001, the Company recognized minority
interest of $9.3 million, $6.7 million and $8.9 million, respectively.

20.   GICs

The obligations under GICs may be called at various times prior to maturity based on certain agreed-upon events. As of December 31, 2003, the
interest rates on these GICs were between 0.8% and 6.07% per annum.

Payments
due under GICs, excluding hedge accounting adjustments and prepaid interest of $14.7 million, in each of the next five years ending December 31 and thereafter,
based on expected withdrawal dates, are as follows (in thousands):

Expected
Withdrawal Date

Principal
Amount2004

$
1,363,1782005


789,1412006


459,2192007


466,9342008


130,738Thereafter


1,004,447Total

$
4,213,657


21.   DERIVATIVE INSTRUMENTS

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

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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 $57.7 million, $35.0 million and $15.4 million in net earned premiums under these agreements for the years ended
December 31, 2003, 2002 and 2001, respectively. The changes in fair value, which were gains of $34.8 million, losses of $50.2 million and gains of $6.7 million for the
years ended December 31, 2003, 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 accrued expenses and other liabilities. The Company included the net par outstanding of $63.8 billion relating to these CDS transactions at December 31,
2003 in the asset-backed balances in Note 13. The losses or gains recognized by recording these contracts at fair value will be determined each quarter based on an estimate of fair value by
analyzing 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 and other
indicative market prices, as appropriate, for the implied rating of each underlying obligation. The Company does not believe the fair-value adjustments are an indication of potential
claims under FSA's guarantees. The inception-to-date net unrealized loss was recorded in accrued expenses and other liabilities and was $9.4 million and
$44.2 million at December 31, 2003 and 2002, respectively.

Derivative
instruments, which are primarily designated as fair-value hedges, are entered into to manage the interest-rate and foreign currency exposure of the
Company's GICs, GIC bond portfolio, VIE debt and VIE bond portfolio and are recorded at fair value. These derivatives generally include interest-rate futures and interest-rate
and currency swap agreements, which are primarily utilized to convert the fixed-rate obligations into U.S. floating-rate obligations. The gains and losses relating to these
fair-value hedges are included in GIC net interest income, GIC net interest expense, VIE net interest income and VIE 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, 2003, 2002 and 2001, the Company recorded a net gain of $0.6 million, a net loss of $0.2 million and a net gain of
$0.2 million, respectively, relating to the ineffectiveness of these hedges. For the years ended December 31, 2003, 2002 and 2001, the Company recorded a net gain of $5.0 million,
$4.3 million and $0, respectively, relating to failed hedges. The inception-to-date net unrealized loss on these derivatives was recorded in accrued expenses and other
liabilities and was $15.8 million and $12.1 million at December 31, 2003 and 2002, respectively.

22.   SECURITIZED LOANS

In 2003 and 2002, FSA exercised certain rights available under its financial guaranty policies and indentures relating to certain loan-backed notes
issued by 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 the GIC Subsidiaries. FSA maintains significant first-loss and quota share reinsurance 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. FSA also consolidated the refinancing
vehicles.

94

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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 net of losses at the date of purchase, has determined cash flows from the pools of securitized loans, net of reinsurance, and is recording income based on the effective yield method. The cash
flows on the securitized loans will be monitored and the effective yield modified to reflect any change in the cash flow estimate on a prospective basis (see Note 26).

23.   SEGMENT REPORTING

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

|                           |              | For the Year Ended December 31, 2003
|-------------------------- | ------------ | ------------------------------------
|
|Revenues:                  |              |                                     
|                           | External     |                                     
|                           | Intersegment |                                     
|Expenses:                  |              |                                     
|                           | External     |                                     
|                           | Intersegment |                                     
|Income before income taxes |              |                                     
|Segment assets             |              |                                     
|                           |              |                                     

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

The
inter-segment assets consist of intercompany notes that are in the financial products investment portfolio and GICs issued by the GIC Subsidiaries that are in the financial guaranty
investment portfolio. The inter-segment revenue relates to interest income on the intercompany assets.

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24.   OTHER ASSETS AND LIABILITIES

The detailed balances that comprise other assets and accrued expenses and other liabilities at December 31, 2003 and 2002 are as follows (in thousands):

|                   |                                                 | 2003 |           | 2002   
|------------------ | ----------------------------------------------- | ---- | --------- | -------
|Other Assets:      |                                                 |      |           |        
|                   | Fair value of VIE derivatives                   |      | $         | 407,742
|                   | Securities purchased under agreements to resell |      |           | 175,000
|                   | Deferred compensation trust                     |      |           | 97,514 
|                   | Asset-backed senior notes                       |      |           | 71,099 
|                   | Tax and loss bonds                              |      |           | 85,512 
|                   | Accrued interest on VIE derivatives             |      |           | 59,100 
|                   | Accrued interest income                         |      |           | 47,634 
|                   | Other assets                                    |      |           | 180,462
|                   |                                                 |      |           |        
|Total Other Assets |                                                 | $    | 1,124,063 |        
|                   |                                                 |      |           |        

|                                             |                                                | 2003 |         | 2002   
|-------------------------------------------- | ---------------------------------------------- | ---- | ------- | -------
|Accrued Expenses and Other Liabilities:      |                                                |      |         |        
|                                             | Payable for securities purchased               |      | $       | 116,878
|                                             | Deferred compensation trust                    |      |         | 97,262 
|                                             | Share performance plan                         |      |         | 114,165
|                                             | Securities sold under agreements to repurchase |      |         | 63,965 
|                                             | Fair-value adjustments on derivatives          |      |         | 25,405 
|                                             | Other liabilities                              |      |         | 304,009
|                                             |                                                |      |         |        
|Total Accrued Expenses and Other Liabilities |                                                | $    | 721,684 |        
|                                             |                                                |      |         |        

25.   VARIABLE INTEREST ENTITIES

In January 2003, the FASB issued FIN 46, which addresses consolidation of VIEs that have one or both of the following characteristics: (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. In
December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest Entities, an interpretation of ARB 51" (FIN 46R). FIN 46R
replaced FIN 46 and is effective for public companies for periods after December 15, 2003.

The
Company applied FIN 46 and consolidated for financial reporting purposes, effective July 1, 2003, FSA Global and Canadian Global. In addition, as a result of the Company
obtaining control rights of another VIE, Premier, on July 1, 2003, the Company consolidated Premier beginning July 1, 2003. FIN 46R requires that, upon consolidation, the Company
initially measure the VIE's assets, liabilities and minority interest at their carrying amounts under existing GAAP as if the entity had been consolidated from the time the Company was considered its
primary beneficiary (or parent). The increase in total assets and total liabilities related to the consolidation of these entities was $2.0 billion. Any differences upon consolidation were
reflected as a cumulative effect of a change in accounting principle. The cumulative effect of a change in accounting principle for Canadian Global resulted in additional income of
$4.8 million, net of income tax. There were no cumulative income statement effects from consolidating FSA Global and Premier. FSA Global is managed as a "matched funding

96

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vehicle,"
in which the proceeds from the issuance of FSA-guaranteed notes are invested in obligations having cash flows substantially matched to those of, and maturing prior to, such
notes. In certain cases, investments of FSA Global consist of GICs issued by the GIC Subsidiaries. Similarly, Canadian Global and Premier have GICs issued by the GIC Subsidiaries in their investment
portfolios. In each such case, the Company's GIC liability and asset are eliminated in consolidation. At December 31, 2003, $559.9 million was eliminated as a result of such
consolidation. In the cases of FSA Global and Canadian Global, permitted activities are limited by charter and do not involve active management; the legal documents that establish the VIEs do not
permit the sale or other disposal of the financial assets they hold, except in automatic response to the terms of such financial assets; and the VIEs are structured as bankruptcy-remote entities. The
Company's management believes that the assets held by the VIEs, including those that are eliminated in consolidation, are beyond the reach of the Company and its creditors, even in bankruptcy or other
receivership. All intercompany insured amounts between FSA and FSA Global and Canadian Global previously included in the Company's outstanding exposure are excluded from the Notes to the Condensed
Consolidated Financial Statements for December 31, 2003.

Following
is a summary of the impact on the consolidated balance sheet of consolidating the VIEs at December 31, 2003 (in thousands):

|                                     |  | Premier/
FSA Global |           | Canadian
Global |   | Intercompany
Eliminations |  | VIE
Total |         
|------------------------------------ |  | ------------------- | --------- | --------------- | - | ------------------------- |  | --------- | --------
|Bonds                                |  | $                   | 1,475,561 |                 | $ | 35,000                    |  | $         |         
|GIC assets                           |  |                     | 430,103   |                 |   | 129,750                   |  |           | (559,853
|Short-term investments               |  |                     | 6,081     |                 |   | 5,021                     |  |           |         
|Other assets                         |  |                     | 474,877   |                 |   | 49,477                    |  |           |         
|Other financial guaranty assets      |  |                     |           |                 |   |                           |  |           | (2,863  
|                                     |  |                     |           |                 |   |                           |  |           |         
|Total assets                         |  | $                   | 2,386,622 |                 | $ | 219,248                   |  | $         | (562,716
|Debt                                 |  | $                   | 2,335,902 |                 | $ | 201,564                   |  |           |         
|GIC liability                        |  |                     |           |                 |   |                           |  |           | (559,853
|Other liabilities                    |  |                     | 51,647    |                 |   | 17,684                    |  |           |         
|Other financial guaranty liabilities |  |                     |           |                 |   |                           |  |           | (2,863  
|                                     |  |                     |           |                 |   |                           |  |           |         
|Total liabilities                    |  | $                   | 2,387,549 |                 | $ | 219,248                   |  | $         | (562,716

Following
is a summary of the impact in the consolidated statement of operations of consolidating the VIEs for the year ended December 31, 2003 (in thousands):

|                                       |  | Premier/
FSA Global |        | Canadian
Global |   | Intercompany
Eliminations |  | VIE
Total |       
|-------------------------------------- |  | ------------------- | ------ | --------------- | - | ------------------------- |  | --------- | ------
|VIE net interest income                |  | $                   | 25,754 |                 | $ | 1,729                     |  | $         | (5,644
|Other income                           |  |                     |        |                 |   | 689                       |  |           | (675  
|Net premiums written                   |  |                     |        |                 |   |                           |  |           | (2,690
|                                       |  |                     |        |                 |   |                           |  |           |       
|Total revenues                         |  | $                   | 25,754 |                 | $ | 2,418                     |  | $         | (9,009
|VIE net interest expense               |  | $                   | 23,305 |                 | $ | 786                       |  |           |       
|Other expenses                         |  |                     | 2,232  |                 |   | 1,528                     |  |           | (3,365
|Financial products net interest income |  |                     |        |                 |   |                           |  |           | (5,644
|                                       |  |                     |        |                 |   |                           |  |           |       
|Total expenses                         |  | $                   | 25,537 |                 | $ | 2,314                     |  | $         | (9,009

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VIE Investments

All bonds in the VIE Portfolio are insured by FSA. The credit quality of the VIE Portfolio, without the benefit of FSA's insurance, at December 31, 2003
was as follows:

Rating (1)

Percent of BondsAAA

3.7
%AA

4.3A

72.0BBB

20.0100.0
%


---

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

December 31, 2003

Amortized Cost

Gross Unrealized Losses

Fair ValueObligations of states and political subdivisions

$
16,200

$


$
16,200Corporate securities


181,163


(846
)

180,317Foreign securities


211,952


(335
)

211,617Asset-backed securities


1,102,427





1,102,427Total

$
1,511,742

$
(1,181
)
$
1,510,561


The
following table shows the gross unrealized losses and fair value (in thousands) of securities in the VIE Portfolio, aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss position, at December 31, 2003:

12 months or moreFair Value

Unrealized
LossesCorporate securities

$
88,262

$
846Foreign securities


61,206


335Total

$
149,468

$
1,181


The
Company periodically monitors its investment portfolio for individual investments in an unrealized loss position in order to assess whether that investment is considered
other-than-temporarily impaired. In each case, the Company determines the nature and cause of the decline and whether the Company maintains the ability and intent to hold the
security until the unrealized loss may reverse or until maturity. At December 31, 2003, there were nine securities that were in an unrealized loss position for a continuous 12-month
period or longer. None of the nine securities had an unrealized loss that exceeded book value by 20% or greater at December 31, 2003. At December 31, 2003, the Company determined that no
investments were considered other-than-temporarily impaired.

The
amortized cost and fair value of bonds in the VIE Portfolio at December 31, 2003, by contractual maturity, are shown below (in thousands). Actual maturities could differ from
contractual

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

Amortized
Cost

Fair ValueDue in one year or less

$
20,000

$
19,972Due after one year through five years


362,796


361,731Due after five years through ten years


10,319


10,231Due after ten years


16,200


16,200Asset-backed securities (stated maturities of 1 to 18 years)


1,102,427


1,102,427Total

$
1,511,742

$
1,510,561


At
December 31, 2003, the interest rates on VIE Debt were between 1.12% and 10.0% per annum.

Payments
due under the VIE Debt (including $1,020.5 million of interest accretion on zero coupon obligations and excluding $155.2 million of hedge accounting adjustments)
in each of the next five years ending December 31 and thereafter, are as follows (in thousands):

Year

Principal
Amount2004

$
211,9002005


205,9322006


67,6742007


185,1542008


39,788Thereafter


2,692,272Total

$
3,402,720


26.   RECENTLY ISSUED ACCOUNTING STANDARDS

In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position
03-3: Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3). SOP 03-3 addresses accounting for differences between contractual cash
flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part,
to credit quality. SOP 03-3 supersedes Practice Bulletin 6 for transactions entered into after the initial application of SOP 03-3. For loans acquired in fiscal years prior to
the effective date of SOP 03-3 and within the scope of Practice Bulletin 6 (such as securitized loans, see Note 22), SOP 03-3 amends the application of Practice Bulletin
6 with regard to accounting for decreases in cash flows expected to be collected.

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

SOP
03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. For loans acquired in fiscal years beginning on or before
December 15, 2004 and that fall within the scope of Practice Bulletin 6 as it applies to decreases in cash flows expected to be collected, SOP 03-3 should

99

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be
applied prospectively for fiscal years beginning after December 15, 2004. Management believes that the implementation of SOP 03-3 will not have a material effect on the Company's
financial position, results of operations or cash flows.

In
December 2003, the Emerging Issues Task Force (EITF) issued EITF Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments" (EITF 03-01). EITF 03-01 requires the Company to disclose certain information about unrealized holding losses on its investment
portfolio that have not been recognized as other-than-temporary impairments. The requirements are effective for fiscal years ending after December 15, 2003, and require
the Company to make disclosure in its financial statements about investments in debt or marketable equity securities with market values below carrying values. See Notes 3 and 25 for disclosures
required by EITF 03-01.

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

None

Item 9A.    Controls and Procedures

The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the
Company's disclosure controls and procedures as of December 31, 2003. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the
possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of
achieving their control objectives. Based upon and as of the date of the evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these
disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934
is recorded, processed, summarized and reported as
and when required. Such evaluation did not identify any change in the Company's internal control over financial reporting that occurred during the period ended December 31, 2003 that has
materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

100

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Part III

Item 10.    Directors and Executive Officers of the Registrant.

Directors

On May 16, 2003, the Company's shareholders appointed ten directors to serve until the Company's next annual meeting of shareholders or until their earlier
resignation or removal. James H. Ozanne, a director of the Company elected in May 2002, resigned in May 2003 when he became the Chief Executive Officer of Fairbanks Capital Holding
Corp., and did not stand for reelection. 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 53      |  | Director of the Company since November 2001. Mr. Bruneel has been a member of the Management Board of Dexia S.A. since July 2001, and Chairman of the Management Board of Dexia Bank Nederland N.V. since November 2002. He
is currently the Chairman of the Board of Directors of Dexia Securities France S.A., a member of the Supervisory Board of Dexia Municipal Agency S.A. and Chairman of the Board of Directors of Artesia Mortgage Capital Corporation. Mr. Bruneel served
as Chairman of the Management Committee of Artesia Banking Corporation (a Belgian-based bank acquired by Dexia S.A. in July 2001) from November 1998 until August 2001 and of BACOB Bank s.c. from January 1995 until August 2001, and was a member of the
Management Committee of Dexia Bank from July 2001 through January 2002. He currently serves as a member of the Board of Directors of DVV Verzekeringen NV, Ehsal and VEV, and Treasurer ofVlaams Omroeporkest en
Kamerkoor.
|------------------------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Robert P. Cochran
Age 54 |  | 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 42     |  | Director of the Company since September 2001. Mr. Deletre has been a member of the Executive Board and Managing Director of Dexia Crédit Local since May 2001. Prior to that time, he held various positions in the French Ministry of Finance
-Treasury, and served as Advisor to the French Minister of Economy and Finance from 1995 to 1997. He is chairman of the board of Dexia Global Structured Finance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Robert N. Downey
Age 68  |  | 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.                                                                                                                                                                                                                                               
|                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

101

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|Jacques Guerber
Age 54  |  | Director of the Company since September 2002. Mr. Guerber has been chairman of the Executive Board of Dexia Crédit Local, a subsidiary of Dexia S.A. formerly known as Crédit Local de France, since January 2000 and a member of the
Executive Committee of Dexia S.A. since December 1999. He was previously senior executive vice president of Crédit Local de France since 1996 and a member of that company's Management Board since 1988. Earlier, he held management positions in
the Local Development Division of Caisse des Dépôts et Consignations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|----------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|David O. Maxwell
Age 73 |  | 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 45 |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Pierre Richard
Age 63   |  | Director and Vice Chairman of the Company since July 2000. Mr. Richard was appointed Group Chief Executive and Chairman of the Executive Committee of Dexia S.A. in December 1999 after its reorganization. He had been co-Chairman of Dexia Group since
its creation through the alliance between Crédit Local de France and Crédit Communal de Belgique in December 1996. In October 1987, when Crédit Local de France was incorporated, he became its Chief Executive Officer and then, in
December 1993, after the firm's privatization, he was named Chairman and Chief Executive Officer. He previously served as Deputy General Manager of Caisse des Dépôts et Consignations and, before that, as head of the Local Authorities
Department at the French Ministry of Interior, where he was closely involved in drafting the new legislation for decentralization. He serves on the boards of the European Investment Bank, Compagnie Nationale Air France, Le Monde SA, Credit du Nord
and Generali France Holding. He has been decorated as anOfficierof theLégion d'Honneurand theOrdre National du
Mériteand as aCommandeurof theOrdre of Leopold II.
|Roger K. Taylor
Age 52  |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

102

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|Rembert von Lowis
Age 50 |  | 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 full-time members of the Management Committee.

|Name                 |  | Age |  | Position                                                                                   
|-------------------- |  | --- |  | -------------------------------------------------------------------------------------------
|Russell B. Brewer II |  | 47  |  | Managing Director of the Company and FSA; Chief Risk Management Officer and Director of FSA
|Joseph W. Simon      |  | 45  |  | Managing Director and Chief Financial Officer of the Company and FSA; Director of FSA      
|Bruce E. Stern       |  | 50  |  | 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 Risk Management Officer of FSA since September 2003. Mr. Brewer was the Chief
Underwriting Officer of FSA from September 1990 until September 2003. He has been a Managing Director of the Company since May 1999 and a director of FSA since
September 1993. From March 1989 to August 1990, Mr. Brewer was
Managing Director, Asset Finance Group, of FSA. Prior to joining FSA in 1986, Mr. Brewer was an Associate Director of Moody's Investors Service, Inc.

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

103

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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.

In
November 2003, Daniel C. Farrell, who had been the Managing Director of FSA in charge of FSA's Corporate Finance Group since December 2000 and a member of the Management
Committee of the Company since January 2002, resigned in order to pursue other opportunities.

Audit Committee

The Company has a separately designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934,
as amended. During 2003, the Audit Committee consisted of Messrs. Von Lowis (who served as Chairman), Deletre and Maxwell and, until his resignation as a director in May 2003,
Mr. Ozanne.

Audit Committee Financial Expert

The Board of Directors of the Company has determined that Audit Committee member David O. Maxwell is an audit committee financial expert as defined by Item 401(h)
of Regulation S-K of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Mr. Maxwell is independent within the meaning of Rule 10A-3 of
the Exchange
Act. Because the Company has only debt securities listed on the New York Stock Exchange ("NYSE"), the independence standards for audit committee members imposed by the NYSE are not applicable to the
Company.

Code of Ethics

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



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

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16 of the 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 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.

104

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Item 11.    Executive Compensation.

Summary Compensation Table

The table below sets forth a summary of all compensation paid to the chief executive officer of the Company and the other four most highly compensated executive
officers of the Company and its subsidiaries, in each case for services rendered in all capacities to the Company and its subsidiaries for the years ended December 31, 2003, 2002 and 2001.

Annual Compensation

Long-Term
Compensation(1)Name and Principal
Position

Year

Salary

Bonus(2)

LTIP
Payouts(2)

All Other
Compensation(3)Robert P. Cochran
    Chairman of the Board and
    Chief Executive Officer

2003
2002
2001

$
490,000
490,000
490,000

$
3,200,000
2,600,000
3,400,000

$
9,213,941
3,078,527
3,460,856

$
4,758,391
115,000
1,928,646Séan W. McCarthy
    President and
    Chief Operating Officer

2003
2002
2001


300,000
300,000
300,000


2,800,000
2,400,000
2,500,000


6,858,901
3,609,374
3,024,757


450,111
127,823
110,709Russell B. Brewer II
    Managing Director and
    Chief Underwriting Officer

2003
2002
2001


240,000
230,000
230,000


800,000
600,000
770,000


2,259,243
1,289,911
1,100,268


1,791,762
74,700
727,407Bruce E. Stern
    Managing Director, General
    Counsel and Secretary

2003
2002
2001


240,000
230,000
230,000


800,000
650,000
770,000


2,269,286
1,304,909
1,093,904


1,463,776
74,700
549,894Joseph W. Simon(4)
    Managing Director and
    Chief Financial Officer

2003
2002


240,000
172,500


500,000
400,000


0
0


0
0


---

105

---



Officer

2003

2002

2001Robert P. Cochran

$
4,668,391




$
1,813,646Séan W. McCarthy


360,111

$
37,823


20,709Russell B. Brewer II


1,701,762





654,057Bruce E. Stern


1,373,776





476,544Joseph W. Simon













2003

2002

2001Officer

Pension Plan

SERP

Pension Plan

SERP

Pension Plan

SERPRobert P. Cochran

$
18,000

$
72,000

$
15,300

$
74,700

$
15,300

$
74,700Séan W. McCarthy


18,000


72,000


15,300


74,700


15,300


74,700Russell B. Brewer II


18,000


72,000


15,300


59,400


15,300


58,050Bruce E. Stern


18,000


72,000


15,300


59,400


15,300


58,050Joseph W. Simon


N/A


N/A


N/A


N/A


N/A


N/A




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 $19.7 million after giving effect to 2003 bonuses (paid in the first quarter of 2004), 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

106

---

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

The
Equity Plan provides for accelerated vesting and payment of performance shares, equity bonus shares and stock options awarded thereunder upon the occurrence of certain change in
control transactions involving the 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.

Sales
under the program are not registered under the Securities Act of 1933 in reliance upon an exemption from registration under Section 4(2) of that Act. None of the directors
made any additional direct or phantom investments under the Director Share Purchase Program during 2003, or any direct investments after 2002, the year of inception of the Program.

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, 2003 (which awards were
made in February 2004), (b) the applicable performance period until payout and (c) the related estimated future payouts at the stated assumed annual rates of adjusted book value
per share and book value per share growth.

107

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LONG-TERM INCENTIVE PLANSAWARDS IN 2003(1)

Estimated Future Payouts(3)Name

Performance
Shares Awarded

Performance
Period Until
Payout

Threshold
(no. of shares)

Target
(no. of shares)

Maximum
(no. of shares)Robert P. Cochran

40,000

(2
)
0

40,000

80,000Séan W. McCarthy

29,000

(2
)
0

29,000

58,000Russell B. Brewer II

10,000

(2
)
0

10,000

20,000Bruce E. Stern

10,000

(2
)
0

10,000

20,000Joseph W. Simon

7,000

(2
)
0

7,000

14,000


---

Compensation Committee Interlocks and Insider Participation

The Human Resources Committee consisted of Messrs. Maxwell (Chairperson), Cochran, Deletre, Downey and Richard during 2003. 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. 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.

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 DCP or SERP.

108

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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, 2004 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 |  | 32,879,842 shares(1)(2)                   |  | 98.975%(2)      
|                                       |  | Boulevard Pachéco 44
B-1000 Brussels, Belgium                                 |  |                                           |  |                 

---

Directors and Executive Officers

The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock at March 15, 2004 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

109

---

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



263,291Bruno Deletre(2)



Robert N. Downey

17,887

29,259Jacques Guerber(2)



Séan W. McCarthy



121,718David O. Maxwell

5,213

19,299Pierre Richard(2)



Roger K. Taylor



113,155Rembert von Lowis(2)



Russell B. Brewer II



36,666Bruce E. Stern



36,666Joseph W. Simon



17,000All executive officers and directors as a group (13 persons)

23,100

637,054


---

Officer

Performance SharesRobert P. Cochran

136,333Sean W. McCarthy

95,666Roger Taylor

16,666Russell B. Brewer II

36,666Bruce E. Stern

36,666Joseph W. Simon

17,000




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, 2004, for (a) each director of the Company,
(b) each executive officer named under "Executive CompensationSummary Compensation Table" and (c) all executive officers and

110

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directors
of the Company as a group. Beneficial ownership is less than 1% for each executive officer and director listed, individually and as a group.

Directors and
Executive Officers(1)

Amount and Nature of Beneficial OwnershipDirk Bruneel

44,010Robert P. Cochran

427,510Bruno Deletre

Robert N. Downey

Jacques Guerber

27,425Séan W. McCarthy

341,120David O. Maxwell

Pierre Richard

29,350Roger K. Taylor

249,250Rembert von Lowis

24,200Russell B. Brewer II

133,287Bruce E. Stern

133,457Joseph W. Simon

11,260All executive officers and directors as a group (13 persons)

1,420,869


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Officer

Leveraged SharesRobert P. Cochran

426,010Séan W. McCarthy

339,620Russell B. Brewer II

130,120Bruce E. Stern

126,330Joseph W. Simon

11,260


111

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Securities Available Under Equity Compensation Plans

The following table sets forth information as of December 31, 2003 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                                                                  |  | 1993 Equity Participation Plan, as amended(3): Equity bonus awards (no longer granted by the Company): 9,984,780; and all other awards: 3,112,263 Director Share Purchase Program(4): 971,523
|Equity compensation plans not approved by security holders (2) |  |                                                                                                |  |                                                                                |  |                                                                                                                                                                                             
|Total                                                          |  | 0                                                                                               |  | Not applicable                                                                  |  | 14,068,566(5)                                                                                                                                                                                

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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

112

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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.

Item 14.    Principal Accountant Fees and Services.

Aggregate fees (in thousands) for professional services by PricewaterhouseCoopers LLP invoiced in 2003 and 2002, were:

2003

2002Audit

$
1,302.1

$
895.5Audit related


220.1


223.8Tax


446.4


258.6Other





110.3Total

$
1,968.6

$
1,488.2


Audit
fees for the years ended December 31, 2003 and 2002, respectively, were for professional services rendered for the audits of the consolidated financial statements of the
Company and statutory and subsidiary audits (including Value Added Tax), issuance of comfort letters and consents. Included in this amount is $0.2 million and $0.2 million in fees
relating to consents that are reimbursed to the Company by the issuer of FSA-insured deals for the years ended December 31, 2003 and 2002, respectively.

Audit
related fees for the years ended December 31, 2003 and 2002, respectively, were for assurance and related services related to the Company's retirement plans and
consultations concerning financial accounting and reporting standards.

Tax
fees for the years ended December 31, 2003 and 2002, respectively, were for services related to tax compliance, including the preparation of tax returns for expatriates,
assistance with tax audits and appeals and tax services for employee benefit plans.

Other
fees for the years ended December 31, 2003 and 2002, respectively, were for services rendered for actuarial certifications and UK benefit plan consultations.

Audit Committee Pre-Approval Policies and Procedures

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

113

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Part IV

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





Schedule

TitleII

Condensed Financial Statements of the Registrant for the Years Ended December 31, 2003, 2002 and 2001.The report of the Registrant's independent auditors with respect to the above listed financial statement schedule is set forth on page 63 of this Report.All other schedules are omitted because they are either inapplicable or the required information is presented in the consolidated financial statements of the Company or the notes thereto.






Exhibit No.

Exhibit2.1

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.)


114

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3.1(B)

Certificate of Merger of White Mountains Holdings, Inc. and the Company into the Company under Section 904 of the Business Corporation Law (effective July 5, 2000). (Previously filed as Exhibit 3.2 to the September 30, 2000 10-Q, and incorporated
herein by reference.)3.2

Amended and Restated By-laws of the Company, as amended and restated on July 5, 2000. (Previously filed as Exhibit 3.3 to the September 30, 2000 10-Q, and incorporated herein by reference.)4.1

Amended and Restated Trust Indenture dated as of February 24, 1999 (the "Amended and Restated Senior Indenture") between the Company and the Senior Debt Trustee. (Previously filed as Exhibit 4.1 to the Company's Registration Statement on Form S-3
(Reg. No. 33-74165), and incorporated herein by reference.)4.1(A)

Form of 67/8% Quarterly Interest Bond Securities due December 15,2101. (Previously filed as Exhibit 2 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated December 12, 2001 (the "December 2001 Form
8-K"), and incorporated herein by reference.)4.1(B)

Officers' Certificate pursuant to Sections 2.01 and 2.03 of the Amended and Restated Senior Indenture. (Previously filed as Exhibit 3 to the December 2001 Form 8-K, and incorporated herein by reference.)4.1(C)

Form of 6.25% Notes due 2102. (Previously filed as Exhibit 3 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated November 6, 2002 and filed November 25, 2002 (the "November 2002 Form 8-K"), and incorporated herein by
reference.)4.1(D)

Officers' Certificate pursuant to Sections 2.01 and 2.03 of the Amended and Restated Senior Indenture. (Previously filed as Exhibit 4 to the November 2002 Form 8-K, and incorporated herein by reference.)


115

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4.1(E)

Form of 5.60% Notes due 2103. (Previously filed as Exhibit 2 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated July 17, 2003 and filed July 30, 2003 (the "July 2003 Form 8-K"), and incorporated herein by reference.)4.1(F)

Officers' Certificate pursuant to Sections 2.01 and 2.03 of the Amended and Restated Senior Indenture. (Previously filed as Exhibit 3 to the July 2003 Form 8-K, and incorporated herein by reference.)10.1

Credit Agreement dated as of August 31, 1998 among FSA, each of its insurance company affiliates listed on Schedule I attached thereto, the Banks from time to time party thereto and Deutsche Bank AG, New York Branch, as agent. (Previously filed as
Exhibit 10 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period ended September 30, 1998, and incorporated herein by reference.)10.1(A)

Amendment No. 5 to the Credit Agreement, dated as of April 25, 2003, among Financial Security Assurance Inc. ("FSA"), the additional borrowers party thereto, various banks, ABN AMRO Bank N.V., The Bank of Nova Scotia, Norddeutsche Landesbank
Girozentrale, New York and/or Cayman Islands Branch, KeyBank National Association and Deutsche Bank AG, New York Branch, as agent (providing, among other things, for The Bank of New York to become the successor Agent). (Previously filed as Exhibit
99.2 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period ended June 30, 2003 (the "June 30, 2003 10-Q"), and incorporated herein by reference.)10.2

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.)10.3(A)

Fourth Amendment to Second Amended and Restated Credit Agreement dated April 30, 2003 among FSA and FSA Insurance Company, the Banks party thereto and Bayerische Landesbank (formerly known as Bayerische Landesbank Girozentrale), acting through its
New York Branch in its capacity as Agent. (Previously filed as Exhibit 99.3 to the June 30, 2003 10-Q, and incorporated herein by reference.)10.4

Supplemental Executive Retirement Plan (amended and restated as of November 14, 2002). (Previously filed as Exhibit 10.4 to the Company's Annual Report on Form 10-K (Commission File No. 1-12644) for the fiscal year ended December 31, 2002 (the
"December 31, 2002 10-K") and incorporated herein by reference.)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 13, 2003).10.7*

Severance Policy for Senior Management (amended and restated as of November 13, 2003).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 (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.)10.11

Put Option Agreement, dated as of June 23, 2003 by and between FSA and Sutton Capital Trust I. (Previously filed as Exhibit 99.5 to the June 30, 2003 10-Q, and incorporated herein by reference.)10.12

Put Option Agreement, dated as of June 23, 2003 by and between FSA and Sutton Capital Trust II. (Previously filed as Exhibit 99.6 to the June 30, 2003 10-Q, and incorporated herein by reference.)10.13

Put Option Agreement, dated as of June 23, 2003 by and between FSA and Sutton Capital Trust III. (Previously filed as Exhibit 99.7 to the June 30, 2003 10-Q, and incorporated herein by reference.)10.14

Put Option Agreement, dated as of June 23, 2003 by and between FSA and Sutton Capital Trust IV. (Previously filed as Exhibit 99.8 to the June 30, 2003 10-Q, and incorporated herein by reference.)21*

List of Subsidiaries.23*

Consent of PricewaterhouseCoopers LLP.24

Powers of Attorney. (Previously filed as Exhibit 24 to the December 31, 2002 10-K and incorporated herein by reference.)31.1*

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2*

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1**

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2**

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1*

Financial Security Assurance Inc. and Subsidiaries 2003 Consolidated Financial Statements and Report of Independent Auditors.


---

(b)    Reports on Form 8-K

On November 7, 2003, the Company filed with the SEC a current report on Form 8-K dated November 6, 2003, pursuant to which it
furnished to the SEC (i) a press release announcing its third quarter 2003 results; (ii) the Company's current Quarterly Operating Supplement; and (iii) a quarterly letter from
its Chairman and Chief Executive Officer; and stating that the Company had posted such materials on November 6, 2003, to its website, http://www.fsa.com.

116

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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:                                                        

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 29, 2004
|/s/SÉAN W. MCCARTHY*Séan W. McCarthy   |  | President, Chief Operating Officer and Director                              |  | March 29, 2004
|/s/JOSEPH W. SIMON*Joseph W. Simon     |  | Managing Director and Chief Financial Officer (Principal Financial Officer)  |  | March 29, 2004
|/s/JEFFREY S. JOSEPH*Jeffrey S. Joseph |  | Managing Director and Controller (Principal Accounting Officer)              |  | March 29, 2004
|/s/DIRK BRUNEEL*Dirk Bruneel           |  | Director                                                                     |  | March 29, 2004
|/s/BRUNO DELETRE*Bruno Deletre         |  | Director                                                                     |  | March 29, 2004
|/s/ROBERT N. DOWNEY*Robert N. Downey   |  | Director                                                                     |  | March 29, 2004
|                                       |  |                                                                              |  |               

117

---

|/s/JACQUES GUERBER*Jacques Guerber     |  | Director                   |  | March 29, 2004
|-------------------------------------- |  | -------------------------- |  | --------------
|/s/DAVID O. MAXWELL*David O. Maxwell   |  | Director                   |  | March 29, 2004
|/s/PIERRE RICHARD*Pierre Richard       |  | Vice Chairman and Director |  | March 29, 2004
|/s/ROGER K. TAYLOR*Roger K. Taylor     |  | Director                   |  | March 29, 2004
|/s/REMBERT VON LOWIS*Rembert von Lowis |  | Director                   |  | March 29, 2004

---

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

118

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Schedule II
Parent Company Condensed Financial Information
Condensed Balance Sheets
(in thousands)

|                                           |                                                            | December 31,
|------------------------------------------ | ---------------------------------------------------------- | ------------
|
|Assets:                                    |                                                            |             
|                                           | Bonds at market value (amortized cost $20,397 and $17,164) |             
|                                           | 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
(in thousands)

|                                                        |  | Year Ended December 31, |        
|------------------------------------------------------- |  | ----------------------- | -------
|
|Investment income                                       |  | $                       | 10,077 
|Net realized gains (losses)                             |  |                         | (909   
|Other income (loss)                                     |  |                         | (97    
|Interest and amortization expense                       |  |                         | (33,026
|Commissions                                             |  |                         | (703   
|Other expenses                                          |  |                         | (1,639 
|Net unrealized gains (losses) on derivative instruments |  |                         | 1,638  
|                                                        |  |                         |        
|                                                        |  |                         | (24,659
|Equity in undistributed net income of subsidiaries      |  |                         | 304,412
|                                                        |  |                         |        
|Income before income taxes                              |  |                         | 279,573
|Income tax benefit                                      |  |                         | 10,833 
|                                                        |  |                         |        
|Net income                                              |  | $                       | 290,586
|                                                        |  |                         |        

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.

119

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.. Schedule II

Parent Company Condensed Financial Information (Continued)

Condensed Statements of Cash Flows
(in thousands)

|                                          |                                                   | Year Ended December 31,                   |      
|----------------------------------------- | ------------------------------------------------- | ----------------------------------------- | -----
|
|Cash flows from operating activities:     |                                                   |                                           |      
|                                          | Other operating expenses recovered (paid), net    |                                           | $    
|                                          | Net investment income received                    |                                           |      
|                                          | Federal income taxes received (paid)              |                                           |      
|                                          | Interest paid                                     |                                           |      
|                                          | Other                                             |                                           |      
|                                          |                                                   |                                           |      
|                                          |                                                   | Net cash used for operating activities    |      
|                                          |                                                   |                                           |      
|Cash flows from investing activities:     |                                                   |                                           |      
|                                          | Proceeds from sales of bonds                      |                                           |      
|                                          | Purchases of bonds                                |                                           |      
|                                          | Investment in subsidiaries                        |                                           |      
|                                          | Net decrease (increase) in short-term investments |                                           |      
|                                          | Other investments                                 |                                           |      
|                                          |                                                   |                                           |      
|                                          |                                                   | Net cash used for investing activities    |      
|                                          |                                                   |                                           |      
|Cash flows from financing activities (b): |                                                   |                                           |      
|                                          | Issuance of notes payable                         |                                           |      
|                                          | Repayment of notes payable                        |                                           |      
|                                          | Surplus notes redeemed (purchased), net           |                                           |      
|                                          | Dividends paid                                    |                                           |      
|                                          |                                                   |                                           |      
|                                          |                                                   | Net cash provided by financing activities |      
|                                          |                                                   |                                           |      
|Net increase (decrease) in cash           |                                                   |                                           | (506 
|Cash at beginning of year                 |                                                   |                                           | 1,752
|                                          |                                                   |                                           |      
|Cash at end of year                       |                                                   | $                                         | 1,246
|                                          |                                                   |                                           |      

---

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.

120

---

Schedule II

Parent Company Condensed Financial Information (Continued)

Condensed Statements of Cash Flows, continued
(in thousands)

|                                                                           |                                                  | Year Ended December 31, |        
|-------------------------------------------------------------------------- | ------------------------------------------------ | ----------------------- | -------
|
|Reconciliation of net income to net cash provided by operating activities: |                                                  |                         |        
|Net income                                                                 |                                                  | $                       | 290,586
|                                                                           | 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 used for operating activities                                         |                                                  | $                       | (25,933
|                                                                           |                                                  |                         |        

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.

121

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









122

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Exhibit Index

|Exhibit No. |  | Exhibit                                                                                                                        
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------
|10.6        |  | Deferred Compensation Plan (amended and restated as of November 13, 2003)                                                      
|10.7        |  | Severance Policy for Senior Management (amended and restated as of November 14, 2003)                                          
|21          |  | List of Subsidiaries                                                                                                           
|23          |  | Consent of PricewaterhouseCoopers LLP                                                                                          
|31.1        |  | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                        
|31.2        |  | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                        
|32.1        |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002         
|32.2        |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002         
|99.1        |  | Financial Security Assurance Inc. and Subsidiaries 2003 Consolidated Financial Statements and Report of Independent Accountants

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

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