Exhibit 99.1





CONSOLIDATED
      FINANCIAL STATEMENTS


Financial
      Guaranty Insurance Company and Subsidiaries


December
      31, 2006


with
      Report of Independent Auditors








Financial
      Guaranty Insurance Company and Subsidiaries





Consolidated
      Financial Statements




December
      31, 2006








**Contents**





Report
                of Independent Auditors
            
            1Consolidated
                Balance Sheets
            
            2Consolidated
                Statements of Income
            
            3Consolidated
                Statements of Stockholder’s Equity
            
            4Consolidated
                Statements of Cash Flows
            
            5Notes
                to Consolidated Financial Statements
            
            6














Report
      of
      Independent Registered Public Accounting Firm








The
      Board
      of Directors and Stockholder


Financial
      Guaranty Insurance Company





We
      have
      audited the accompanying consolidated balance sheets of Financial Guaranty
      Insurance Company and Subsidiaries (the “Company”) as of December 31, 2006 and
      2005, and the related consolidated statements of income, stockholder's equity,
      and cash flows for each of the three years in the period ended December 31,
      2006. These financial statements are the responsibility of the Company's
      management. Our responsibility is to express an opinion on these financial
      statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States).  Those standards require that
      we plan and perform the audit to obtain reasonable assurance about whether
      the
      financial statements are free of material misstatement. We were not engaged
      to
      perform an audit of the Company’s internal control over financial reporting. Our
      audit included consideration of internal control over financial reporting as
      a
      basis for designing audit procedures that are appropriate in the circumstances,
      but not for the purpose of expressing an opinion on the effectiveness of the
      Company's internal control over financial reporting. Accordingly, we express
      no
      such opinion. An audit also 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.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of the Company at
      December 31, 2006 and 2005, and the consolidated results of their operations
      and
      their cash flows for each of the three years in the period ended December 31,
      2006 in conformity with U.S. generally accepted accounting
      principles.




/S/
      Ernst
& Young LLP








New
      York,
      New York


February
      2, 2007





1


Financial
      Guaranty Insurance Company and Subsidiaries





Consolidated
      Balance Sheets





*(Dollars
      in thousands, except per share amounts)*


**December
                  31,**
                **2006**
              
              **December
                  31,**
                **2005***(Unaudited)***Assets**Fixed
                  maturity securities, available for sale, at fair value (amortized
                  cost of
                  $3,627,344 in 2006 and $3,277,291 in 2005)
              
              **$**
              **3,627,007**
              
              $
              3,258,738Variable
                  interest entity fixed maturity securities, held to maturity at
                  amortized
                  cost
              
              
              **750,000**
              
              
              -Short-term
                  investments
              
              
              **211,726**
              
              
              159,334Total
                  investments
              
              
              **4,588,733**
              
              
              3,418,072Cash
                  and cash equivalents
              
              
              **29,963**
              
              
              45,077Accrued
                  investment income
              
              
              **49,843**
              
              
              42,576Reinsurance
                  recoverable on losses
              
              
              **1,485**
              
              
              3,271Prepaid
                  reinsurance premiums
              
              
              **156,708**
              
              
              110,636Policy
                  acquisition costs deferred, net
              
              
              **93,170**
              
              
              63,330Receivable
                  from related parties
              
              
              **2,483**
              
              
              9,539Property
                  and equipment, net of accumulated depreciation of $2,107 in 2006
                  and $885
                  in 2005
              
              
              **2,617**
              
              
              3,092Prepaid
                  expenses and other assets
              
              
              **17,589**
              
              
              10,354Foreign
                  deferred tax asset
              
              
              **3,491**
              
              
              3,500Current
                  income tax receivable
              
              
              -
              
              
              2,158Total
                  assets
              
              **$**
              **4,946,082**
              
              $
              3,711,605**Liabilities
                  and stockholder’s equity**Liabilities:Unearned
                  premiums
              
              **$**
              **1,347,592**
              
              $
              1,201,163Losses
                  and loss adjustment expense reserves
              
              
              **40,299**
              
              
              54,812Ceded
                  reinsurance balances payable
              
              
              **7,524**
              
              
              1,615Accounts
                  payable and accrued expenses and other liabilities
              
              
              **43,405**
              
              
              36,359Capital
                  lease obligations
              
              
              **2,941**
              
              
              4,262Payable
                  for securities purchased
              
              
              **10,770**
              
              
              -Variable
                  interest entity floating rate notes
              
              
              **750,000**
              
              
              -Accrued
                  interest expense - variable interest entity
              
              
              **1,298**
              
              
              -Current
                  income taxes payable
              
              
              **17,520**
              
              
              -Deferred
                  income taxes
              
              
              **76,551**
              
              
              45,963Dividends
                  payable
              
              
              **10,000**
              
              
              -Total
                  liabilities
              
              
              **2,307,900**
              
              
              1,344,174Stockholder’s
                  equity:Common
                  stock, par value $1,500 per share; 10,000 shares authorized, issued
                  and
                  outstanding
              
              
              **15,000**
              
              
              15,000Additional
                  paid-in capital
              
              
              **1,901,799**
              
              
              1,894,983Accumulated
                  other comprehensive income (loss), net of tax
              
              
              **6,500**
              
              
              (13,597
              )Retained
                  earnings
              
              
              **714,883**
              
              
              471,045Total
                  stockholder’s equity
              
              
              **2,638,182**
              
              $
              2,367,431Total
                  liabilities and stockholder’s equity
              
              **$**
              **4,946,082**
              
              $
              3,711,605





*See
      accompanying notes to consolidated financial
      statements.*


2


Financial
      Guaranty Insurance Company and Subsidiaries





Consolidated
      Statements of Income





*(Dollars
      in thousands)*


**Year
                  ended**
                **December
                  31,**
                **2006**
              
              **Year
                  ended**
                **December
                  31,**
                **2005**
              
              **Year
                  ended**
                **December
                  31,**
                **2004**Revenues:Gross
                  direct and assumed premiums written
              
              **$**
              **441,231**
              
              $
              410,202
              
              $
              323,575Reassumed
                  ceded premiums
              
              
              -
              
              
              -
              
              
              4,959Ceded
                  premiums written
              
              
              **(74,417**
              **)**
              
              (29,148
              )
              
              (14,656
              )Net
                  premiums written
              
              
              **366,814**
              
              
              381,054
              
              
              313,878Change
                  in net unearned premiums
              
              
              **(100,357**
              **)**
              
              (156,485
              )
              
              (138,929
              )Net
                  premiums earned
              
              
              **266,457**
              
              
              224,569
              
              
              174,949Net
                  investment income
              
              
              **138,475**
              
              
              117,072
              
              
              97,709Interest
                  income - investments held by variable interest entity
              
              
              **35,893**
              
              
              -
              
              
              -Net
                  realized gains
              
              
              **274**
              
              
              101
              
              
              559Netrealized and unrealized gains (losses)on
                  credit derivative contracts
              
              
              **507**
              
              
              (167
              )
              
              -Other
                  income
              
              
              **1,815**
              
              
              762
              
              
              736Total
                  revenues
              
              
              **443,421**
              
              
              342,337
              
              
              273,953Expenses:Loss
                  and loss adjustment expenses
              
              
              **(8,700**
              **)**
              
              18,506
              
              
              5,922Underwriting
                  and other operating expenses
              
              
              **91,614**
              
              
              82,064
              
              
              73,426Policy
                  acquisition costs deferred, net
              
              
              **(39,728**
              **)**
              
              (38,069
              )
              
              (32,952
              )Amortization
                  of policy acquisition costs deferred
              
              
              **11,486**
              
              
              8,302
              
              
              2,038Interest
                  expense - debt held by variable interest entity
              
              
              **35,893**
              
              
              -
              
              
              -Total
                  expenses
              
              
              **90,565**
              
              
              70,803
              
              
              48,434Income
                  before income tax expense
              
              
              **352,856**
              
              
              271,534
              
              
              225,519Income
                  tax expense:Current
              
              
              **67,895**
              
              
              32,370
              
              
              42,510Deferred
              
              
              **21,123**
              
              
              32,738
              
              
              12,923Total
                  income tax expense
              
              
              **89,018**
              
              
              65,108
              
              
              55,433Net
                  income
              
              **$**
              **263,838**
              
              $
              206,426
              
              $
              170,086


*See
      accompanying notes to consolidated financial statements.*


3


Financial
      Guaranty Insurance Company and Subsidiaries




Consolidated
      Statements of Stockholder’s Equity




*(Dollars
      in thousands)*





**Common**
              **Stock**
            
            **Additional**
              **Paid-in**
              **Capital**
            
            **Accumulated
                Other**
              **Comprehensive**
              **(Loss)
                Income,**
              **Net
                of Tax**
            
            **Retained**
              **Earnings**
            
            **Total**Balance
                at January 1, 2004
            
            
            15,000
            
            
            1,857,772
            
            
            2,059
            
            
            94,533
            
            
            1,969,364Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            170,086
            
            
            170,086Other
                comprehensive income:Change
                in fixed maturity securities available for sale, net of
                tax
            
            
            -
            
            
            -
            
            
            9,340
            
            
            -
            
            
            9,340Change
                in foreign currency translation adjustment, net of tax
            
            
            -
            
            
            -
            
            
            4,086
            
            
            -
            
            
            4,086Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            183,512Capital
                contribution
            
            
            -
            
            
            25,000
            
            
            **-**
            
            
            -
            
            
            25,000Balance
                at December 31, 2004
            
            
            15,000
            
            
            1,882,772
            
            
            15,485
            
            
            264,619
            
            
            2,177,876Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            206,426
            
            
            206,426Other
                comprehensive income:Change
                in fixed maturity securities available for sale, net of
                tax
            
            
            -
            
            
            -
            
            
            (23,550
            )
            
            -
            
            
            (23,550
            )Change
                in foreign currency translation adjustment, net of tax
            
            
            -
            
            
            -
            
            
            (5,532
            )
            
            -
            
            
            (5,532
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            177,344Capital
                contribution
            
            
            -
            
            
            12,211
            
            
            -
            
            
            -
            
            
            12,211Balance
                at December 31, 2005
            
            
            15,000
            
            
            1,894,983
            
            
            (13,597
            )
            
            471,045
            
            
            2,367,431Net
                Income
            
            
            -
            
            
            -
            
            
            -
            
            
            263,838
            
            
            263,838Other
                comprehensive income:Change
                in fixed maturity securities available for sale, net of
                tax
            
            
            -
            
            
            -
            
            
            11,901
            
            
            -
            
            
            11,901Change
                in foreign currency translation adjustment, net of tax
            
            
            -
            
            
            -
            
            
            8,196
            
            
            -
            
            
            8,196Total
                comprehensive income
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            283,935Dividends
                declared to FGIC Corp.
            
            
            -
            
            
            -
            
            
            -
            
            
            (20,000
            )
            
            (20,000
            )Amortization
                of stock options and restricted stock
            
            
            -
            
            
            6,816
            
            
            -
            
            
            -
            
            
            6,816Balance
                at December 31, 2006
            
            $
            15,000
            
            $
            1,901,799
            
            $
            6,500
            
            $
            714,883
            
            $
            2,638,182




*See
      accompanying notes to consolidated financial statements.*





4


Financial
      Guaranty Insurance Company and Subsidiaries





Consolidated
      Statements of Cash Flows





*(Dollars
      in thousands)*


**Year
                  ended**
                **December
                  31,**
                **2006**
              
              **Year
                  ended**
                **December
                  31,**
                **2005**
              
              **Year
                  ended**
                **December
                  31,**
                **2004****Operating
                  activities**Net
                  income
              
              **$**
              **263,838**
              
              $
              206,426
              
              $
              170,086Adjustments
                  to reconcile net income to net cash provided by operating
                  activities:Amortization
                  of policy acquisition costs deferred
              
              
              **11,486**
              
              
              8,574
              
              
              2,038Policy
                  acquisition costs deferred
              
              
              **(39,728**
              **)**
              
              (38,069
              )
              
              (32,952
              )Depreciation
                  of property and equipment
              
              
              **1,222**
              
              
              721
              
              
              164Amortization
                  of fixed maturity securities
              
              
              **33,774**
              
              
              31,504
              
              
              37,013Amortization
                  of short-term investments
              
              
              **131**
              
              
              481
              
              
              29Net
                  realized gains on investments
              
              
              **(274**
              **)**
              
              (101
              )
              
              (559
              )Stock
                  compensation expense
              
              
              **6,816**
              
              
              -
              
              
              -Change
                  in accrued investment income, prepaid expenses, foreign deferred
                  tax
                  asset, and other assets, net
              
              
              **(14,725**
              **)**
              
              (8,504
              )
              
              (5,545
              )Change
                  in realized and unrealized gains on credit derivative
                  contracts
              
              
              **1,336**
              
              
              167
              
              
              -Change
                  in current income taxes receivable
              
              
              **-**
              
              
              -
              
              
              126Change
                  in reinsurance recoverable on losses
              
              
              **1,786**
              
              
              (217
              )
              
              5,011Change
                  in prepaid reinsurance premiums
              
              
              **(46,072**
              **)**
              
              (1,344
              )
              
              14,476Change
                  in other reinsurance receivables
              
              
              **-**
              
              
              -
              
              
              5,295Change
                  in receivable from related parties
              
              
              **7,056**
              
              
              (8,737
              )
              
              8,957Change
                  in unearned premiums
              
              
              **147,589**
              
              
              157,829
              
              
              124,452Change
                  in loss and loss adjustment expenses
              
              
              **(14,513**
              **)**
              
              15,631
              
              
              (1,286
              )Change
                  in ceded reinsurance balances payable and accounts payable and
                  accrued
                  expenses and other liabilities
              
              
              **10,529**
              
              
              8,923
              
              
              7,348Change
                  in current income taxes payable
              
              
              **19,678**
              
              
              (6,559
              )
              
              4,401Change
                  in accrued interest expense - variable interest entity
              
              
              **1,298**
              
              
              -
              
              
              -Change
                  in deferred federal income taxes
              
              
              **20,878**
              
              
              19,252
              
              
              12,923Net
                  cash provided by operating activities
              
              
              **412,105**
              
              
              385,977
              
              
              351,977**Investing
                  activities**Sales
                  and maturities of fixed maturity securities
              
              
              **198,186**
              
              
              122,638
              
              
              284,227Purchases
                  of fixed maturity securities
              
              
              **(576,386**
              **)**
              
              (520,089
              )
              
              (546,028
              )Purchases,
                  sales and maturities of short-term investments, net
              
              
              **(52,126**
              **)**
              
              (19,342
              )
              
              (126,125
              )Receivable
                  for securities sold
              
              
              **-**
              
              
              (20
              )
              
              170Payable
                  for securities purchased
              
              
              **10,770**
              
              
              (5,715
              )
              
              5,715Purchase
                  of fixed assets
              
              
              **(477**
              **)**
              
              (1,405
              )
              
              (2,572
              )Purchase
                  of investments held by variable interest entity
              
              
              **(750,000**
              **)**
              
              -
              
              
              -Net
                  cash used in investing activities
              
              
              **(1,170,033**
              **)**
              
              (423,933
              )
              
              (384,613
              )**Financing
                  activities**Proceeds
                  from issuance of debt held by variable interest entity
              
              
              **750,000**
              
              
              -
              
              
              -Capital
                  contribution
              
              
              **-**
              
              
              12,211
              
              
              25,000Dividends
                  paid
              
              
              **(10,000**
              **)**
              
              -
              
              
              -Net
                  cash provided by financing activities
              
              
              **740,000**
              
              
              12,211
              
              
              25,000Effect
                  of exchange rate changes on cash
              
              
              **2,814**
              
              
              1,530
              
              
              (1,717
              )Net
                  decrease in cash and cash equivalents
              
              
              **(15,114**
              **)**
              
              (24,215
              )
              
              (9,353
              )Cash
                  and cash equivalents at beginning of period
              
              
              **45,077**
              
              
              69,292
              
              
              78,645Cash
                  and cash equivalents at end of period
              
              **$**
              **29,963**
              
              $
              45,077
              
              $
              69,292**Supplemental
                  disclosure of cash flow information**Income
                  taxes paid
              
              **$**
              **47,507**
              
              $
              49,613
              
              $
              40,890Interest
                  paid - debt held by variable interest entity
              
              **$**
              **34,595**
              
              
              -
              
              
              -





*See
      accompanying notes to consolidated financial statements.*


5


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*





**1.
      Business and Organization**





Financial
      Guaranty Insurance Company (the “Company” or “FGIC”) is a wholly owned
      subsidiary of FGIC Corporation (“FGIC Corp.”). The Company provides financial
      guaranty insurance and other forms of credit enhancement for public finance
      and
      structured finance obligations. The Company’s financial strength is rated “Aaa”
by Moody’s Investors Service, Inc., “AAA” by Standard & Poor’s Rating
      Services, a division of The McGraw-Hill Companies, Inc., and “AAA” by Fitch
      Ratings, Inc. The Company is licensed to write financial guaranty insurance
      in
      all 50 states, the District of Columbia, the Commonwealth of Puerto Rico, the
      U.S. Virgin Islands, and, through a branch, the United Kingdom. In addition,
      a
      United Kingdom subsidiary of the Company is authorized to write financial
      guaranty business in the United Kingdom and has passport rights to write
      business in other European Union member countries.





On
      December 18, 2003, an investor group consisting primarily of The PMI Group,
      Inc.
      (“PMI”), affiliates of the Blackstone Group L.P. (“Blackstone”), affiliates of
      the Cypress Group L.L.C. (“Cypress”) and affiliates of CIVC Partners L.P.
      (“CIVC”) (collectively, the “Investor Group”) completed the acquisition of FGIC
      Corp. from a subsidiary of General Electric Capital Corporation (“GE Capital”)
      in a transaction valued at approximately $2,200,000 (the “Transaction”). An
      affiliate of GE Capital owns 2,346 shares, or 100%, of FGIC Corp.’s Senior
      Participating Mandatorily Convertible Modified Preferred Stock (“Senior
      Preferred Shares”), with an aggregate liquidation preference of $287,255 as of
      December 31, 2006, and approximately 5% of FGIC Corp.’s outstanding common
      stock.





PMI
      is
      the largest stockholder of FGIC Corp., owning approximately 42% of its common
      stock at December 31, 2006 and 2005.  Blackstone, Cypress and CIVC
      owned approximately 23%, 23% and 7% of FGIC Corp.’s common stock, respectively,
      at December 31, 2006 and 2005.





**2.
      Basis of Presentation**





The
      consolidated financial statements include the accounts of the Company and all
      other entities in which the Company has a controlling financial interest. All
      significant intercompany balances have been eliminated.





The
      preparation of consolidated financial statements in conformity with accounting
      principles generally accepted in the United States (“GAAP”) requires management
      to make estimates and assumptions that affect the amounts reported in the
      consolidated financial statements and the accompanying notes. Actual results
      could differ from those estimates.





The
      accompanying financial statements have been prepared on the basis of GAAP,
      which
      differs in certain respects from the accounting practices prescribed or
      permitted by the New York State Insurance Department (see Note 4). Certain
      2005
      and 2004 amounts have been reclassified to conform to the 2006
      presentation.


6
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**3.
      Summary of Significant Accounting Policies**





The
      Company’s significant accounting policies are as follows:





**a.
      Investments**





All
      the
      Company’s fixed maturity securities are classified as available for sale and are
      recorded on the trade date at fair value. Unrealized gains and losses are
      recorded as a separate component of accumulated other comprehensive (loss)
      income, net of applicable income taxes, in the consolidated statements of
      stockholders’ equity. Short-term investments are carried at fair value, which
      approximates cost.





Bond
      discounts and premiums are amortized over the remaining terms of the respective
      securities. Realized gains or losses on the sale of investments are determined
      based on the specific identification method.





Securities
      that have been determined to be other than temporarily impaired are reduced
      to
      realizable value, establishing a new cost basis, with a charge to realized
      loss
      at such date.





**b.
      Cash and Cash Equivalents**





The
      Company considers all bank deposits, highly liquid securities and certificates
      of deposit with maturities of three months or less at the date of purchase
      to be
      cash equivalents. These cash equivalents are carried at cost, which approximates
      fair value.





**c.
      Premium Revenue Recognition**





Direct
      and assumed premiums are received either up-front or over time on an installment
      basis. The premium collection method is determined at the time the policy is
      issued. Up-front premiums are paid in full at the inception of the policy and
      are earned over the period of risk in proportion to the total amount of
      principal and interest amortized in the period as a proportion of the original
      principal and interest outstanding. Installment premiums are collected
      periodically and are reflected in income pro rata over the period covered by
      the
      premium payment, including premiums received on credit default swaps (see Note
      6).





Gross
      direct and assumed premiums written for the years ended December 31, 2006,
      2005,
      and 2004 include $15,989, $965, and $0, respectively, of assumed premiums
      written.


7


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**3.
      Summary of Significant Accounting Policies (continued)**





Unearned
      premiums represent the portion of premiums received applicable to future periods
      on insurance policies in force. When an obligation insured by the Company is
      refunded by the issuer prior to the end of the expected policy coverage period,
      any remaining unearned premium is recognized at that time. A refunding occurs
      when an insured obligation is called or legally defeased prior to stated
      maturity. Premiums earned on refundings were $41,836, **** $54,795,
      and $42,695 for the years ended December 31, 2006, 2005, and 2004,
      respectively.





Ceded
      premiums are recognized in a manner consistent with the premium earned on the
      underlying policies.





**d.
      Policy Acquisition Costs**





Policy
      acquisition costs include only those expenses that relate directly to and vary
      with premium production. Such costs include compensation of employees involved
      in marketing, underwriting and policy issuance functions, rating agency fees,
      premium taxes, ceding commissions paid on assumed policies and certain other
      expenses. In determining policy acquisition costs, the Company must estimate
      and
      allocate the percentage of its costs and expenses that are attributable to
      premium production, rather than to other activities. Policy acquisition costs,
      net of ceding commission income on premiums ceded to reinsurers, are deferred
      and amortized over the period in which the related premiums are earned.
      Anticipated loss and loss adjustment expenses, future maintenance costs on
      the
      in-force business and net investment income are considered in determining the
      recoverability of acquisition costs.




**e.
      Loss and Loss Adjustment Expense Reserves**





Provision
      for loss and loss adjustment expenses falls into two categories: case reserves
      and watchlist reserves. Case reserves are established for the value of estimated
      losses on specific insured obligations that are presently or likely to be in
      payment default and for which future loss is probable and can be reasonably
      estimated. These reserves represent an estimate of the present value of the
      anticipated shortfall between (1) payments on insured obligations plus
      anticipated loss adjustment expenses and (2) anticipated cash flow from, and
      proceeds to be received on, sales of any collateral supporting the obligation
      and/or other anticipated recoveries. The discount rate used in calculating
      the
      net present value of estimated losses is based upon the risk-free rate for
      the
      duration of the anticipated shortfall.


8
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**3.
      Summary of Significant Accounting Policies (continued)**





The
      Company establishes watchlist reserves to recognize the potential for claims
      against the Company on insured obligations that are not presently in payment
      default, but which have migrated to an impaired level where there is a
      substantially increased probability of default. These reserves reflect an
      estimate of probable loss given evidence of impairment, and a reasonable
      estimate of the amount of loss given default. The methodology for establishing
      and calculating the watchlist reserve relies on a categorization and assessment
      of the probability of default, and loss severity in the event of default, of
      the
      specific impaired obligations on the watchlist based on historical trends and
      other factors. The watchlist reserves are adjusted as necessary to reflect
      changes in the loss expectation inherent in the group of impaired credits.





The
      reserves for loss and loss adjustment expenses are reviewed regularly and
      updated based on claim payments and the results of surveillance. The Company
      conducts ongoing insured portfolio surveillance to identify all impaired
      obligations and thereby provide a materially complete recognition of potential
      losses for each accounting period. The reserves are necessarily based upon
      estimates and subjective judgments about the outcome of future events, and
      actual results will likely differ from these estimates. Adjustments of estimates made in prior years may result in additional loss
      and
      loss adjustment expenses or a reduction of loss and loss adjustment expenses
      in
      the period an adjustment is made.





Reinsurance
      recoverable on losses is calculated in a manner consistent with the calculation
      of loss and loss adjustment expenses.





**f.
      Income Taxes**





Deferred
      tax assets and liabilities are recognized to reflect the tax impact attributable
      to differences between the financial statement carrying amounts of existing
      assets and liabilities and their respective tax bases.





Deferred
      tax assets and liabilities are measured using statutory tax rates expected
      to
      apply to taxable income in the years in which temporary differences are expected
      to be recovered or settled. The effect of a change in tax rates on deferred
      tax
      assets and liabilities is recognized in income in the period in which a change
      occurs.





**g.
      Property and Equipment**





Property
      and equipment consists of office furniture, fixtures, computer equipment and
      software and leasehold improvements that are reported at cost less accumulated
      depreciation. Office furniture and fixtures are depreciated on a straight-line
      basis over five years. Leasehold improvements are amortized over their estimated
      service lives or over the life of the lease, whichever is shorter. Computer
      equipment and software are depreciated over three years. Maintenance and repairs
      are charged to expense as incurred.


9
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**3.
      Summary of Significant Accounting Policies (continued)**





**h.
      Foreign Currency Translation**





The
      Company has an established foreign branch and three subsidiaries in the United
      Kingdom and insured exposure from a former branch in France. The Company has
      determined that the functional currencies of these operations are their local
      currencies. Accordingly, the assets and liabilities of these operations are
      translated into U.S. dollars at the rates of exchange at December 31, 2006
      and
      2005, and revenues and expenses are translated at average monthly exchange
      rates. The cumulative translation gain (loss) at December 31, 2006 and 2005
      was
      $6,750 and $(1,446), respectively, net of tax (expense) benefit of ($3,580)
      and
      $723, respectively, and is reported as a separate component of accumulated
      other
      comprehensive income in the consolidated statements of stockholders’
equity.





**i.
      Stock Compensation Plan**





FGIC
      Corp. has an incentive stock plan that provides for stock-based compensation,
      including stock options, restricted stock awards and restricted stock units.
      Stock options are granted for a fixed number of shares with an exercise price
      equal to or greater than the estimated fair value of the common stock at the
      date of the grant. Restricted stock awards and units are valued at the estimated
      fair value of the common stock on the grant date. Prior
      to
      January 1, 2006, the Company accounted for grants under this plan under the
      recognition and measurement provisions of Accounting Principles Board (“APB”)
      Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      and
      related interpretations, as permitted by Statement of Financial Accounting
      Standards (“SFAS”) No. 123, *Accounting
      for Stock-Based Compensation* .


10


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**3.
      Summary of Significant Accounting Policies (continued)**





Effective
      January 1, 2006, the Company adopted the fair value recognition provisions
      of SFAS
      No.
      123(R), *Share-Based
      Payment* (“SFAS
      No. 123 (R)), using the modified-prospective-transition method. Under that
      method, compensation cost includes all share-based payments granted prior to,
      but not yet vested as of, January 1, 2006, based on the grant date fair value
      estimated in accordance with SFAS No. 123(R). The Company has estimated the
      fair
      value of all stock options at the date of grant using the Black-Scholes-Merton
      option pricing model. Results for prior periods have not been
      restated.





**j.
      Variable Interest Entities**





Financial
      Interpretation No.46-R, *Consolidation
      of Variable Interest Entities* (“FIN
      46-R”), provides accounting and disclosure rules for determining whether certain
      entities should be consolidated in the Company’s consolidated financial
      statements. An entity is subject to FIN 46-R, and is called a Variable Interest
      Entity (“VIE”), if it has (i) equity that is insufficient to permit the entity
      to finance its activities without additional subordinated financial support
      or
      (ii) equity investors that cannot make significant decisions about the entity’s
      operations or that do not absorb the majority of expected losses or receive
      the
      majority of expected residual returns of the entity.


11
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**3.
      Summary of Significant Accounting Policies (continued)**





Under
      FIN
      46-R, a VIE is consolidated by its primary beneficiary, which is the party
      that
      has a majority of the expected losses or a majority of the expected residual
      returns of the VIE, or both. FIN 46-R requires disclosures for companies that
      have either a primary or significant variable interest in a VIE. All other
      entities not considered VIEs are evaluated for consolidation under SFAS No.
      94, *Consolidation
      of all Majority-Owned Subsidiaries.*





As
      part
      of its structured finance business, the Company insures debt obligations or
      certificates issued by special purpose entities. The Company has evaluated
      the
      relevant transactions and does not believe any such transactions require
      consolidation or disclosure under FIN 46-R other than as disclosed in Note
      10.





**k.
      Derivative Instruments**





Under
      SFAS No. 133, *Accounting
      for Derivative Instruments and Hedging Activities,* as ** amended
      by SFAS No. 149, *Amendment
      of Statement 133 on Derivative Instruments and Hedging
      Activities* ,
      all
      derivative instruments are recognized on the consolidated balance sheet at
      their
      fair value, and changes in fair value are recognized immediately in earnings
      unless the derivatives qualify as hedges.





The
      Company provides credit default swaps (“CDSs”) to certain buyers of credit
      protection by entering into contracts that reference collateralized debt
      obligations from cash and synthetic structures backed by pools of corporate,
      consumer or structured finance debt .
      It also
      offers credit protection on public finance and structured finance obligations
      in
      CDS form. The Company considers CDS 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, and to record losses and loss adjustment expenses and changes in
      fair
      value as incurred.


12
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*
 **3.
        Summary of Significant Accounting Policies (continued)**
  **l.
        New Accounting Pronouncements**





In
      June
      2006, the Financial Accounting Standards Board (the “FASB”) issued FASB
      Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes* (“FIN
      48”), an interpretation of SFAS No. 109, *Accounting
      for Income Taxes* .
      FIN 48
      clarifies the accounting for uncertainty in income taxes recognized in an
      entity’s financial statements in accordance with SFAS No. 109 and prescribes
      metrics for the financial statement recognition and measurement of a tax
      position taken or expected to be taken in a tax return. FIN 48 also provides
      guidance on other matters related to accounting for income taxes. FIN 48 is
      applicable for fiscal years beginning after December 15, 2006, with earlier
      application encouraged if financial statements, including interim financial
      statements, have not been issued for the period of adoption. The Company has
      not
      elected early application, and the interpretation is not expected to have a
      material impact on the Company’s operating results or financial
      condition.





In
      February 2006, the FASB issued SFAS No. 155, *Accounting
      for Certain Hybrid Financial Instruments* .
      SFAS No. 155 amends SFAS No. 133 , and
      SFAS No. 140, *Accounting
      for Transfers and Servicing of Financial Assets and Extinguishment of
      Liabilities* , and addresses issues raised in SFAS No. 133 Implementation Issue No. D1, *Application
      of Statement 133* t *o
      Beneficial Interests in Securitized Financial Assets* .
      The primary objectives of SFAS No. 155 are: (i) with respect to SFAS No. 133,
      to
      address the accounting for beneficial interests in securitized financial assets
      and (ii) with respect to SFAS No. 140, eliminate a restriction on the passive
      derivative instruments that a qualifying special purpose entity may hold. SFAS
      No.
      155 is effective for those financial instruments acquired or issued after
      January 1, 2007. The Company will adopt SFAS No. 155 on January 1, 2007 and is currently evaluating the
      implications of SFAS No. 155 on its financial statements. The adoption of SFAS
      No. 155 is not expected to have a material impact on the Company’s operating
      results or financial condition.





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* . 
      SFAS No. 157 defines
      fair value, establishes a framework for measuring fair value in generally
      accepted accounting principles, and requires additional disclosures about fair
      value measurements. SFAS No. 157 does not require any new fair value
      measurements, but its application could change current practices in determining
      fair value.  SFAS
      No.
      157 is effective for financial statements issued for fiscal years beginning
      after November 15, 2007.  The Company is currently evaluating the implications of SFAS No. 157 and its potential
      impact on the Company’s financial statements.


13


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**3.
      Summary of Significant Accounting Policies (continued)**





**m.
      Review of Financial Guaranty Industry Accounting Practices**





The
      FASB
      is drafting a pronouncement to address loss reserving, premium recognition
      and
      deferred acquisition costs in the financial guaranty industry. Currently, the
      financial guaranty industry accounts for financial guaranty insurance contracts
      under SFAS No. 60, *Accounting
      and Reporting by Insurance Enterprises,* which
      was
      developed prior to the emergence of the financial guaranty industry. As SFAS
      No.
      60 does not specifically address financial guaranty contracts, there has been
      diversity in the manner in which different financial guarantors account for
      these contracts. The purpose of the pronouncement would be to provide
      authoritative guidance on accounting for financial guaranty contracts issued
      by
      insurance companies that are not accounted for as derivative contracts under
      SFAS No. 133. When the FASB issues a final pronouncement, the Company, along
      with other companies in the financial guaranty industry, may be required to
      change certain aspects of accounting for loss reserves, premium income and
      deferred acquisition costs. It is not possible to predict the impact the FASB’s
      pronouncement may have on the Company’s accounting practices.





**4.
      Statutory Accounting Practices**





Statutory-basis
      surplus of the Company at December 31, 2006 and 2005 was $1,130,779 and
      $1,162,904, respectively. Statutory-basis net income for the years ended
      December 31, 2006, 2005 and 2004 was $220,519, $192,009 and $144,100,
      respectively. The
      Company's statutory contingency reserves were $1,274,274 and $1,035,397 as
      of
      December 31, 2006 and 2005.


14
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**5.
      Investments**





The
      amortized cost and fair values of investments classified as fixed maturity
      securities are as follows:





**Amortized**
              **Cost**
            
            **Gross**
              **Unrealized**
              **Gains**
            
            **Gross**
              **Unrealized**
              **Losses**
            
            **Fair
                Value****At
                December 31, 2006****Available
                for sale:**Obligations
                of states and political subdivisions
            
            **$**
            **3,117,989**
            
            **$**
            **27,105**
            
            **$**
            **20,879**
            
            **$**
            **3,124,215**Asset-
                and mortgage-backed securities
            
            
            **275,647**
            
            
            **814**
            
            
            **3,574**
            
            
            **272,887**U.S.
                Treasury securities and obligations of U.S. government corporations
                and
                agencies
            
            
            **90,978**
            
            
            **528**
            
            
            **1,655**
            
            
            **89,851**Corporate
                bonds
            
            
            **87,805**
            
            
            **85**
            
            
            **1,776**
            
            
            **86,114**Debt
                securities issued by foreign governments
            
            
            **41,426**
            
            
            **15**
            
            
            **245**
            
            
            **41,196**Preferred
                stock
            
            
            **13,499**
            
            
            **-**
            
            
            **755**
            
            
            **12,744**Total
                fixed maturity securities
            
            
            **3,627,344**
            
            
            **28,547**
            
            
            **28,884**
            
            
            **3,627,007**Short-term
                investments
            
            
            **211,749**
            
            
            **-**
            
            
            **23**
            
            
            **211,726****Held
                to maturity:**Variable
                interest entity fixed maturity securities
            
            
            **750,000**
            
            
            **-**
            
            
            **-**
            
            
            **750,000**Total
                investments
            
            **$**
            **4,589,093**
            
            **$**
            **28,547**
            
            **$**
            **28,907**
            
            **$**
            **4,588,733**








**Amortized**
              **Cost**
            
            **Gross**
              **Unrealized**
              **Gains**
            
            **Gross**
              **Unrealized**
              **Losses**
            
            **Fair
                Value****At
                December 31, 2005**Obligations
                of states and political subdivisions
            
            $
            2,777,807
            
            $
            12,718
            
            $
            26,410
            
            $
            2,764,115Asset-
                and mortgage-backed securities
            
            
            209,148
            
            
            135
            
            
            3,490
            
            
            205,793U.S.
                Treasury securities and obligations of U.S. government corporations
                and
                agencies
            
            
            148,785
            
            
            1,387
            
            
            2,036
            
            
            148,136Corporate
                bonds
            
            
            91,422
            
            
            501
            
            
            1,486
            
            
            90,437Debt
                securities issued by foreign governments
            
            
            30,930
            
            
            345
            
            
            5
            
            
            31,270Preferred
                stock
            
            
            19,199
            
            
            427
            
            
            639
            
            
            18,987Total
                fixed maturity securities
            
            
            3,277,291
            
            
            15,513
            
            
            34,066
            
            
            3,258,738Short-term
                investments
            
            
            159,334
            
            
            -
            
            
            -
            
            
            159,334Total
                investments
            
            $
            3,436,625
            
            $
            15,513
            
            $
            34,066
            
            $
            3,418,072


15
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**5.
      Investments (continued)**





The
      following table shows gross unrealized losses and the fair value of fixed
      maturity securities, aggregated by investment category and the length of time
      that individual securities have been in a continuous unrealized loss position,
      at December 31, 2006:





**Less
                Than 12 Months**
            
            **12
                Months or More**
            
            **Total****Fair**
              **Value**
            
            **Unrealized
                Losses**
            
            **No.
                of Securities**
            
            **Fair**
              **Value**
            
            **Unrealized
                Losses**
            
            **No.
                of Securities**
            
            **Fair**
              **Value**
            
            **Unrealized
                Losses**
            
            **No.
                of Securities**Obligations
                of states and political subdivisions
            
            $
            582,407
            
            $
            1,971
            
            
            173
            
            $
            1,173,894
            
            $
            18,908
            
            
            263
            
            $
            1,756,301
            
            $
            20,879
            
            
            436Asset-
                and mortgage-backed securities
            
            
            54,862
            
            
            365
            
            
            13
            
            
            149,103
            
            
            3,209
            
            
            40
            
            
            203,965
            
            
            3,574
            
            
            53U.S.
                Treasury securities and obligations of U.S. government corporations
                and
                agencies
            
            
            11,988
            
            
            78
            
            
            5
            
            
            53,238
            
            
            1,578
            
            
            10
            
            
            65,226
            
            
            1,656
            
            
            15Other
            
            
            54,123
            
            
            542
            
            
            73
            
            
            62,892
            
            
            1,478
            
            
            50
            
            
            117,015
            
            
            2,020
            
            
            123Preferred
                stock
            
            
            -
            
            
            -
            
            
            -
            
            
            12,742
            
            
            756
            
            
            1
            
            
            12,742
            
            
            756
            
            
            1Total
                temporarily impaired securities
            
            $
            703,380
            
            $
            2,956
            
            
            264
            
            $
            1,451,869
            
            $
            25,929
            
            
            364
            
            $
            2,155,249
            
            $
            28,885
            
            
            628





The
      unrealized losses in the Company’s investments were caused by interest rate
      increases. The Company has evaluated the credit ratings of these securities
      and
      noted no deterioration. Because the decline in market value is attributable
      to
      changes in interest rates and not credit quality, and because the Company has
      the ability and intent to hold these investments until a recovery of fair value
      above amortized cost, which may be maturity, the Company did not consider these
      investments to be other than temporarily impaired at December 31,
      2006.





Investments
      in fixed maturity securities carried at fair value of $4,456 and $4,625 as
      of
      December 31, 2006 and 2005, respectively, were on deposit with various
      regulatory authorities, as required by law.





The
      amortized cost and fair values of investments in fixed maturity securities
      available for sale at December 31, 2006 are shown below by contractual maturity
      date. Actual maturities may differ from contractual maturities because borrowers
      may have the right to call or prepay obligations with or without
      penalties.





**Amortized**
              **Cost**
            
            **Fair**
              **Value**Due
                within one year
            
            $
            72,446
            
            $
            72,036Due
                after one year through five years
            
            
            746,986
            
            
            734,423Due
                after five years through ten years
            
            
            1,496,067
            
            
            1,490,829Due
                after ten years
            
            
            1,311,845
            
            
            1,329,719Total
            
            $
            3,627,344
            
            $
            3,627,007


16
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**5.
      Investments (continued)**





For
      the
      years ended December 31, 2006, 2005 and 2004, proceeds from sales of fixed
      maturity securities, available for sale, were $20,781, $31,380 and $178,030,
      respectively. For the years ended December 31, 2006, 2005 and 2004, gross gains
      of $382, $185 and $1,859 respectively, and gross losses of $108, $84 and $1,300,
      respectively, were realized on such sales.





Net
      investment income of the Company was derived from the following
      sources:





**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**Income
                from fixed maturity securities
            
            **$**
            **130,498**
            
            $
            112,616
            
            $
            97,720Income
                from short-term investments
            
            
            **10,556**
            
            
            6,801
            
            
            1,450Total
                investment income
            
            
            **141,054**
            
            
            119,417
            
            
            99,170Investment
                expenses
            
            
            **(2,579**
            **)**
            
            (2,345
            )
            
            (1,461
            )Net
                investment income
            
            
            **138,475**
            
            
            117,072
            
            
            97,709Interest
                income - investments held by variable interest entity
            
            
            **35,893**
            
            
            -
            
            
            -**$**
            **174,368**
            
            
            117,072
            
            
            97,709





As
      of
      December 31, 2006, the Company did not have more than 3%
      of its
      investment portfolio concentrated in a single issuer or industry; however,
      the
      Company had the following investment concentrations by state:





**Fair
                Value**New
                York
            
            $
            325,042Texas
            
            
            281,781Florida
            
            
            223,742New
                Jersey
            
            
            191,543Illinois
            
            
            186,600California
            
            
            180,295Massachusetts
            
            
            155,202Michigan
            
            
            128,2681,672,473All
                other states
            
            
            1,389,883All
                other investments
            
            
            776,377Total
                investments
            
            $
            3,838,733


17
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**6.
      Derivative Instruments**





The
      Company provides CDSs to certain buyers of credit protection by entering into
      contracts that reference collateralized debt obligations from cash and synthetic
      structures backed by pools of corporate, consumer or structured finance debt.
      It
      also offers credit protection on public finance and structured finance
      obligations in CDS form. The Company considers CDS 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 revenues as a
      component of premiums, and to record claims payments, expected claims as loss
      and loss adjustment expenses, and changes in fair value as “Net realized and
      unrealized gains (losses) on credit derivative contracts” on the Consolidated
      Statements of Income. The Company recorded revenue under CDS agreements of
      $17,095, $3,036 and $0 for the years ended December 31, 2006, 2005 and 2004,
      respectively. As of December 31, 2006, the Company has recorded no losses and
      loss adjustments expenses related to CDS agreements.





The
      gains
      and losses recognized by recording CDS agreements at fair value are determined
      each quarter based on quoted market prices, if available. If quoted market
      prices are not available, the determination of fair value is based on an
      internally developed model. As of December 31, 2006 and 2005, all fair value
      prices were determined using an internally developed model. The following table
      summarizes the realized and unrealized gains (losses) on credit derivative
      agreements.




**Year
                ended December 31,****2006**
            
            **2005**Change
                in unrealized gains
            
            **$**
            **2,887**
            
            $
            545Change
                in unrealized losses
            
            
            **(4,223**
            **)**
            
            (712
            )Realized
                gains
            
            
            **1,843**
            
            
            -Realized
                losses
            
            
            -
            
            
            -Net
                realized and unrealized gains (losses) on credit derivative
                contracts
            
            **$**
            **507**
            
            $
            (167
            )





The
      mark-to-market gain and (loss) on the CDS portfolio were $314 and ($1,817)
      at
      December 31, 2006, and $545 and ($712) at December 31, 2005, and were recorded
      in “Other assets” and in “Other liabilities,” respectively.


18
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**7.
      Income Taxes**




The
      Company files a consolidated federal income tax return with FGIC Corp. The
      method of allocation between FGIC Corp. and its subsidiaries is determined
      under
      a tax sharing agreement approved by the Company’s Board of Directors and the New
      York State Insurance Department, and is based upon separate return
      calculations.





The
      Company is permitted a tax deduction, subject to certain limitations, for
      amounts required to be set aside in statutory contingency reserves by state
      law
      or regulation. The deduction is allowed only to the extent the Company purchases
      U.S. Government non-interest bearing tax and loss bonds in an amount equal
      to
      the tax benefit attributable to such deductions. Purchases of tax and loss
      bonds
      are recorded as a reduction of current tax expense. The Company did not purchase
      any tax and loss bonds in the year ended December 31, 2006. For the years ended
      December 31, 2005 and 2004, the Company purchased $13,565 and $10,810,
      respectively, of tax and loss bonds.





The
      following is a reconciliation of foreign and domestic income taxes computed
      at
      the statutory income tax rate and the provision for foreign and domestic income
      taxes:




**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**Income
                taxes computed on income before provision for federal income taxes,
                at the
                statutory income tax rate
            
            **$**
            **123,500**
            
            $
            95,037
            
            $
            78,932State
                and local income taxes, net of Federal income taxes
            
            
            **756**
            
            
            453
            
            
            479Tax
                effect of:Tax-exempt
                interest
            
            
            **(35,646**
            **)**
            
            (31,072
            )
            
            (28,015
            )Other,
                net
            
            
            **408**
            
            
            690
            
            
            4,037Provision
                for income taxes
            
            **$**
            **89,018**
            
            $
            65,108
            
            $
            55,433





Following
      are the foreign and domestic components of provision of income
      taxes:





**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**ForeignCurrent
            
            **$**
            **(383**
            **)**
            $
            2,409
            
            $
            (983
            )Deferred
            
            
            **(752**
            **)**
            
            (3,038
            )
            
            -DomesticCurrent
            
            
            **68,278**
            
            
            29,961
            
            
            43,492Deferred
            
            
            **21,875**
            
            
            35,776
            
            
            12,924Total
            
            **$**
            **89,018**
            
            $
            65,108
            
            $
            55,433


19


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**7.
      Income Taxes (continued)**





The
      tax
      effects of temporary differences that give rise to significant portions of
      the
      net deferred tax liability at December 31, 2006 and 2005 are presented
      below:





**2006**
            
            **2005**Deferred
                tax assets:Tax
                and loss bonds
            
            **$**
            **24,375**
            
            $
            24,375Loss
                and loss adjustment expense reserves
            
            
            **3,717**
            
            
            6,180AMT
                credit carryforward
            
            
            **−**
            
            
            7,140Property
                and equipment
            
            
            **125**
            
            
            83Deferred
                compensation
            
            
            **5,222**
            
            
            1,483Capital
                lease
            
            
            **2,591**
            
            
            2,483Net
                operating loss on foreign subsidiaries
            
            
            **4,228**
            
            
            2,948Other
            
            
            **586**
            
            
            266Total
                gross deferred tax assets
            
            
            **40,844**
            
            
            44,958Deferred
                tax liabilities:Contingency
                reserves
            
            
            **42,656**
            
            
            42,656Unrealized
                gains on fixed maturity securities
              available
                for sale
            
            
            **15,734**
            
            
            12,883Deferred
                acquisition costs
            
            
            **26,558**
            
            
            19,639Premium
                revenue recognition
            
            
            **22,915**
            
            
            10,359Profit
                commission
            
            
            **1,444**
            
            
            1,435Unrealized
                gains on foreign currency
            
            
            **3,581**
            
            
            194Other
            
            
            **1,016**
            
            
            255Total
                gross deferred tax liabilities
            
            
            **113,904**
            
            
            87,421Net
                deferred tax liability
            
            **$**
            **73,060**
            
            $
            42,463





As
      of
      December 31, 2006 and 2005, there were gross foreign deferred tax assets of
      $4,359 and $3,677, respectively, and gross foreign deferred tax liabilities
      of
      $868 and $177, respectively. The net operating losses on foreign subsidiaries
      of
      $14,094 as of December 31, 2006 were generated by FGIC’s United Kingdom
      subsidiaries. The United Kingdom does not allow net operating losses to be
      carried back, but does permit them to be carried forward indefinitely. Based
      upon projections of future taxable income over the periods in which the deferred
      tax assets are deductible and the estimated reversal of future taxable temporary
      differences, the Company believes it is more likely than not that it will
      realize the benefits of these deductible differences and, therefore, has not
      established a valuation allowance at December 31, 2006 and 2005.


20


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**7.
      Income Taxes (continued)**





The
      Company’s consolidated income tax return for the year ended December 31, 2004 is
      currently under examination by tax authorities. In the opinion of management,
      adequate provision has been made for any additional taxes that may become due
      as
      a result of current or future examinations by tax authorities.





**8.
      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 under policies issued by the ceding company in consideration for a portion
      of the related premiums received. The ceding company typically will receive
      a
      ceding commission from the reinsurer.





The
      Company uses reinsurance to increase its capacity to write insurance for
      obligations of large, frequent issuers; to meet internal, rating agency or
      regulatory single risk limits; to diversify risk; and to manage rating agency
      and regulatory capital requirements. In 2005 and 2006, the Company arranged
      reinsurance primarily on a facultative (transaction-by-transaction) basis.
      During 2006, the Company began arranging reinsurance on a proportional share
      basis, as well.





The
      Company seeks to place reinsurance with financially strong reinsurance companies
      since, as a primary insurer, the Company is required to fulfill all its
      obligations to policyholders even where a reinsurer fails to perform its
      obligations under the applicable reinsurance agreement. The Company regularly
      monitors the financial condition of its reinsurers. Under most of the Company’s
      reinsurance agreements, the Company has the right to reassume all the exposure
      ceded to a reinsurer (and receive all the remaining unearned premiums ceded)
      in
      the event of a ratings downgrade of the reinsurer or the occurrence of certain
      other events. In certain of these cases, the Company also has the right to
      impose additional ceding commissions.





In
      2004,
      some of the Company’s reinsurers were downgraded by the rating agencies,
      reducing the financial benefits of using reinsurance under rating agency capital
      adequacy models, because the Company must allocate additional capital to the
      related reinsured exposure. In connection with such a downgrade, the Company
      reassumed $4,959 of ceded premiums for the year ended December 31,
      2004.





Under
      certain reinsurance agreements, the Company holds collateral in the form of
      letters of credit and trust agreements. Such collateral totaled $102,370 at
      December 31, 2006, and can be drawn on in the event of default by the
      reinsurer.


21
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**8.
      Reinsurance (continued)**





Reinsurance
      decreased the following balances recorded in the consolidated statements of
      income as follows:





**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**Net
                premiums earned
            
            **$**
            **28,324**
            
            $
            25,921
            
            $
            24,173Loss
                and loss adjustment expenses
            
            
            **1,722**
            
            
            217
            
            
            4,759




**9.** **Loss
      and Loss Adjustment Expenses**





Activity
      in the reserves for loss and loss adjustment expenses is summarized as
      follows:





**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**Case
                reserves
            
            **$**
            **33,328**
            
            $
            15,700
            
            $
            18,900Watchlist
                reserves
            
            
            **21,484**
            
            
            23,481
            
            
            21,567Balance
                at beginning of period
            
            
            **54,812**
            
            
            39,181
            
            
            40,467Less
                reinsurance recoverable
            
            
            **(3,271**
            **)**
            
            (3,054
            )
            
            (8,065
            )Net
                balance
            
            
            **51,541**
            
            
            36,127
            
            
            32,402Incurred
                related to:Current
                period
            
            
            -
            
            
            23,985
            
            
            11,756Prior
                periods
            
            
            **(8,700**
            **)**
            
            (5,479
            )
            
            (5,834
            )Total
                incurred
            
            
            **(8,700**
            **)**
            
            18,506
            
            
            5,922Paid
                related to:Current
                period
            
            
            -
            
            
            (1,993
            )
            
            -Prior
                periods
            
            
            **(4,027**
            **)**
            
            (1,099
            )
            
            (2,197
            )Total
                paid
            
            
            **(4,027**
            **)**
            
            (3,092
            )
            
            (2,197
            )Net
                balance
            
            
            **38,814**
            
            
            51,541
            
            
            36,127Plus
                reinsurance recoverable
            
            
            **1,485**
            
            
            3,271
            
            
            3,054Case
                reserves
            
            
            **28,558**
            
            
            33,328
            
            
            15,700Watchlist
                reserves
            
            
            **11,741**
            
            
            21,484
            
            
            23,481Balance
                at end of period
            
            **$**
            **40,299**
            
            $
            54,812
            
            $
            39,181


22
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**9.
      Loss and Loss Adjustment Expenses (continued)**





Case
      reserves were discounted at interest rates of approximately 4.6% and 4.5% in
      2006 and 2005, respectively. The amount of the discount at December 31, 2006
      and
      2005 was $6,369 and $15,015, respectively.





At
      December 31, 2005, the Company had insured public finance obligations located
      in
      the City of New Orleans and the immediately surrounding areas and an
      investor-owned utility in New Orleans that were impacted by Hurricane
      Katrina.  During the year ended December 31, 2006, incurred loss expense
      consisted primarily of the release of reserves on certain obligations impacted
      by Hurricane Katrina due to the improved financial condition of these credits
      and activity related to several structured finance transactions.  During
      the year ended December 31, 2005, incurred loss expense consisted primarily
      of
      the establishment of reserves on obligations impacted by Hurricane Katrina
      and
      incurred expense related to several structured finance transactions.  Loss
      and loss adjustment expense included (benefit) expense of $(7,919) and $20,093
      related to obligations impacted by Hurricane Katrina for the years ended
      December 31, 2006 and 2005, respectively.





At
      December 31, 2006 and 2005 loss reserves and reinsurance recoverables included
      $8,967 and $255 and $21,833 and $1,740, respectively, related to obligations
      impacted by Hurricane Katrina. Loss reserves at December 31, 2006 and 2005
      were
      based on management’s assessment that the associated insured obligations have
      experienced impairment due to diminished revenue sources. Given the
      unprecedented nature of the events and the magnitude of damage in the affected
      areas related to Hurricane Katrina, the loss reserves were necessarily based
      upon estimates and subjective judgments about the outcomes of future events.
      The
      loss reserves were adjusted as additional information was available.





The
      Company paid no claims related to insured public finance obligations impacted
      by
      Hurricane Katrina during the year ended December 31, 2006. During the year
      ended
      December 31, 2005, the Company paid claims totaling $4,855 related to the
      insured public finance obligations and was fully reimbursed for these claims
      payments in 2005.





During
      the years ended December 31, 2006 and 2005, the Company paid claims totaling
      $4,216 and $1,055, respectively, related to the investor-owned utility impacted
      by Hurricane Katrina and received reimbursements of $796 in 2006, for these
      claims payments.  For the years ended December 31, 2006 and 2005, the
      Company paid loss adjustment expenses for professional fees totaling $1,835
      and
      $748, respectively, related to the investor-owned utility and received
      reimbursements of $1,792 for these expenses in 2006. The Company has not
      recorded a potential recovery for paid claims and loss adjustment expenses
      that
      have not been reimbursed as of December 31, 2006.





During
      the year ended December 31, 2004, the increase in incurred loss and loss
      adjustment expense related to several structured finance transactions of one
      particular issuer.


23


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**10.
      Variable Interest Entities**





FIN
      46-R
      provides accounting and disclosure rules for determining whether certain
      entities should be consolidated in the Company’s consolidated financial
      statements. An entity is subject to FIN 46-R, and is called a variable interest
      entity (“VIE”), if it has (i) equity that is insufficient to permit the entity
      to finance its activities without additional subordinated financial support
      or
      (ii) equity investors that cannot make significant decisions about the entity’s
      operations or that do not absorb the majority of its expected losses or receive
      the majority of its expected residual returns. A VIE must be consolidated by
      its
      primary beneficiary, which is the party that has a majority of the VIE’s
      expected losses or a majority of its expected residual returns, or
      both.





Additionally,
      FIN 46-R requires disclosures for companies that have either a primary or
      significant variable interest in a VIE. All other entities not considered VIEs
      are evaluated for consolidation under SFAS No. 94, *Consolidation
      of all Majority-Owned Subsidiaries.*





As
      part
      of its structured finance business, the Company insures debt obligations or
      certificates issued by special purpose entities. During the first quarter of
      2006, the Company consolidated a VIE as a result of financial guarantees
      provided by the Company on one transaction related to the securitization of
      life
      insurance reserves. This third-party VIE had assets of $750,000
      and an equal amount of liabilities at December 31, 2006 *,* which
      are shown under “Assets - Variable interest entity fixed maturity securities,
      held to maturity at amortized cost” and “Liabilities - Variable interest entity
      floating rate notes,” respectively, on the Company’s consolidated balance sheet
      at December 31, 2006. In addition, accrued investment income includes $1,298
      related to the VIE’s fixed income maturity securities, and the corresponding
      liability is shown under “Accrued investment expense-variable interest entity”
on the Company’s consolidated balance sheet at December 31, 2006. Although the
      third-party VIE is included in the consolidated financial statements, its
      creditors do not have recourse to the general assets of the Company outside
      of
      the financial guaranty policy provided to the VIE. The Company has evaluated
      its
      other structured finance transactions and does not believe any of the
      third-party entities involved in these transactions requires consolidation
      or
      disclosure under FIN 46-R. Interest income and expense of $35,893 and $35,893,
      respectively, were recognized in the year ended December 31, 2006 on the assets
      and liabilities of the VIE and are included on the Consolidated Statements
      of
      Income in “Interest income - investments held by variable interest entity” and
“Interest expense - debt held by variable interest entity,” respectively.


24


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*





**10.
      Variable Interest Entities (continued)**





The
      Company has entered into agreements providing for the issuance of contingent
      preferred trust securities by a group of special purpose trusts. Each trust
      is
      solely responsible for its obligations, and has been established for the purpose
      of entering into a put agreement with the Company that obligates the trusts,
      at
      the Company’s discretion, to purchase Perpetual Preferred Stock of the Company.
      The purpose of this arrangement is to provide capital support to the Company
      by
      allowing it to obtain immediate access to new capital at its sole discretion
      at
      any time through the exercise of the put options. These trusts are considered
      VIEs under FIN 46-R. However, the Company is not considered a primary
      beneficiary and therefore is not required to consolidate the
      trusts.





**11.
      Related Party Transactions**





The
      Company had various service agreements with subsidiaries of General Electric
      Company and GE Capital. These agreements provided for the payment by the Company
      of certain payroll and office expenses, investment fees pertaining to the
      management of the Company’s investment portfolio, and telecommunication service
      charges. Approximately $179 in expenses were incurred during the year ended
      December 31, 2004 related to such agreements and are reflected in the
      accompanying consolidated financial statements. No expenses were incurred during
      the years 2006 and 2005.





The
      Company is party to a capital lease agreement with a subsidiary of GE Capital.
      The lease agreement covers leasehold improvements made to the Company’s
      headquarters as well as furniture and fixtures and computer hardware and
      software used by the Company (see Note 19).





In
      2004,
      the Company entered into a $300,000 soft capital facility, with GE Capital
      as
      lender and administrative agent. The soft capital facility, which replaced
      the
      capital support facility that the Company previously had with GE Capital, had
      an
      initial term of eight years. The Company paid GE Capital $1,132 under this
      agreement for the year ended December 31, 2004. This agreement was terminated
      by
      the Company in July 2004 and was replaced by a new soft capital facility (see
      Note 16).




25


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**11.
      Related Party Transactions (continued)**





FGIC
      Corp. is party to transaction fee and monitoring fee agreements with the members
      of the Investor Group. Pursuant to these agreements, an affiliate of each member
      of the Investor Group received its pro rata portion of an aggregate transaction
      fee equal to $25,000. In addition, each of the members of the Investor Group
      will receive, in exchange for providing certain financial advisory services
      on
      behalf of FGIC Corp., its pro rata share of an aggregate $5,000 annual
      monitoring fee. FGIC Corp. may defer paying the monitoring fee in certain
      circumstances and did elect to defer in the period between December 18, 2003
      and
      September 30, 2005. During 2005, FGIC Corp. paid the members of the Investor
      Group an aggregate of $10,192 in payment of the monitoring fee covering the
      period from December 18, 2003 through December 31, 2005. During 2006, FGIC
      Corp.
      paid the members of the Investor Group an aggregate of $3,789 for the monitoring
      fee covering the year ended December 31, 2006. As of December 31, 2006, FGIC
      Corp. had $1,211 payable to the Investor Group for the monitoring fee covering
      the year ended December 31, 2006. Pursuant to the transaction fee and monitoring
      fee agreements, FGIC Corp. has agreed to indemnify the members of the Investor
      Group and their respective affiliates and other related parties for losses
      relating to the transaction fee and monitoring fee agreements.





The
      Company insures certain non-municipal issues with GE Capital involvement as
      sponsor of the insured securitization and/or servicer of the underlying assets.
      For some of these issues, GE Capital also provides first loss protection in
      the
      event of default. Gross premiums written on these issues amounted to $2, $3
      and
      $6 for the years ended December 31, 2006, 2005 and 2004, respectively. As of
      December 31, 2006 and 2005, principal outstanding on these deals before
      reinsurance was $5,667 and $6,142, respectively.





During
      2006, the Company, in the normal course of operations, has entered into
      reinsurance transactions with PMI Guaranty Co. and PMI Mortgage Insurance Co.,
      which are both wholly-owned subsidiaries of PMI. For the years ended December
      31, 2006 and 2005, ceded premiums written were $4,041 and $582, respectively,
      and ceding commission income was $578 and $114, respectively. Accounts payable
      due to these subsidiaries were $1,283 and $102 at December 31, 2006 and 2005,
      respectively.





The
      Company, in the normal course of operations, has entered into reinsurance
      transactions with RAM Reinsurance Company Ltd (“RAM Re”), which is 24% owned by
      PMI. For the years ended December 31, 2006 and 2005, ceded premiums written
      for
      these transactions were $9,824 and $4,582, respectively, and ceding commission
      income was $2,929 and $1,369, respectively. Accounts payable due to RAM Re
      were
      $91 and $3 at December 31, 2006 and 2005, respectively.


26
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**11.
      Related Party Transactions (continued)**





Cypress,
      a member of the Investor Group, is reported to own approximately 15% of
      Scottish Re Group Limited (“Scottish Re”). During 2006, the Company entered
      into a structured finance transaction and assumed a structured finance
      transaction in which subsidiaries of Scottish Re were involved. Neither
      transaction involves (a) a guaranty by the Company of any obligation of Scottish
      Re, or (b) the payment of any fees or other amounts between the Company and
      Scottish Re. As of December 31, 2006, there were no amounts due to or from
      Scottish Re. Gross premiums written and premiums earned of $699 and $637,
      respectively, are reflected in the Consolidated Statements of Income for the
      year ended December 31, 2006.





The
      Company believes that the terms of the transactions involving GE Capital, PMI
      subsidiaries, RAM Re and Scottish Re described above were substantially
      identical to comparable transactions between unaffiliated parties.





**12.
      Compensation Plans**





Since
      January 1, 2004, the Company has offered a defined contribution savings plan
      under Section 401(k) of the Internal Revenue Code. This plan covers
      substantially all employees who meet minimum age and service requirements and
      allows participants to defer a portion of their annual compensation on a pre-tax
      basis (for 2006, up to $15 for employees under age 50, plus an additional “catch
      up” contribution of up to $5 for employees 50 and older). The Company may also
      make discretionary contributions to the plan on behalf of employees. The Company
      contributed $4,255, $3,429 and $2,532 to the plan on behalf of employees for
      the
      years ended December 31, 2006, 2005 and 2004, respectively.





The
      Company also offers a non-qualified deferred compensation plan for certain
      employees whose cash compensation equals or exceeds the cap under the 401(k)
      Plan. These employees may defer up
      to
      100% of their pre-tax incentive compensation to a future date and accumulate
      tax-deferred earnings on this compensation. The Company may also make
      discretionary contributions to the plan on behalf of employees. The Company
      contributed $827, $583 and $470 to the plan on behalf of employees for the
      years
      ended December 31, 2006, 2005 and 2004, respectively.





**13.
      Stock Compensation Plan**





Employees
      of the Company may receive stock-based compensation under a FGIC Corp. incentive
      stock plan that provides for stock-based compensation, including stock options,
      restricted stock awards and restricted stock units. Stock options are granted
      for a fixed number of shares with an exercise price equal to or greater than
      the
      fair value of the shares at the date of the grant. Restricted stock awards
      and
      restricted stock units are valued at the fair value of the stock on the grant
      date, with no cost to the grantee. Prior
      to
      January 1, 2006, the Company accounted for those plans under the recognition
      and
      measurement provisions of APB Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      and
      related interpretations, as permitted by SFAS No. 123, *Accounting
      for Stock-Based Compensation* .


27


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**13.
      Stock Compensation Plan (continued)**





No
      stock-based employee compensation cost related to stock options was recognized
      in the Consolidated Statements of Income for the years ended December 31, 2005
      and 2004, as all options granted through that date had an exercise price equal
      to the fair value of the underlying common stock on the date of grant. For
      grants of restricted stock units, unearned compensation, equivalent to the
      estimated fair value of the common stock at the date of grant, was recorded
      as a
      separate component of stockholders’ equity and subsequently amortized to
      compensation expense over the vesting period.





Effective
      January 1, 2006, the Company adopted the fair value recognition provisions
      of
      SFAS No. 123(R), *Share-Based
      Payment* ,
      using
      the modified-prospective-transition method. Under that method, compensation
      cost
      includes all share-based payments granted prior to, but not yet vested as of,
      January 1, 2006, based on the grant date fair value estimated in accordance
      with
      SFAS No. 123(R). The Company estimated the fair value of all stock options
      at
      the date of grant using the Black-Scholes-Merton option pricing model. Results
      for prior periods have not been restated.





As
      a
      result of adopting SFAS No. 123(R) effective January 1, 2006, the Company’s
      income before income taxes and net income for the year ended December 31, 2006
      were impacted as follows:





**Year
                ended**
              **December
                31, 2006**Income
                before income taxes
            
            **$**
            **(6,816**
            **)**Income
                tax benefit
            
            
            **2,386**Net
                income
            
            **$**
            **(4,430**
            **)**





The
      following table illustrates the effect on net income if the Company had applied
      the fair value recognition provisions of SFAS No. 123(R) to stock options
      granted during the years ended December 31, 2005 and 2004. For purposes of
      this
      pro forma disclosure, the value of the stock options is amortized to expense
      over the stock options’ vesting periods.


**Year
                  ended**
                **December
                  31,****2005**
              
              **2004**Net
                  income, as reported
              
              $
              190,466
              
              $
              156,880Stock
                  option compensation expense determined under fair value-based method,
                  net
                  of tax
              
              
              (2,109
              )
              
              (1,200
              )Pro
                  forma net income
              
              $
              188,357
              
              $
              155,680
 28
   Financial
          Guaranty Insurance Company and Subsidiaries
 
 Notes
          to
          Consolidated Financial Statements (continued)
 
 
 *(Dollars
          in thousands, except per share amounts)*


**13.
      Stock Compensation Plan (continued)**





A
      summary
      of option activity for the years ended December 31, 2006, 2005 and 2004 is
      as
      follows:





**Number
                of Shares Subject to Options**
            
            **Weighted
                Average Exercise Price per Share**Balance
                at December 31, 2003:
            
            
            93,373
            
            $
            840Granted
            
            
            22,017
            
            
            752Exercised
            
            
            -
            
            
            -Forfeited
            
            
            (1,237
            )
            
            746Expired
            
            
            -
            
            
            -Balance
                at December 31, 2004:
            
            
            114,153
            
            
            824Granted
            
            
            27,145
            
            
            711Exercised
            
            
            -
            
            
            -Forfeited
            
            
            (1,876
            )
            
            685Expired
            
            
            -
            
            
            -Balance
                at December 31, 2005:
            
            
            139,422
            
            
            804Granted
            
            
            38,113
            
            
            850Exercised
            
            
            -
            
            
            -Forfeited
            
            
            (6,504
            )
            
            776Expired
            
            
            -
            
            
            -Balance
                at December 31, 2006:
            
            
            171,031
            
            $
            815Shares
                subject to options exercisable at:December
                31, 2006
            
            
            72,585
            
            $
            818December
                31, 2005
            
            
            42,630
            
            $
            840December
                31, 2004
            
            
            22,831
            
            $
            824





Exercise
      prices for the stock options outstanding at December 31, 2006 range from $600
      to
      $1,080 per share. At December 31, 2006, the weighted average remaining
      contractual life of the outstanding options was approximately seven years.
      Stock
      options granted in 2006 vest ratably over four years and expire seven years
      from
      the date of grant. All stock options granted prior to December 31, 2005 vest
      ratably over five years and expire ten years from the date of grant.


29


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




13.
      Stock
      Compensation Plan (continued)





The
      weighted average per share fair value of the stock options granted during the
      years ended December 31, 2006, 2005 and 2004 was $238.00, $211.94, and $48.21,
      respectively, estimated at the date of grant, using the Black-Scholes-Merton
      option valuation model based on the following assumptions:





**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**Expected
                life
            
            
            **4
                Years**
            
            
            5
                Years
            
            
            5
                YearsRisk-free
                interest rate
            
            
            **4.46%**
            
            
            3.691%
            
            
            4.021%Volatility
                factor
            
            
            **25.0%**
            
            
            25.0%
            
            
            25.0%Dividend
                yield
            
            
            **-**
            
            
            -
            
            
            -





The
      total
      fair value of stock options granted during the years ended December 31, 2006,
      2005 and 2004 was approximately $9,071, $5,753 and $1,100,
      respectively.





As
      of
      December 31, 2006, there was $5,584 of total unrecognized compensation cost
      related to unvested stock options granted. These costs are expected to be
      recognized through April 30, 2010.


30
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**13.
      Stock Compensation Plan (continued)**




*Restricted
      Stock Units*




The
      Company recorded $ 880
      and
      $45 in compensation expense related to the grant of restricted stock units
      for
      the years ended December 31, 2006 and 2005, respectively.


A
      summary
      of restricted stock units is as follows:





**Shares**
            
            **Weighted**
              **Average
                Grant**
              **Date
                Fair Value**Balance
                at December 31, 2003:
            
            
            **-**
            
            
            **-**Granted
            
            
            200
            
            
            600Delivered
            
            
            **-**
            
            
            **-**Forfeited
            
            
            **-**
            
            
            **-**Balance
                at December 31, 2004:
            
            
            200
            
            $
            600Granted
            
            
            37
            
            
            710Delivered
            
            
            **-**
            
            
            **-**Forfeited
            
            
            **-**
            
            
            **-**Balance
                at December 31, 2005:
            
            
            237
            
            
            617Granted
            
            
            3,275
            
            
            850Delivered
            
            
            (237
            )
            
            617Forfeited
            
            
            (213
            )
            
            850Balance
                at December 31, 2006:
            
            
            3,062
            
            
            850





As
      of
      December 31, 2006 there was $1,451
      of
      total unrecognized compensation cost related to unvested restricted stock units
      granted. These costs are expected to be recognized through January 31,
      2009.





**14.
      Dividends**





Under
      New
      York insurance law, the Company may pay dividends to FGIC Corp. only from earned
      surplus, subject to the following limitations: (a) the Company’s statutory
      surplus after any dividend may not be less than the minimum required paid-in
      capital, which was $72,500 in 2006, 2005, and 2004 and (b) dividends may
      not exceed the lesser of 10% of its surplus or 100% of adjusted net investment
      income, as defined by New York insurance law, for the preceding twelve-month
      period, without the prior approval of the New York State Superintendent of
      Insurance.


31
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**14.
      Dividends (continued)**





During
      the year ended December 31, 2006, the Company declared dividends to FGIC Corp.
      totaling $20,000 on its common stock and paid dividends of $10,000 to FGIC
      Corp., which owns all of the Company’s common stock. During the years ended
      December 31, 2005 and 2004, the Company did not declare nor pay dividends to
      FGIC Corp.




**15.
      Revolving Credit Facility**





During
      December 2005, FGIC Corp. and the Company entered into a $250,000 senior
      unsecured revolving credit facility that matures on December 11, 2010. The
      facility is provided by a syndicate of banks and other financial institutions.
      In connection with the facility, $150 in syndication costs were prepaid and
      will
      be amortized into expense over the term of the facility. The facility replaced
      a
      similar one-year facility that matured in December 2005. No draws have been
      made
      under either facility.




**16.
      Preferred Trust Securities**





On
      July
      19, 2004, the Company entered into a $300,000 facility, consisting of Money
      Market Committed Preferred Custodial Trust Securities (“CPS Securities”). This
      facility replaced a $300,000 “soft capital” facility previously provided by GE
      Capital. Under the 2004 facility, each of six separate Delaware trusts (the
      “Trusts”), issues $50,000 in perpetual CPS Securities on a rolling 28-day
      auction rate basis. Proceeds from these securities are invested in high quality,
      short-term securities and are held in the respective Trusts. Each Trust is
      solely responsible for its obligations and has been established for the purpose
      of entering into a put agreement with the Company, which obligates the Trusts,
      at the Company’s discretion, to purchase perpetual Preferred Stock of the
      Company.





In
      this
      way, the program provides capital support to the Company by allowing it to
      obtain immediate access to new capital at its sole discretion at any time
      through the exercise of the put options. In connection with the establishment
      of
      the Trusts, the Company incurred $4,638 of expenses, which is included in “Other
      operating expenses” for the year ended December 31, 2004. The Company recorded
      expenses for the right to put its shares to the Trusts of $1,432, $1,806, and
      $905 for the years ended December 31, 2006, 2005, and 2004,
      respectively.


32


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**17.
      Financial Instruments**





(a) Fair
          Value of Financial Instruments


The
      following methods and assumptions were used by the Company in estimating the
      fair values of financial instruments:





*Fixed
      Maturity Securities:* Fair
      values for fixed maturity securities are based on quoted market prices, if
      available. If a quoted market price is not available, fair values are estimated
      using quoted market prices for similar securities. Fair value disclosure for
      fixed maturity securities is included in the consolidated balance sheets and
      in
      Note 5.





*Short-Term
      Investments:* Short-term
      investments are carried at fair value, which approximates cost.





*Cash
      and Cash Equivalents, Accrued Investment Income, Prepaid Expenses and Other
      Assets, Receivable from Related Parties, Ceded Reinsurance Balances Payable,
      Accounts Payable and Accrued Expenses and Payable for Securities Purchased:* The
      carrying amounts of these items approximate their fair values.





The
      estimated fair values of the Company’s financial instruments at December 31,
      2006 and 2005 were as follows:


**2006**
              
              **2005****Carrying**
                **Amount**
              
              **Fair**
                **Value**
              
              **Carrying**
                **Amount**
              
              **Fair**
                **Value**Financial
                  assets:Cash
                  on hand and in-demand accounts
              
              **$**
              **29,963**
              
              **$**
              **29,963**
              
              $
              45,077
              
              $
              45,077Short-term
                  investments
              
              
              **211,726**
              
              
              **211,726**
              
              
              159,334
              
              
              159,334Fixed
                  maturity securities, available for sale
              
              
              **3,627,007**
              
              
              **3,627,007**
              
              
              3,258,738
              
              
              3,258,738Variable
                  interest entity fixed maturity securities, held to
                  maturity
              
              
              **750,000**
              
              
              **750,000**
              
              
              -
              
              
              -




*Financial
      Guaranties:* The
      carrying value of the Company’s financial guaranties is represented by the
      unearned premium reserve, net of deferred acquisition costs, loss and loss
      adjustment expense reserves and prepaid reinsurance premiums. Estimated fair
      values of these guaranties are based on an estimate of the balance that is
      necessary to bring the future returns for the Company’s embedded book of
      business to a market return. The estimated fair values of such financial
      guaranties was $1,176,823 compared to a carrying value of $1,243,530 as of
      December 31, 2006, and $1,098,165 compared to a carrying value of $1,099,045
      as
      of December 31, 2005 *.*


33
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**17.
      Financial Instruments (continued)**





As
      of
      December 31, 2006 and 2005, the net present value of future installment premiums
      was approximately $630,831 and $393,000, respectively, both discounted at
      5%.





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





(b)
            Concentrations
                of Credit Risk





The
      Company considers its role in providing insurance to be credit enhancement
      rather than credit substitution. The Company insures only those securities
      that,
      in its judgment, are of investment grade quality. The Company has established
      and maintains its own underwriting standards that are based on those aspects
      of
      credit that the Company deems important for the particular category of
      obligations considered for insurance.





Credit
      criteria include economic and social trends, debt management, financial
      management and legal and administrative factors, the adequacy of anticipated
      cash flows, including the historical and expected performance of assets pledged
      to secure payment of securities under varying economic scenarios, and underlying
      levels of protection, such as insurance or over-collateralization.





In
      connection with underwriting new issues, the Company sometimes requires, as
      a
      condition to insuring an issue, that collateral be pledged or, in some
      instances, that a third-party guaranty be provided for the term of the issue
      by
      a party of acceptable credit quality obligated to make payment prior to any
      payment by the Company. The types and extent of collateral varies, but may
      include residential and commercial mortgages, corporate and/or government debt
      and consumer receivables.




As
      of
      December 31, 2006, the Company’s total outstanding principal insured was
      $299,889,266, net of reinsurance of $29,888,237. The Company’s insured portfolio
      as of December 31, 2006 was broadly diversified by geographic and bond market
      sector, with no single obligor representing more than 1% of the Company’s
      principal insured outstanding, net of reinsurance. The insured portfolio
      includes exposure executed in the form of a credit derivative. The principal
      written in the form of credit derivatives was $25,888,996 at December 31,
      2006.


34


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**17.
      Financial Instruments (continued)**





As
      of
      December 31, 2006, the composition of principal insured by type of issue, net
      of
      reinsurance, was as follows:





**Net
                Principal**
              **Outstanding**Municipal:Tax-supported
            
            $
            134,917,574Utility
                revenue
            
            
            35,337,159Transportation
            
            
            24,501,099Education
            
            
            10,259,116Health
                Care
            
            
            6,495,630Investor-owned
                utilities
            
            
            4,825,029Housing
            
            
            1,582,963Other
            
            
            1,417,555Non-municipal
                and international
            
            
            80,553,141Total
            
            $
            299,889,266





As
      of
      December 31, 2006, the composition of principal insured ceded to reinsurers
      was
      as follows:





**Ceded
                Principal**
              **Outstanding**Reinsurer:Radian
                Asset Assurance Inc.
            
            $
            9,104,883Assured
                Guaranty Corp
            
            
            5,634,737BluePoint
                RE
            
            
            3,933,256Assured
                Guaranty Re Ltd.
            
            
            3,167,811RAM
                Reinsurance Company Ltd.
            
            
            2,637,039Other
            
            
            5,410,511Total
            
            $
            29,888,237





The
      Company did not have recoverables in excess of 3% of stockholders’ equity from
      any single reinsurer.




The
      Company’s insured gross and net principal and interest outstanding was
      $519,514,036 and $468,625,903, respectively, as of December 31,
      2006.


35


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**17.
      Financial Instruments (continued)**





FGIC
      is
      authorized to do business in all 50 states, the District of Columbia, the
      Commonwealth of Puerto Rico, the U.S. Virgin Islands and in the United Kingdom.
      Principal insured outstanding at December 31, 2006 by state, net of reinsurance,
      was as follows:





**Net
                Principal**
              **Outstanding**California
            
            $
            35,178,629New
                York
            
            
            22,327,210Florida
            
            
            15,617,186Pennsylvania
            
            
            14,525,136Texas
            
            
            12,799,320Illinois
            
            
            11,957,490New
                Jersey
            
            
            10,150,268Michigan
            
            
            8,685,038Ohio
            
            
            7,056,980Arizona
            
            
            6,556,683All
                other states
            
            
            74,482,184Mortgage
                and asset-backed
            
            
            67,980,672International
            
            
            12,572,470Total
            
            $
            299,889,266





36


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**18.
      Commitments and Contingencies**





*Lease
      Obligations*





The
      Company leases office space and equipment under operating lease agreements
      in
      the United States and the United Kingdom. Rent expense under operating leases
      for the years ended December 31, 2006, 2005 and 2004 was $4,319, $3,631, and
      $3,070 respectively. Future payments associated with these leases are as follows
      as of December 31, 2006:





**Operating
                Lease**
              **Commitment**
              **Amount**Year:2007
            
            $
            3,7402008
            
            
            4,8412009
            
            
            5,9802010
            
            
            6,0132011
            
            
            6,1092012
                and thereafter
            
            
            52,170Total
                minimum future rental payments
            
            $
            78,853





In
      connection with the Transaction, the Company entered into a capital lease with
      an affiliate of GE Capital, covering leasehold improvements and computer
      equipment to be used at its headquarters. At the lease termination date of
      June
      30, 2009, the Company will own the leased equipment. Future payments associated
      with this lease are as follows as of December 31, 2006:





**Capital
                Lease**
              **Commitment**
              **Amount**Year
                ending December 31:2007
            
            
            1,5452008
            
            
            1,3912009
            
            
            265Total
            
            
            3,201Less
                interest
            
            
            258Present
                value of minimum lease payments
            
            $
            2,943


37
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*


**18.
      Commitments and Contingencies (continued)**





*Justice
      Department Subpoena*





On
      November 15, 2006, FGIC received a grand jury subpoena from the Antitrust
      Division of the U.S. Department of Justice. Based upon press reports, FGIC
      believes that the subpoena relates to an ongoing criminal investigation of
      alleged bid rigging of awards of municipal guaranteed investment contracts
      (“Municipal GICs”) and that several other companies (including other financial
      guarantors) received similar subpoenas.





Until
      December 18, 2003, FGIC was affiliated with certain companies (the “Former
      Affiliates”) that provided Municipal GICs; however, at no time did FGIC provide
      program insurance for Municipal GICs. The Former Affiliates remained a part
      of
      GE Capital after the Transaction, and all obligations under the outstanding
      Municipal GICs remained with the Former Affiliates.





The
      subpoena contains no allegations or statements concerning FGIC’s activities or
      business practices, and FGIC is not aware of any such allegations. FGIC has
      complied with all requests of the Justice Department and intends to continue
      to
      cooperate fully with the investigation.





**19.
      Comprehensive Income**





Accumulated
      other comprehensive income (loss) of the Company consists of net unrealized
      gains and losses on investment securities and foreign currency translation
      adjustments. The components of other comprehensive income for the years ended
      December 31, 2006, 2005 and 2004 are as follows:





**Year
                ended December 31, 2006****Before**
              **Tax**
              **Amount**
            
            **Tax**
            
            **Net
                of**
              **Tax**
              **Amount**Unrealized
                holding gains arising during the year
            
            **$**
            **18,583**
            
            **$**
            **(6,504**
            **)**
            **$**
            **12,079**Less
                reclassification adjustment for gains realizedin
                net income
            
            
            **(274**
            **)**
            
            **96**
            
            
            **(178**
            **)**Unrealized
                gains on investments
            
            
            **18,309**
            
            
            **(6,408**
            **)**
            
            **11,901**Foreign
                currency translation adjustment
            
            
            **11,583**
            
            
            **(3,387**
            **)**
            
            **8,196**Total
                other comprehensive income
            
            **$**
            **29,892**
            
            **$**
            **(9,795**
            **)**
            **$**
            **20,097**


38
   Financial
        Guaranty Insurance Company and Subsidiaries
 
 Notes
        to
        Consolidated Financial Statements (continued)
 
 
 *(Dollars
        in thousands, except per share amounts)*
  **19.
        Comprehensive Income (continued)**





**Year
                ended December 31, 2005****Before**
              **Tax**
              **Amount**
            
            **Tax**
            
            **Net
                of**
              **Tax**
              **Amount**Unrealized
                holding losses arising during the year
            
            $
            (36,050
            )
            $
            12,566
            
            $
            (23,484
            )Less
                reclassification adjustment for gains realizedin
                net income
            
            
            (101
            )
            
            35
            
            
            (66
            )Unrealized
                losses on investments
            
            
            (36,151
            )
            
            12,601
            
            
            (23,550
            )Foreign
                currency translation adjustment
            
            
            (8,454
            )
            
            2,922
            
            
            (5,532
            )Total
                other comprehensive loss
            
            $
            (44,605
            )
            $
            15,523
            
            $
            (29,082
            )








**Year
                ended December 31, 2004****Before**
              **Tax**
              **Amount**
            
            **Tax**
            
            **Net
                of**
              **Tax**
              **Amount**Unrealized
                holding gains arising during the year
            
            $
            14,928
            
            $
            (5,225
            )
            $
            9,703Less
                reclassification adjustment for gains realizedin
                net income
            
            
            (559
            )
            
            196
            
            
            (363
            )Unrealized
                gains on investments
            
            
            14,369
            
            
            (5,029
            )
            
            9,340Foreign
                currency translation adjustment
            
            
            6,286
            
            
            (2,200
            )
            
            4,086Total
                other comprehensive income
            
            $
            20,655
            
            $
            (7,229
            )
            $
            13,426


39


Financial
      Guaranty Insurance Company and Subsidiaries





Notes
      to
      Consolidated Financial Statements (continued)








*(Dollars
      in thousands, except per share amounts)*




**20.
      Quarterly Financial Information (Unaudited)**




**Three
                months ended**
            
            **Year
                ended****March
                31,**
              **2006**
            
            **June
                30,**
              **2006**
            
            **September**
              **30,
                2006**
            
            **December**
              **31,
                2006**
            
            **December**
              **31,
                2006**Gross
                premiums written
            
            $
            89,281
            
            $
            163,260
            
            $
            85,030
            
            $
            103,660
            
            $
            441,231Net
                premiums written
            
            
            82,585
            
            
            134,373
            
            
            66,590
            
            
            83,266
            
            
            366,814Net
                premiums earned
            
            
            59,464
            
            
            71,845
            
            
            62,738
            
            
            72,410
            
            
            266,457Net
                investment income and net realized gains
            
            
            32,319
            
            
            34,038
            
            
            35,803
            
            
            36,315
            
            
            138,475Interest
                income-investments held by variable interest entity
            
            
            4,937
            
            
            9,658
            
            
            10,033
            
            
            11,265
            
            
            35,893Other
                incomeand
                net realized and unrealized gains (expense) on credit derivative
                products
            
            
            308
            
            
            (48
            )
            
            1,596
            
            
            740
            
            
            2,596Total
                revenues
            
            
            97,028
            
            
            115,493
            
            
            110,170
            
            
            120,730
            
            
            443,421Losses
                and loss adjustment expenses
            
            
            (1,933
            )
            
            (265
            )
            
            520
            
            
            (7,022
            )
            
            (8,700
            )Interest
                expense - debt held by variable interest entity
            
            
            4,937
            
            
            9,658
            
            
            10,033
            
            
            11,265
            
            
            35,893Income
                before taxes
            
            
            77,573
            
            
            90,732
            
            
            85,119
            
            
            99,432
            
            
            352,856Net
                income
            
            
            58,711
            
            
            67,211
            
            
            63,563
            
            
            74,353
            
            
            263,838





**Three
                months ended**
            
            **Year
                ended****March
                31,**
              **2005**
            
            **June
                30,**
              **2005**
            
            **September**
              **30,
                2005**
            
            **December**
              **31,
                2005**
            
            **December**
              **31,
                2005**Gross
                premiums written
            
            $
            84,404
            
            $
            131,335
            
            $
            96,787
            
            $
            97,676
            
            $
            410,202Net
                premiums written
            
            
            82,609
            
            
            113,305
            
            
            92,331
            
            
            92,809
            
            
            381,054Net
                premiums earned
            
            
            52,633
            
            
            61,907
            
            
            54,794
            
            
            55,235
            
            
            224,569Net
                investment income and net realized gains
            
            
            27,558
            
            
            28,389
            
            
            30,117
            
            
            31,109
            
            
            117,173Other
                income (expense)
            
            
            426
            
            
            90
            
            
            402
            
            
            (323
            )
            
            595Total
                revenues
            
            
            80,617
            
            
            90,386
            
            
            85,313
            
            
            86,021
            
            
            342,337Losses
                and loss adjustment expenses
            
            
            (2,611
            )
            
            (3,066
            )
            
            20,693
            
            
            3,490
            
            
            18,506Income
                before taxes
            
            
            71,100
            
            
            81,377
            
            
            48,783
            
            
            70,274
            
            
            271,534Net
                income
            
            
            53,306
            
            
            59,992
            
            
            39,407
            
            
            53,721
            
            
            206,426




40