<PAGE>

Capital RE Corporation and Subsidiaries
Financial Highlights

<TABLE>
<CAPTION>

                                                                    Year Ended December 31,
                                                ------------------------------------------------------------
(Dollars in thousands except per share amounts)  1996         1995         1994         1993         1992
------------------------------------------------------------------------------------------------------------
<S>                                             <C>          <C>          <C>          <C>          <C>
SUMMARY OF OPERATIONS
Gross Premiums Written                          $129,818     $107,599      $94,851      $85,367      $79,283
Net Premiums Written                             105,188       89,508       82,795       73,946       53,153
Net Premiums Earned                               92,436       60,097       58,850       44,936       27,799
Net Investment Income                             51,558       46,654       40,113       32,131       23,760
Net Realized Gains                                 1,471           53        1,780          881        5,487
Total Revenues                                   146,416      107,085      101,462       79,477       58,443
Net Income                                        56,524       45,527       39,806       36,354       30,153
------------------------------------------------------------------------------------------------------------
BALANCE SHEET
Investment Portfolio                             901,102      771,767      638,751      552,405      443,688
Total Assets                                   1,156,401      981,885      810,040      711,633      608,547
Net Deferred Premium Revenue                     265,070      252,318      222,907      198,960      147,079
Stockholders' Equity                             489,346      411,943      325,514      323,832      279,593
------------------------------------------------------------------------------------------------------------
PER SHARE DATA
Earnings Per Share                                  3.61         3.08         2.69         2.43         2.16
Book Value Per Share                               30.86        27.82        22.02        21.66        18.71
------------------------------------------------------------------------------------------------------------
STATUTORY SURPLUS AND RESERVES
Unearned Premium Reserve                         307,236      278,980      242,574      218,095       163,812
Contingency Reserve                              123,363       89,685       63,591       43,459        34,472
Policyholders' Surplus                           443,451      412,884      401,743      304,222       250,720
Total Policyholders'Surplus and Reserves         874,051      781,549      707,908      565,776       449,004
-------------------------------------------------------------------------------------------------------------

</TABLE>


                                       2

<PAGE>



Capital Re Corporation and Subsidiaries
Audited Consolidated Financial Statements
Year ended December 31, 1996


<TABLE>
<CAPTION>
Contents
<S>                                                                    <C>

Management's Discussion and Analysis ................................. 22

Report of Independent Auditors ....................................... 31

Consolidated Balance Sheets .......................................... 32

Consolidated Statements of Income .................................... 34

Consolidated Statements of Stockholders' Equity ...................... 35

Consolidated Statements of Cash Flows ................................ 36

Notes to Consolidated Financial Statements ........................... 37

Officers and Directors ............................................... 54

Shareholder Information .............................................. 55
</TABLE>











                                      21
<PAGE>

Capital Re Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations


General

Capital Re Corporation (the "Corporation") was incorporated in the State of
Delaware in December 1991, and is the successor by merger to a Maryland
corporation incorporated in 1986. The Corporation is an insurance holding
company and has six wholly-owned operating subsidiaries. Capital Reinsurance
Company ("Capital Reinsurance"), domiciled in the state of Maryland, commenced
operations in January 1988. Capital Reinsurance is engaged in the business of
financial guaranty reinsurance, primarily the reinsurance of municipal and non-
municipal bond insurance policies. Capital Mortgage Reinsurance Company
("Capital Mortgage"), a New York-domiciled company, commenced operations in
February 1994. Capital Mortgage reinsures only residential mortgage guaranty
insurance obligations. KRE Reinsurance Ltd. ("KRE"), (formerly Capital Mortgage
Reinsurance Company (Bermuda) Ltd.), a Bermuda-domiciled company, commenced
operations in March 1994. KRE is engaged in the business of reinsuring financial
guaranty, mortgage guaranty and trade credit and other specialty insurance
policies, both as a direct reinsurer of third party primary insurers and as a
retrocessionaire of Capital Reinsurance, Capital Mortgage, and Capital Credit
Reinsurance Company, Ltd. ("Capital Credit"). Capital Credit, also a Bermuda-
domiciled insurance company, commenced operations in February 1990. Capital
Credit reinsures trade credit and other specialty insurance lines concentrated
in Western Europe and the United States and is a retrocessionaire of Capital
Reinsurance and Capital Mortgage. Capital Title Reinsurance Company ("Capital
Title"), a New York-domiciled insurance company, commenced operations in March
1996. Capital Title is engaged in the business of reinsuring title insurance
policies. In November 1996, the Corporation acquired, through its newly formed
United Kingdom holding company, Capital Re (UK) Holdings, 100% of the issued
shares of Tower Street Holdings Limited (now known as RGB Holdings, Ltd.), the
holding company for RGB Underwriting Agencies Ltd. ("RGB"). RGB is a managing
agency and presently manages five syndicates operating in the Lloyd's of London
insurance market. In connection with this acquisition, the Corporation
established a corporate name at Lloyd's to support underwriting on the managed
syndicates. The corporate name participates in a non-marine and a life
syndicate. At December 31, 1996, the results of RGB and the corporate name at
Lloyd's are consolidated in the Corporation's financial statements. The goodwill
associated with this acquisition will be amortized over twenty years. In
December 1996, the Corporation entered into a joint venture with GCR Holdings
Limited to form a Bermuda-based insurer, Capital Global Underwriters Limited
("CGUL"), which will specialize in financial reinsurance, including financial
guaranty, mortgage guaranty and finite risk reinsurance. The Corporation,
through its subsidiary, KRE, owns a fifty percent interest in CGUL and controls
9.9% of its voting stock. The Corporation accounts for its investment in CGUL
under the equity method.



                                      22
<PAGE>

Results of Operations

Year Ended December 31, 1996, versus
Year Ended December 31, 1995

Net income for the year ended December 31, 1996, increased 24.2% to $56.5
million from $45.5 million for the same period of 1995. On a per share basis,
net income increased to $3.61 for the year ended December 31, 1996, from $3.08
for the same period of 1995, or 17.2%. In addition, net operating income (net
income excluding realized gains and losses) increased 21.3% to $55.3 million for
the year ended December 31, 1996, from $45.6 million for the same period in
1995. On a per share basis, net operating income increased to $3.53 for the year
ended December 31, 1996, from $3.09 for the same period of 1995, or 14.2%.
Growth in net premiums earned to $92.4 million from $60.1 million, or 53.7%, was
the principal cause of the increase in net income. Growth in net premiums earned
is a result of the Corporation's successful diversification into the mortgage,
trade credit and other specialty reinsurance lines of business.

Gross premiums written increased 20.6% to $129.8 million for the year ended
December 31, 1996, from $107.6 million for the same period of 1995. This
increase was primarily due to growth in the mortgage guaranty, trade credit and
other specialty lines of business. In addition, Capital Title established its
first reinsurance relationships in 1996, which contributed $1.8 million in
premiums written for the year ended December 31, 1996. Non-municipal premiums
written decreased to $10.9 million for the year ended December 31, 1996, from
$17.2 million for the same period last year because of the positive impact on
gross premiums written in the fourth quarter of 1995 of several large
reinsurance transactions, which had upfront premium payments. The following
table shows gross written premiums by line of business for the year ended
December 31, 1996 and December 31, 1995.

<TABLE>
<CAPTION>

                                        Year ended
Gross Premiums Written                 December 31,
                                    ----------------
(Dollars in millions)                  1996     1995
----------------------------------------------------
<S>                                  <C>      <C>
Municipal                            $ 48.3   $ 44.2
Mortgage                               53.7     39.1
Non-Municipal                          10.9     17.2
Credit and Specialty                   15.1      7.1
Title                                   1.8      0.0
----------------------------------------------------
                                     $129.8   $107.6
</TABLE>

Net premiums written increased by 17.5% to $105.2 million for the year ended
December 31, 1996, from $89.5 million for the same period in 1995. This increase
is commensurate with the increase in gross premiums written explained above. The
following table shows net premiums written by line of business for the year
ended December 31, 1996, and December 31, 1995.


<TABLE>
<CAPTION>

                                        Year ended
Net Premiums Written                   December 31,
                                    ----------------
(Dollars in millions)                  1996     1995
----------------------------------------------------
<S>                                  <C>      <C>
Municipal                            $ 36.7    $38.1
Mortgage                               40.9     27.6
Non-Municipal                          10.9     17.2
Credit and Specialty                   14.9      6.6
Title                                   1.8      0.0
----------------------------------------------------
                                     $105.2    $89.5
</TABLE>



                                      23
<PAGE>

Capital Re Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations continued


For the year ended December 31, 1996, net premiums earned increased 53.7% to
$92.4 million from $60.1 million for the comparable 1995 period. This increase
was primarily due to growth in net premiums earned in the mortgage, and credit
and specialty reinsurance lines of business. For the year ended December 31,
1996, net refunded earned premium increased to $5.8 million from $0.8 million
for the comparable period in 1995. Excluding the effects of net refunded earned
premium, net premiums earned increased 46.2% to $86.7 million from $59.3 million
for the year ended December 31, 1996 and 1995, respectively. A refunding
extinguishes the Corporation's reinsurance liability for the refunded obligation
and the Corporation then recognizes revenue equal to the remaining related
deferred premium revenue. The following table shows net premiums earned by line
of business for the year ended December 31, 1996 and December 31, 1995. For the
year ended December 31, 1996 and 1995, ceded earned premium was $14.7 million
and $8.0 million, respectively.

<TABLE>
<CAPTION>

                                        Year ended
Net Premiums Earned                    December 31,
                                    ----------------
(Dollars in millions)                  1996     1995
----------------------------------------------------
<S>                                  <C>      <C>
Municipal                             $27.5    $25.6
Mortgage                               43.9     22.1
Non-Municipal                           7.2      6.4
Credit and Specialty                   12.2      6.0
Title                                   1.6      0.0
-----------------------------------------------------
                                      $92.4    $60.1
</TABLE>


For the year ended December 31, 1996, net investment income increased 10.5% to
$51.6 million from $46.7 million for the comparable period in 1995. Growth in
investment income was primarily attributable to a larger investment portfolio
caused by (i) an increase in invested assets from positive operating cash flows
during the year ended December 31, 1996, and (ii) a public offering in the first
quarter of 1996 of the Corporation's common stock which generated $25.9 million
in net proceeds to the Corporation. In addition, the Corporation recognized net
realized gains of $1.5 million for the year ended December 31, 1996, compared to
net realized gains of $0.1 million for same period in 1995. Realized gains and
losses are expected in connection with the Corporation's new emphasis on a total
return investment strategy implemented during 1996.

Loss and loss adjustment expenses increased to $9.5 million from $2.6 million
for the year ended December 31, 1996 and 1995, respectively. Losses recorded in
the year ended December 31, 1996, were primarily attributable to normal loss
development in the mortgage guaranty and credit reinsurance lines of business
which constitute an increasing portion of the Corporation's assumed book of
business. Ceded losses for the year ended December 31, 1996 and 1995, were $6.5
million and $2.6 million, respectively.

Total expenses, including loss and loss adjustment expenses, increased 47.4% to
$69.3 million for the year ended December 31, 1996, from $47.0 million in the
same period of 1995. This increase was primarily attributable to commissions
associated with the increased level of premiums assumed, normal loss development
from the

                                      24
<PAGE>

mortgage and credit lines of business and increased net profit commissions
payable under certain of the Corporation's reinsurance contracts. In addition,
the combined ratio increased to 61.7% for the year ended December 31, 1996, from
56.8% for the comparable 1995 period. This increase is an expected result of the
Corporation's diversification strategy, which is producing more business from
lines with relatively higher combined ratios than the financial guaranty
reinsurance business.

For the year ended December 31, 1996, the total tax provision increased to $20.6
million from $14.5 million for the same period in 1995. In addition, the
effective tax rate increased to 26.7% in the third quarter of 1996, from 24.2%
in the same period of 1995. This increase occurred in response to the
Corporation's strategy of using a greater proportion of new cash flow to
purchase taxable securities during 1996.

Year Ended December 31, 1995 versus
Year Ended December 31, 1994
Net income for the year ended December 31, 1995, increased 14.3% to $45.5
million from $39.8 million for the same period of 1994. On a per share basis,
net income increased to $3.08 for the year ended December 31, 1995, from $2.69
for the same period of 1994, or 14.5%. Growth in net investment income to $46.7
million from $40.1 million, or 16.5%, and a decrease in profit commission
expense to $0.9 million from $4.0 million, were the principal causes of the
increase in net income.

Gross premiums written increased 13.4% to $107.6 million for the year ended
December 31, 1995, from $94.9 million for the same period of 1994. This increase
was primarily due to an increase in gross premiums written from the
Corporation's expansion of its mortgage guaranty reinsurance and credit
reinsurance business lines. The following table shows gross written premiums by
line of business for the year ended December 31, 1995, and December 31, 1994.

<TABLE>
<CAPTION>

                                        Year ended
Gross Premiums Written                 December 31,
                                    ----------------
(Dollars in millions)                  1996     1995
----------------------------------------------------
<S>                                  <C>      <C>
Municipal                            $ 44.2    $56.9
Mortgage                               39.1     30.1
Non-Municipal                          17.2      5.3
Credit                                  7.1      2.6
----------------------------------------------------
                                     $107.6    $94.9
</TABLE>

The decrease of $12.7 million of gross premiums written in the municipal bond
reinsurance line of business was primarily due to a decline in new municipal
bond issuance, a consequent decline in aggregate primary insurance premiums, and
reduced reinsurance ceded in the municipal bond segment of the financial
guaranty market. However, this decrease was offset by an increase of $12.0
million of gross premiums written in the non-municipal financial guaranty line
of business.

Net premiums written increased by 8.1% to $89.5 million for the year ended
December 31, 1995, from $82.8 million for the same period in 1994. This increase
followed from the causes described above for the increase in gross premiums
written. The following table shows net premiums written by line of business for
the year ended December 31, 1995, and December 31, 1994.


                                      25
<PAGE>

Capital Re Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations continued


<TABLE>
<CAPTION>

                                        Year ended
Net Premiums Written                   December 31,
                                    ----------------
(Dollars in millions)                  1996     1995
----------------------------------------------------
<S>                                  <C>      <C>
Municipal                             $38.1    $50.1
Mortgage                               27.6     23.8
Non-Municipal                          17.2      6.3
Credit                                  6.6      2.6
----------------------------------------------------
                                      $89.5    $82.8
</TABLE>


For the year ended December 31, 1995, net premiums earned increased 2.0% to
$60.1 million from $58.9 million for the comparable 1994 period. This slight
increase was primarily due to increases in net premiums earned in the mortgage,
credit and non-municipal reinsurance lines of business, partially offset by a
decline in net refunded earned premium. For the year ended December 31, 1995,
net refunded earned premium decreased to $0.8 million from $9.2 million for the
comparable period in 1994. Excluding the effects of net refunded earned premium,
net premiums earned increased 19.3% to $59.3 million from $49.7 million for the
year ended December 31, 1995 and 1994, respectively. A refunding extinguishes
the Corporation's reinsurance liability for the refunded obligation and the
Corporation then recognizes revenue equal to the remaining related deferred
premium revenue. The following table shows net premiums earned by line of
business for the year ended December 31, 1995, and December 31, 1994.

<TABLE>
<CAPTION>

                                        Year ended
Net Premiums Written                   December 31,
                                   -----------------

(Dollars in millions)                  1996     1995
----------------------------------------------------
<S>                                  <C>      <C>

Municipal                             $25.6    $34.5
Mortgage                               22.1     16.8
Non-Municipal                           6.4      5.3
Credit                                  6.0      2.3
----------------------------------------------------
                                      $60.1    $58.9
</TABLE>


For the year ended December 31, 1995, net investment income increased 16.5% to
$46.7 million from $40.1 million for the comparable period in 1994. Growth in
investment income was primarily attributable to an increase in invested assets
from positive operating cash flows during the twelve months ended December 31,
1995.

The Corporation recognized net realized gains of $0.1 million for the year ended
December 31, 1995 compared to $1.8 million for the same period in 1994. The 1995
net realized gains included a write-down of $2.6 million on a planned
amortization class interest-only collateralized mortgage obligation ("CMO") in
accordance with the provisions of Emerging Issues Task Force ("EITF") Issue No.
93-18, which requires cash flows of volatile CMOs to be discounted to their fair
value below amortized cost to the extent that any portion of this difference is
considered to be other than temporary. Included in the 1994 net realized gains
was a $1.0 million write-down on the same security. The carrying value of this
security has been reduced to its currently expected discounted realizable
amount.

Loss and loss adjustment expenses increased to $2.6 million from $2.2 million
for the year ended December 31, 1995 and 1994, respectively. Losses recorded in
the year ended 1995 were primarily attributable to the mortgage guaranty and
credit

                                      26
<PAGE>

reinsurance lines of business. This increase is reflective of the maturation of
the books of business assumed in prior years and is consistent with the expected
loss development pattern for these lines of business.

Total expenses decreased 2.9% to $47.0 million for the year ended December 31,
1995, from $48.4 million in the same period of 1994. Also, the expense ratio
decreased to 52.4% for the year ended December 31, 1995, from 58.2% for the
comparable 1994 period. This decrease was due to lower profit commission
expenses associated with favorable results under certain retrocessional
agreements.

For the year ended December 31, 1995, the total tax provision increased to $14.5
million from $13.3 million for the same period in 1994. However, the effective
tax rate decreased to 24.2% for the year ended December 31, 1995, from 25.0%.
This decrease occurred in response to the Corporation's strategy of using a
greater proportion of new cash flow to purchase tax-exempt securities during
1995.

Liquidity and Capital Resources
The Corporation relies on dividends from Capital Reinsurance for funds used in
its operations. The major sources of liquidity for Capital Reinsurance are funds
generated from reinsurance premiums, net investment income and maturing
investments. Capital Reinsurance is domiciled in the state of Maryland, and
under Maryland insurance law, the amount of the surplus of Capital Reinsurance
available for distribution as dividends is subject to certain statutory
restrictions. The amount available for distribution from Capital Reinsurance
during 1996 with notice to, but without prior approval of, the Maryland
Insurance Commissioner was limited to 10% of Capital Reinsurance's
policyholders' surplus as of December 31, 1995, or approximately $32.9 million.
For the year ended December 31, 1996, Capital Reinsurance paid $17.5 million in
dividends to the Corporation.

Credit Re Corporation relies on dividends from its wholly owned subsidiary,
Capital Credit, for funds which it provides the Corporation. Capital Credit's
major sources of liquidity are also funds generated from reinsurance premiums,
net investment income and maturing investments. Capital Credit is a Bermuda-
domiciled insurer whose distributions are governed by Bermuda law. Under Bermuda
law and the by-laws of Capital Credit, dividends may be paid out of the profits
of the company (defined as accumulated realized profits less accumulated
realized losses). Distributions to shareholders may also be paid out of Capital
Credit's surplus limited by requirements that such company must at all times (i)
maintain the minimum share capital required under Bermuda Law, and (ii) have
relevant assets in an amount equal to or greater than 75% of relevant
liabilities, all as defined under Bermuda Law. Since its organization, Capital
Credit has not declared nor paid any dividends.

Capital Mortgage and Capital Title are subject to the dividend restrictions
imposed under New York Insurance Law. Accordingly, dividends may only be
declared and distributed out of earned surplus (as defined under New York
Insurance Law). Additionally, no dividend may be declared or distributed in an
amount which, together with all dividends declared or distributed by Capital
Mortgage during the preceding twelve months, exceeds the lesser of 10% of the
company's surplus to policyholders as shown by its last Annual Statutory
Statement on file with the New York



                                      27
<PAGE>

Capital Re Corporation and Subsidiaries
Management's Discussion and Analysis of Financial Condition
and Results of Operations continued

Insurance Department, or 100% of adjusted net investment income (as defined
under New York Insurance Law) during such period, unless, upon prior
application, the Superintendent of Insurance approves a greater dividend
distribution based upon his finding that Capital Mortgage will retain sufficient
surplus to support its obligations and writings. KRE's dividends and
distributions to its sole shareholder, Capital Mortgage, are governed by Bermuda
law, and are subject to the same restrictions as those described in the
preceding paragraph for Capital Credit. To date, Capital Mortgage, KRE and
Capital Title have not declared or paid any dividends.

In January 1994, the Corporation formed and capitalized, through the purchase of
common shares, Capital Re LLC. Capital Re LLC exists solely for the purpose of
issuing preferred and common shares and lending the proceeds of such issuance to
the Corporation to fund its business operations. In January 1994, Capital Re LLC
issued $75.0 million of Company obligated mandatorily redeemable preferred
securities, the proceeds of which were loaned to the Corporation. The
Corporation has, among other undertakings, unconditionally guaranteed all
legally declared and unpaid dividends of Capital Re LLC. The Company obligated
mandatorily redeemable preferred securities were issued at $25 par value per
share and pay monthly dividends at a rate of 7.65% per annum. Also in January
1994, Capital Reinsurance and Capital Credit invested an aggregate of $120.0
million to capitalize Capital Mortgage. Of the total original contribution of
$120.0 million, Capital Reinsurance invested $94.8 million and Capital Credit
invested $25.2 million.


On February 12, 1996, the Corporation completed a public offering of
approximately 3.5 million shares of common stock. Of the 3.5 million shares, an
institutional shareholder sold 2.6 million shares and the Corporation sold
853,120 shares in the public offering generating net proceeds to the Corporation
of approximately $25.9 million of which $21.5 million was used to complete the
$25 million capitalization of Capital Title. The remaining $4.4 million was used
for Corporation expenses associated with the public offering and general
corporate purposes. The Corporation received no proceeds from the institutional
shareholder's sale of shares.

During 1996, the Corporation paid three quarterly common stock dividends at a
rate of $0.06 per share. In December of 1996, the Corporation's Board of
Directors authorized an increase of the quarterly common stock dividend rate to
$0.07 per share, or $0.28 annually. For the year ended December 31, 1996, common
dividends were declared and paid in the amount of $3.9 million or $0.25 per
share.

Cash flows from operations for the year ended December 31, 1996 and 1995,
consisting of reinsurance premiums collected net of expenses, investment income
and income taxes, were $95.9 million and $73.7 million, respectively. The
Corporation believes that current levels of cash flow from operations provide
the Corporation with sufficient liquidity to meet its operating needs. The
Corporation's non-operating cash outflows are primarily dedicated to (i) fixed-
income investment activity, (ii) the payment of dividends on its common shares,
(iii) payments of interest on long-term debt and (iv) the payment of its loan
obligations to Capital Re LLC.


                                      28
<PAGE>

At December 31, 1996, cash and investments approximated $916.4 million, an
increase of $140.1 million, or 18.0%, from $776.3 million at December 31, 1995.
In managing its investment portfolio, the Corporation places a high priority on
quality and liquidity. As of December 31, 1996, the entire investment portfolio
was invested in highly-rated fixed income securities. At December 31, 1996,
approximately $200.8 million or 22.3% of the Corporation's investment portfolio
was comprised of mortgage-backed securities ("MBS"). Of the MBS portfolio,
approximately $142.8 million or 71.1% is backed by agencies or entities
sponsored by the U.S. government as to the full amount of principal and
interest. As of December 31, 1996, the entire MBS portfolio was invested in
triple A rated securities.

Prepayment risk is an inherent risk of holding MBS. However, the degree of
prepayment risk is particular to the type of MBS held. The Corporation limits
its exposure to prepayments by purchasing less volatile types of MBS. As of
December 31, 1996, $52.2 million or approximately 26.0% of the MBS portfolio was
invested in collateralized mortgage obligations ("CMOs") which are characterized
as planned amortization class CMOs ("PACs"). PACs are securities whose cash
flows are designed to remain constant over a variety of mortgage prepayment
environments. Other classes in the CMO security are structured to accept the
volatility of mortgage prepayment changes, thereby insulating the PAC class. Of
the remaining MBS portfolio, $148.6 million, or 74.0%, was invested in mortgage-
backed pass-throughs or sequential CMOs. Pass-throughs are securities in which
the monthly cash flows of principal and interest (both scheduled and
prepayments) generated by the underlying mortgages are distributed on a pro-rata
basis to the holders of securities. A sequential MBS is structured to divide the
CMO security into sequentially ordered classes. Receipt of principal payments
within classes is contingent on the retirement of all previously paying classes.
Generally, interest payments are made currently on all classes. While these
securities are more sensitive to prepayment risk than PACs, they are not
considered highly volatile securities. While the Corporation may consider
investing in any tranche of a sequential MBS, the individual security's
characteristics (duration, relative value, underlying collateral, etc.) along
with aggregate portfolio risk management determine which tranche of sequential
MBS will be purchased. At December 31, 1996, the Corporation had no securities
such as interest-only securities, principal-only securities, or MBS purchased at
a substantial premium to par that have the potential for loss of a significant
portion of the original investment due to changes in the prepayment rate of the
underlying loans supporting the security.

On January 31, 1997, the Corporation extended its existing agreement with
Deutsche Bank AG for the provision of a $25.0 million liquidity facility (the
"DB Liquidity Facility") which is available for general corporate purposes. The
DB Liquidity Facility was extended for one year and is scheduled to expire on
January 26, 1998. The Corporation has not borrowed under the DB Liquidity
Facility. Capital Reinsurance also entered into an agreement on January 31, 1994
with Deutsche Bank AG for a credit facility of up to $75.0 million specifically
designed to provide rating agency qualified capital to further support Capital
Reinsurance's claims-paying resources. This agreement expires January 27, 2004.


                                      29
<PAGE>

Capital Re Corporation and Subsidiaries
Management's Discussion and Analyses of Financial Condition
and Results of Operations continued

In addition, on August 20, 1996, the Corporation entered into a credit agreement
with Chase Manhattan Bank for the provision of a $25.0 million credit facility
(the "Chase Facility") which is available for general corporate purposes.
Furthermore, on August 26, 1996, the Corporation utilized $16.0 million of the
Chase Facility for purposes of paying subordinated notes which came due.
Interest on the bank note issued under the Chase Facility is payable quarterly
based upon the Corporation's chosen interest rate option under the terms of the
Chase Facility. In November of 1996, the Corporation utilized the remaining $9
million of the Chase Facility for purposes of acquiring RGB.















                                      30
<PAGE>

Report of Independent Auditors







Board of Directors and Stockholders
Capital Re Corporation

We have audited the accompanying consolidated balance sheets of Capital Re
Corporation and Subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as 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 Capital Re
Corporation and Subsidiaries at December 31, 1996 and 1995, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally accepted
accounting principles.




January 21, 1997








                                      31
<PAGE>
Capital Re Corporation and Subsidiaries
Consolidated Balance Sheets

<TABLE>
<CAPTION>

                                                                               December 31,
                                                                   ----------------------------------
(Dollars in thousands except share amounts)                              1996                    1995
-----------------------------------------------------------------------------------------------------
<S>                                                                <C>                       <C>
Assets
Fixed maturity securities available for sale,
  at market (amortized cost: $800,137 in 1996
  and $652,966 in 1995)                                            $  825,678                $687,657
Short-term investments, at cost, which
  approximates market                                                  75,424                  84,110
-----------------------------------------------------------------------------------------------------
Total investments                                                     901,102                 771,767

Cash                                                                   15,285                   4,537
Accrued investment income                                              12,287                   9,481
Deferred acquisition costs                                            111,364                 102,353
Prepaid reinsurance premiums                                           72,034                  62,133
Reinsurance recoverable on ceded losses                                 1,833                   2,524
Funds held under reinsurance contracts                                  3,861                   3,832
Premiums receivable                                                     5,794                  17,907
Property and equipment, at cost (net of
  accumulated depreciation and amortization
  of $1,502 in 1996 and $1,014 in 1995)                                 2,291                   1,702
Goodwill                                                               13,567                      --
Investment in CGUL                                                     10,000                      --
Other assets                                                            6,983                   5,649
-----------------------------------------------------------------------------------------------------
Total assets                                                       $1,156,401                $981,885
=====================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.


                                      32
<PAGE>

<TABLE>
<CAPTION>

                                                                                December 31,
                                                                   -----------------------------------
(Dollars in thousands except share amounts)                              1996                     1995
------------------------------------------------------------------------------------------------------
<S>                                                                <C>                        <C>
Liabilities
Deferred premium revenue                                           $   337,104                $314,451
Reserve for losses and loss adjustment expenses                         19,902                  12,783
Profit commission liability                                             13,329                   8,806
Ceded balances payable                                                      50                   8,000
Bank note payable                                                       25,000                      --
Subordinated notes payable                                                  --                  16,000
Long-term debt                                                          74,782                  74,744
Deferred federal income taxes payable                                   58,474                  50,187
Other liabilities                                                       20,665                   9,971
Liability for securities purchased                                      42,749                      --
------------------------------------------------------------------------------------------------------
Total liabilities                                                      592,055                 494,942
------------------------------------------------------------------------------------------------------
Company obligated mandatorily redeemable preferred
   securities of Capital Re LLC                                         75,000                  75,000
------------------------------------------------------------------------------------------------------
Stockholders' equity
  Preferred stock--$.01 par value per share:
    25,000,000 shares authorized; no shares
    issued or outstanding                                                   --                      --
  Common stock--$.01 par value per share:
    75,000,000 shares authorized; 15,856,762 and
    14,805,055 shares issued and outstanding in
    1996 and 1995                                                          160                     150
   Additional paid-in capital                                          222,525                 191,654
   Retained earnings                                                   253,807                 201,228
   Treasury stock--189,700 and 182,700 shares in 1996
     and 1995, respectively                                             (3,870)                 (3,638)
   Net unrealized gain on fixed maturity securities available
     for sale                                                           16,602                  22,549
   Net unrealized gain on foreign currency translation                     122                      --
------------------------------------------------------------------------------------------------------
Total stockholders' equity                                             489,346                 411,943
------------------------------------------------------------------------------------------------------
Total liabilities, preferred securities of Capital Re LLC and
   stockholders' equity                                             $1,156,401                $981,885
======================================================================================================
</TABLE>

                                      33
<PAGE>

Capital Re Corporation and Subsidiaries
Consolidated Statements of Income



<TABLE>
<CAPTION>

                                                                              Year ended December 31,
                                                                    ----------------------------------------
(Dollars in thousands except per share amounts)                          1996            1995           1994
------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>             <C>            <C>
Revenues
Gross written premiums                                                $129,818       $107,599       $ 94,851
Ceded premiums                                                         (24,630)       (18,091)       (12,056)
------------------------------------------------------------------------------------------------------------
Net written premiums                                                   105,188         89,508         82,795
Increase in deferred premium revenue                                   (12,752)       (29,411)       (23,945)
------------------------------------------------------------------------------------------------------------
Earned premiums                                                         92,436         60,097         58,850
Net investment income                                                   51,558         46,654         40,113
Net realized gains                                                       1,471             53          1,780
Other income                                                               951            281            719
------------------------------------------------------------------------------------------------------------
Total revenues                                                         146,416        107,085        101,462
------------------------------------------------------------------------------------------------------------

Expenses
Losses and loss adjustment expenses                                      9,483          2,637          2,167
Acquisition costs                                                       39,725         32,607         34,099
Increase in deferred acquisition costs                                  (9,011)       (11,705)       (12,628)
Profit commission expense                                                6,008            902          4,009
Other operating expenses                                                10,796          9,710          8,787
Foreign exchange gains (losses)                                           (377)           228             --
Interest expense                                                         6,895          6,893          6,539
Minority interest in Capital Re LLC                                      5,738          5,738          5,387
------------------------------------------------------------------------------------------------------------
Total expenses                                                          69,257         47,010         48,360
------------------------------------------------------------------------------------------------------------
Income before provision for federal income taxes                        77,159         60,075         53,102

Provision for federal income taxes:
   Current                                                               9,146          9,175          6,976
   Deferred                                                             11,489          5,373          6,320
------------------------------------------------------------------------------------------------------------
Total provision for federal income taxes                                20,635         14,548         13,296
------------------------------------------------------------------------------------------------------------
Net income                                                            $ 56,524       $ 45,527       $ 39,806
============================================================================================================

Per share data
Weighted average common shares outstanding                              15,656         14,788         14,825
Net income per share of common stock                                  $   3.61       $   3.08       $   2.69
Cash dividend per common share                                        $   0.25       $   0.21       $   0.20
------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.



                                      34
<PAGE>

Capital Re Corporation and Subsidiaries
Consolidated Statements of Stockholders' Equity


<TABLE>
<CAPTION>

                                                                              Year ended December 31,
                                                                       -------------------------------------
(Dollars in thousands except per share amounts)                           1996           1995           1994
------------------------------------------------------------------------------------------------------------
<S>                                                                    <C>            <C>            <C>
Common stock
Balance at beginning of period                                             150            150            149
Common stock issued                                                          8             --              1
Exercise of stock options, including tax benefit                             2             --             --
------------------------------------------------------------------------------------------------------------
Balance at end of period                                                   160            150            150
------------------------------------------------------------------------------------------------------------
Additional paid-in capital
Balance at beginning of period                                         191,654        191,214        190,902
Issuance of common stock                                                25,485            440            312
Exercise of stock options, including tax benefit                         5,386             --             --
------------------------------------------------------------------------------------------------------------
Balance at end of period                                               222,525        191,654        191,214
------------------------------------------------------------------------------------------------------------
Retained earnings
Balance at beginning of period                                         201,228        158,806        121,959
Net Income                                                              56,524         45,527         39,806
Dividend                                                                (3,945)        (3,015)        (2,959)
------------------------------------------------------------------------------------------------------------
Balance at end of period                                               253,807        201,228        158,806
------------------------------------------------------------------------------------------------------------
Treasury stock
Balance at beginning of period                                          (3,638)        (3,638)            --
Purchase of treasury stock at cost                                        (232)            --         (3,638)
------------------------------------------------------------------------------------------------------------
Balance at end of period                                                (3,870)        (3,638)        (3,638)
------------------------------------------------------------------------------------------------------------
Foreign exchange translation
Balance at beginning of period                                               0            (20)           (10)
Foreign exchange translation                                               122             20            (10)
------------------------------------------------------------------------------------------------------------
Balance at end of period                                                   122              0            (20)
------------------------------------------------------------------------------------------------------------
Net unrealized gain (loss) on fixed
  maturity securities available for sale
Balance at beginning of period                                          22,549        (20,998)        10,832
Fixed maturities available for sale adjustments                         (5,947)        43,547        (31,830)
------------------------------------------------------------------------------------------------------------
Balance at end of period                                                16,602         22,549        (20,998)
------------------------------------------------------------------------------------------------------------
Total stockholders' equity                                             489,346        411,943        325,514
============================================================================================================
</TABLE>

                                      35
<PAGE>

Capital Re Corporation and Subsidiaries
Consolidated Statements of Cash Flows


<TABLE>
<CAPTION>

                                                                              Year ended December 31,
                                                                    ----------------------------------------
(Dollars in thousands)                                                   1996            1995           1994
------------------------------------------------------------------------------------------------------------
<S>                                                                 <C>            <C>            <C>
Net income                                                          $   56,524     $   45,527     $   39,806
Adjustments to reconcile net income to net cash provided
   by operating activities:
   Amortization of discount on long-term debt                               38             38             38
   Net amortization of investment security discounts                       293          1,573          2,099
   Provision for deferred federal income taxes                          11,489          5,351          6,320
   Acquisition costs deferred                                          (39,725)       (32,607)       (34,099)
   Amortization of deferred acquisition costs                           30,714         20,902         21,471
   Change in accrued investment income                                  (2,806)           462         (2,547)
   Change in premiums receivable                                         2,467        (13,864)        (1,657)
   Change in deferred premium revenue, net                              12,752         29,411         23,947
   Change in reserve for losses and loss adjustment expenses, net        7,810          2,557          5,926
   Change in funds held under reinsurance contracts                         --             16          6,194
   Net realized gains on investments                                    (1,471)           (53)        (1,780)
   Change in ceded balances payable                                     (7,950)         8,000             --
   Other                                                                25,795          6,371          2,518
------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities                               95,930         73,684         68,236
------------------------------------------------------------------------------------------------------------

Investing activities
Fixed maturity securities available-for-sale:
   Purchases                                                          (741,415)      (226,955)      (202,516)
   Sales                                                               589,143        165,775         53,437
   Maturities                                                            6,280          7,100         36,170
Fixed maturity securities held-to-maturity:
   Purchases                                                                --             --        (11,573)
   Maturities                                                               --          6,028         14,782
Purchases of short-term investments, net                                 8,686        (21,649)       (23,774)
Investment in subsidiaries                                             (25,791)          (304)          (273)
Other investing activities                                              42,211             --             --
------------------------------------------------------------------------------------------------------------
Net cash used in investing activities                                 (120,886)       (70,005)      (133,747)
------------------------------------------------------------------------------------------------------------

Financing activities
Net proceeds from sale of preferred shares of subsidiary                    --             --         72,753
Net proceeds from sale of stock                                         25,493            440            313
Net proceeds from exercise of stock options                              5,388             --             --
Net proceeds from issuance of notes payable                              9,000             --             --
Purchase of treasury stock, at cost                                       (232)            --         (3,638)
Dividends paid                                                          (3,945)        (3,105)        (2,959)
------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities                     35,704         (2,665)        66,469
------------------------------------------------------------------------------------------------------------
Increase in cash                                                        10,748          1,014            958
Cash at beginning of year                                                4,537          3,523          2,565
------------------------------------------------------------------------------------------------------------
Cash at end of year                                                 $   15,285    $     4,537    $     3,523
============================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.

                                      36
<PAGE>
Capital Re Corporation and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 1996


1. Business and Organization
Capital Re Corporation (the "Corporation") was incorporated in the State of
Delaware in December 1991, and is the successor by merger to a Maryland
corporation incorporated in 1986. The Corporation is an insurance holding
company and has six wholly-owned operating subsidiaries. Capital Reinsurance
Company ("Capital Reinsurance"), domiciled in the state of Maryland, commenced
operations in January 1988. Capital Reinsurance is principally engaged in the
business of financial guaranty reinsurance, which includes the reinsurance of
municipal and non-municipal bond reinsurance policies. Capital Mortgage
Reinsurance Company ("Capital Mortgage"), a New York-domiciled company,
commenced operations in February 1994. Capital Mortgage reinsures only
residential mortgage guaranty insurance obligations originating principally in
the United States and the United Kingdom. KRE Reinsurance Ltd. ("KRE"),
(formerly Capital Mortgage Reinsurance Company (Bermuda) Ltd.) a Bermuda-
domiciled company, commenced operations in March 1994. KRE is engaged in the
business of reinsuring financial guaranty, mortgage guaranty and trade credit
and other specialty insurance policies, both as a direct reinsurer of third
party primary insurers and as a retrocessionaire of Capital Reinsurance, Capital
Mortgage and Capital Credit Reinsurance Company, Ltd. ("Capital Credit").
Capital Credit, also a Bermuda-domiciled insurance company, commenced operations
in February 1990. Capital Credit reinsures trade credit and other specialty
insurance lines, concentrated in Western Europe and the United States and is a
retrocessionaire of Capital Reinsurance and Capital Mortgage. Capital Title
Reinsurance Company ("Capital Title"), a New York-domiciled insurance company,
commenced operations in March 1996. Capital Title is engaged in the business of
reinsuring title insurance policies. In November 1996, the Corporation, through
its newly formed United Kingdom holding company, Capital Re (UK) Holdings,
acquired 100% of the issued shares of Tower Street Holdings Limited (now known
as RGB Holdings, Ltd.), the holding company for RGB Underwriting Agencies Ltd.
("RGB"). RGB is a managing agency and presently manages five syndicates
operating in the Lloyd's of London insurance market. In connection with this
acquisition, the Corporation established a corporate name at Lloyd's to support
underwriting on the managed syndicates. The corporate name participates in a non
marine and a life syndicate. At December 31, 1996, the results of RGB and the
corporate name at Lloyd's are consolidated in the Corporation's financial
statements. The goodwill associated with this acquisition will be amortized over
twenty years.

Also in December 1996, the Corporation entered into a joint venture with GCR
Holdings Limited to form a Bermuda-based insurer, Capital Global Underwriters
Limited ("CGUL"), which will specialize in financial reinsurance, including
financial guaranty, mortgage guaranty and finite risk reinsurance. The
Corporation, through its subsidiary, KRE, owns a fifty percent interest in CGUL
and controls 9.9% of its voting stock. The Corporation accounts for its
investment in CGUL under the equity method.

2. Significant Accounting Policies

Basis of Presentation
The accompanying consolidated financial statements include the accounts and
operations of the Corporation and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated.

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported


                                      37
<PAGE>

Capital Re Corporation and Subsidiaries
Notes to Consolidated Financial Statements continued

amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.

The 1995 and 1994 financial statements have been reclassified to conform with
the 1996 presentation.

Significant accounting policies are as follows:

Investments in Securities

The Corporation accounts for its investments in fixed maturity securities in
accordance with FASB Statement No. 115 ("SFAS 115"), "Accounting for Certain
Investments in Debt and Equity Securities." Management determines the
appropriate classification of securities at the time of purchase. At December
31, 1996 and 1995, investments in fixed maturity securities were designated as
available-for-sale.

The Corporation invests in mortgage-backed securities, including collateralized
mortgage obligations. The Corporation recognizes income for these securities
using a constant effective yield based on anticipated prepayments and the
estimated economic life of the securities. When actual prepayments differ
significantly from anticipated prepayments, the effective yield is recalculated
to reflect actual payments to date and anticipated future payments. The net
investment in the security is adjusted to the amount that would have existed had
the new effective yield been applied since the acquisition of the security. That
adjustment is included in net investment income. Short-term investments are
carried at cost, which approximates market value. Realized gains and losses on
sale or maturity of investments and declines in value judged to be other-than-
temporary are determined by specific identification and included in net realized
gains.

The amortized cost of fixed maturity securities is adjusted for amortization of
premiums and accretion of discounts. That amortization or accretion is included
in net investment income.

Premium Revenue Recognition
Financial Guaranty: Generally, financial guaranty reinsurance premiums which
include municipal and non-municipal transactions are paid entirely at contract
inception. For purposes of earnings recognition, premiums are allocated to each
year in the term of the guaranty and are earned pro-rata over the period of
risk. Accordingly, the deferred premium revenue represents the portion of
premiums written that is applicable to the unexpired risk of reinsured bonds and
notes.

Mortgage Guaranty: Mortgage guaranty reinsurance premiums are collected on both
a single premium basis and annual payment basis. All premiums written are
initially deferred as deferred premium revenue and earned pro-rata over the
policy term. Premiums paid in lump sum on policies covering more than one year
are amortized over the policy life in accordance with the expiration of risk.
Premiums paid annually are earned on a monthly pro-rata basis over the annual
period.

Trade Credit: Trade credit reinsurance contracts are typically issued on an
annual basis with premiums payable quarterly or semi-annually. Premiums are
earned pro-rata over the covered period under the terms of each contract.

Title Insurance: Title reinsurance premiums are generally paid up front.
Premiums are earned as written.

Deferred Acquisition Costs
Acquisition costs include only those expenses that relate to, and vary with,
premium production, including commissions, brokerage and costs of underwriting
and marketing personnel. Acquisition costs are deferred and amortized over the
period in which the related premiums are

                                      38
<PAGE>

earned. Ceding commission income on premiums ceded to other reinsurers reduces
acquisition costs. Anticipated losses, loss adjustment expenses and the
remaining costs of servicing the reinsured issues are considered in determining
the recoverability of acquisition costs.

Losses and Loss Adjustment Expenses
Financial Guaranty: Financial guaranty reserves for losses and loss adjustment
expenses are equal to the present value of the expected loss on any reinsured
risks having, in management's judgment, a probable payment default. At December
31, 1996 and 1995, reserves for losses and loss adjustment expenses were
discounted approximately $0.4 million using an average rate of 6.0% in 1996 and
6.75% in 1995.

Mortgage Guaranty: For the mortgage guaranty business, reserves are established
for reported insurance losses and loss adjustment expenses based on the receipt
of notices of default from ceding companies. Reserves are also established for
estimated losses incurred on notices of default not yet reported to ceding
companies. Reserves for ultimate losses are established by management using
estimated claim rates and claim amounts.

Trade Credit: For the trade credit reinsurance business, loss reserves are
established according to management's loss expectations which are based on
historical loss development patterns experienced by the ceding companies on
similar business as well as management's view of current macroeconomic
conditions in the countries in which the policies apply.

Title Insurance: For title reinsurance business, reserves are established for
reported insurance losses and loss adjustment expenses based upon receipt of
notices of a claim from the ceding companies. As of December 31, 1996, there
were no title insurance losses ceded to the Corporation.

Contingent Commissions
Under the terms of certain of the Corporation's reinsurance contracts, the
Corporation is obligated to pay the ceding company a contingent commission based
upon a specified percentage of the net underwriting profits. As of December 31,
1996 and 1995, the Corporation's liability for the present value of expected
future payments is shown on the balance sheet under the caption "Profit
commission liability."

Stock Based Compensation
The Corporation grants stock options to certain employees for a fixed number of
shares to employees with an exercise price equal to the fair value of the shares
at the date of grant. The Corporation accounts for stock option grants in
accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees,"
and, accordingly, recognizes no compensation expense for the stock option
grants.

Income Taxes
In accordance with FASB Statement No. 109, "Accounting for Income Taxes,"
deferred federal income taxes are provided on the temporary difference between
the tax basis of an asset or liability and its reported amount in the financial
statements that will result in deductible or taxable amounts in future years
when the reported amount of the asset or liability is recovered or settled. Such
temporary differences relate principally to premium revenue recognition,
deferred acquisition costs, and contingency reserve. The Internal Revenue Code
permits companies writing financial guaranty insurance and mortgage guaranty
insurance to deduct from taxable income amounts added to the statutory
contingency reserve, subject to certain limitations. The amounts deducted must
be included in taxable income in the tenth or twentieth year following the year
of deduction dependent on the type of business, or in the event that incurred
losses exceed certain statutorily established levels and the contingency reserve
is released to cover such excess losses.

                                      39
<PAGE>

Capital Re Corporation and Subsidiaries
Notes to Consolidated Financial Statements continued

However, the tax benefits obtained from such deductions must be invested in
noninterest-bearing U.S. Government tax and loss bonds. The Corporation records
purchases of tax and loss bonds as payments of federal income taxes.

Earnings Per Share
Net income per share of common stock is computed by dividing net income by the
weighted average number of shares of common stock outstanding during each year.
The effect of outstanding stock options in 1996, 1995 and 1994 was not dilutive
in the computation of earnings per share.

3. Statutory Accounting Practices
The financial statements are prepared on the basis of GAAP, which differs in
certain respects from accounting practices prescribed or permitted by the
Maryland Insurance Administration and the Insurance Department of the State of
New York (the insurance departments in the states of domicile of Capital
Reinsurance and Capital Mortgage and Capital Title, respectively), as well as
the statutory requirements of the Minister of Finance of the Island of Bermuda
(place of domicile of Capital Credit and KRE). Statutory accounting practices
for the Corporation's insurance subsidiaries differ from GAAP as follows:

  Acquisition costs are charged to current operations as incurred rather than as
  related premiums are earned;

  A contingency reserve is computed on the basis of statutory requirements
  regardless of when loss contingencies actually exist;

  A title statutory premium reserve is established based upon assumed exposure
  regardless of when loss contingencies actually exist;

  Federal income taxes are only provided on taxable income for which income
  taxes are currently payable, while under GAAP, deferred income taxes are
  provided with respect to temporary differences.

  Purchases of tax and loss bonds are reflected as admitted assets, while under
  GAAP they are recorded as federal income tax payments;

  Financial guaranty premiums are earned in direct proportion to the payment of
  debt service rather than pro-rata over the period of risk;

  Investments in fixed maturity securities are reported at amortized cost or
  market value based on the National Association of Insurance Commissioners
  ("NAIC") rating; under GAAP, these fixed maturity investments are carried in
  accordance with SFAS 115 (see Note 2).

  Certain assets designated as "non-admitted assets" are charged directly to
  statutory capital and surplus, but are reflected as assets under GAAP.

  Holding company guarantees (approved by Bermuda's Minister of Finance) issued
  for the benefit of Capital Credit and KRE under which the holding company is
  obligated under certain circumstances to invest additional capital in each
  company are admitted assets and included as part of statutory capital and
  surplus.

The following is a reconciliation of the Corporation's consolidated GAAP net
income and stockholders' equity to the corresponding consolidated statutory
amounts for its insurance subsidiaries:


                                      40
<PAGE>

<TABLE>
<CAPTION>

                                                                                   Year ended December 31,
                                                                           -------------------------------------
(Dollars in thousands)                                                       1996            1995           1994
----------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>            <C>            <C>
Consolidated GAAP net income                                              $ 56,524       $ 45,527       $ 39,806
Premium revenue recognition                                                (14,851)        (6,995)          (532)
Deferred acquisition costs                                                  (9,011)       (11,705)       (12,628)
Deferral of income taxes                                                    11,489          5,373          6,320
Tax and loss bonds                                                           4,848          4,116          1,964
Interest expense and minority interest in
  Capital Re LLC                                                            12,633         12,631         11,925
Other, including non-insurance subsidiaries                                 (4,091)        (3,160)        (3,768)
----------------------------------------------------------------------------------------------------------------
Consolidated statutory net income                                         $ 57,541       $ 45,787       $ 43,087
================================================================================================================

                                                                                      Year ended December 31,
                                                                                 -------------------------------
(Dollars in thousands)                                                              1996                    1995
----------------------------------------------------------------------------------------------------------------
GAAP stockholders' equity                                                      $ 489,346               $ 411,943
Premium revenue recognition                                                      (42,166)                (26,662)
Deferred acquisition costs                                                      (111,364)               (102,353)
Profit commission                                                                 (8,067)                   (86)
Unrealized (gain) loss on fixed maturity securities available for sale           (25,541)                (34,691)
Deferral of income taxes                                                          58,474                  50,187
Tax and loss bonds                                                                17,157                  12,309
Contingency reserve                                                             (123,363)                (89,685)
Long-term debt and Company obligated mandatorily redeemable
   preferred securities of Capital Re LLC                                        174,782                 165,744
Parental guarantee                                                                30,000                  30,000
Goodwill                                                                         (13,567)                     --
Other, including noninsurance subsidiaries                                        (2,240)                 (3,822)
----------------------------------------------------------------------------------------------------------------
Consolidated statutory policyholders' surplus                                  $ 443,451               $ 412,884
================================================================================================================
</TABLE>

                                      41
<PAGE>

Capital Re Corporation and Subsidiaries
Notes to Consolidated Financial Statements continued


4. Insurance in Force--Financial
Guaranty and Mortgage Guaranty
Financial Guaranty: At December 31, 1996, the Corporation's reinsured financial
guaranty portfolio included the reinsured portfolios of Capital Reinsurance,
Capital Credit and KRE, net of eliminations and was broadly diversified by bond
type, geographic location and maturity schedule, with no single risk
representing more than 1.9% of the Corporation's net par in force. The
Corporation limits its exposure to losses from reinsured financial guarantees by
underwriting primarily investment grade obligations and retroceding a portion of
its risks to other insurance companies.

Net financial guaranty par in force was approximately $39.4 billion at December
31, 1996. The composition at December 31, 1996, by type of issue and the range
of final maturities, was as follows:

<TABLE>
<CAPTION>
                                                                                         Range
                                                                  Net Par               of Final
(Dollars in billions)                                            in Force              Maturities
-------------------------------------------------------------------------------------------------
<S>                                                                <C>                 <C>
Type of Issue
Tax-backed                                                          $11.7              1-40 years
Utility                                                              11.1              1-40 years
Non-municipal                                                         5.3              1-35 years
Health care                                                           5.2              1-40 years
Special revenue                                                       4.7              1-40 years
Housing                                                               1.0              1-40 years
U.S. Government                                                       0.4              1-40 years
-------------------------------------------------------------------------------------------------
                                                                    $39.4
=================================================================================================
</TABLE>

The reinsured portfolio contained exposures in each of the 50 states. Net par in
force at December 31, 1996, by state, was as follows:

<TABLE>
<CAPTION>

                                                                                          Net Par
(Dollars in billions)                                                                    in Force
-------------------------------------------------------------------------------------------------
<S>                                                                                         <C>
California                                                                                  $ 4.4
New York                                                                                      4.2
Florida                                                                                       2.6
Texas                                                                                         2.0
Pennsylvania                                                                                  1.9
Others (each less than 4%)                                                                   24.3
-------------------------------------------------------------------------------------------------
                                                                                            $39.4
=================================================================================================
</TABLE>

                                      42
<PAGE>

Mortgage Guaranty: At December 31, 1996, the Corporation's net mortgage guaranty
insurance in force (representing the current principal balance of all mortgage
loans that are currently reinsured) and direct primary net risk in force was
approximately $8.0 billion and $2.3 billion, respectively. California represents
the Corporation's largest U.S. risk concentration at approximately 22%, however,
its total U.S. distribution of mortgage guaranty risk in force parallels that of
the U.S. primary mortgage insurance industry.

5. Investments in Securities
The following summarizes the Corporation's aggregate investment portfolio at
December 31, 1996:

<TABLE>
<CAPTION>

                                                                             Gross          Gross
                                                           Amortized    Unrealized     Unrealized      Estimated
(Dollars in thousands)                                          Cost         Gains         Losses     Fair Value
-----------------------------------------------------------------------------------------------------------------
<S>                                                        <C>            <C>            <C>           <C>
Fixed maturity securities
  available for sale:
    U.S. Treasury securities and
      obligations of U.S. government agencies              $  75,960      $  1,525       $   (428)     $  77,057
    Obligations of states and political subdivisions         398,006        21,058            (98)       418,966
    Corporate securities                                     115,013           751           (231)       115,533
    Mortgage-backed securities                               197,928         3,147           (313)       200,762
    Emerging markets                                          13,230           136             (6)        13,360
-----------------------------------------------------------------------------------------------------------------
Total available-for-sale                                     800,137        26,617         (1,076)       825,678
Short-term investments                                        75,424            --             --         75,424
-----------------------------------------------------------------------------------------------------------------
Total investments                                           $875,561       $26,617        $(1,076)      $901,102
=================================================================================================================
</TABLE>

The following summarizes the Corporation's aggregate investment portfolio at
December 31, 1995:


<TABLE>
<CAPTION>
                                                                             Gross          Gross
                                                           Amortized    Unrealized     Unrealized      Estimated
(Dollars in thousands)                                          Cost         Gains         Losses     Fair Value
----------------------------------------------------------------------------------------------------------------
<S>                                                        <C>            <C>               <C>        <C>
Fixed maturity securities
  available for sale:
    U.S. Treasury securities and
      obligations of U.S. government agencies              $  30,219      $  1,615          $  --      $  31,834
    Obligations of states and political subdivisions         332,229        26,871           (126)       358,974
    Corporate securities                                     134,130         1,977           (126)       135,981
    Mortgage-backed securities                               156,388         4,778           (298)       160,868
----------------------------------------------------------------------------------------------------------------
Total available-for-sale                                     652,966        35,241           (550)       687,657
Short-term investments                                        84,110            --             --         84,110
----------------------------------------------------------------------------------------------------------------
Total investments                                           $737,076       $35,241          $(550)      $771,767
================================================================================================================
</TABLE>


                                      43
<PAGE>

Capital Re Corporation and Subsidiaries
Notes to Consolidated Financial Statements continued


The amortized cost and estimated fair value of fixed maturity securities
available-for-sale at December 31, 1996, by contractual maturity are shown
below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.

<TABLE>
<CAPTION>

                                                                          Amortized
(Dollars in thousands)                                                         Cost             Fair Value
-----------------------------------------------------------------------------------------------------------
<S>                                                                       <C>                     <C>
Maturity:
  Due in 1997-2001                                                        $  89,923               $  90,581
  Due in 2002-2006                                                           85,694                  87,058
  Due after 2006                                                            426,592                 447,277
  Mortgage-backed securities                                                197,928                 200,762
-----------------------------------------------------------------------------------------------------------
Total                                                                      $800,137                $825,678
===========================================================================================================
</TABLE>

In 1996, the Corporation realized gross gains and losses of $8.5 million and
($7.0) million, respectively. In 1995, the Corporation realized gross gains and
losses of $3.5 million and ($3.4) million, respectively. Included in gross
losses in 1995 were ($2.6) million for other than temporary declines in value.
In 1994, the Corporation realized gross gains and losses of $3.2 million and
($1.4) million, respec tively. Included in gross losses in 1994 were ($1.1)
million for other than temporary declines in value. Approximately 22.3% of the
Corporation's total investment portfolio of $901.1 million at December 31, 1996
is comprised of mortgage-backed securities ("MBS"), including collateralized
mortgage obligations. Of the securities in the MBS portfolio, approximately
71.1% are backed by agencies or entities sponsored by the U.S. government. As of
December 31, 1996, the weighted average credit quality of the Corporation's
entire investment portfolio was triple A.

Net investment income is derived from the following sources:


<TABLE>
<CAPTION>

                                                                                Year ended December 31,
                                                                       --------------------------------------
(Dollars in thousands)                                                    1996            1995           1994
-------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>            <C>            <C>
Income from fixed maturity securities                                   $46,207        $42,730        $38,458
Income from short-term investments                                        6,351          4,406          2,156
-------------------------------------------------------------------------------------------------------------
Total investment income                                                  52,558         47,136         40,614
Less investment expenses                                                 (1,000)          (482)          (501)
-------------------------------------------------------------------------------------------------------------
Net investment income                                                   $51,558        $46,654        $40,113
=============================================================================================================
</TABLE>

                                      44
<PAGE>

Under agreements with its cedants and in accordance with statutory requirements,
certain of the Corporation's subsidiaries maintain fixed maturity securities in
trust accounts for the benefit of reinsured companies and for the protection of
policyholders in states in which they are not licensed. The carrying amount of
such restricted balances amounted to approximately $31.9 million and $30.5
million at December 31, 1996 and 1995, respectively. Additionally, at December
31, 1996 and 1995, $3.7 million and $5.1 million, respectively, was on deposit
with state insurance departments to satisfy regulatory requirements.

6. Reserves for Unpaid Losses and Loss
Adjustment Expenses
The following table provides a reconciliation of the beginning and ending
reserve balances for unpaid losses and loss adjustment expenses ("LAE").



<TABLE>
<CAPTION>

                                                                                   Year ended December 31,
                                                                          --------------------------------------
(Dollars in thousands)                                                        1996           1995           1994
----------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>             <C>            <C>
Reserve for losses and LAE, net of related reinsurance
  recoverables, at beginning of year                                       $10,245         $7,702         $1,776
Add:
  Provision for unpaid losses and LAE for claims
    occurring in the current year, net of reinsurance                        8,370          1,660          1,296
  Increase in estimated losses and LAE for claims
    occurring in prior years, net of reinsurance                             1,113            977            871
----------------------------------------------------------------------------------------------------------------
  Incurred losses during the current year, net of reinsurance                9,483          2,637          2,167
----------------------------------------------------------------------------------------------------------------
Deduct:
  Losses and LAE payments (net of recoverables) for claims
    occurring in the current year                                               10           (474)           (32)
  Losses and LAE payments (net of recoverables) for claims
    occurring in the prior year                                              1,959            568         (3,727)
----------------------------------------------------------------------------------------------------------------
                                                                             1,969             94         (3,759)
----------------------------------------------------------------------------------------------------------------

Reserve for unpaid losses and LAE, net of related
  reinsurance recoverables, at end of year                                  17,759         10,245          7,702
Unrealized foreign exchange loss on reserve revaluation                        310             14             --
Reinsurance recoverables on unpaid losses
  and LAE, at end of year                                                    1,833          2,524          1,310
----------------------------------------------------------------------------------------------------------------
Reserve for unpaid losses and LAE, gross of reinsurance
  recoverables on unpaid losses at end of year                             $19,902        $12,783         $9,012
================================================================================================================
</TABLE>

                                      45
<PAGE>

Capital Re Corporation and Subsidiaries
Notes to Consolidated Financial Statements continued


Incurred losses in 1996 and 1995 were principally from the mortgage guaranty and
trade credit reinsurance lines of business. Incurred losses in 1994 were caused
primarily by increases in reserves estimated for mortgage guaranty losses. The
increases for 1996, 1995 and 1994 are consistent with the expected loss
development patterns for the mortgage guaranty and trade credit lines of
business.

7. Debt and Liquidity Facility
Debt consists of:


<TABLE>
<CAPTION>
                                                                                      Year ended December 31,
                                                                                --------------------------------
(Dollars in thousands)                                                              1996                    1995
----------------------------------------------------------------------------------------------------------------
<S>                                                                             <C>                      <C>
7.75% Debentures due 2002, net of unamortized
   discount of $0.2 million in 1996 and $0.3 million in 1995
   ("Debentures")                                                                $74,782                 $74,744
Subordinated Notes due August 1996                                                    --                  16,000
Bank note payable                                                                 25,000                      --
----------------------------------------------------------------------------------------------------------------
Total                                                                            $99,782                 $90,744
================================================================================================================
</TABLE>

The Debentures include certain covenants none of which significantly restrict
the Corporation's operating activities or dividend paying ability. During 1996,
the Corporation entered into a $25.0 million credit facility with Chase
Manhattan Bank, expiring August 20, 1997. Interest on the facility is payable
semi-annually at a rate equal to the then London Interbank offered rate plus 40
basis points. The Corpo-ration utilized $16.0 million, of this $25.0 million
facility to retire the subordinated notes and the remaining $9.0 million of the
credit facility for purposes of acquiring Tower Street Holdings.

On January 31, 1997, the Corporation renewed an agreement with Deutsche Bank AG
for the provision of a $25.0 million liquidity facility which will be available
for general corporate purposes expiring January 26, 1998. Capital Reinsurance
also renewed an agreement on January 31, 1997 with Deutsche Bank AG for a credit
facility of up to $75.0 million specifically designed to provide rating agency
qualified capital to further support Capital Reinsurance's claims-paying
resources. This agreement expires January 27, 2004.

During 1996, 1995 and 1994, the Corporation paid total interest of approximately
$6.9 million, $6.9 million and $6.5 million, respectively.

8. Income Taxes
The Corporation and its subsidiaries file a consolidated federal income tax
return. The Corporation's effective federal corporate tax rate for 1996, 1995
and 1994 was 26.7%, 24.2% and 25.0%, respectively.

A reconciliation from the tax provision calculated at the federal statutory rate
of 35% in 1996, 1995 and 1994, to the total tax is as follows:


                                      46
<PAGE>

<TABLE>
<CAPTION>

                                                                                  Year ended December 31,
                                                                          --------------------------------------
(Dollars in thousands)                                                        1996           1995           1994
----------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>            <C>            <C>
Tax provision at statutory rate                                            $27,006        $21,026        $18,586
Tax-exempt interest                                                         (6,710)        (5,940)        (5,594)
Other, net                                                                     339           (538)           304
----------------------------------------------------------------------------------------------------------------
Total federal income tax provision                                         $20,635        $14,548        $13,296
================================================================================================================
</TABLE>

The liability for deferred federal income taxes reflects the tax effect of the
following temporary differences:


<TABLE>
<CAPTION>

                                                                                      Year ended December 31,
                                                                                --------------------------------
(Dollars in thousands)                                                              1996                    1995
----------------------------------------------------------------------------------------------------------------
<S>                                                                             <C>                     <C>
Deferral of acquisition costs                                                   $ 39,033                $ 35,824
Contingency reserve                                                               30,670                  22,186
Deferred premium revenue                                                           3,198                  (1,031)
Other than temporary declines in value of investments                                 --                  (2,293)
Unrealized gain on fixed maturity securities available for sale                    8,940                  12,142
Other                                                                                430                     499
----------------------------------------------------------------------------------------------------------------
Effects of temporary differences                                                  82,271                  67,327
Credit for alternative minimum tax carryforwards                                  (6,640)                 (4,831)
Tax and loss bonds                                                               (17,157)                (12,309)
----------------------------------------------------------------------------------------------------------------
Liability for deferred federal income taxes                                     $ 58,474                $ 50,187
================================================================================================================
</TABLE>

Income taxes paid during 1996, 1995 and 1994 were approximately $7.9 million,
$8.7 million and $6.2 million, respectively.

9. Reinsurance Ceded
To limit its exposure on assumed risks, the Corporation enters into certain
proportional and nonproportional retrocessional agreements that cede a portion
of risks underwritten to other insurance companies. In the event that any or all
of the reinsurers were unable to meet their obligations, the Corporation would
be liable for such defaulted amounts.

For the years ended December 31, 1996, 1995 and 1994, ceded earned premiums were
$14.7 million, $8.0 million and $11.5 million, respectively. Ceded losses for
the same periods were $6.5 million, $2.6 million and $3.7 million, respectively.

During 1993, Capital Reinsurance entered into a multi-year nonproportional
reinsurance contract which provides for aggregate loss protection of $80.0
million in exchange for $19.5 million of premium. Additional premiums may become
payable dependent upon the level of losses incurred. During 1993, Capital Credit
entered into similar multi-year reinsurance contracts which provide for
aggregate loss protection of $34.0 million in exchange for $4.3 million in
premiums. Additional premiums may also become payable dependent upon the level
of losses incurred.



                                      47
<PAGE>

Capital Re Corporation and Subsidiaries
Notes to Consolidated Financial Statements continued

During 1994, Capital Reinsurance entered into a portfolio excess of loss
reinsurance contract which provides $100.0 million aggregate loss protection on
specified municipal obligations in excess of $82.0 million of losses. Capital
Mortgage entered into a similar portfolio excess of loss reinsurance contract
which provides $30.0 million aggregate loss protection in excess of a specified
loss ratio covering all reinsured obligations. Premiums due on both contracts
are not dependent upon the level of losses incurred.

During 1995, Capital Mortgage entered into an assumption agreement whereby it
provides excess of loss reinsurance on an existing portfolio of mortgage pool
insurance. In connection with this assumed transaction, Capital Mortgage is
required to cede a portion of the risks, thereby reducing its total net
retention. Total ceded premiums under the contract were approximately $21.6
million. Total expected assumed premiums of $56.0 million are payable in seven
annual installments of $8.0 million. Contingent commissions will be payable on
the assumed reinsurance and receivable on the ceded reinsurance, dependent upon
the level of losses incurred under the contract.

10. Fair Values of Financial Instruments
The following methods and assumptions were used by the Corporation in estimating
its fair value disclosure for financial instruments. These determinations were
made based on available market information and appropriate valuation
methodologies. Considerable judgment is required to interpret market data to
develop the estimates and therefore, they may not necessarily be indicative of
the amount the Corporation could realize in a current market exchange.

Cash and Short-term Investments
The carrying amount reported in the balance sheet for these instruments
approximates fair value.

Fixed Maturity Securities
The fair value for fixed maturity securities shown in Note 5 is based on quoted
market prices.

Deferred Premium Revenue
The fair value of the Corporation's deferred premium revenue is based on
entering into a cession of the entire portfolio with third party reinsurers
under market conditions. This figure was determined by using the statutory basis
unearned premium reserve, net of deferred acquisition costs, and the present
value of the estimated future cash flow stream from installment premiums. At
December 31, 1996, the fair value of the Corporation's net deferred premium
revenue was estimated to be $272.0 million.

Reserve for Losses and Loss Adjustment
Expenses, Net of Reinsurance Recoverable
on Ceded Losses
The carrying amount is composed of the present value of the expected cash flows
for case basis claims. Accordingly, the carrying amount is deemed the best
estimate of fair value as of December 31, 1996.

Debt
The fair value of the Corporation's $75.0 million of outstanding Debentures is
determined based on the projected cash flows discounted by the sum of the
seven-year U.S. treasury yield at December 31, 1996, and the appropriate credit
spread for similar debt instruments. At Decem-ber 31, 1996, the fair value of
the Corporation's Debentures was estimated to be $77.2 million.

                                      48
<PAGE>

The carrying amount of the Corporation's bank notes payable of $25.0 million
approximates fair value due to their floating interest rate provision.

Preferred Securities of Capital Re LLC
The fair value of the Corporation's $75.0 million Company obligated mandatorily
redeemable preferred securities of Capital Re LLC at December 31, 1996, was
$72.4 million based on the closing price per share on the New York Stock
Exchange at that date.

11. Dividends
Under Maryland's insurance law, the amount of surplus available for distribution
as dividends is subject to certain statutory provisions, which generally
prohibit the payment of dividends in any twelve-month period without prior
approval of the Maryland Commissioner of Insurance in an amount exceeding 10% of
statutory capital and surplus at the preceding December 31. The amount available
for distribution from Capital Reinsurance during 1996 with notice to, but
without prior approval of, the Maryland Commissioner of Insurance under the
Maryland insurance law was approximately $32.9 million. During 1996, Capital
Reinsurance paid dividends in the amount of $17.5 million to the Corporation.

Credit Re has never paid a dividend to the Corporation. Were it to pay dividends
to the Corporation, it would rely on dividends from its wholly-owned subsidiary,
Capital Credit. Capital Credit's and KRE's dividend distributions are governed
by Bermuda law. Under Bermuda law and the By-Laws of Capital Credit and KRE,
dividends may be paid out of the profits of Capital Credit and KRE (defined as
accumulated realized profits less accumulated realized losses). Distributions to
shareholders may also be paid out of Capital Credit's and KRE's surplus limited
by requirements that Capital Credit and KRE must at all times (i) maintain the
minimum share capital required under Bermuda law and (ii) have relevant assets
in an amount equal to or greater than 75% of relevant liabilities, all as
defined under Bermuda law. Since their organization, Capital Credit and KRE have
not declared or paid any dividends.

Under New York Insurance Law, neither Capital Mortgage nor Capital Title may pay
any dividend to shareholders which, together with all dividends declared or
distributed by it during the preceding twelve months, exceeds the lesser of 10%
of its surplus to policyholders as shown by its last statement on file with the
superintendent, or 100% of adjusted net investment income during such period
unless specifically allowed by the superintendent. To date, Capital Mortgage and
Capital Title have not declared or paid any dividends. The maximum dividend
payable during 1996 is approximately $6.1 million.

12. Commitments
At December 31, 1996, future minimum rental payments under the terms of the
Corporation's noncancellable operating leases for office space are $1.2 million
for the year 1997, $0.8 million for the years 1998, 1999, 2000 and 2001, and
$6.5 million in the aggregate thereafter. These future minimum rental payments
totaling $10.9 million have not been reduced by minimum sublease rentals of $0.8
million due in the future under noncancellable subleases. These payments are
subject to escalations in building operating costs and real estate taxes. Total
rent expense amounted to approximately $0.9 million in each of the years 1996,
1995 and 1994.


                                      49
<PAGE>

Capital Re Corporation and Subsidiaries
Notes to Consolidated Financial Statements continued





13. Capital Re LLC
In January 1994, the Corporation formed and capitalized Capital Re LLC, a
limited liability company organized under the laws of the Turks and Caicos
Islands. Additionally, in January 1994, Capital Re LLC issued $75,000,000, 7.65%
of cumulative monthly income preferred shares, the proceeds of which were loaned
to the Corporation. The preferred shares were issued at $25 par value per share
and are shown on the balance sheet under the caption "Company obligated
mandatorily redeemable preferred securities of Capital Re LLC." The Corporation
guarantees the payment of the monthly dividend as well as any amounts upon
liquidation or redemption which cannot occur prior to January 31, 1999, at the
Corporation's discretion. Capital Re LLC exists solely for the purpose of
issuing preferred and common shares and lending the proceeds to the Corporation
to fund its business operations. The total amount paid to preferred shareholders
for the years ended 1996 and 1995 was approximately $5.7 million and is shown on
the income statement under the caption "Minority interest in Capital Re LLC."

14. Compensation Plans
Prior to its initial public offering, the Corporation had a stock incentive plan
wherein eligible employees were granted shares of restricted common stock.
Shares awarded under the Plan amounted to 696,000 at December 31, 1991. For
these awards, the difference between the price paid by the employees and the
market value of the award at the date of grant, if any, was recorded as deferred
compensation and was amortized ratably over the four-year vesting period. Upon
completion of the initial public offering in 1992, these shares became vested
and all restrictions lapsed.

To enable recipients of awards under the stock incentive plan to meet tax
obligations which may have resulted from such awards, the Corporation agreed to
make loans to recipients, payable upon ultimate disposition of their shares or
three years after their termination of employment. As of December 31, 1996 and
1995, total loans outstanding under all officer loan programs were approximately
$1.74 million and $1.78 million, respectively, at the end of the year, and are
included under the caption "Other assets."

On April 15, 1992, the Corporation adopted the 1992 Stock Option Plan (the
"Option Plan"). The Option Plan enables key employees to benefit from
appreciation in the price of the common stock of the Corporation. The Option
Plan provides for grants of incentive stock options ("ISO"), which are intended
to qualify under Section 422 of the Internal Revenue Code and of options which
are intended not to so qualify ("NQSO"). ISO's and NQSO's may be granted at a
price not less than 100% of the fair market value as determined on the date
granted. ISO's and NQSO's awarded are exercisable in four equal yearly
installments commencing one year after the date of grant and expire ten years
from the date of grant. According to the terms of the Option Plan, the aggregate
number of shares subject to option awards shall not exceed 1,450,000. Also, all
options granted have 10 year terms and vest 25% per annum over the term of
continued employment.

In 1993, the Corporation also adopted a stock option plan (the "Director's
Plan") for the benefit of its outside directors. The terms of the plan are
similar to those of the employee plan except that options become fully vested at
the time of grant. According to the terms of the Director's Plan, the aggregate
number of shares subject to option award shall not exceed 30,000.

The Corporation has elected to follow Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" (APB 25) and


                                      50
<PAGE>

related interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Corporation's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.

Pro forma information regarding net income and earnings per share is required by
State-ment 123, and has been determined as if the Corporation had accounted for
its employee stock options under the fair value method of that statement. The
fair value for these options was estimated at the date of grant using a Black-
Schole's option pricing model with the following weighted-average assumptions
for 1996 and 1995, respectively: risk-free interest rates of 5.42% and 7.36%
dividend yields of 0.80% and 0.88%; volatility factors of the expected market
price of the Corporation's common stock of 19.10 and 29.94; and an expected life
of the options of 7 years.

The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Corporation's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' expected lives. The Corporation's pro
forma information follows (in thousands, except for per share information):

<TABLE>
<CAPTION>

(Dollars in thousands)                                                              1996                   1995
----------------------------------------------------------------------------------------------------------------
<S>                                                                              <C>                    <C>
Pro forma net income                                                             $56,030                 $45,273
Pro forma earnings per common share                                              $  3.58                 $  3.06
----------------------------------------------------------------------------------------------------------------

A summary of the Corporation's stock option activity, and related information
for the years ended December 31 follows:

<CAPTION>
                                                                     1996                         1995
                                                            -----------------------      -----------------------
                                                                         Weighted-                     Weighted-
                                                                           Average                       Average
                                                                          Exercise                      Exercise
                                                             Options         Price        Options          Price
----------------------------------------------------------------------------------------------------------------
<S>                                                          <C>            <C>           <C>             <C>
Outstanding, beginning of year                               908,000        $20.77        686,400         $19.56
Granted                                                      277,500         31.49        248,400          23.99
Exercised                                                   (205,587)        19.69        (22,575)         19.51
Forfeited                                                    (11,313)        26.50         (4,225)         19.62
----------------------------------------------------------------------------------------------------------------
Outstanding, end of year                                     968,600        $24.01        908,000         $20.77
================================================================================================================
Exercisable, end of year                                     422,447        $20.25        395,150         $19.63
----------------------------------------------------------------------------------------------------------------
</TABLE>

                                      51
<PAGE>

Capital Re Corporation and Subsidiaries
Notes to Consolidated Financial Statements continued

<TABLE>
<CAPTION>

(Dollars in thousands)                                                              1996                    1995
----------------------------------------------------------------------------------------------------------------
<S>                                                                               <C>                     <C>
Weighted-average fair value of options
  granted during the year                                                         $10.92                  $11.03
----------------------------------------------------------------------------------------------------------------
</TABLE>

Exercise prices for options outstanding as of December 31, 1996, ranged from
$19.50 to $39.88. The weighted-average remaining contractual life of those
options is approximately 7.5 years.

In 1996, the Corporation adopted a performance share plan for the benefit of
senior executives of the Corporation. The plan is intended to align senior
management with the interest of the shareholders. To achieve this objective, the
plan ties awards granted under the plan with earning per share growth and with
total shareholder return and share price. These shares will be awarded at
December 31, 1999. The Corporation recognized $1.0 million in deferred
compensation expense for the year ended December 31, 1996.

The Corporation maintains a savings incentive plan which is qualified under
Section 401 of the Internal Revenue Code. The savings incentive plan is
available to all full-time employees with a minimum of six months of service.
Eligible participants may contribute 9% of their base salary subject to a
maximum of $9,500 for 1996. Contributions are matched by the Corporation at a
rate of 100%, up to 6% of the participants' contribution subject to certain
limitations and vest at a rate of 25% per year starting with the second year of
service. The Corporation contributed approximately $0.3 million, $0.2 million,
and $0.1 million in 1996, 1995 and 1994, respectively.

The Corporation also maintains a profit sharing plan which is available to all
full-time employees with a minimum of six months of service. Annual
contributions to the plan are at the discretion of the Board of Directors. The
plan contains a qualified portion and a nonqualified portion. Total expense
incurred under the plan amounted to approximately $0.03 million in 1996 and
1995, and $0.5 million in 1994.

The Corporation does not provide health care or life insurance benefits to
retirees.

15. Major Customers
The Corporation derives the majority of its gross written premiums from a small
number of primary insurers. The primary insurers which accounted for 10% or more
of gross written premiums are as follows:


<TABLE>
<CAPTION>

                                                                   Year ended December 31,
                                                            -------------------------------------
                                                             1996           1995           1994
-------------------------------------------------------------------------------------------------
<S>                                                          <C>            <C>            <C>
Primary Insurer
CMAC                                                           15.9%          11.5%             *
MBIA                                                           14.9           17.8           19.4
FGIC                                                           11.9              *           26.0
PMI                                                            10.7           10.5           18.8
AMBAC                                                             *           12.1              *
FSA                                                               *           14.9           11.4
-------------------------------------------------------------------------------------------------
* Less than 10%
</TABLE>

                                      52
<PAGE>

This customer concentration results from the small number of primary insurance
companies which are dedicated to writing financial guaranty and mortgage
guaranty insurance. The loss of a major customer would have the effect of
reducing the Corporation's gross written premiums. However, on a year-to-year
basis the Corporation is not particularly vulnerable to the loss of any of its
major customers because prior to the end of each calendar year, its reinsurance
treaty agreements are renewed for the following year and are generally not
cancelable until the following year-end. Further, because written premium are
earned over many years, net income would not be materially impacted in any
single year.

16. Quarterly Financial Summary (Unaudited)

<TABLE>
<CAPTION>
                                                        1st          2nd          3rd           4th
(Dollars in thousands except per share amounts)     Quarter      Quarter      Quarter       Quarter         Year
----------------------------------------------------------------------------------------------------------------
<S>                                                 <C>          <C>          <C>          <C>          <C>
1996
Gross written premiums                              $34,255      $30,957      $43,220       $21,386     $129,818
Net written premiums                                 18,060       26,902       40,500        19,726      105,188
Earned premiums                                      20,104       22,322       22,005        28,005       92,436
Net investment income and
  net realized gains                                 12,191       11,781       12,781        16,276       53,029
Income before provision for
  federal income tax                                 17,193       18,207       18,808        22,951       77,159
Net income                                           12,767       13,285       13,955        16,517       56,524
Net income per common share                         $  0.84      $  0.85      $  0.88       $  1.04     $   3.61
----------------------------------------------------------------------------------------------------------------

1995
Gross written premiums                              $24,189      $21,202      $23,977       $38,231     $107,599
Net written premiums                                 21,748       19,302       20,789        27,669       89,508
Earned premiums                                      13,929       16,584       13,322        16,262       60,097
Net investment income and
  net realized gains                                 11,530       11,493       11,546        12,138       46,707
Income before provision for
  federal income tax                                 14,350       15,004       15,099        15,622       60,075
Net income                                           11,077       11,264       11,353        11,833       45,527
Net income per common share                         $  0.75      $  0.76      $  0.77       $  0.80     $   3.08
----------------------------------------------------------------------------------------------------------------

1994
Gross written premiums                              $33,344      $23,743      $22,003       $15,761     $ 94,851
Net written premiums                                 20,732       24,439       21,128        16,496       82,795
Earned premiums                                      16,999       17,015       12,144        12,692       58,850
Net investment income and
  net realized gains                                 10,390        9,913       10,540        11,050       41,893
Income before provision for
  federal income tax                                 14,130       14,282       12,810        11,880       53,102
Net income                                           10,407       10,549        9,583         9,267       39,806
Net income per common share                         $  0.70      $  0.71      $  0.65       $  0.63     $   2.69
----------------------------------------------------------------------------------------------------------------
</TABLE>

                                      53
<PAGE>

Capital Re Corporation and Subsidiaries
Officers and Directors


Executive Officers of Capital Re Corporation


Michael E. Satz
Chairman, President  and
Chief Executive Officer

Executive Vice Presidents
David A. Buzen
Laurence C. D. Donnelly
Jerome F. Jurschak

Senior Vice Presidents
Stephen Donnarumma
Susan L. Hooker
Alan S. Roseman
Joseph W. Swain


--------------------------------------------------------------------------------
RGB Underwriting Agencies Ltd.

Peter Brotherton              Alan D. Satterford
Active Underwriter            Active Underwriter


--------------------------------------------------------------------------------
Board of Directors of Capital Re Corporation


Michael E. Satz/(3)/
Chairman, President  and
Chief Executive Officer

Harrison W. Conrad, Jr./(2,3)/

Richard L. Huber/(1)/
Vice Chairman,
Strategy and Finance
Aetna Life & Casualty Co.

Steven D. Kesler/(2,3)/
President
Constellation
Investments, Inc.


Steven H. Newman/(2,3)/
Chairman and President
Underwriters Re Group, Inc.

Philip H. Robinson/(1)/

Edwin L. Russell/(2)/
President  and
Chief Executive Officer
Minnesota Power & Light Company

Dan R. Skowronski, Esq./(1)/
General Counsel
Constellation Holdings, Inc.


Barbara D. Stewart/(1,2)/
President
Stewart Economics, Inc.

Jeffrey F. Stuermer/(1,3)/
Manager of Taxes
Minnesota Power & Light Company

Board Committees:
1. Audit Committee
2. Compensation Committee
3. Investment Committee



                                      54
<PAGE>

Capital Re Corporation and Subsidiaries
Shareholder Information


Corporate Headquarters
Capital Re Corporation
1325 Avenue of the Americas
New York, New York  10019
Telephone: 212-974-0100
Fax: 212-581-3268

Annual Meeting
The annual meeting of shareholders of Capital
Re Corporation will be held on May 21, 1997, at
10:00 a.m. at The Equitable, 787 Seventh Avenue,
49th Floor, New York, New York 10019.


Form 10-K
A copy of the Corporation's annual report on Form-10K
to the Securities and Exchange Commission is available
on request, and without charge, by writing to the Director
of Communications, Capital Re Corporation, 1325 Avenue
of the Americas, New York, New York 10019.

Transfer Agent, Registrar and Dividend
Disbursing Agent
ChaseMellon Financial Shareholder Services
85 Challenger Road
Overpeck Center
Ridgefield Park, New Jersey 07660
1-800-526-0801

Shareholder Information
For further shareholder information,
please contact:

Capital Re Corporation
Director of Communications
1325 Avenue of the Americas
New York, New York  10019
212-974-0100

Investor Relations Contacts
David A. Buzen
Executive Vice President
Chief Financial Officer
212-974-0100

Catherine C. Bailey
Director of Communications
212-974-0100

<TABLE>
<CAPTION>
                                                    Market Price
                           Dividends      ---------------------------------
COMMON STOCK DATA        Paid Per share      High        Low        Close
---------------------------------------------------------------------------
<S>                      <C>              <C>           <C>        <C>
1996
1st Quarter                     $0.06        $36        $28 7/8     $36
2nd Quarter                     $0.06        $38        $32 5/8     $36 3/4
3rd Quarter                     $0.06        $39 3/8    $33 1/4     $38
4th Quarter                     $0.07        $46 5/8    $38 3/8     $46 5/8
---------------------------------------------------------------------------
1995
1st Quarter                     $0.05        $27 1/8    $22         $23 1/8
2nd Quarter                     $0.05        $36 1/4    $22 5/8     $26
3rd Quarter                     $0.05        $30        $25 1/2     $30
4th Quarter                     $0.06        $31 5/8    $28         $30 3/4
---------------------------------------------------------------------------
</TABLE>

<PAGE>

                            Capital Re Corporation
                          1325 Avenue of the Americas
                           New York, New York 10019
                            Telephone: 212-974-0100
                               Fax: 212-581-3268

                          Capital Reinsurance Company
                          1325 Avenue of the Americas
                           New York, New York 10019
                            Telephone: 212-974-0100
                               Fax: 212-581-3268

                     Capital Mortgage Reinsurance Company
                          1325 Avenue of the Americas
                           New York, New York 10019
                            Telephone: 212-974-3703
                               Fax: 212-262-9391

                             KRE Reinsurance Ltd.
                               P. O. Box HM 1022
                                Clarendon House
                              Church Street West
                            Hamilton HM DX, Bermuda
                            Telephone: 809-292-4402

                   Capital Credit Reinsurance Company, Ltd.
                               P. O. Box HM 1022
                                Clarendon House
                              Church Street West
                            Hamilton HM DX, Bermuda
                            Telephone: 809-292-4402

                       Capital Title Reinsurance Company
                          1325 Avenue of the Americas
                           New York, New York 10019
                            Telephone: 212-974-0100
                               Fax: 212-581-3268

                        RGB Underwriting Agencies, Ltd.
                                2 Minster Court
                                 Mincing Lane
                                London EC3 7FX
                           Telephone: 0171-283-0802
                              Fax: 0171-929-3413


 Design: Donovan and Green Still-Life Photography: Reven T. C. Wurman Portrait
                Photography: Bard Martin Printing: Tanagraphics