UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549



FORM 10-Q



SQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended June 30, 2007OR£TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934

For the transition period from   to

Commission file number 001-32950



SECURITY CAPITAL ASSURANCE LTD(Exact name of registrant as specified in its charter)



|                                                                     |  |                                                  
|-------------------------------------------------------------------- |  | -------------------------------------------------
|BERMUDA(State or other jurisdiction ofincorporation or organization) |  | NOT APPLICABLE(I.R.S. EmployerIdentification No.)

26 Reid Street, Hamilton, Bermuda HM 11(Address of principal executive offices and zip code)

(441) 295-7135
  (Registrants telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
  such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YesSNo£

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule
  12b-2 of the Exchange Act. (Check one): Large accelerated filer£Accelerated filer£Non-accelerated filerS

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes£NoS

As of August 10, 2007, there were 65,309,230 outstanding Common Shares, $0.01 par value per share, of the registrant.





---

SECURITY CAPITAL ASSURANCE LTDINDEX TO FORM 10-Q
PART I. FINANCIAL INFORMATION
    
    Page NoItem 1.
    
    Financial Statements:Interim Consolidated Balance Sheets as of June 30, 2007 (Unaudited)
      and December 31, 2006
    
    3Interim Consolidated Statements of Operations and Comprehensive
      Income for the Three Months Ended June 30, 2007 and 2006
      (Unaudited) and the Six Months Ended June 30, 2007 and 2006
      (Unaudited)
    
    4Interim Consolidated Statements of Shareholders Equity for the Six
      Months Ended June 30, 2007 (Unaudited) and the Year Ended
      December 31, 2006
    
    5Interim Consolidated Statements of Cash Flows for the Six Months
      Ended June 30, 2007 and 2006 (Unaudited)
    
    6Notes to Unaudited Interim Consolidated Financial Statements
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and
      Results of Operations
    
    23Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    54Item
          4.
    
    Controls
            and Procedures
    
    54Item 4T.
    
    Controls and Procedures
    
    54PART II. OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    55Item 1A.
    
    Risk Factors
    
    55Item 2.
    
    Unregistered Sales of Equity Securities and Use of ProceedsItem
          3.
    
    Defaults Upon Senior Securities
    
    56Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    56Item
          5.
    
    Other Information
    
    56Item 6.
    
    Exhibits
    
    57Signatures
    
    582

PART IFINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SECURITY CAPITAL ASSURANCE LTDINTERIM CONSOLIDATED BALANCE SHEETS(U.S. dollars in thousands, except share amounts)
(Unaudited)As ofJune 30,2007
    
    As ofDecember 31,2006ASSETSInvestmentsDebt securities available for sale, at fair value (amortized cost: 2007  $2,259,673; 2006  $1,755,184)
    
    
    $
    
    2,218,131
    
    
    
    $
    
    1,736,462Short-term investments, at fair value (amortized cost: 2007  $57,501; 2006  $222,930)
    
    
    
    57,279
    
    
    
    
    221,901Total investments
    
    
    
    2,275,410
    
    
    
    
    1,958,363Cash and cash equivalents
    
    
    
    184,512
    
    
    
    
    202,548Accrued investment income
    
    
    
    18,188
    
    
    
    
    16,515Deferred acquisition costs
    
    
    
    105,375
    
    
    
    
    93,809Prepaid reinsurance premiums
    
    
    
    79,706
    
    
    
    
    59,983Premiums receivable
    
    
    
    20,620
    
    
    
    
    12,936Reinsurance balances recoverable on unpaid losses
    
    
    
    82,775
    
    
    
    
    88,616Intangible assets  acquired licenses
    
    
    
    11,529
    
    
    
    
    11,529Deferred income tax asset
    
    
    
    16,201
    
    
    
    
    18,182Other assets
    
    
    
    38,031
    
    
    
    
    34,333Total assets.
    
    
    $
    
    2,832,347
    
    
    
    $
    
    2,496,814LIABILITIES, MINORITY INTEREST ANDSHAREHOLDERS EQUITYLiabilitiesUnpaid losses and loss adjustment expenses
    
    
    $
    
    174,528
    
    
    
    $
    
    178,517Deferred premium revenue
    
    
    
    861,880
    
    
    
    
    795,906Reinsurance premiums payable
    
    
    
    12,518
    
    
    
    
    13,952Payable for investments purchased
    
    
    
    
    
    
    
    
    5,435Accounts payable, accrued expenses and other liabilities
    
    
    
    89,934
    
    
    
    
    82,468Total liabilities
    
    
    
    1,138,860
    
    
    
    
    1,076,278Commitments and contingenciesMinority interest  redeemable preferred shares of subsidiary.
    
    
    
    39,000
    
    
    
    
    54,016Shareholders EquitySeries A perpetual non-cumulative preference shares  (Par value $0.01 per share; 250,000 shares authorized; issued and outstanding  At June 30, 2007: 250,000, at
      December 31, 2006: 0)
    
    
    
    3
    
    
    
    
    Common shares  (Par value $0.01 per share; 500,000,000 shares authorized; shares issued and outstanding  At June 30, 2007: 65,298,275, at December 31, 2006: 64,634,292)
    
    
    
    653
    
    
    
    
    646Additional paid in capital
    
    
    
    1,237,005
    
    
    
    
    987,798Retained earnings
    
    
    
    458,363
    
    
    
    
    397,781Accumulated other comprehensive loss
    
    
    
    (41,537
    )
    
    
    
    
    (19,705
    )Total shareholders equity
    
    
    
    1,654,487
    
    
    
    
    1,366,520Total liabilities, minority interest and shareholders equity
    
    
    $
    
    2,832,347
    
    
    
    $
    
    2,496,814See accompanying Notes to Unaudited Interim Consolidated Financial Statements
3

SECURITY CAPITAL ASSURANCE LTDINTERIM CONSOLIDATED STATEMENTS OFOPERATIONS AND COMPREHENSIVE INCOME(U.S. dollars in thousands, except per share amounts)
(Unaudited)Three Months EndedJune 30,
    
    (Unaudited)Six Months EndedJune 30,2007
    
    2006
    
    2007
    
    2006RevenuesGross premiums written
    
    
    $
    
    65,157
    
    
    
    $
    
    99,351
    
    
    
    $
    
    154,652
    
    
    
    $
    
    170,131Reinsurance premiums assumed
    
    
    
    5,504
    
    
    
    
    8,292
    
    
    
    
    20,967
    
    
    
    
    19,695Total premiums written
    
    
    
    70,661
    
    
    
    
    107,643
    
    
    
    
    175,619
    
    
    
    
    189,826Ceded premiums
    
    
    
    (8,564
    )
    
    
    
    
    (6,160
    )
    
    
    
    
    (28,797
    )
    
    
    
    
    (13,752
    )Net premiums written
    
    
    
    62,097
    
    
    
    
    101,483
    
    
    
    
    146,822
    
    
    
    
    176,074Change in net deferred premium revenue
    
    
    
    (7,905
    )
    
    
    
    
    (45,942
    )
    
    
    
    
    (46,251
    )
    
    
    
    
    (82,720
    )Net premiums earned (net of ceded premiums earned of $5,193, $10,021, $9,074 and $18,224)
    
    
    
    54,192
    
    
    
    
    55,541
    
    
    
    
    100,571
    
    
    
    
    93,354Net investment income
    
    
    
    30,263
    
    
    
    
    16,129
    
    
    
    
    56,388
    
    
    
    
    31,191Net
      realized losses on investments
    
    
    
    (1,654
    )
    
    
    
    
    (10,717
    )
    
    
    
    
    (1,542
    )
    
    
    
    
    (16,400
    )Net realized and unrealized (losses) gains on derivative financial instruments
    
    
    
    (22,175
    )
    
    
    
    
    301
    
    
    
    
    (29,104
    )
    
    
    
    
    (3,549
    )Fee income and other
    
    
    
    85
    
    
    
    
    971
    
    
    
    
    85
    
    
    
    
    2,231Total revenues
    
    
    
    60,711
    
    
    
    
    62,225
    
    
    
    
    126,398
    
    
    
    
    106,827ExpensesNet losses and loss adjustment expenses
    
    
    
    3,028
    
    
    
    
    2,880
    
    
    
    
    2,227
    
    
    
    
    6,329Acquisition costs, net
    
    
    
    3,779
    
    
    
    
    4,542
    
    
    
    
    7,749
    
    
    
    
    7,224Operating expenses
    
    
    
    26,553
    
    
    
    
    17,492
    
    
    
    
    50,623
    
    
    
    
    34,587Total expenses
    
    
    
    33,360
    
    
    
    
    24,914
    
    
    
    
    60,599
    
    
    
    
    48,140Income before income tax and minority interest
    
    
    
    27,351
    
    
    
    
    37,311
    
    
    
    
    65,799
    
    
    
    
    58,687Income tax expense (benefit)
    
    
    
    632
    
    
    
    
    (203
    )
    
    
    
    
    711
    
    
    
    
    (188
    )Income before minority interest
    
    
    
    26,719
    
    
    
    
    37,514
    
    
    
    
    65,088
    
    
    
    
    58,875Minority interest  dividends on redeemable preferred shares
    
    
    
    804
    
    
    
    
    1,126
    
    
    
    
    1,918
    
    
    
    
    5,738Net income
    
    
    
    25,915
    
    
    
    
    36,388
    
    
    
    
    63,170
    
    
    
    
    53,137Dividends on Series A perpetual non-cumulative preference shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income available to common shareholders
    
    
    $
    
    25,915
    
    
    
    $
    
    36,388
    
    
    
    $
    
    63,170
    
    
    
    $
    
    53,137Earnings per share available to common shareholders:Basic
    
    
    $
    
    0.40
    
    
    
    $
    
    0.79
    
    
    
    $
    
    0.98
    
    
    
    $
    
    1.15Diluted
    
    
    $
    
    0.40
    
    
    
    $
    
    0.79
    
    
    
    $
    
    0.98
    
    
    
    $
    
    1.15Weighted-average common shares outstanding:(Shares in thousands)Basic
    
    
    
    64,136
    
    
    
    
    46,127
    
    
    
    
    64,136
    
    
    
    
    46,127Diluted
    
    
    
    64,507
    
    
    
    
    46,127
    
    
    
    
    64,423
    
    
    
    
    46,127Comprehensive income:Net income
    
    
    $
    
    25,915
    
    
    
    $
    
    36,388
    
    
    
    $
    
    63,170
    
    
    
    $
    
    53,137Change in unrealized depreciation of investments, net of deferred tax benefit of $214, $57, $181, and $57
    
    
    
    (28,203
    )
    
    
    
    
    (10,859
    )
    
    
    
    
    (21,832
    )
    
    
    
    
    (29,339
    )Total comprehensive (loss) income
    
    
    $
    
    (2,288
    )
    
    
    
    $
    
    25,529
    
    
    
    $
    
    41,338
    
    
    
    $
    
    23,798See accompanying Notes to Unaudited Interim Consolidated Financial Statements
4

SECURITY CAPITAL ASSURANCE LTDINTERIM CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS EQUITY(U.S. dollars in thousands)
(Unaudited)Six MonthsEnded June 30,2007
    
    Year EndedDecember 31,2006Series A perpetual non-cumulative preference sharesBalance  beginning of year
    
    
    $
    
    
    
    
    
    $
    
    Issuance of shares
    
    
    
    3
    
    
    
    
    Balance  end of period
    
    
    
    3
    
    
    
    
    Common sharesBalance  beginning of year
    
    
    
    646
    
    
    
    
    461Issuance of common shares
    
    
    
    7
    
    
    
    
    185Balance  end of period
    
    
    
    653
    
    
    
    
    646Additional Paid-In CapitalBalance  beginning of year
    
    
    
    987,798
    
    
    
    
    605,951Issuance of Series A redeemable preferred shares, net of underwriting fees and issuance costs
    
    
    
    246,580
    
    
    
    
    Initial public offering proceeds, net of underwriting fees and issuance costs
    
    
    
    (250
    )
    
    
    
    
    341,082Restricted stock and stock options
    
    
    
    2,638
    
    
    
    
    827Capital contributions
    
    
    
    239
    
    
    
    
    39,938Balance  end of period
    
    
    
    1,237,005
    
    
    
    
    987,798Retained EarningsBalance  beginning of year
    
    
    
    397,781
    
    
    
    
    281,709Net income
    
    
    
    63,170
    
    
    
    
    117,355Dividends on common shares
    
    
    
    (2,588
    )
    
    
    
    
    (1,283
    )Balance  end of period
    
    
    
    458,363
    
    
    
    
    397,781Accumulated Other Comprehensive LossBalance  beginning of year
    
    
    
    (19,705
    )
    
    
    
    
    (20,307
    )Net change in unrealized appreciation of investments
    
    
    
    (21,832
    )
    
    
    
    
    602Balance  end of period
    
    
    
    (41,537
    )
    
    
    
    
    (19,705
    )Total shareholders equity
    
    
    $
    
    1,654,487
    
    
    
    $
    
    1,366,520See accompanying Notes to Unaudited Interim Consolidated Financial Statements
5

SECURITY CAPITAL ASSURANCE LTDINTERIM CONSOLIDATEDSTATEMENTS OF CASH FLOWS(U.S. dollars in thousands)
(Unaudited)Six Months EndedJune 30,2007
    
    2006Cash provided by operating activities:Net income available to common shareholders
    
    
    $
    
    63,170
    
    
    
    $
    
    53,137Adjustments to reconcile net income to net cash provided by operating activities:Net realized (gains) losses on investments
    
    
    
    1,542
    
    
    
    
    16,400Net realized and unrealized losses on derivative financial instruments
    
    
    
    29,104
    
    
    
    
    3,549Amortization of premium on bonds
    
    
    
    871
    
    
    
    
    2,028Minority interest  dividends on redeemable preferred shares
    
    
    
    1,918
    
    
    
    
    5,738Deferred tax provision (benefit)
    
    
    
    2,163
    
    
    
    
    (774
    )(Increase)
        in accrued investment income
    
    
    
    (1,673
    )
    
    
    
    
    (1,049
    )(Increase) in deferred acquisition costs
    
    
    
    (11,566
    )
    
    
    
    
    (11,346
    )(Increase) decrease in prepaid reinsurance premiums
    
    
    
    (19,723
    )
    
    
    
    
    4,471(Increase) in premiums receivable
    
    
    
    (7,684
    )
    
    
    
    
    (3,129
    )Decrease (increase) in reinsurance balances recoverable on unpaid losses
    
    
    
    5,841
    
    
    
    
    (1,245
    )(Decrease) increase in unpaid losses and loss adjustment expenses
    
    
    
    (3,989
    )
    
    
    
    
    6,011Increase in deferred premium revenue
    
    
    
    65,974
    
    
    
    
    78,249(Decrease) increase in reinsurance premiums payable
    
    
    
    (1,434
    )
    
    
    
    
    1,248Other, net
    
    
    
    (23,398
    )
    
    
    
    
    (7,385
    )Total adjustments
    
    
    
    37,946
    
    
    
    
    92,766Net cash provided by operating activities
    
    
    
    101,116
    
    
    
    
    145,903Cash flows from investing activities:Proceeds from sale of debt securities
    
    
    
    80,243
    
    
    
    
    216,757Purchases of debt securities
    
    
    
    (689,502
    )
    
    
    
    
    (331,408
    )Net sales (purchases) of short-term investments
    
    
    
    97,139
    
    
    
    
    (32,022
    )Proceeds from maturity of debt securities and short term investments
    
    
    
    165,242
    
    
    
    
    41,152Net cash used in investing activities
    
    
    
    (346,878
    )
    
    
    
    
    (105,521
    )Cash flows from financing activities:Dividends on common shares
    
    
    
    (2,588
    )
    
    
    
    
    Net cash proceeds from issuance of Series A perpetual non-cumulative preference shares
    
    
    
    247,248
    
    
    
    
    Extraordinary dividend on redeemable preferred shares
    
    
    
    (15,016
    )
    
    
    
    
    Dividends on redeemable preferred shares
    
    
    
    (1,918
    )
    
    
    
    
    (2,559
    )Net cash provided by (used in) financing activities
    
    
    
    227,726
    
    
    
    
    (2,559
    )Decrease (increase) in cash and cash equivalents
    
    
    
    (18,036
    )
    
    
    
    
    37,823Cash and cash equivalents  beginning of year
    
    
    
    202,548
    
    
    
    
    54,593Cash and cash equivalents  end of period
    
    
    $
    
    184,512
    
    
    
    $
    
    92,416Supplemental Cash Flow DisclosureNon-cash capital contributions
    
    
    $
    
    239
    
    
    
    $
    
    1,352See accompanying Notes to Unaudited Interim Consolidated Financial Statements
6

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
On March 17, 2006, XL Capital Ltd (XL Capital) formed Security Capital Assurance Ltd (SCA), as a wholly owned Bermuda based subsidiary holding company. On July 1, 2006, XL Capital
  contributed all its ownership interests in its financial guarantee insurance and financial guarantee reinsurance operating businesses to SCA. The aforementioned operating businesses consisted of: (i)
  XL Capital Assurance Inc. (XLCA) and its wholly-owned subsidiary, XL Capital Assurance (U.K.) Limited (XLCA-UK) and (ii) XL Financial Assurance Ltd. (XLFA). XLCA was an indirect
  wholly owned subsidiary of XL Capital and all of XLFA was owned by XL Capital except for a preferred stock interest which is owned by Financial Security Assurance Holdings Ltd. (FSAH), an
  entity which is otherwise not related to XL Capital or SCA. SCA, XLCA, XLFA and all other subsidiaries of SCA are hereafter collectively referred to as the Company.
On August 4, 2006, SCA completed the sale of 18,009,119 of its common shares through an initial public offering (the IPO). SCA received net proceeds from the IPO of $341.3 million. In
  addition, XL Capital sold 5,430,774 of SCAs common shares (including 992,165 common shares pursuant to the exercise of an over-allotment option granted to underwriters) from its holdings directly
  to the public in a secondary offering concurrent with the IPO. SCA did not receive any of the proceeds from the aforementioned sale by XL Capital. Immediately after the IPO and the secondary
  offering, XL Capital owned 40,696,471 SCA common shares, which represented approximately a 63 percent economic interest in SCA, adjusted for restricted share awards to the Companys employees
  and management granted at the effective date of the IPO. In June 2007, XL Capital completed the sale of an additional 10,627,422 common shares of SCA from its holdings (including 947,400
  common shares pursuant to the exercise of an over-allotment option granted to underwriters). SCA did not receive any of the proceeds from this sale. Immediately after such sale XL Capital owned
  30,069,049 common shares of SCA, which represented approximately a 46 percent voting and economic interest in SCA, adjusted for restricted share awards to the Companys employees and
  management outstanding as of such date. Prior to XL Capitals sale of SCA common shares in June 2007 its voting interest in SCA was subject to limitations contained in our bye-laws.
2. Basis of Presentation and Consolidation
The unaudited interim consolidated financial statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America
  (GAAP) and, in the opinion of management, reflect all adjustments, consisting of normally recurring adjustments, necessary for a fair presentation of the Companys consolidated financial condition,
  results of operations and cash flows for the periods presented, including the elimination of all significant inter-company accounts and transactions. In addition, certain reclassifications have been made
  to prior period consolidated financial statement amounts to conform to current year presentation. There was no effect on prior period reported net income as a result of these reclassifications.
Interim consolidated financial statements do not include all of the information and footnotes required by GAAP for annual financial statements. The preparation of financial statements in
  conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of 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. In addition, the results of operations
  for the interim period ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007. These interim consolidated financial statements of
  the Company should be read in conjunction with the annual audited consolidated financial statements of the Company as of December 31, 2006 and 2005 and for the years ended December 31, 2006,
  2005, and 2004 included in the Companys Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 15, 2007.
7

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
For the period ended June 30, 2006, certain expenses reflected in the financial statements include allocations of expenses by XL Capital related to general and administrative services provided to
  the Company. These expenses were allocated based on estimates of the cost incurred by XL Capital to provide these services to the Company. Management believes that the methods used to
  estimate the costs allocated to the Company are reasonable. However, these results do not necessarily represent what the historical consolidated financial position, results of operations and cash flows
  of the Company would have been if the Company had been a separate stand-alone entity during the periods presented.
3. Derivative Financial Instruments
The Companys derivative financial instruments principally include credit default swaps issued to its customers and guarantees of interest rate swap contracts in connection with its guarantees of
  certain debt obligations.
Credit default swaps and financial guarantees of interest rate swaps entered into by the Company meet the definition of a derivative instrument under Financial Accounting Standards Board
  (FASB) Statement of Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), as amended by SFAS No. 149. Credit default swaps are
  recognized at fair value and recorded as either assets or liabilities in the accompanying consolidated balance sheets. The Company intends to hold these derivative instruments until maturity.
The fair values of derivative instruments are determined using models developed by the Company and are dependent upon a number of market factors including changes in interest rates, credit
  spreads, changes in credit quality, and expected recovery rates. The change resulting from movements in these factors is unrealized as the contracts are not traded to realize this value. Other elements
  of the change in fair value are based upon pricing established at the inception of the contract, as well as events triggering loss payments under the contracts by the Company.
Changes in the fair value of credit default swaps attributable to earnings from premiums received by the Company from the issuance of such contracts are recorded in the line item caption
  entitled net premiums earned in the accompanying consolidated statement of operations. In addition, changes in the fair value of credit default swaps attributable to losses from actual and expected
  payments to counterparties under such contracts are recorded in the line item caption entitled net losses and loss adjustment expenses in the accompanying consolidated statement of operations, and
  the remaining components of the change in fair value of credit default swaps, which are attributable to the market and other factors discussed above, are recorded in the line item caption entitled
  net realized and unrealized gains (losses) on derivative financial instruments in the accompanying consolidated statement of operations. This presentation is applicable only to credit default swaps
  issued by the Company that it has the intent and ability to hold to maturity.
The Companys credit default swap portfolio generally requires the Company to meet payment obligations for referenced credits within the portfolio in the event of specific credit events after
  exhaustion of various first-loss protection levels. These credit events are contract-specific, but generally cover bankruptcy, failure to pay and repudiation. The Companys credit default swap portfolio
  consists of structured pools of corporate obligations that were awarded investment-grade ratings at the deals inception. At June 30, 2007, on a net par basis, approximately 97% of the portfolio was
  rated AAA with the remaining 3% rated at or above investment-grade and the weighted average term of the contracts in-force was 8.4 years.
The following tables present the amounts related to credit default swaps and other derivative financial instruments reflected in our financial statements as of and for the periods indicated:
8

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
Three Months Ended
    
    Six Months EndedJune 30, 2007
    
    June 30, 2006
    
    June 30, 2007
    
    June 30, 2006(U.S. dollars in thousands)Statement of Operations:Net premiums earned
    
    
    $
    
    9,177
    
    
    
    $
    
    5,668
    
    
    
    $
    
    16,654
    
    
    
    $
    
    10,715Net losses and loss adjustment expenses
    
    
    
    870
    
    
    
    
    724
    
    
    
    
    1,887
    
    
    
    
    1,274Net realized and unrealized (losses) gains on derivative financial instruments
    
    
    
    (22,175
    )
    
    
    
    
    301
    
    
    
    
    (29,104
    )
    
    
    
    
    (3,549
    )As atJune 30,2007
    
    As atDecember 31,2006Balance sheet:Reinsurance balances recoverable on unpaid losses
    
    
    $
    
    960
    
    
    
    $
    
    1,111Other assets
    
    
    
    7,633
    
    
    
    
    11,976Unpaid losses and loss adjustment expenses
    
    
    
    16,018
    
    
    
    
    14,283Deferred premium revenue
    
    
    
    103
    
    
    
    
    137Accounts payable, accrued expenses and other liabilities
    
    
    
    28,940
    
    
    
    
    5,1174. Recent Accounting Pronouncements
Proposed Statement of Financial Accounting Standards (SFAS), Accounting for Financial Guarantee Insurance Contracts
On April 18, 2007, the Financial Accounting Standards Board (FASB) issued Proposed SFAS, Accounting for Financial Guarantee Insurance Contracts  an interpretation of FASB Statement
  No. 60. This proposed Statement would clarify how FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises, applies to financial guarantee insurance contracts. This proposed
  Statement, among other things, would change current industry practices with respect to the recognition of premium revenue and claim liabilities. In addition, this proposed Statement would require
  that the measurement of the initial deferred premium revenue (liability) be the present value of the contractual premium due pursuant to the terms of the financial guarantee insurance contract,
  thereby changing current industry accounting practice with respect to insurance contracts priced on an installment basis by requiring that the present value of all contractual premiums due under such
  contracts, currently or in the future, be recorded on the companys balance sheet as premiums receivable. Under current industry practice such premiums are not reflected on the balance sheet.
In regard to premium revenue recognition, the proposed Statement provides for premium to be recognized as revenue, for both upfront and installment paying policies, in proportion to the
  insured contractual principal and interest payments made by the issuer of the insured financial obligation, rather than being recognized over the term of each maturity for upfront premium paying
  policies, or over the installment period for installment premium paying policies. This change would generally result in a volatile revenue recognition pattern over the life of the insured obligation as
  premium would only be recognized as the insured obligations principal or interest is paid. Furthermore, for certain bonds such as investor-owned utilities, CDOs and many other types of asset-backed
  securities that do not have periodic payments, this change would result in significantly slower and back-ended revenue recognition. The volatility would be most evident for insured securities whereby
  the principal payments are made at maturity but would also impact public finance insured securities with customized amortization schedules. For installment paying policies, the proposed Statement
  requires that the discount, equating to the difference between gross installment premiums and the present value of installment premiums, be recognized as investment income rather than premiums.
  We expect that the initial effect of applying the revenue recognition provisions of the Statement as currently proposed will be material to the Companys financial statements.
9

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
In regard to the recognition of claim liabilities, the proposed Statement provides that claim liabilities shall be established when the insurance enterprise expects that a claim loss will exceed the
  deferred premium revenue (liability) for a contract based on expected cash flows discounted using a risk-adjusted rate at initial recognition of the claim liability and, that, the assumptions underlying
  such liability be consistent with the information tracked and monitored through the companys surveillance list maintained by the insurance enterprise to evaluate credit deterioration in its insured
  financial obligations. We expect that implementation of this guidance as currently proposed would cause the Company to de-recognize its reserves for unallocated losses and loss adjustment expenses
  and preclude it from providing such reserves in the future.
The comment period for the proposed Statement expired on June 18, 2007. A round table discussion between the FASB and interested parties who provided comments on the proposed
  Statement has been rescheduled to early September 2007 from mid-July of 2007. Currently the proposed Statement is due to be effective for fiscal years beginning after December 15, 2007. The
  Company is continuing to evaluate the effect of the proposed Statement on its financial statements.
SFAS No. 155, Accounting for Certain Hybrid Financial Instruments
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments (SFAS 155), which amends SFAS No. 133, Accounting for Derivative Instruments
  and Hedging Activities (SFAS 133) and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140), and addresses issues raised
  in SFAS 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. The primary objectives of SFAS 155 are: (i) with respect to SFAS
  133, to address the accounting for beneficial interests in securitized financial assets and (ii) with respect to SFAS 140, to eliminate a restriction on the passive derivative instruments that a qualifying
  special purpose entity may hold. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entitys first fiscal year that begins after September 15, 2006. The
  Company adopted SFAS 155 on January 1, 2007 and it has had no effect on the Companys financial condition or results of operations.
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 prescribes a
  recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on
  de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company
  adopted FIN 48 on January 1, 2007 and it has not had any effect on the Companys financial condition or results of operations.
SFAS No. 157, Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157) which defines fair value, establishes a framework for measuring fair value in generally accepted
  accounting principles, and expands disclosures about fair value measurements. This Statement is applicable in conjunction with other accounting pronouncements that require or permit fair value
  measurements, where the FASB previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new
  fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within these fiscal years. The Company is
  currently evaluating the effect the adoption of SFAS 157 will have on its financial statements.
10

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 provides the Company an irrevocable option to
  report selected financial assets and liabilities at fair value with changes in fair value recorded in earnings. The option is applied, on a contract-by-contract basis, to an entire contract and not only to
  specific risks, specific cash flows or other portions of that contract. Upfront costs and fees related to a contract for which the fair value option is elected shall be recognized in earnings as incurred
  and not deferred. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar
  types of assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the effect, if any, the adoption of SFAS 159 will have on
  its financial statements.
Proposed FASB Staff Position EITF 03-6-a, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities
In October 2006, the FASB issued proposed FASB Staff Position EITF 03-6-a, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.
  This FASB Staff Position (FSP) addresses whether instruments granted in share-based payment transactions may be participating securities prior to vesting and, therefore, need to be included in the
  earnings allocation in computing basic earnings per share (EPS) pursuant to the two-class method described in paragraphs 60 and 61 of FASB Statement No. 128, Earnings Per Share. A share-
  based payment award that contains a non-forfeitable right to receive cash when dividends are paid to common shareholders irrespective of whether that award ultimately vests or remains unvested
  shall be considered a participating security as these rights to dividends provide a non-contingent transfer of value to the holder of the share-based payment award. Accordingly, these awards should be
  included in the computation of basic EPS pursuant to the two-class method. The guidance in this proposed FSP would be effective in the first reporting period beginning after the FASB posts the
  final FSP to its website. All prior period EPS data will have to be adjusted retrospectively to reflect the provisions of the FSP. Under the terms of the Companys restricted stock awards, grantees are
  entitled to the right to receive dividends on the unvested portions of their awards. There is no requirement to return these dividends in the event the unvested awards are forfeited in the future.
  Accordingly, this FSP will have an effect on the Companys EPS calculations should the FASB adopt the proposed guidance during 2007. The Company will continue to evaluate the effect of this
  guidance.
5. Premiums Earned from Refunded and Called Bonds
Premiums earned include $5.7 million and $23.2 million, and $7.0 million and $25.2 million for the three and six months ended June 30, 2007 and 2006, respectively, related to refunded and called
  bonds.
6. Related Party Transactions
Concurrent with the IPO, the Company entered into arrangements with affiliates of XL Capital: (i) to provide it protection with respect to adverse development on certain transactions, (ii) to
  have exposures transferred to it or re-assume exposures under certain financial guarantee policies that were originally reinsured to, or written on behalf of, the Company by XLI, due principally to
  single risk constraints and rating agency capital adequacy requirements applicable to the Company at the time that business was first written, (iii) to cancel the Companys reinsurance of certain non-
  financial guarantee business ceded to it by XLI, and (iv) to govern certain aspects of Companys relationship with XL Capital after the IPO, including a series of service agreements under which
  subsidiaries of XL Capital will provide certain services to the Company or receive certain services from the Company for a period of time after the IPO. The aforementioned arrangements are
  discussed further below.
11

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
In addition, in connection with the IPO, XL Capital agreed to fund a portion of long-term compensation awarded by XL Capital to employees of SCA prior to the IPO and which remained
  outstanding under XL Capitals long-term compensation plans subsequent to the IPO. In this regard, SCA reflects the full cost of the periodic charges from such long-term compensation in its
  earnings each period, XL Capital charges approximately 60% of such cost to SCA, and SCA records a capital contribution from XL Capital equal to the remaining 40% of such cost. The aggregate
  remaining future cost of such long-term compensation to SCA is approximately $1.3 million at June 30, 2007, of which SCA will pay XL Capital approximately $0.8 million and XL Capital will fund
  $0.5 million. During the three and six months ended June 30, 2007, respectively, the Company recorded compensation expense related to such awards of $0.2 million and $0.5 million, respectively.
Services Agreements with Affiliates
Prior to the IPO, the Company purchased various services from affiliates of XL Capital under various agreements and continues to purchase such services under new agreements that became
  effective at the date of the IPO. Such services principally include: (i) information technology support, (ii) reinsurance and retrocessional consulting and management services, (iii) actuarial, finance,
  legal, internal audit services and certain investment management services. For the three and six months ended June 30, 2007 and 2006, the Company incurred costs under the aforementioned
  agreements aggregating $1.5 million and $2.2 million, and $2.5 million and $4.7 million, respectively, which are reflected in operating expenses in the accompanying consolidated statements of
  operations.
Employee Benefit Plans
The Company maintains a qualified defined contribution pension plan for the benefit of all eligible employees and a non-qualified deferred compensation plan for the benefit of certain employees
  (collectively, the SCA Plans). Prior to the IPO, XL America, Inc (XLA) maintained plans, with substantially the same terms, which employees of the Company participated in (the XLA Plans).
  Discretionary contributions to the SCA Plans and XLA Plans are based on a fixed percentage of employee contributions and compensation, as defined aforementioned plans. For the three and six
  months ended June 30, 2007 and 2006, the Company incurred costs under the aforementioned plans aggregating $1.7 million and $0.5 million, and $3.4 million and $1.2 million, respectively, which are
  reflected in operating expenses in the accompanying consolidated statements of operations.
Reinsurance Agreements with Affiliates and Other Guarantees
The Company has the following reinsurance agreements with affiliates. Certain of the agreements discussed below may be terminated under certain conditions, as defined in the agreements.

    
    
    
    Effective August 4, 2006, certain subsidiaries of XL Capital indemnified the Company for all losses and loss adjustment expenses incurred in excess of its retained reserves at the effective date
      of the agreement relating to an insured project financing described in Note 9 (a). In consideration for the aforementioned indemnifications the Company is obligated to pay such affiliates
      approximately $9.8 million on an installment basis over the life of the aforementioned project financing. As this premium is due irrespective of any early termination of the underlying insurance
      transaction, the Company recorded a liability of approximately $7.0 million at the effective date of the indemnifications (representing the present value of the obligation discounted at 5.0%,
      which reflects the rate on treasury obligations with a term to maturity commensurate with that of the liability) and a corresponding deferred cost, which are reflected in the accompanying
      consolidated balance sheet in reinsurance premiums payable and prepaid reinsurance premiums, respectively. For the three and six months ended June 30, 2007, the Company incurred costs
      under the aforementioned12

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
agreements aggregating approximately $0.2 million and $0.4 million and the balance of the aforementioned liability and deferred cost was $6.4 million at June 30, 2007.
    
    
    
    Effective August 4, 2006, XLA has undertaken to indemnify the Company for any diminution in value below their carrying value at June 30, 2006 of the notes and preferred shares described in
      Note 9, which notes and preferred shares were acquired in connection with the satisfaction of a claim under a financial guarantee insurance policy issued by XLCA. In addition, pursuant to the
      aforementioned indemnity, XLA agreed to indemnify the Company for any costs arising out of any litigation or future claim in connection with the aforementioned insurance policy. See Note 9
      for further information regarding amounts recovered or recoverable by SCA under the indemnity.
    
    
    
    On August 4, 2006, XLFA terminated a facultative quota share reinsurance treaty with XLI that had been effective since 2001. As a result of the termination, XLI returned $26.5 million of
      premiums to XLFA, XLFA returned ceding commissions of $7.8 million to XLI, and XLI paid XLFA $18.7 million. The effect on the Companys results of operations for the three and six
      month periods ended June 30, 2007 and 2006 from the subject business was not material.
    
    
    
    On August 4, 2006, and XLI agreed to cancel from inception the reinsurance of certain business ceded under a facultative quota share reinsurance treaty that was effective since 1999. As a
      result of this cancellation, XLFA paid XLI $0.2 million, XLI assumed XLFAs obligation for $1.2 million of reserves for losses and loss adjustment expenses, and XLFA recorded a capital
      contribution of $1.0 million. In addition, on such date, XLFA assumed certain business from XLI pursuant to the aforementioned reinsurance treaty. As a result thereof, XLFA recorded
      assumed premiums of approximately $8.0 million, ceding commissions of approximately $1.0 million and received cash from XLI of approximately $7.0 million. There was no effect on the
      Companys results of operations from this transaction for the three and six months ended June 30, 2007 and the effect on the Companys results of operations from the subject business for the
      three and six month periods ended June 30, 2006 was not material.
    
    
    
    Effective October 1, 2001, XLFA entered into an excess of loss reinsurance agreement with XLI. This agreement covers a portion of XLFAs liability arising as a result of losses on policies
      written by XLFA that are in excess of certain limits and are not covered by other reinsurance agreements. This agreement provides indemnification only for the portion of any loss covered by
      this agreement in excess of 10% of XLFAs surplus, up to an aggregate amount of $500 million, and excludes coverage for liabilities arising other than pursuant to the terms of an underlying
      policy. The Company incurred expense under this agreement of approximately $0.1 million and $0.3 million, and $0.1 million and $0.3 million, respectively, for the three and six month periods
      ended June 30, 2007 and 2006.
    
    
    
    Effective November 1, 2002, XLCA entered into a facultative reinsurance arrangement (the XL Re Treaty) with XL Reinsurance America, Inc. (XL RE AM). Under the terms of the XL Re
      Treaty, XL RE AM agrees to reinsure risks insured by XLCA under financial guarantee insurance policies up to the amount necessary for XLCA to comply with single risk limitations set forth
      in Section 6904(d) of the New York Insurance Laws. Such reinsurance was on an automatic basis prior to the effective date of the IPO and is on a facultative basis on and after the effective
      date of the IPO. The reinsurance provided by XL RE AM may be on an excess of loss or quota share basis. The Company is allowed up to a 30% ceding commission (or such other
      percentage on an arms-length basis) on ceded premiums written under the terms of this agreement.
    
    
    
    Since it commenced operations, XLFA has entered into several reinsurance arrangements with subsidiaries and affiliates of FSAH (hereafter referred to as FSA) to reinsure certain policies
      issued by FSA which guarantee the timely payment of the principal of and interest on various types of debt obligations. XLFAs obligations under certain of these arrangements are guaranteed
      by XLI. Effective upon the IPO, the guarantee was terminated with respect to all new business assumed by XLFA under such arrangement, but the guarantee remains in effect with respect to13

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
cessions under the agreement prior to the IPO. Premiums assumed by XLFA under its reinsurance arrangements with FSA represented 26.5% and 72.9%, and 62.6% and 70.7% of the
      Companys total reinsurance premiums assumed for the three and six months ended June 30, 2007 and 2006, respectively.
    
    
    
    XLFA has guaranteed certain of XLIs obligations in connection with certain transactions where XLIs customer required such credit enhancement. Each of these transactions has a double
      trigger structure, meaning that XLFA does not have to pay a claim unless both the underlying transaction and XLI default. For each of these transactions, XLFA has entered into a
      reimbursement agreement with XLI, pursuant to which XLI pays XLFA a fee for providing its guarantee and XLI grants XLFA a security interest in a portion of the payments received by it
      from its client. As of June 30, 2007 and December 31, 2006, XLFAs aggregate net par outstanding relating to such guarantees was $522.8 million and $522.8 million, respectively.
    
    
    
    Effective May 1, 2004, XLI entered into an agreement with XLCA which unconditionally and irrevocably guarantees to XLCA the full and complete payment when due of all of XLFAs
      obligations under its facultative quota share reinsurance agreement with XLCA, under which agreement XLFA has assumed business from XLCA since December 19, 2000. The gross par value
      of business guaranteed by XLI under this agreement was approximately $81.9 billion and $83.1 billion as of June 30, 2007 and December 31, 2006, respectively. The XLI guarantee agreement
      terminated with respect to any new business produced by XLCA and ceded to XLFA pursuant to the facultative quota share reinsurance agreement after the effective date of the IPO, but the
      guarantee remains in effect with respect to cessions under the such agreement prior to the IPO.
    
    
    
    The Company provides financial guarantee insurance policies insuring timely payment of investment agreements issued by XL Asset Funding Company I LLC (XLAF), an affiliate of the
      Company. As of June 30, 2007 and December 31, 2006, the aggregate face amount of such investment agreements insured by the Company was $4.5 billion and $3.9 billion, respectively. In
      addition, the Company insures XLAFs obligations under certain derivative contracts issued and purchased by XLAF. As of June 30, 2007, the total notional value of such contracts insured was
      $170.0 million. The Company recorded earned premiums of $1.1 million and $1.0 million, and $2.0 million and $1.9 million, respectively, in each of the three and six month periods ended
      June 30, 2007 and 2006, relating to the aforementioned contracts.Other Matters
In connection with the secondary offering of SCA common shares by XL Capital in June 2007 (see Note 1), SCA was obligated, pursuant to registration rights granted to XL Capital in connection
  with the IPO, to pay certain offering costs of up to five secondary offerings of SCA common shares by XL Capital (of at least $50 million in value unless XL Capital holds less than such amount at
  the time of its exercise of registration rights), not including the secondary offering completed by XL Capital concurrent with the IPO. Accordingly, as a result of the secondary offering completed in
  June 2007, the Company incurred expenses of approximately $1.0 million, which is reflected in operating expenses in the Companys consolidated results of operations for the three and six months
  ended June 30, 2007. As of June 30, 2007, SCA is obligated to pay offering costs in connection with XL Capitals sale of its SCA common share holdings in up to four more offerings of such shares.
7. Income Taxes
XLFA is not subject to any taxes in Bermuda on either income or capital gains under current Bermuda law. In the event that there is a change such that these taxes are imposed, XLFA would
  be exempted from any such tax until March 2016 pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966, and Amended Act of 1987.
14

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
XLCA is subject to federal, state and local corporate income taxes and other taxes applicable to U.S. corporations. The U.S. federal income tax liability is determined in accordance with the
  principles of the consolidated tax provisions of the Internal Revenue Code and Regulations. XLCA has operations in subsidiary and branch form in certain international jurisdictions that are subject
  to relevant taxes in those jurisdictions.
XLCA files a consolidated tax return with SCA Holdings US Inc. (the U.S. common parent of the Company) and its subsidiaries. Prior to July 1, 2006, XLCA was consolidated with XLA for
  purposes of determining its income tax liability at, and prior to, such date (see Note 1). As of June 30, 2007 and December 31, 2006, the Company had a U.S. federal income tax payable of $1.2
  million and $5.3 million, respectively.
As of June 30, 2007 and December 31, 2006, the Company had deferred income tax assets of $16.2 million and $18.2 million, respectively. Such deferred tax assets were net of a valuation
  allowance of $4.2 million and $1.9 million as of June 30, 2007 and December 31, 2006, respectively. The valuation allowance relates to net unrealized capital losses and a net realized capital loss that
  may not be realized within a reasonable period. At June 30, 2007, the Company had net unrealized capital losses and a net realized capital loss carry forward of approximately $2.5 million and $1.9
  million respectively, against which a valuation allowance has been established. Management believes it is more likely than not that the tax benefit relating to the Companys deferred tax assets, net of
  the valuation allowance discussed above, will be realized. The net realized capital loss carry forward will expire in 2012.
Deferred income taxes have not been accrued with respect to undistributed earnings of foreign subsidiaries. If the earnings were to be distributed, as dividends or otherwise, such amounts may be
  subject to withholding taxation in the state of the paying entity. Currently, however, no withholding taxes have been accrued with respect to the earnings, as it is the intention of management that
  such earnings will remain reinvested indefinitely.
The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007. The adoption of Interpretation No. 48 had no effect on
  the Companys financial statements.
With few exceptions, the Company is no longer subject to tax examinations by tax authorities in the major jurisdictions in which the Company operates for years prior to 2003 in the U.S. and
  2002 in the U.K.
The Companys policy is to recognize any interest accrued related to unrecognized tax benefits as a component of interest expense and penalties in operating expenses. The Company does not
  have any accrued liabilities relating to interest and penalties as at June 30, 2007 or December 31, 2006, respectively.
8. Segments
The Companys business activities are organized and managed in two operating segments: financial guarantee insurance and financial guarantee reinsurance. These segments are managed
  separately because they provide different products or services to different customers, are subject to different regulation, and require different strategies.
Products comprising the financial guarantee insurance segment primarily include financial guarantee insurance of public finance and structured finance debt securities and credit default swaps.
  Products comprising the reinsurance segment primarily include reinsurance of financial guarantee insurance products issued by financial guarantee insurance companies.
Set forth in the table below is certain financial information with respect to the Companys operating segments for each of the three-month and six-month periods ended June 30, 2007 and 2006.
  The accounting policies of the segments are the same as those described in the summary of significant accounting policies included in the notes to the Companys audited historical financial
  statements as of December 31, 2006 and 2005 and for the years ended December 31, 2006, 2005 and 2004 included in our
15

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
Annual Report on Form 10-K. The Company evaluates the performance of each operating segment based on underwriting profit or loss before income taxes, nonrecurring items (e.g., items of an
  unusual or infrequent nature), and inter-segment transactions. Certain costs and operating expenses are allocated to each of the segments based on: (i) a review of the nature of such costs, and (ii)
  time studies analyzing the amount of employee compensation costs incurred by each segment.
Three Months EndedJune 30,
    
    Six Months EndedJune 30,2007
    
    2006
    
    2007
    
    2006(U.S. dollars in thousands)Financial guarantee insurance segment:Gross premiums written
    
    
    $
    
    65,157
    
    
    
    $
    
    99,351
    
    
    
    $
    
    154,652
    
    
    
    $
    
    170,131Ceded premiums
    
    
    
    (8,564
    )
    
    
    
    
    (6,160
    )
    
    
    
    
    (28,797
    )
    
    
    
    
    (13,752
    )Net premiums written
    
    
    
    56,593
    
    
    
    
    93,191
    
    
    
    
    125,855
    
    
    
    
    156,379Change in net deferred premium revenue
    
    
    
    (9,583
    )
    
    
    
    
    (43,898
    )
    
    
    
    
    (39,484
    )
    
    
    
    
    (76,742
    )Net premiums earned
    
    
    
    47,010
    
    
    
    
    49,293
    
    
    
    
    86,371
    
    
    
    
    79,637Fee and other income
    
    
    
    85
    
    
    
    
    971
    
    
    
    
    85
    
    
    
    
    2,231Total underwriting revenues
    
    
    
    47,095
    
    
    
    
    50,264
    
    
    
    
    86,456
    
    
    
    
    81,868Net losses and loss adjustment expenses
    
    
    
    2,961
    
    
    
    
    2,311
    
    
    
    
    1,743
    
    
    
    
    4,847Acquisition costs, net
    
    
    
    2,496
    
    
    
    
    3,045
    
    
    
    
    5,107
    
    
    
    
    4,329Operating expenses
    
    
    
    19,028
    
    
    
    
    14,608
    
    
    
    
    35,578
    
    
    
    
    30,045Total underwriting expenses
    
    
    
    24,485
    
    
    
    
    19,964
    
    
    
    
    42,428
    
    
    
    
    39,221Financial guarantee insurance underwriting profit
    
    
    $
    
    22,610
    
    
    
    $
    
    30,300
    
    
    
    $
    
    44,028
    
    
    
    $
    
    42,647Financial guarantee reinsurance segment:Reinsurance premiums assumed
    
    
    $
    
    5,504
    
    
    
    $
    
    8,292
    
    
    
    $
    
    20,967
    
    
    
    $
    
    19,695Change in net deferred premium revenue
    
    
    
    1,678
    
    
    
    
    (2,044
    )
    
    
    
    
    (6,767
    )
    
    
    
    
    (5,978
    )Net premiums earned and total underwriting revenue
    
    
    
    7,182
    
    
    
    
    6,248
    
    
    
    
    14,200
    
    
    
    
    13,717Net losses and loss adjustment expenses
    
    
    
    67
    
    
    
    
    569
    
    
    
    
    484
    
    
    
    
    1,482Acquisition costs, net
    
    
    
    1,283
    
    
    
    
    1,497
    
    
    
    
    2,642
    
    
    
    
    2,895Operating expenses
    
    
    
    2,688
    
    
    
    
    2,884
    
    
    
    
    6,390
    
    
    
    
    4,542Total underwriting expenses
    
    
    
    4,038
    
    
    
    
    4,950
    
    
    
    
    9,516
    
    
    
    
    8,919Financial guarantee reinsurance underwriting profit
    
    
    $
    
    3,144
    
    
    
    $
    
    1,298
    
    
    
    $
    
    4,684
    
    
    
    $
    
    4,798Total segment underwriting profit
    
    
    $
    
    25,754
    
    
    
    $
    
    31,598
    
    
    
    $
    
    48,712
    
    
    
    $
    
    47,445Corporate and other:Net investment income
    
    
    
    30,263
    
    
    
    
    16,129
    
    
    
    
    56,388
    
    
    
    
    31,191Net
      realized losses on investments
    
    
    
    (1,654
    )
    
    
    
    
    (10,717
    )
    
    
    
    
    (1,542
    )
    
    
    
    
    (16,400
    )Net
        realized and unrealized (losses) gains on derivative financial instruments
    
    
    
    (22,175
    )
    
    
    
    
    301
    
    
    
    
    (29,104
    )
    
    
    
    
    (3,549
    )Subtotal
    
    
    
    32,188
    
    
    
    
    37,311
    
    
    
    
    74,454
    
    
    
    
    58,687Corporate operating expenses
    
    
    
    4,837
    
    
    
    
    
    
    
    
    
    8,655
    
    
    
    
    Income before income tax and minority interest
    
    
    
    27,351
    
    
    
    
    37,311
    
    
    
    
    65,799
    
    
    
    
    58,687Income
        tax expense (benefit)
    
    
    
    632
    
    
    
    
    (203
    )
    
    
    
    
    711
    
    
    
    
    (188
    )Income before minority interest
    
    
    
    26,719
    
    
    
    
    37,514
    
    
    
    
    65,088
    
    
    
    
    58,875Minority interest  dividends on redeemable preferred shares
    
    
    
    804
    
    
    
    
    1,126
    
    
    
    
    1,918
    
    
    
    
    5,738Net income
    
    
    
    25,915
    
    
    
    
    36,388
    
    
    
    
    63,170
    
    
    
    
    53,137Dividends on perpetual preference shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income available to common shareholders
    
    
    $
    
    25,915
    
    
    
    $
    
    36,388
    
    
    
    $
    
    63,170
    
    
    
    $
    
    53,13716

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
9. Liability for Losses and Loss Adjustment Expenses
The Companys liability for losses and loss adjustment expenses consists of case basis reserves and unallocated reserves. Activity in the liability for losses and loss adjustment expenses is
  summarized as follows:
Six Months EndedJune 30, 2007
    
    Year EndedDecember 31, 2006Case Reserves
    
    Unallocated Reserves
    
    Case Reserves
    
    Unallocated Reserves(U.S. dollars in thousands)Gross unpaid losses and loss adjustment expenses at beginning of year
    
    
    $
    
    85,351
    
    
    
    $
    
    93,166
    
    
    
    $
    
    69,382
    
    
    
    $
    
    77,986Unpaid losses and loss expenses recoverable
    
    
    
    (70,842
    )
    
    
    
    
    (17,774
    )
    
    
    
    
    (52,316
    )
    
    
    
    
    (16,901
    )Net unpaid losses and loss adjustment expenses at beginning of year
    
    
    
    14,509
    
    
    
    
    75,392
    
    
    
    
    17,066
    
    
    
    
    61,085Increase (decrease) in net losses and loss adjustment expenses incurred in respect of losses occurring in:Current year
    
    
    
    
    
    
    
    
    5,891
    
    
    
    
    
    
    
    
    
    14,307Prior years
    
    
    
    (3,664
    )
    
    
    
    
    
    
    
    
    
    651
    
    
    
    
    Cancellation of contract assumed from affiliate
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,177
    )
    
    
    
    
    Less net losses and loss adjustment expenses paid
    
    
    
    (375
    )
    
    
    
    
    
    
    
    
    
    (2,031
    )
    
    
    
    
    Net unpaid losses and loss adjustment expenses at end of period
    
    
    
    10,470
    
    
    
    
    81,283
    
    
    
    
    14,509
    
    
    
    
    75,392Unpaid losses and loss expenses recoverable
    
    
    
    65,565
    
    
    
    
    17,210
    
    
    
    
    70,842
    
    
    
    
    17,774Gross unpaid losses and loss adjustment expenses at end of period
    
    
    $
    
    76,035
    
    
    
    $
    
    98,493
    
    
    
    $
    
    85,351
    
    
    
    $
    
    93,166Set forth below is a discussion of certain case basis reserves established by the Company. The Company has been indemnified with respect to loss development relating to the insurance
  transactions described under (a) and (b) below by subsidiaries of XL Capital in connection with SCAs IPO. As a result of such indemnifications, all adverse loss development on such insurance
  transactions subsequent to the effective date of the IPO, which is in excess of the Companys carried reserves for such transactions at the date of the IPO, will be absorbed by the aforementioned
  affiliates of XL Capital. Such protection does not relieve the Company of its obligations under the aforementioned insurance transactions. Accordingly, the Company is still liable under the insurance
  transactions in the event that the affiliates of XL Capital do not meet their obligations under the indemnifications. For further information with respect to the indemnifications see Note 6.
(a)
    
    
    
    As of June 30, 2007, the Company carried a gross case basis reserve for losses and loss adjustment expenses of approximately $74.0 million ($8.7 million after reinsurance to XLI and XL RE
      AM) relating to an insured project financing. There was no change in the reserve from December 31, 2006. The total remaining par insured by the Company in connection with this
      transaction is $215.8 million, net of applicable carried case reserves, as of June 30, 2007. The estimate of loss was based on assumptions and estimates extending over many years into the
      future. There is currently no payment default with respect to this transaction. Management continues to monitor the exposure and will revise its loss estimate if necessary, as new information
      becomes available.17

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
(b)
    
    
    
    As of December 31, 2006, the Company carried a liability of $5.0 million relating to a dispute in regard to certain exposures associated with notes which were insured by the Company and
      collateralized by loans to medical providers. Because the Companys liability in regard to this dispute was fully indemnified by XLA pursuant to the indemnification discussed above and in
      Note 6, the Company also carried a recoverable from XLA for $5.0 million as of December 31, 2006. During the three months ended March 31, 2007, the Company reduced the liability and
      corresponding recoverable from XLA by $1.1 million to reflect an agreement in principal among the parties to settle the dispute in exchange for a payment by the Company of $3.9 million.
      The settlement payment was made in May 2007 reducing the reserve and related recoverable to zero.(c)
    
    
    
    As of December 31, 2006, the Company carried a case basis reserve for losses and loss adjustment expenses of $3.3 million (none of which was reinsured) representing the present value of the
      loss expected to be incurred in the future with respect to an insured residential mortgage securitization. During the three months ended March 31, 2007, the insured obligation was retired as a
      result of the exercise of a clean-up call by the sponsor of the securitization thereby eliminating the Companys exposure without loss. Accordingly, the Company recorded a reduction in its
      provision for losses and loss adjustment expenses for the three months ended March 31, 2007 of $3.3 million resulting from the elimination of the aforementioned reserve.10. Earnings per Common Share
Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period excluding the dilutive effect of stock
  option and restricted stock awards outstanding. Diluted earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding including the
  dilutive effect of stock option and restricted stock awards outstanding.
The following table sets forth the computation of basic and diluted earnings per share:
Three Months EndedJune 30,
    
    Six Months EndedJune 30,2007
    
    2006
    
    2007
    
    2006(U.S. Dollars in thousands, except per share amounts)Net income available to common shareholders
    
    
    $
    
    25,915
    
    
    
    $
    
    36,388
    
    
    
    $
    
    63,170
    
    
    
    $
    
    53,137Basic shares(1)
    
    
    
    64,136
    
    
    
    
    46,127
    
    
    
    
    64,136
    
    
    
    
    46,127Common stock equivalents
    
    
    
    371
    
    
    
    
    
    
    
    
    
    287
    
    
    
    
    Diluted shares(1)
    
    
    
    64,507
    
    
    
    
    46,127
    
    
    
    
    64,423
    
    
    
    
    46,127Basic earnings per common share
    
    
    $
    
    0.40
    
    
    
    $
    
    0.79
    
    
    
    $
    
    0.98
    
    
    
    $
    
    1.15Diluted earnings per common share
    
    
    $
    
    0.40
    
    
    
    $
    
    0.79
    
    
    
    $
    
    0.98
    
    
    
    $
    
    1.15

(1)
    
    
    
    Per share amounts for the three and six months ended June 30, 2006 are based on 46,127,245 shares outstanding. In July 2006, immediately prior to the IPO, a stock split of the Companys outstanding common shares was effected. The
      accompanying Interim Consolidated Financial Statements and share amounts have been retroactively adjusted for the effects of such stock split.11. Exposures under Guarantees
The Company provides financial guarantee insurance and reinsurance to support public and private borrowing arrangements. Financial guarantee insurance guarantees the timely payment of
  principal and interest on insured obligations to third party holders of such obligations in the event of default by an
18

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
issuer. The Companys potential liability in the event of non-payment by the issuer of an insured or reinsured obligation represents the aggregate outstanding principal insured or reinsured under its
  policies and contracts and related interest payable at the date of default. In addition, the Company provides credit protection on specific referenced credits or on pools of specific referenced credits
  through the issuance of credit default swaps. Under the terms of credit default swaps, the seller of credit protection makes a specified payment to the buyer of credit protection upon the occurrence
  of one or more specified credit events with respect to a reference obligation or entity. The Companys potential liability under credit default swaps represents the notional amount of such swaps.
As of June 30, 2007, the Companys net outstanding par exposure under its in-force financial guarantee insurance and reinsurance policies and contracts aggregated to $100.9 billion and net
  reserves for losses and loss adjustment expenses relating to such exposures was $76.7 million at such date. In addition, as of June 30, 2007, the Companys notional exposure under credit default swaps
  aggregated to $41.7 billion and the net liability for these credit default swaps and other derivatives reflected in the Companys balance sheet as of June 30, 2007 was $36.5 million.
12. Stock-Based and Long-Term Compensation Plans
Prior to the IPO, certain employees of the Company participated under XL Capitals stock-based and long-term compensation plans and expense relating thereto was reflected in the Companys
  results of operations. Subsequent to the IPO, SCA adopted its own stock-based and long-term incentive plan and certain awards to employees of the Company under XL Capitals stock-based
  compensation and long-term incentive plans were converted to SCAs plans. Expense relating to awards to employees of the Company under XL Capital plans that were not so converted and remain
  outstanding continues to be recognized in the Companys financial statements.
Set forth below is certain information in regard to stock option and restricted stock awards made under SCAs stock-based and long-term incentive plan, as well as certain information in regard
  to awards to SCA employees that remain outstanding under XL Capitals stock-based compensation and long-term incentive plans.
SCA Stock-Based Compensation Plans
The following is a summary of stock option awards as of June 30, 2007, and related activity for the six month period then ended:
Number ofShares
    
    WeightedAverageExercisePrice
    
    WeightedAverageRemainingContractualTerm
    
    AggregateIntrinsicValueOutstanding  December 31, 2006
    
    
    
    647,963
    
    
    
    $
    
    20.50
    
    
    
    
    2.8 years
    
    
    
    $
    
    6,719,376Granted
    
    
    
    229,825
    
    
    
    $
    
    30.00
    
    
    
    
    2.7 years
    
    
    
    
    199,948Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cancelled
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding  June 30, 2007
    
    
    
    877,788
    
    
    
    $
    
    22.99
    
    
    
    
    2.8 years
    
    
    
    $
    
    6,919,324The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Companys closing stock price on June 30, 2007 and the exercise price,
  multiplied by the number of in-the-money-options) that would have been received by the option holders had all option holders exercised their options on June 30, 2007. Total unrecognized stock
  based compensation
19

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
expense related to non-vested stock options was approximately $4.6 million as of June 30, 2007, related to 877,788 options, which is expected to be recognized over a weighted-average period of 2.8
  years.
The following is a summary of restricted stock awards as of June 30, 2007, and related activity for the six month period then ended:
Number ofShares
    
    WeightedAverageGrantPrice
    
    WeightedAverageRemainingContractualTerm
    
    RemainingUnrecognizedCompensationExpenseAt June 30,2007Outstanding  December 31, 2006
    
    
    
    497,928
    
    
    
    $
    
    20.50
    
    
    
    
    4.19 years
    
    
    
    $
    
    7,990,090Granted
    
    
    
    698,141
    
    
    
    $
    
    29.63
    
    
    
    
    3.65 years
    
    
    
    
    18,227,558Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cancelled
    
    
    
    (34,158
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding  June 30, 2007
    
    
    
    1,161,911
    
    
    
    $
    
    26.59
    
    
    
    
    3.82 years
    
    
    
    $
    
    26,217,648Awards of restricted stock had a weighted average grant date fair value of $26.59. During the three and six months ended June 30, 2007, SCA recognized approximately $1.7 million and $2.7
  million, respectively, of compensation expense related to its restricted stock awards. There were 28,645 and 34,158 shares respectively, of restricted stock forfeited and no shares vested during the
  three and six months ended June 30, 2007.
Total unrecognized stock based compensation expense related to non-vested restricted stock was approximately $26.2 million at June 30, 2007, which is expected to be recognized over a weighted-
  average period of 3.8 years.
SCA Long-Term Compensation Plans
a. Deferred Cash Awards
Effective August 4, 2006, all outstanding and unvested awards to employees of the Company under XL Capital plans, known as deferred cash awards, were involuntarily converted to awards
  under SCAs plan. All the terms, conditions and values of the awards made under SCAs plan pursuant to such conversion were structured to mirror the terms of the awards made under XL Capitals
  plan. The Awards vest as set forth in the applicable Award agreements, and the requisite service period is equivalent to the vesting period. The Awards contain certain restrictions, prior to vesting,
  relating to, among other things, forfeiture in the event of termination of employment and transferability.
During
    the three and six months ended June 30, 2007, the Company recognized approximately
    $1.6 million and $2.9 million of compensation expense, respectively, related
    to deferred cash awards. Also, during the three and six months ended June
    30, 2007, the Company granted deferred cash awards of approximately $0.1
    million and $1.1 million, respectively. Total unrecognized compensation expense
    related to non-vested deferred cash awards was approximately $11.9 million
    as of June 30, 2007. The non-vested unrecognized compensation expense relating
    to the deferred cash awards are expected to be recognized over a weighted-average
    period of 2.0 years.
b. Long Term Incentive Plan Awards
In connection with the IPO, XL Capital and the Company offered eligible employees of the Company the opportunity to exchange all of their outstanding unvested restricted Class A Ordinary
  Shares of XL Capital and options to purchase Class A Ordinary Shares of XL Capital, which were
20

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
awarded to such employees under XL Capital Plans prior to the IPO, for a long term incentive plan award (the LTIP Award) from SCA to be granted under SCAs Plan (the Exchange Offer).
An LTIP Award is the right to receive a cash payment, or base amount, from SCA of no less than 75% of the target amount indicated in each offerees award letter. Such target amount
  will be adjusted higher or lower (but in no event lower than the base amount) based on the performance of SCA pursuant to the terms and conditions specified in the Award. The Awards vest as set
  forth in the applicable Award agreements, and the requisite service period is equivalent to the vesting period. The Awards contain certain restrictions, prior to vesting, relating to, among other things,
  forfeiture in the event of termination of employment and transferability.
The aggregate target amount of LTIP Awards outstanding at June 30, 2007 was $13.3 million. There were no cancellations, forfeitures, or new issuances of such awards during the three and six
  months ended June 30, 2007. During the three and six months ended June 30, 2007, the Company recognized $1.6 million and $3.2 million of compensation expense relating to such awards. Total
  unrecognized compensation expense related to non-vested LTIP Awards based on managements best estimate of the ultimate payout or value of such awards was approximately $9.8 million as of
  June 30, 2007. The non-vested unrecognized compensation expense relating to LTIP Awards are expected to be recognized over a weighted-average period of 1.5 years.
Refer to Note 6 for information regarding outstanding unvested restricted Class A Ordinary Shares of XL Capital and options to purchase Class A Ordinary Shares of XL Capital that were not
  exchanged under the Exchange Offer and remain outstanding under XL Capital plans.
13. Series A Perpetual Non-Cumulative Preference Shares
On April 5, 2007, SCA consummated the sale of $250 million Series A Perpetual Non-Cumulative Preference Shares (the SCA Series A Preference Shares) which were offered for sale pursuant
  to a private placement. Gross proceeds from the offering were $250.0 million, offering costs were $3.4 million, and net proceeds were $246.6 million. The SCA Series A Preference Shares are
  perpetual securities with no fixed maturity date and, if declared by the Board of SCA, will pay a fixed dividend, on a semi-annual basis during the first and third quarters of each fiscal year, at the
  annualized rate of 6.88% until September 30, 2017. After such date, the Series A Preference Shares, if declared by the Board of SCA, will pay dividends, on a quarterly basis, at a floating rate based
  on three-month LIBOR plus 2.715%. Dividends on the SCA Series A Preference Shares are non-cumulative. The SCA Series A Preference Shares have a liquidation preference of $1,000 per
  preference share. As of June 30, 2007 there has been no dividend declared by the Companys board of directors on the SCA Series A Preference Shares and, as such, there is no dividend reflected in
  the accompanying financial statements with respect to these securities.
In connection with the sale of the SCA Series A Preference Shares, the Company entered into a Replacement Capital Covenant (the Replacement Capital Covenant), whereby the Company
  agreed for the benefit of holders of one or more designated series of its long-term debt securities that the Company may issue in the future that (i) the Company will not redeem, exchange or
  purchase the SCA Series A Preference Shares and (ii) none of the Companys subsidiaries will purchase or exchange the SCA Series A Preference Shares, except, subject to certain limitations, to the
  extent that the applicable redemption, exchange or purchase price does not exceed a specified amount of cash proceeds from the sale of certain specified qualifying replacement capital securities
  raised during the period commencing on the 180th calendar day prior to the date of notice of the redemption or the date of purchase. The Company has made no decision as to whether, or when,
  the Company would issue debt securities that would have the benefit of that covenant. While such provisions are in effect, there could be circumstances
21

SECURITY CAPITAL ASSURANCE LTDNOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS (continued)
where the Company would wish to redeem, exchange or purchase some or all of the SCA Series A Preference Shares but be restricted from doing so. The Replacement Capital Covenant may be
  terminated if (i) holders of at least a majority by principal amount of the then-effective series of covered debt consent or agree in writing to terminate the Replacement Capital Covenant, (ii) the
  Company no longer has outstanding any indebtedness that qualifies as covered debt or (iii) the Company no longer has any outstanding SCA Series A Preference Shares. In addition, if not earlier
  terminated, the Replacement Capital Covenant will terminate on September 30, 2047; provided, however, that the September 30, 2047 termination date may be extended at the Companys option.
14. Other Matters
On July 31, 2007 our board of directors declared a quarterly dividend of $.02 per common share payable on September 28, 2007 to shareholders of record on September 14, 2007. Also, on July
  31, 2007 our board of directors declared a semi-annual dividend on the SCA Series A Preference Shares aggregating $8.4 million, which is payable on October 1, 2007 to shareholders of record of the
  SCA Series A Preference Shares on September 28, 2007. Any future dividends will be subject to the discretion and approval of the Board of Directors.
On February 27, 2007, the board of directors of XLFA approed: (i) an extraordinary dividend of $15.0 million on its Series A Redeemable Preferred Shares, and (ii) a reduction in the stated
  value of the remaining outstanding Series A Redeemable Preferred Shares by a corresponding amount. Payment of the extraordinary dividend and the reduction in the stated value of the Series A
  Redeemable Preferred Shares occurred on March 30, 2007. This transaction was accounted for as a redemption of the preferred shares. As a result of the decrease in stated value, the Companys
  annual fixed dividend requirement on the Series A Redeemable Preferred Shares will be reduced from $4.5 million to $3.2 million. These redeemable preferred shares are reflected in the
  accompanying consolidated balance sheet of the Company as minority interest  redeemable preferred shares.
22

ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations contains forward-looking statements that involve risks and uncertainties. Our actual results could differ
  materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below. See also, Cautionary Note Regarding Forward-Looking Statements
  below for a list of factors that could cause actual results to differ materially from those contained in any forward-looking statement.
Overview
General
We are a Bermuda-domiciled holding company whose operating subsidiaries provide credit enhancement and protection products to the public finance and structured finance markets throughout
  the United States and internationally.
We provide credit enhancement and protection through the issuance of financial guarantee insurance policies and credit default swaps, as well as the reinsurance of financial guarantee insurance
  and credit default products written by other insurers. Financial guarantee insurance provides an unconditional and irrevocable guarantee to the holder of a debt obligation of full and timely payment
  of principal and interest. In the event of a default under the obligation, the insurer has recourse against the issuer and/or any related collateral (which is more common in the case of insured asset-
  backed obligations or other non-municipal debt) for amounts paid under the terms of the policy. Credit default swaps are derivative contracts that offer credit protection relating to a particular
  security or pools of specified securities. Under the terms of a credit default swap, the seller of credit protection makes a specified payment to the buyer of credit protection upon the occurrence of
  one or more specified credit events with respect to a referenced security. Our financial guarantee reinsurance provides a means by which financial guarantee insurance companies can manage and
  mitigate risks in their in-force business and/or increase their capacity to write such business.
Organization Background, Initial Public Offering, and Ownership by XL Capital
We were formed as an indirect wholly owned Bermuda based subsidiary of XL Capital on March 17, 2006. On July 1, 2006, XL Capital contributed all its ownership interests in its financial
  guarantee insurance and financial guarantee reinsurance operating businesses to us. The aforementioned operating businesses consisted of: (i) XL Capital Assurance Inc. (XLCA) and its wholly-
  owned subsidiary, XL Capital Assurance (U.K.) Limited (XLCA-UK) and (ii) XL Financial Assurance Ltd. (XLFA). XLCA was an indirect wholly owned subsidiary of XL Capital and all of
  XLFA was owned by XL Capital except for a preferred stock interest which is owned by Financial Security Assurance Holdings Ltd. (FSAH), an entity which is otherwise not related to XL
  Capital or us. On August 4, 2006, we completed the sale of 18,009,119 of our common shares through an initial public offering (the IPO) at $20.50 per share. We received net proceeds from the
  offering of $341.3 million. In addition, XL Capital sold 5,430,774 of our common shares (including 992,165 pursuant to the exercise of an over-allotment option granted to underwriters) from its
  holdings directly to the public in a secondary offering concurrent with our IPO. We did not receive any of the proceeds from the aforementioned sale by XL Capital. Immediately after the IPO and
  the secondary offering, XL Capital owned 40,696,471 of our common shares which represented approximately a 63 percent economic interest in SCA, adjusted for restricted share awards to our
  employees and management made at the effective date of the IPO. In June 2007, XL Capital completed the sale of an additional 10,627,422 common shares of SCA from its holdings (including
  947,400 common shares pursuant to the exercise of an over-allotment option granted to underwriters). We did not receive any of the proceeds from this sale. Immediately after such sale XL Capital
  owned 30,069,049 of our common shares which represented approximately a 46 percent voting and economic interest in SCA, adjusted for restricted share awards to our employees and management
  outstanding as of such date. Prior to XL Capitals sale of SCA common shares in June 2007 its voting interest in SCA was subject to limitations contained in our bye-laws. See Liquidity and Capital
  Resources for further details regarding the use of proceeds from our IPO.
23

Offering of Series A Perpetual Non-Cumulative Preference Shares
On April 5, 2007, we consummated the sale of $250 million of our Series A Perpetual Non-Cumulative Preference Shares (the SCA Series A Preference Shares) which were offered for sale
  pursuant to a private placement. Gross proceeds from the offering were $250.0 million, offering costs were $3.4 million, and net proceeds were $246.6 million. The SCA Series A Preference Shares
  are perpetual securities with no fixed maturity date and, if declared by the Board of SCA, will pay a fixed dividend, on a semi-annual basis during the third and first quarters of each fiscal year, at
  the annualized rate of 6.88% until September 30, 2017. After such date, the Series A Preference Shares, if declared by the Board of SCA, will pay dividends, on a quarterly basis, at a floating rate
  based on three-month LIBOR plus 2.715%. Dividends on the SCA Series A Preference Shares are non-cumulative. The SCA Series A Preference Shares have a liquidation preference of $1,000 per
  preference share. See Liquidity and Capital ResourcesCapital Resources.
Key Factors Affecting Profitability
We
    believe that the financial guarantee business is significantly affected by
    economic cycles. For example, a robust economy featuring a good or improving
    credit environment is beneficial to the in-force portfolios of financial
    guarantee insurers and reinsurers. Historically, however, when such conditions
    have existed for an extended period, credit spreads tend to narrow and pricing
    and demand for financial guarantee insurance and reinsurance tend to decline.
    A deteriorating economic and credit environment, in contrast, is typically
    marked by widening credit spreads and increasing pricing for financial guarantee
    products. However, a prolonged period of weak or declining economic activity
    could stress in-force financial guarantee insured portfolios and result in
    claims or could adversely impact capital adequacy due to deterioration in
    the credit quality of in-force insured portfolios. During the past several
    years, economic conditions and the credit environment have been strong and,
    as a result, credit spreads have generally narrowed and new aggregate business
    production of primary insurers has generally slowed. More recently credit
    spreads across most bond sectors have widened reflecting wide spread concerns
    of potential credit erosion which have been caused by the widely published
    problems in the subprime mortgage and collateralized debt obligation (CDO) markets.
    We are exposed to subprime mortgages directly, through our guarantees of
    residential mortgage-backed securities and indirectly, through our guarantees
    of CDOs of asset-backed securities. As of June 30, 2007, our total exposure
    to such mortgages aggregated $4.8 billion of net par outstanding, representing
    approximately 3% of our total in-force guaranteed net par outstanding at
    such date. Of our total direct guaranteed subprime mortgage net par exposure
    at June 30, 2007, 42% was rated AAA, 13% was rated AA+,
    38% was rated AA-, and 7% was rated A-. All  of our
    indirect subprime exposure are in CDOs where our guarantees attach at super AAA. As of June 30, 2007, there are
    no guaranteed subprime mortgage exposures among our closely monitored credits,
    which are discussed below. See additional information in regard to our subprime
    exposure furnished to the Securities and Exchange Commission on August 3,
    2007 on Form 8-K.
We derive our revenues principally from: (i) premiums from our insurance and reinsurance businesses, (ii) net investment income and net realized gains and losses from our investment portfolio
  supporting these businesses and (iii) realized and unrealized gains and losses on derivative financial instruments.
Our premiums are a function of the amount of par or notional amount of debt obligations that we guarantee, market prices and the type of debt obligation guaranteed. We receive premiums
  either on an upfront basis when the policy is issued or the contract is executed or on an installment basis over the life of the applicable transaction.
Premiums are accounted for as written when due; therefore when we enter into policies that provide for upfront premium, all of the premium on the policy is accounted for as written generally
  when the policy commences. The portion of the upfront premium that has been written but has not yet been earned is carried on our balance sheet as deferred premium revenue. When we enter into
  policies that provide for installment premium, only that installment of the premium that is then due (generally the current monthly, quarterly or semiannual installment) is accounted for as written.
  Future premium installments during the remainder of the life of the installment-based policy are not reflected on our financial statements. Therefore, the amount of total premiums written that we
  report for any period will
24

be affected by the mix of policies that we wrote in that period on an upfront and, in that period and prior periods, on an installment basis. Generally, a financial guarantee insurance company
  with a growing in-force book of business should recognize an increasing amount of net earned premium from policies written in prior reporting periods, whether premiums are received on an upfront
  or installment basis. Future installments of premium on business written in a period are reported by financial guarantors as a component of adjusted gross premiums, a non-GAAP financial measure,
  which is discussed in more detail below. The amount of installment premiums actually realized by us in the future (and that would be otherwise reflected in revenue) could be reduced due to factors
  such as early termination of insurance contracts or accelerated prepayments of underlying obligations.
Our investment income is a function of the amount of our invested assets and the yield that we earn on those assets. The investment yield will be a function of market interest rates at the time
  of investment, as well as the type, credit quality and duration of our invested assets. In addition, we could realize gains or losses on the sale of securities in our investment portfolio or recognize an
  other-than-temporary impairment as a result of changing market conditions, including changes in market interest rates, and changes in the credit quality of our invested assets.
Unrealized gains and losses on credit default swaps and insurance policies that we account for as derivative contracts are a function of changes in the estimated fair value of those contracts. We
  expect these unrealized gains and losses to fluctuate primarily based on changes in credit spreads and the credit quality of the referenced securities. We generally hold these derivative contracts to
  maturity. When we hold a derivative contract to maturity, the cumulative unrealized gains and losses will net to zero if we incur no credit losses on that contract. In certain circumstances, we may
  choose to terminate a credit derivative prior to its maturity (for example, upon a deterioration in underlying credit quality).
Our expenses primarily consist of losses and loss adjustment expenses, acquisition costs, and operating expenses. Acquisition costs are related to the production of new financial guarantee
  insurance business and commissions paid on reinsurance assumed. These costs are generally deferred and recognized over the period in which the related premiums are earned. Operating expenses
  consist primarily of costs relating to compensation of our employees, information technology, office premises, and professional fees.
Other Measures Used by Management to Evaluate Operating Performance
The following are certain financial measures management considers important in evaluating the Companys operating performance:
We evaluate our periodic sales performance by reviewing a non-GAAP measure known as adjusted gross premiums. Adjusted gross premiums for any period equals the sum of: (i) upfront
  premiums written in such period, (ii) current installment premiums on business written in such period and (iii) expected future installment premiums on contracts written during such period that
  remain in force and for which there is a binding obligation on the part of the insured to pay the future installment premiums, discounted at 7%, which we refer to as the present value of future
  installment premiums, or PVFIP, on business written during such period. The 7% discount rate was established when our subsidiaries first started reporting adjusted gross premiums based upon a
  view at the time that 7% was the appropriate discount for these future premiums and that rate has not been changed in order to preserve comparability among periods. This measure adjusts for the
  fact, as described above, that upfront premiums are recorded in full as total premiums written at inception of the contract but future installment premiums are not. PVFIP is not reflected on our
  consolidated balance sheet. PVFIP can be negatively affected by prepayments and refundings, early terminations, credit losses or other factors impacting our in-force book of business.
The following is a reconciliation of total premiums written to adjusted gross premiums. Total premiums written is the most directly comparable GAAP financial measure.
25

(U.S dollars in millions)
    
    Three Months EndedJune 30,
    
    Six Months EndedJune 30,2007
    
    2006
    
    2007
    
    2006Total upfront premiums written
    
    
    $
    
    31.9
    
    
    
    $
    
    74.6
    
    
    
    $
    
    104.7
    
    
    
    $
    
    127.0Total installment premiums written
    
    
    
    38.8
    
    
    
    
    33.0
    
    
    
    
    70.9
    
    
    
    
    62.8Total premiums written
    
    
    
    70.7
    
    
    
    
    107.6
    
    
    
    
    175.6
    
    
    
    
    189.8Present value of estimated future installment premiums written and assumed on contracts issued in the current period, discounted at 7%
    
    
    
    42.7
    
    
    
    
    49.6
    
    
    
    
    76.8
    
    
    
    
    77.8Adjusted gross premiums
    
    
    $
    
    113.4
    
    
    
    $
    
    157.2
    
    
    
    $
    
    252.4
    
    
    
    $
    
    267.6We also review non-GAAP measures known as operating income and core income. While operating income and core income are not substitutes for net income available to common
  shareholders computed in accordance with GAAP, they are useful measures of performance used by management, equity analysts and investors. Operating income measures net income available to
  common shareholders, as determined in accordance with GAAP, excluding net realized gains (losses) on investments, net realized and unrealized gains (losses) on derivative financial instruments, and
  certain other items. In addition, in determining operating income, we have made an adjustment to the amount of dividends on our perpetual non-cumulative preference shares reported in accordance
  with GAAP during the period to reflect the amount of such dividends that would be attributable to the period as if such dividends were accrued ratably over the period. Core income represents
  operating income excluding the impact of refundings, calls and other accelerations. The definitions of operating income and core income used by the Company may differ from definitions of operating
  earnings and core earnings used by other financial guarantors. See Managements Discussion and Analysis of Financial Condition and Results of OperationsOffering of Series A Perpetual Non-
  Cumulative Preference Shares.
We also view our book value per share attributable to common shareholders as an additional measure of our performance. This metric is calculated by dividing common shareholders equity by
  the number of outstanding common shares (excluding outstanding restricted sharessee Note 12 to the Unaudited Interim Consolidated Financial Statements) at any period end. Book value per share
  attributable to common shareholders is affected primarily by our net income available to common shareholders and also by any changes in net unrealized gains and losses on our invested assets. Book
  value per share attributable to common shareholders was $21.95 at June 30, 2007, as compared to $21.31 at December 31, 2006. The increase in book value was primarily attributable to net income
  available to common shareholders, offset in part by an increase in net unrealized losses on our invested assets.
The activities of our surveillance department are integral to the identification of specific credits that have experienced deterioration in credit quality and to the assessment of whether losses on
  such credits are probable, as well as any estimation of the amount of loss expected to be incurred with respect to such credits. Closely monitored credits are divided into four categories: (i) Special
  Monitoring Listinvestment grade credits where a covenant or trigger may be breached or is close to being breached and warrants closer monitoring; (ii) Yellow Flag Listcredits that we determine to
  be non-investment grade but a loss or claim is unlikely; (iii) Red Flag Listcredits where we do not expect an ultimate loss but a claim is possible but not probable; and (iv) Loss Listcredits where we
  have either paid a loss or expect to suffer a loss and have recorded a case reserve. Out of over 2,500 credits in our in-force portfolio only 21 credits are in one of the four above categories. Credits
  that are not closely monitored credits are considered fundamentally sound, normal risk.
26

The following table presents our consolidated in-force financial guarantee net par outstanding at June 30, 2007 and December 31, 2006 by category of closely monitored credit:
(U.S. dollars in millions, except percentages)
    
    As of June 30, 2007
    
    As of December 31, 2006Net ParOutstanding
    
    % of Net ParOutstanding
    
    Net ParOutstanding
    
    % of Net ParOutstandingFundamentally sound normal risk
    
    
    $
    
    141,482
    
    
    
    
    99.2
    %
    
    
    
    $
    
    117,318
    
    
    
    
    99.4
    %Closely monitored credits:Special monitoring
    
    
    
    1,095
    
    
    
    
    0.8
    %
    
    
    
    
    558
    
    
    
    
    0.5
    %Yellow flag
    
    
    
    2
    
    
    
    
    0.0
    %
    
    
    
    
    3
    
    
    
    
    0.0
    %Red flag
    
    
    
    3
    
    
    
    
    0.0
    %
    
    
    
    
    37
    
    
    
    
    0.0
    %Loss list(1)
    
    
    
    12
    
    
    
    
    0.0
    %
    
    
    
    
    96
    
    
    
    
    0.1
    %Subtotal
    
    
    
    1,112
    
    
    
    
    0.8
    %
    
    
    
    
    694
    
    
    
    
    0.6
    %Total
    
    
    $
    
    142,594
    
    
    
    
    100.0
    %
    
    
    
    $
    
    118,012
    
    
    
    
    100.0
    %

(1)
    
    
    
    At June 30, 2007 and December 31, 2006, the loss list consisted of three and four guarantee contracts, respectively, with remaining net par outstanding of $11.5 million and $95.8 million, respectively, against which net reserves of $9.9 million and
      $13.6 million have been established, respectively- see Note 9 to the accompanying Unaudited Interim Consolidated Financial Statements.The following table sets forth our consolidated in-force financial guarantee net par outstanding by S&P rating category as of the dates indicated.
(U.S. dollars in millions, except percentages)
    
    Outstandingas of June 30,2007
    
    Percent ofTotal Net ParOutstanding
    
    Outstanding as ofDecember 31,2006
    
    Percent ofTotal Net ParOutstandingS&P Rating Category(1):AAA
    
    
    $
    
    53,302
    
    
    
    
    37.3
    %
    
    
    
    $
    
    34,559
    
    
    
    
    29.3
    %AA
    
    
    
    19,634
    
    
    
    
    13.8
    %
    
    
    
    
    17,846
    
    
    
    
    15.1
    %A
    
    
    
    36,414
    
    
    
    
    25.5
    %
    
    
    
    
    35,226
    
    
    
    
    29.9
    %BBB
    
    
    
    32,594
    
    
    
    
    22.9
    %
    
    
    
    
    29,889
    
    
    
    
    25.3
    %Below investment grade
    
    
    
    650
    
    
    
    
    0.5
    %
    
    
    
    
    492
    
    
    
    
    0.4
    %Total
    
    
    $
    
    142,594
    
    
    
    
    100.0
    %
    
    
    
    $
    
    118,012
    
    
    
    
    100.0
    %

(1)
    
    
    
    If unrated by S&P, an internal assessment of underlying credit quality is used to calculate a rating.Segments
Our businesses are organized and managed in two operating segments: financial guarantee insurance and financial guarantee reinsurance. Our financial guarantee insurance segment offers
  financial guarantee insurance policies and credit default swaps. Our financial guarantee reinsurance segment reinsures financial guarantee policies and credit default swaps issued by other monoline
  financial guarantee insurance companies. We evaluate the performance of each operating segment based upon underwriting profit or loss before income taxes, nonrecurring items (for example, items
  of an unusual or infrequent nature) and inter-segment transactions. Certain costs and operating expenses are allocated to each of the segments based upon: (i) a review of the nature of such costs and
  (ii) time studies analyzing the amount of employee compensation costs incurred by each segment. Except for the foregoing allocations, the accounting policies of the segments are the same as those
  described in the summary of significant accounting policies in our consolidated financial statements presented in our Annual Report on Form 10-K.
27

Executive Overview
See certain information with respect to members of our Board of Directors, Executive Officers and Key Employees in our Annual Report on Form 10-K for the fiscal year ended December 31,
  2006, which was filed with the Securities and Exchange Commission on March 15, 2007.
Critical Accounting Policies and Estimates
See information with respect to our critical accounting policies and estimates in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, which was filed with the Securities
  and Exchange Commission on March 15, 2007.
Results of Operations
Consolidated Results of Operations
The following table presents summary consolidated statement of operations data for the three and six month periods ended June 30, 2007 and 2006:
(Unaudited)Three Months EndedJune 30,
    
    (Unaudited)Six Months EndedJune 30,2007
    
    2006
    
    2007
    
    2006RevenuesGross premiums written
    
    
    $
    
    65,157
    
    
    
    $
    
    99,351
    
    
    
    $
    
    154,652
    
    
    
    $
    
    170,131Reinsurance premiums assumed
    
    
    
    5,504
    
    
    
    
    8,292
    
    
    
    
    20,967
    
    
    
    
    19,695Total premiums written
    
    
    
    70,661
    
    
    
    
    107,643
    
    
    
    
    175,619
    
    
    
    
    189,826Ceded premiums
    
    
    
    (8,564
    )
    
    
    
    
    (6,160
    )
    
    
    
    
    (28,797
    )
    
    
    
    
    (13,752
    )Net premiums written
    
    
    
    62,097
    
    
    
    
    101,483
    
    
    
    
    146,822
    
    
    
    
    176,074Change in net deferred premium revenue
    
    
    
    (7,905
    )
    
    
    
    
    (45,942
    )
    
    
    
    
    (46,251
    )
    
    
    
    
    (82,720
    )Net premiums earned (net of ceded premiums earned of $5,193, $10,021, $9,074 and $18,224)
    
    
    
    54,192
    
    
    
    
    55,541
    
    
    
    
    100,571
    
    
    
    
    93,354Net investment income
    
    
    
    30,263
    
    
    
    
    16,129
    
    
    
    
    56,388
    
    
    
    
    31,191Net
      realized losses on investments
    
    
    
    (1,654
    )
    
    
    
    
    (10,717
    )
    
    
    
    
    (1,542
    )
    
    
    
    
    (16,400
    )Net realized and unrealized (losses) gains on derivative financial instruments
    
    
    
    (22,175
    )
    
    
    
    
    301
    
    
    
    
    (29,104
    )
    
    
    
    
    (3,549
    )Fee income and other
    
    
    
    85
    
    
    
    
    971
    
    
    
    
    85
    
    
    
    
    2,231Total revenues
    
    
    
    60,711
    
    
    
    
    62,225
    
    
    
    
    126,398
    
    
    
    
    106,827ExpensesNet losses and loss adjustment expenses
    
    
    
    3,028
    
    
    
    
    2,880
    
    
    
    
    2,227
    
    
    
    
    6,329Acquisition costs, net
    
    
    
    3,779
    
    
    
    
    4,542
    
    
    
    
    7,749
    
    
    
    
    7,224Operating expenses
    
    
    
    26,553
    
    
    
    
    17,492
    
    
    
    
    50,623
    
    
    
    
    34,587Total expenses
    
    
    
    33,360
    
    
    
    
    24,914
    
    
    
    
    60,599
    
    
    
    
    48,140Income before income tax and minority interest
    
    
    
    27,351
    
    
    
    
    37,311
    
    
    
    
    65,799
    
    
    
    
    58,687Income tax expense (benefit)
    
    
    
    632
    
    
    
    
    (203
    )
    
    
    
    
    711
    
    
    
    
    (188
    )Income before minority interest
    
    
    
    26,719
    
    
    
    
    37,514
    
    
    
    
    65,088
    
    
    
    
    58,875Minority interest  dividends on redeemable preferred shares
    
    
    
    804
    
    
    
    
    1,126
    
    
    
    
    1,918
    
    
    
    
    5,738Net income
    
    
    
    25,915
    
    
    
    
    36,388
    
    
    
    
    63,170
    
    
    
    
    53,137Dividends on Series A perpetual non-cumulative preference shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income available to common shareholders
    
    
    $
    
    25,915
    
    
    
    $
    
    36,388
    
    
    
    $
    
    63,170
    
    
    
    $
    
    53,13728

Segment Results of Operations
The following table presents summary statement of operations data for our operating segments for the three and six month periods ended June 30, 2007 and 2006:
(U.S. dollars in thousands)
    
    Three Months EndedJune 30,
    
    Six Months EndedJune 30,2007
    
    2006
    
    2007
    
    2006Financial guarantee insurance segment:Gross premiums written
    
    
    $
    
    65,157
    
    
    
    $
    
    99,351
    
    
    
    $
    
    154,652
    
    
    
    $
    
    170,131Ceded premiums
    
    
    
    (8,564
    )
    
    
    
    
    (6,160
    )
    
    
    
    
    (28,797
    )
    
    
    
    
    (13,752
    )Net premiums written
    
    
    
    56,593
    
    
    
    
    93,191
    
    
    
    
    125,855
    
    
    
    
    156,379Change in net deferred premium revenue
    
    
    
    (9,583
    )
    
    
    
    
    (43,898
    )
    
    
    
    
    (39,484
    )
    
    
    
    
    (76,742
    )Net premiums earned
    
    
    
    47,010
    
    
    
    
    49,293
    
    
    
    
    86,371
    
    
    
    
    79,637Fee and other income
    
    
    
    85
    
    
    
    
    971
    
    
    
    
    85
    
    
    
    
    2,231Total underwriting revenues
    
    
    
    47,095
    
    
    
    
    50,264
    
    
    
    
    86,456
    
    
    
    
    81,868Net losses and loss adjustment expenses
    
    
    
    2,961
    
    
    
    
    2,311
    
    
    
    
    1,743
    
    
    
    
    4,847Acquisition costs, net
    
    
    
    2,496
    
    
    
    
    3,045
    
    
    
    
    5,107
    
    
    
    
    4,329Operating expenses
    
    
    
    19,028
    
    
    
    
    14,608
    
    
    
    
    35,578
    
    
    
    
    30,045Total underwriting expenses
    
    
    
    24,485
    
    
    
    
    19,964
    
    
    
    
    42,428
    
    
    
    
    39,221Financial guarantee insurance underwriting profit
    
    
    $
    
    22,610
    
    
    
    $
    
    30,300
    
    
    
    $
    
    44,028
    
    
    
    $
    
    42,647Financial guarantee reinsurance segment:Reinsurance premiums assumed
    
    
    $
    
    5,504
    
    
    
    $
    
    8,292
    
    
    
    $
    
    20,967
    
    
    
    $
    
    19,695Change in net deferred premium revenue
    
    
    
    1,678
    
    
    
    
    (2,044
    )
    
    
    
    
    (6,767
    )
    
    
    
    
    (5,978
    )Net premiums earned and total underwriting revenue
    
    
    
    7,182
    
    
    
    
    6,248
    
    
    
    
    14,200
    
    
    
    
    13,717Net losses and loss adjustment expenses
    
    
    
    67
    
    
    
    
    569
    
    
    
    
    484
    
    
    
    
    1,482Acquisition costs, net
    
    
    
    1,283
    
    
    
    
    1,497
    
    
    
    
    2,642
    
    
    
    
    2,895Operating expenses
    
    
    
    2,688
    
    
    
    
    2,884
    
    
    
    
    6,390
    
    
    
    
    4,542Total underwriting expenses
    
    
    
    4,038
    
    
    
    
    4,950
    
    
    
    
    9,516
    
    
    
    
    8,919Financial guarantee reinsurance underwriting profit
    
    
    $
    
    3,144
    
    
    
    $
    
    1,298
    
    
    
    $
    
    4,684
    
    
    
    $
    
    4,798Total segment underwriting profit
    
    
    $
    
    25,754
    
    
    
    $
    
    31,598
    
    
    
    $
    
    48,712
    
    
    
    $
    
    47,445Corporate and other:Net investment income
    
    
    
    30,263
    
    
    
    
    16,129
    
    
    
    
    56,388
    
    
    
    
    31,191Net
      realized losses on investments
    
    
    
    (1,654
    )
    
    
    
    
    (10,717
    )
    
    
    
    
    (1,542
    )
    
    
    
    
    (16,400
    )Net realized and unrealized (losses) gains on derivative financial instruments
    
    
    
    (22,175
    )
    
    
    
    
    301
    
    
    
    
    (29,104
    )
    
    
    
    
    (3,549
    )Subtotal
    
    
    
    32,188
    
    
    
    
    37,311
    
    
    
    
    74,454
    
    
    
    
    58,687Corporate operating expenses
    
    
    
    4,837
    
    
    
    
    
    
    
    
    
    8,655
    
    
    
    
    Income before income tax and minority interest
    
    
    
    27,351
    
    
    
    
    37,311
    
    
    
    
    65,799
    
    
    
    
    58,687Income
        tax expense (benefit)
    
    
    
    632
    
    
    
    
    (203
    )
    
    
    
    
    711
    
    
    
    
    (188
    )Income before minority interest
    
    
    
    26,719
    
    
    
    
    37,514
    
    
    
    
    65,088
    
    
    
    
    58,875Minority interest  dividends on redeemable preferred shares
    
    
    
    804
    
    
    
    
    1,126
    
    
    
    
    1,918
    
    
    
    
    5,738Net income
    
    
    
    25,915
    
    
    
    
    36,388
    
    
    
    
    63,170
    
    
    
    
    53,137Dividends on Series A perpetual non-cumulative preference shares
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income available to common shareholders
    
    
    $
    
    25,915
    
    
    
    $
    
    36,388
    
    
    
    $
    
    63,170
    
    
    
    $
    
    53,13729

Discussion of Consolidated and Segment Results of Operations for the Three Months Ended June 30, 2007 Compared to the Three Months Ended June 30, 2006
Summary Discussion of Consolidated Results of Operations
Comparison of three months ended June 30, 2007 to three months ended June 30, 2006. Net income available to common shareholders for the three months ended June 30, 2007 was $25.9 million,
  a decrease of $10.5 million from $36.4 million reported during the same period in 2006. Net income for the three months ended June 30, 2007 included $1.7 million of net realized losses on
  investments, as compared to net realized losses of approximately $10.7 million recorded during the same period in 2006. In addition, also included in net income available to common shareholders for
  the three months ended June 30, 2007 was approximately $22.2 million of net unrealized losses on derivative financial instruments, as compared to net unrealized gains on derivative financial
  instruments of $0.3 million recorded in the comparable period in 2006.
The
    decrease in net income available to common shareholders of $10.5 million
    for the three months ended June 30, 2007, as compared to the same period
    in 2006, was primarily driven by: (i) higher net unrealized losses on derivative
    financial instruments of $22.2 million, resulting primarily from widening
    credit spreads on our in-force portfolio of written credit default swaps
    that guarantee senior triple-A high-grade structured finance CDOs and
    CDOs of CDOs, (ii) higher operating expenses of $9.1 million resulting primarily
    from increased compensation due to an increase in the number of our employees,
    an increase in the volume of our credit default swap business (the costs
    of which cannot be deferred under GAAP), and continued investment in our
    infrastructure, (iii) lower earned premiums of $1.3 million resulting from
    a significant period over period decrease in refundings of $17.5 million
    (which is discussed further below), substantially offset by growth in earned
    premiums in our global infrastructure and CDO lines of business, as well
    as lower reinsurance cessions to XLI, and (iv) lower fee revenue of approximately
  $0.9 million, offset in part by (v) an increase in investment income of $14.1
    million reflecting a significant period over period increase in average invested
    assets and higher yields on new money investments, (vi) lower net realized
    losses on investments of $9.1 million. (during the three months ended June
    30, 2007, we reported net realized losses of $1.7 million, as compared to
    $10.7 of net realized losses in the same period in 2006, of which $9.0 million
    related to an impairment charge on investments acquired in satisfaction of
    a claim), and (vii) lower acquisition costs of $0.8 million resulting primarily
    from lower period over period refundings in the our insurance segment net
    of higher acquisition costs from the growth in our in-force business.
Set forth below is additional information with respect to earned premiums and new business production.
Net premiums earned for the three months ended June 30, 2007 of $54.2 million included $5.7 million of earnings from the early retirement of certain guaranteed obligations (e.g., refundings of
  insured obligations) (or $5.1 million, net of accelerated amortization of deferred acquisition costs related to the earnings from such refundings), as compared to $23.2 million during the comparable
  period in 2006 (or $21.4 million, net of accelerated amortization of deferred acquisition costs related to the earnings from such refundings). Our business production as measured by adjusted gross
  premiums (which includes upfront premiums written in the period, current installment premiums due on business written in the period and expected future installment premiums on business written
  during the period discounted at 7%) totaled $113.4 million for the three months ended June 30, 2007, a decrease of $43.8 million, as compared to $157.2 million reported in the comparable period in
  2006. The decrease was primarily due to lower production in the Public Finance and Global Infrastructure lines of business of $47.5 million and $ 41.3 million, respectively, offset in part by higher
  adjusted gross premium production in CDO line of business of $44.4 million reflecting an increase in demand. The decrease in production in the Public Finance line of business is primarily the results
  of intense price competition, whereas the decrease in production in Global Infrastructure business is due largely to the opportunistic nature of this line of business.
30

Detailed Discussion of Consolidated and Segment Results of Operations by Financial Statement Line Item
Gross Premiums Written
All our gross premiums written are from our financial guarantee insurance segment. Gross premiums written during the period include: (i) premiums received upfront on policies or contracts
  written during the period, (ii) installment premiums due during the period on in-force policies or contracts that were written prior to the period, and (iii) installment premiums due during the period
  on policies and contracts written during the period. Gross premiums written during the period do not include installment premiums due in future periods. Accordingly, our premiums written during
  any period are a function of the type and volume of contracts we write (upfront versus installment), as well as prevailing market prices. Factors affecting market prices include credit spreads, interest
  rates, competition and new issuance. Generally, financial guarantee insurers are able to charge higher premiums when credit spreads widen. The following table presents, for the periods indicated, the
  amount of gross premiums written attributable to upfront and installment policies and contracts:
(U.S dollars in thousands)
    
    Three Months EndedJune 30,2007
    
    2006Gross premiums writtenUpfront policies/contracts
    
    
    $
    
    30,121
    
    
    
    $
    
    73,057Installment policies/contracts
    
    
    
    35,036
    
    
    
    
    26,294Total
    
    
    $
    
    65,157
    
    
    
    $
    
    99,351The following table presents, for the periods indicated, the amount of gross premiums written by line of business:
(U.S dollars in thousands)
    
    Three Months EndedJune 30,2007
    
    2006Gross premiums writtenPublic finance
    
    
    $
    
    19,464
    
    
    
    $
    
    41,086Structured finance
    
    
    
    25,625
    
    
    
    
    22,669International finance
    
    
    
    20,068
    
    
    
    
    35,596Total
    
    
    $
    
    65,157
    
    
    
    $
    
    99,351Gross
    premiums written were $65.2 million for the three months ended June 30, 2007,
    a decrease of $34.2 million or 34.4%, as compared to $99.4 million recorded
    in the comparable period in 2006. The decrease was primarily attributable
    to lower gross written premium production in our global infrastructure and
    public finance lines of business of $30.4 million and $15.5 million, offset
    in part by a $10.1 million increase in installment premiums resulting from
    the growth of such in-force business. The decrease in global infrastructure
    gross premiums written reflects the opportunistic nature of this business
    and the decrease in public finance gross premiums written reflects intense
    price competition in this sector. The increase in installment premium business
    primarily reflects growth in our in-force book of global infrastructure,
    collateralized debt obligation (CDO), and power & utilities
    business.
Reinsurance Premiums Assumed
All our reinsurance premiums assumed are from our financial guarantee reinsurance segment. The majority of our financial guarantee reinsurance business is assumed from affiliates of FSA.
31

The following table presents, for the periods indicated, the amount of reinsurance premiums assumed from affiliates of FSA and other third-party primary companies:
(U.S dollars in thousands)
    
    Three Months EndedJune 30,2007
    
    2006Reinsurance premiums assumedAffiliates of FSA
    
    
    $
    
    1,460
    
    
    
    $
    
    6,368XLI
    
    
    
    184
    
    
    
    
    Third-party companies
    
    
    
    3,860
    
    
    
    
    1,924Total
    
    
    $
    
    5,504
    
    
    
    $
    
    8,292The following table presents, for the periods indicated, the amount of reinsurance premiums assumed attributable to upfront and installment policies and contracts:
(U.S dollars in thousands)
    
    Three Months EndedJune 30,2007
    
    2006Reinsurance premiums assumedUpfront policies/contracts
    
    
    $
    
    1,758
    
    
    
    $
    
    4,603Installment policies/contracts
    
    
    
    3,746
    
    
    
    
    3,689Total
    
    
    $
    
    5,504
    
    
    
    $
    
    8,292The following table presents, for the periods indicated, the amount of reinsurance premiums assumed by line of business:
(U.S dollars in thousands)
    
    Three Months EndedJune 30,2007
    
    2006Reinsurance premiums assumedPublic finance
    
    
    $
    
    361
    
    
    
    $
    
    (1,249
    )Structured finance
    
    
    
    1,484
    
    
    
    
    1,100International finance
    
    
    
    3,659
    
    
    
    
    8,441Total
    
    
    $
    
    5,504
    
    
    
    $
    
    8,292Reinsurance premiums assumed were $5.5 million for the three months ended June 30, 2007, a decrease of $2.8 million or 33.7%, as compared to $8.3 million recorded in the comparable period
  in 2006. The decrease was due to lower international finance assumed premiums of $4.8 million, partially offset by an increase in structured and public finance assumed premiums of $0.4 million and
  $1.6 million, respectively. The changes in public finance and structured finance premiums assumed reflects an adjustment made during the three months ended June 30, 2006 to record the difference
  between actual assumed premiums during the prior quarter to that estimated during such period. The decrease in International Finance is primarily due to the run-off of the in-force policies. The
  amount of reinsurance ceded to us depends upon the type and amount of insurance written by primary companies, their capital needs and other factors. Such reinsurance is generally structured on a
  facultative basis.
The increase in public finance premiums assumed reflects an adjustment made during the three months ended June 30, 2006 to record the difference between actual assumed premiums during the
  prior quarter to that estimated during such period. The amount of reinsurance ceded to us depends upon the type and amount of insurance written by primary companies, their capital needs and
  other factors. Such reinsurance is generally structured on a facultative basis.
Ceded Premiums
We manage our in-force business based on single-risk limits to avoid concentration in single names and to mitigate event risk. For transactions that exceed these limits, we cede the excess to
  XLI, XL RE AM, or third-party reinsurers. Through these cessions, we gain greater flexibility to manage large single risks and reduce concentration in specific bond sectors and geographic regions.
  Part of our long-term
32

strategy is to reduce reinsurance to XLI and XL RE AM, and increase our third-party reinsurance relationships. To the extent that we cede a portion of our exposure to one or more reinsurance
  companies, we can reduce our concentration to particular issuers and help to control the diversification of our in-force business. In addition, use of reinsurance can increase our capacity to write new
  business and strengthen our financial ratios.
The following table presents, for the periods indicated, the amount of premiums ceded to XLI, XL RE AM and other third-party reinsurers:
(U.S dollars in thousands)
    
    Three Months EndedJune 30,2007
    
    2006Ceded premiumsXLI
    
    
    $
    
    
    
    
    
    $
    
    (2,044
    )XL RE AM
    
    
    
    (615
    )
    
    
    
    
    (165
    )Other third-party reinsurers
    
    
    
    (7,949
    )
    
    
    
    
    (3,951
    )Total
    
    
    $
    
    (8,564
    )
    
    
    
    $
    
    (6,160
    )All our ceded premiums are from our financial guaranty insurance segment. Ceded premiums were $8.6 million for the three months ended June 30, 2007, an increase of $2.4 million, as compared
  to $6.2 million recorded in the comparable prior year period. The primary use of reinsurance is to meet the single risk limits established by regulatory bodies. The increase in ceded premiums is due
  to the issuance of guarantees that exceeded such limits, thus, requiring reinsurance to reduce the companys exposure.
Net Premiums Earned
Financial guarantee upfront premiums are earned in proportion to the expiration of the related risk and financial guarantee installment premiums are earned ratably over the installment period,
  generally one to three months. In addition, when an insured issue is retired early, is called by the issuer or is in substance paid in advance through a refunding accomplished by placing U.S.
  Government securities in escrow, the remaining deferred premium revenue is earned at that time. While reinsurance premiums assumed are earned based on reports from the reinsured companies, we
  believe that the underlying reinsured companies generally follow the revenue recognition policies and practices discussed above.
The following table presents, for the periods indicated, the amount of earned premiums attributable to upfront and installment policies:
(U.S dollars in thousands)
    
    Three Months EndedJune 30,2007
    
    2006Net premiums earnedUpfront policies/contracts
    
    
    $
    
    21,223
    
    
    
    $
    
    27,506Installment policies/contracts
    
    
    
    32,969
    
    
    
    
    28,035Total
    
    
    $
    
    54,192
    
    
    
    $
    
    55,541Net premiums earned were $54.2 million for the three months ended June 30, 2007, a decrease of $1.3 million or 2.3%, as compared to $55.5 million in the comparable period in 2006. The
  decrease in earned premiums was primarily attributable to lower earned premiums in our financial guarantee insurance segment of $2.3 million, offset in part by higher earned premiums in our
  financial guarantee reinsurance segment of approximately $0.9 million. Lower earned premium in our financial guarantee insurance segment was primarily attributable to a decrease in refundings,
  calls, and other accelerations during the period of $17.3 million, offset in part by higher earned premiums, which was primarily attributable to growth in earned premiums from our global
  infrastructure and CDO lines of business, as well as lower earned premiums ceded to XLI.
Net Investment Income
Net investment income was $30.3 million for the three months ended June 30, 2007, an increase of $14.2 million or 88.2% as compared to $16.1 million in the comparable period in 2006. The
  increase in net investment income was due primarily to higher average invested assets and higher new money yields.
33

The increase in our average invested assets period over period was primarily attributable to operating cash flows since the comparable period in 2006, the net proceeds from our IPO, cash capital
  contributions from XL Capital and the transfer of certain business to us from affiliates of XL Capital in connection with our IPO, and the net proceeds from the SCA Series A Preference Shares,
  which were issued in April 2007.
The following tables present net investment income, average invested assets, and the effective yield on our average invested assets for the three months ended June 30, 2007 and 2006, and the
  average duration of our invested assets as of June 30, 2007 and 2006:
(U.S dollars in thousands, except percentages)
    
    Three Months EndedJune 30,2007
    
    2006Net investment income
    
    
    $
    
    30,263
    
    
    
    $
    
    16,129Average invested assets(1)
    
    
    $
    
    2,483,490
    
    
    
    $
    
    1,513,447Effective yield(2)
    
    
    
    4.9
    %
    
    
    
    
    4.3
    %

(1)
    
    
    
    Represents the quarterly average of the amortized cost of debt securities, short-term investments and cash and cash equivalents for the respective periods.(2)
    
    
    
    Effective yield represents net investment income, on an annualized basis, as a percentage of average invested assets during the period. The increase in the effective yield was due to the investment of operating, financing and investing cash flows
      at higher interest rates.As of June 30,2007
    
    2006Weighted average duration in years
    
    
    
    3.4
    
    
    
    
    3.4Net Realized Gains (Losses) on Investments
Net realized losses on investments were $1.7 million for the three months ended June 30, 2007, as compared to $10.7 million in the comparable period in 2006. Net realized losses during the
  three months ended June 30, 2007 included approximately $1.0 million of net realized losses relating to sales of certain securities which were made to lengthen the duration of our investment portfolio
  and an other than temporary impairment charge of $0.3 million relating to two securities. During the three months ended June 30, 2006, net realized losses primarily consisted of an impairment
  charge of $9.0 million relating to certain investments acquired in satisfaction of a claim. As a result of the aforementioned sales during the three months ended June 30, 2007, the weighted average
  duration of our investment portfolio increased to 3.4 years at June 30, 2007 from 2.9 years at March 31, 2007.
Net Realized and Unrealized Gains (Losses) on Derivative Financial Instruments
The Companys derivative financial instruments principally include credit default swaps issued to its customers and guarantees of interest rate swap contracts in connection with its guarantees of
  certain debt obligations. Changes in the fair value of credit default swaps attributable to earnings from premiums received by us from the issuance of such contracts are recorded in net premiums
  earned in the consolidated statement of operations. In addition, changes in the fair value of credit default swaps attributable to losses from actual and expected payments to counterparties under such
  contracts are recorded in losses and loss adjustment expense in the consolidated statement of operations, and the remaining components of the change in fair value of credit default swaps, which are
  attributable to changes in interest rates, credit spreads, credit quality, expected recovery rates and other market factors, are recorded in net realized and unrealized gains (losses) on derivative
  financial instruments. The Companys credit default swap portfolio consists of structured pools of corporate obligations that were awarded investment-grade ratings at the deals inception. At June 30,
  2007, on a net par basis, approximately 97% of the portfolio was rated AAA with the remaining 3% rated at or above investment-grade and the weighted average term of the contracts in-force was
  8.4 years.
Net realized and unrealized losses on derivative financial instruments, which consisted only of unrealized amounts, were $22.2 million for the three months ended June 30, 2007, an increase of
  $22.5 million, as compared to unrealized gains of $0.3 million reported in the comparable period in 2006. The net unrealized loss on derivative financial instruments reported during the three months
  ended June 30,
34

2007 primarily consisted of unrealized losses aggregating $24.4 million on investment grade credit default swaps, partially offset by unrealized gains on insured interest rate swaps aggregating $2.8
  million. The unrealized loss on credit default swaps principally resulted from widening credit spreads across most sectors, particularly Senior AAA High-Grade Structured Finance CDOs, which alone
  generated $13.8 million of unrealized losses on approximately $14.7 billion of par exposure. The benchmark spread used to mark these deals increased from 23 bps to 30 bps during the quarter. In
  addition, our credit default swaps on CDOs of CDOs (CDOs of CDOs are securitizations of CDOs), generated unrealized losses of $5.1 million due to widening credit spreads in the specific sectors
  underlying these instruments. We have only four credit default swaps in-force covering $1.2 billion of such notional exposure. In regard to insured interest rate swaps, the $2.8 million of unrealized
  gains resulted from an increase in the LIBOR benchmark interest rate during the three months ended June 30, 2007.
Net Losses and Loss Adjustment Expenses
Net losses and loss expenses include current year net losses incurred and adverse or favorable development of prior year net loss and loss expenses reserves. The following table presents, for the
  periods indicated, the activity in our reserves for losses and loss adjustment expenses, net of reinsurance:
(U.S. dollars in thousands)
    
    FinancialGuaranteeInsurance
    
    FinancialGuaranteeReinsurance
    
    ConsolidatedTotalBeginning balance, April 1, 2007
    
    
    $
    
    69,976
    
    
    
    $
    
    18,744
    
    
    
    $
    
    88,720Case reserve provision
    
    
    
    
    
    
    
    
    (378
    )
    
    
    
    
    (378
    )Loss adjustment expense reserve provision
    
    
    
    210
    
    
    
    
    5
    
    
    
    
    215Unallocated reserve provision
    
    
    
    2,751
    
    
    
    
    440
    
    
    
    
    3,191Net losses and loss adjustment expenses
    
    
    
    2,961
    
    
    
    
    67
    
    
    
    
    3,028Paid losses and loss adjustment expenses
    
    
    
    14
    
    
    
    
    (9
    )
    
    
    
    
    5Ending balance, June 30, 2007
    
    
    $
    
    72,951
    
    
    
    $
    
    18,802
    
    
    
    $
    
    91,753Beginning balance, April 1, 2006
    
    
    $
    
    62,782
    
    
    
    $
    
    18,158
    
    
    
    $
    
    80,940Case reserve provision
    
    
    
    
    
    
    
    
    154
    
    
    
    
    154Loss adjustment expense reserve provision
    
    
    
    (30
    )
    
    
    
    
    144
    
    
    
    
    114Unallocated reserve provision
    
    
    
    2,341
    
    
    
    
    271
    
    
    
    
    2,612Net losses and loss adjustment expenses
    
    
    
    2,311
    
    
    
    
    569
    
    
    
    
    2,880Paid losses and loss adjustment expenses
    
    
    
    (854
    )
    
    
    
    
    (49
    )
    
    
    
    
    (903
    )Ending balance, June 30, 2006
    
    
    $
    
    64,239
    
    
    
    $
    
    18,678
    
    
    
    $
    
    82,917Net
    losses and loss adjustment expenses were $3.0 million for the three months
    ended June 30, 2007, an increase of $0.1 million, or 3%, as compared to $2.9
    million recorded in comparable period in 2006. The increase in net losses
    and loss adjustment expenses was primarily attributable to higher net losses
    and loss adjustment expenses in the insurance segment of $0.7 million, partially
    offset by lower net losses and loss adjustment expenses in the reinsurance
    segment of $0.5 million.
Higher net losses and loss adjustment expenses in the insurance segment during the three months ended June 30, 2007 were primarily due to a period over period increase in unallocated reserves
  of $0.5 million resulting from growth in our in-force business the portfolio and an increase in loss adjustment expenses of $0.2 million.
A decrease in net losses and loss adjustment expenses of $0.5 million in the reinsurance segment during the three months ended June 30, 2007 as compared to the prior year period resulted from
  a $0.7 million decrease in case basis provisions for losses and loss adjustment expenses (a decrease in the provision of $0.4 million in 2007 vs. an increase of $0.3 million in 2006) partially offset by an
  increase in unallocated reserves of $0.2 million, driven by growth in the portfolio.
35

Acquisition Costs, Net
The following table presents the components of acquisition costs, net, during the periods indicated:
(U.S dollars in thousands)
    
    Three Months EndedJune 30,2007
    
    2006Amortization of deferred acquisition costs and ceding commissionsFinancial Guarantee Insurance:Acquisition costs
    
    
    $
    
    3,866
    
    
    
    $
    
    5,908Ceding commissions
    
    
    
    (1,370
    )
    
    
    
    
    (2,863
    )Net acquisition costs
    
    
    
    2,496
    
    
    
    
    3,045Financial Guarantee Reinsurance:Acquisition costs
    
    
    
    1,283
    
    
    
    
    1,497Acquisition costs, net
    
    
    $
    
    3,779
    
    
    
    $
    
    4,542Capitalized acquisition costs in the financial guarantee insurance segment consist of a portion of compensation, travel and entertainment and marketing costs, as well as premium and excise taxes,
  rating agency fees and legal costs associated with the production of new business. Such capitalized acquisition costs are reduced by ceding commission income on premiums ceded to reinsurers.
Net acquisition costs in the financial guarantee insurance segment decreased $0.5 million, or 18.1% in the three months ended June 30, 2007, as compared to the comparable period in 2006,
  primarily due to a decrease in refundings. Accelerated amortization due to refundings was $0.5 million during the three months ended June 30, 2007, as compared to $1.8 million in the year ago
  quarter. Excluding the impact of refundings, net acquisition costs in the financial guarantee insurance segment increased by approximately $0.8 million during the three months ended June 30, 2007, as
  compared to the same period in 2006. The increase primarily resulted from growth in our in-force business and a decrease in ceding commission revenue. The decrease in ceding commission revenue
  was due to a commutation of a reinsurance arrangement with XLI in conjunction with our IPO.
Acquisition costs in the financial guarantee reinsurance segment represent commissions paid to acquire assumed business. Amortization of acquisition costs in the financial guarantee reinsurance
  segment was $1.3 million during the three months ended June 30, 2007, a decrease of $0.2 million, as compared to the same period in 2006. The decrease was due to higher letter of credit fees in the
  year ago period. Excluding the impact of the letter of credit fees, acquisition costs in the financial guarantee reinsurance segment were slightly higher quarter over quarter, reflective of higher
  reinsurance net premiums earned.
Operating Expenses
Operating expenses were $26.6 million for the three months ended June 30, 2007, an increase of $9.1 million or 52.0%, as compared to $17.5 million in the comparable period in 2006. Operating
  expenses for the three months ended June 30, 2007 are comprised of operating expenses of our financial guarantee insurance and reinsurance segments, as well as corporate operating expenses, which
  consist of costs associated with SCA being a stand-alone public company. Operating expenses of our financial guarantee insurance and reinsurance segments aggregated $21.7 million for the three
  months ended June 30, 2007, an increase of 4.2 million, as compared to $17.5 million in the same period in 2006. The increase in operating expenses of our financial guarantee insurance and
  reinsurance segments resulted primarily from increased compensation related to a net increase in the number of our employees, an increase in the volume of our credit default swap business (the
  costs of which cannot be deferred), and continued investment in our infrastructure. During the three months ended June 30, 2007 we reported corporate operating expenses of $4.8 million, which
  included approximately $1.0 million of expense incurred by the Company in connection with the secondary offering of SCA common shares by XL Capital. See Managements Discussion and
  Analysis of Financial Condition and Results of OperationsOrganization Background, Initial Public Offering, and Ownership by XL Capital and Note 6 to the Unaudited Interim Consolidated
  Financial Statements included elsewhere herein.
36

Income tax expense
Income tax expense was $0.6 million for the three months ended June 30, 2007, an increase of $0.8 million, as compared to a benefit of $0.2 million recorded in the comparable period in 2006.
  See Note 7 to the Unaudited Interim Consolidated Financial Statements included elsewhere herein.
Minority Interest  Dividends on Redeemable Preferred Shares
Dividends on redeemable preferred shares were $0.8 million for the three months ended June 30, 2007, a decrease of $0.3 million, as compared to $1.1 million recorded during the same period in
  2006. The decrease was due to an extraordinary dividend of $15.0 million paid by XLFA on the preferred shares on March 30, 2007 and a corresponding reduction in the stated value of the
  remaining outstanding Series A Redeemable Preferred Shares. As a result of the reduction in stated value, dividends on the redeemable preferred shares are $0.8 million quarterly subsequent to
  March 31, 2007. See Liquidity and Capital Resources  XLFA Preferred Share Dividend Requirements.
Dividends on SCA Series A Preference Shares
Because dividends on our SCA Series A Preference Shares are non-cumulative and the declaration of such dividends are subject to the discretion of the Companys Board of Directors, under
  GAAP such dividends can only be recognized when declared by the board and may not be accreted ratably over the each fiscal year. In addition, because the governing documents underlying the
  SCA Series A Preference Sharesprovide for semi-annual dividends, dividends will only be recognized during the third and first quarters of each fiscal year, if declared by the Board of Directors.
  During the three months ended June 30, 2007 no dividends on our SCA Series A Preference Shares were declared by our Board of Directors. See Managements Discussion and Analysis of
  Financial Condition and Results of OperationsOffering of Series A Perpetual Non-Cumulative Preference Shares.
Discussion of Consolidated and Segment Results of Operations for the Six Months Ended June 30, 2007 Compared to the Six Months Ended June 30, 2006
Summary Discussion of Consolidated Results of Operations
Comparison of six months ended June 30, 2007 to six months ended June 30, 2006.Net income available to common shareholders for the six months ended June 30, 2007 was $63.2 million, an
  increase of $10.1 million from $53.1 reported during the same period in 2006. Net income for the six months ended June 30, 2007 included $1.5 million of net realized losses on investments, as
  compared to net realized losses of approximately $16.4 million recorded during the same period in 2006. In addition, also included in net income available to common shareholders for the six months
  ended June 30, 2007 was approximately $29.1 million of net unrealized losses on derivative financial instruments, as compared to net unrealized losses on derivative financial instruments of $3.5
  million recorded in the comparable period in 2006.
The increase in our net income available to common shareholders of $10.1 million for the six months ended June 30, 2007, as compared to the same period in 2006, was primarily driven by: (i)
  higher net premiums earned of $7.2 million resulting from growth in earned premiums in our global infrastructure and CDO lines of business and lower reinsurance cessions to XLI, partially offset by
  a significant period over period decrease in refundings of approximately $18.2 million, (ii) an increase in investment income of $25.2 million reflecting a significant period over period increase in
  average invested assets and higher yields on new money investments, (iii) lower net realized losses on investments of $14.9 million (during the six months ended June 30, 2007, we reported net
  realized losses of $1.5 million, as compared to $16.4 million of net realized losses in the same period in 2006, of which $14.0 million related to an impairment charge on investments acquired in
  satisfaction of a claim), (iv) lower net losses and loss adjustment expenses of $4.1 million, which primarily resulted from favorable development of case basis reserves for losses and loss adjustment
  expenses, and (v) lower dividends on our redeemable preferred shares, offset in part by (vi) higher net unrealized losses on derivative financial instruments of $25.6 million, resulting primarily from
  widening credit spreads on our in-force portfolio of written credit default swaps that
37

guarantee senior triple-A high-grade structured finance collateralized debt obligations (CDOs) and CDOs of CDOs (CDOs of CDOs are securitizations of CDOs), (vii) higher operating expenses of
  $16.0 million resulting primarily from increased compensation due to an increase in the number of our employees, an increase in the volume of our credit default swap business (the costs of which
  cannot be deferred under GAAP), and continued investment in our infrastructure.
Set forth below is additional information with respect to earned premiums and new business production.
Net premiums earned for the six months ended June 30, 2007 of $100.6 million included $7.0 million of earnings from the early retirement of certain guaranteed obligations (e.g., refundings of
  insured obligations) (or $6.1million, net of accelerated amortization of deferred acquisition costs related to the earnings from such refundings), as compared to $25.2 million during the comparable
  period in 2006 (or $23.1 million, net of accelerated amortization of deferred acquisition costs related to the earnings from such refundings). Our business production as measured by adjusted gross
  premiums (which includes upfront premiums written in the period, current installment premiums due on business written in the period and expected future installment premiums on business written
  during the period discounted at 7%) totaled $252.3 million for the six months ended June 30, 2007, a decrease of $15.7 million, as compared to $268.0 million reported in the comparable period in
  2006. The decrease was primarily due to lower production in the Public Finance and Global Infrastructure lines of business of $54.2 million and $48.3 million, respectively, offset in part by higher
  adjusted gross premium production in CDO line of business of $59.9 million reflecting an increase in demand, as well as higher adjusted gross premiums in the Specialized Risk, Power & Utilities, and
  Consumer ABS lines of business. The decrease in production in the Public Finance line of business is primarily the results of intense price competition, whereas the decrease in production in Global
  Infrastructure business is due largely to the opportunistic nature of this line of business.
Detailed Discussion of Consolidated and Segment Results of Operations by Financial Statement Line Item
Gross Premiums Written
All our gross premiums written are from our financial guarantee insurance segment. Gross premiums written during the period include: (i) premiums received upfront on policies or contracts
  written during the period, (ii) installment premiums due during the period on in-force policies or contracts that were written prior to the period, and (iii) installment premiums due during the period
  on policies and contracts written during the period. Gross premiums written during the period do not include installment premiums due in future periods. Accordingly, our premiums written during
  any period are a function of the type and volume of contracts we write (upfront versus installment), as well as prevailing market prices. Factors affecting market prices include credit spreads, interest
  rates, competition and the volume of new issuances. Generally, financial guarantee insurers are able to charge higher premiums when credit spreads widen. The following table presents, for the
  periods indicated, the amount of gross premiums written attributable to upfront and installment policies and contracts:
(U.S dollars in thousands)
    
    Six Months EndedJune 30,2007
    
    2006Gross premiums writtenUpfront policies/contracts
    
    
    $
    
    90,389
    
    
    
    $
    
    119,060Installment policies/contracts
    
    
    
    64,263
    
    
    
    
    51,071Total
    
    
    $
    
    154,652
    
    
    
    $
    
    170,13138

The following table presents, for the periods indicated, the amount of gross premiums written by line of business:
(U.S dollars in thousands)
    
    Six Months EndedJune 30,2007
    
    2006Gross premiums writtenPublic finance
    
    
    $
    
    51,602
    
    
    
    $
    
    73,881Structured finance
    
    
    
    47,209
    
    
    
    
    36,682International finance
    
    
    
    55,841
    
    
    
    
    59,568Total
    
    
    $
    
    154,652
    
    
    
    $
    
    170,131Gross premiums written were $154.7 million for the six months ended June 30, 2007, a decrease of $15.5 million or 9.1%, as compared to $170.1 million recorded in the comparable period in
  2006. The decrease was due to the period over period decrease in the amount and relative mix of upfront, as compared to installment priced transactions. The decrease in upfront business was
  primarily attributable to lower production in the public finance and global infrastructure lines of business. The decrease in public finance gross premiums written reflects intense price competition in
  this sector and the decrease in global infrastructure gross premiums written reflects the opportunistic nature of this business. The increase in installment premium business primarily reflects growth in
  our CDO and consumer ABS lines of businesses.
Reinsurance Premiums Assumed
All our reinsurance premiums assumed are from our financial guarantee reinsurance segment. The majority of our financial guarantee reinsurance business is assumed from affiliates of FSA.
The following table presents, for the periods indicated, the amount of reinsurance premiums assumed from affiliates of FSA and other third-party primary companies:
(U.S dollars in thousands)
    
    Six Months EndedJune 30,2007
    
    2006Reinsurance premiums assumedAffiliates of FSA
    
    
    $
    
    15,284
    
    
    
    $
    
    15,104XLI
    
    
    
    184
    
    
    
    
    Third-party companies
    
    
    
    5,499
    
    
    
    
    4,591Total
    
    
    $
    
    20,967
    
    
    
    $
    
    19,695The following table presents, for the periods indicated, the amount of reinsurance premiums assumed attributable to upfront and installment policies and contracts:
(U.S dollars in thousands)
    
    Six Months EndedJune 30,2007
    
    2006Reinsurance premiums assumedUpfront policies/contracts
    
    
    $
    
    14,349
    
    
    
    $
    
    10,949Installment policies/contracts
    
    
    
    6,618
    
    
    
    
    8,746Total
    
    
    $
    
    20,967
    
    
    
    $
    
    19,695The following table presents, for the periods indicated, the amount of gross reinsurance premiums assumed by line of business:
(U.S dollars in thousands)
    
    Six Months EndedJune 30,2007
    
    2006Reinsurance premiums assumedPublic finance
    
    
    $
    
    898
    
    
    
    $
    
    251Structured finance
    
    
    
    3,735
    
    
    
    
    4,800International finance
    
    
    
    16,334
    
    
    
    
    14,644Total
    
    
    $
    
    20,967
    
    
    
    $
    
    19,69539

Reinsurance premiums assumed were $21.0 million for the six months ended June 30, 2007, an increase of $1.3 million or 6.6%, as compared to $19.7 million recorded in the comparable period in
  2006. The increase was primarily higher international and public finance premiums assumed, partially offset by a decrease in structured finance assumed premiums. The increase in international finance
  was primarily due to a few large upfront transactions during the current quarter in the utilities sector. The decrease in structured finance assumed premiums was due to a general decline in volume in
  this sector. The amount of reinsurance ceded to us depends upon the type and amount of insurance written by primary companies, their capital needs and other factors. Such reinsurance is generally
  structured on a facultative basis.
Ceded Premiums
We manage our in-force business based on single-risk limits to avoid concentration in single names and to mitigate event risk. For transactions that exceed these limits, we cede the excess to
  XLI, XL RE AM, or third-party reinsurers. Through these cessions, we gain greater flexibility to manage large single risks and reduce concentration in specific bond sectors and geographic regions.
  Part of our long-term strategy is to reduce reinsurance to XLI and XL RE AM, and increase our third-party reinsurance relationships. To the extent that we cede a portion of our exposure to one or
  more reinsurance companies, we can reduce our concentration to particular issuers and help to control the diversification of our in-force business. In addition, use of reinsurance can increase our
  capacity to write new business and strengthen our capital adequacy.
The following table presents, for the periods indicated, the amount of premiums ceded to XLI, XL RE AM and other third-party reinsurers:
(U.S dollars in thousands)
    
    Six Months EndedJune 30,2007
    
    2006Ceded premiumsXLI
    
    
    $
    
    (605
    )
    
    
    
    $
    
    (7,743
    )XL RE AM
    
    
    
    (3,763
    )
    
    
    
    
    (543
    )Other third-party reinsurers
    
    
    
    (24,429
    )
    
    
    
    
    (5,466
    )Total
    
    
    $
    
    (28,797
    )
    
    
    
    $
    
    (13,752
    )All our ceded premiums are from our financial guaranty insurance segment. Ceded premiums were $28.8 million for the six months ended June 30, 2007, an increase of $15.0 million, as compared
  to $13.8 million recorded in the comparable prior year period. The primary use of reinsurance is to meet the single risk limits established by regulatory bodies. The increase in ceded premiums is due
  to the issuance of guarantees that exceeded such limits, thus, requiring reinsurance to reduce the companys exposure. The increase in premiums ceded to other third-party reinsurers during the six
  months ended June 30, 2007 was primarily due to the placement of reinsurance relating to a large structured finance transaction written at the end of 2006, as well as our reduced reliance on
  reinsurance capacity from affiliates of XL Capital.
Net Premiums Earned
Financial guarantee upfront premiums are earned in proportion to the expiration of the related risk and financial guarantee installment premiums are earned ratably over the installment period,
  generally one to six months. In addition, when an insured issue is retired early, is called by the issuer or is in substance paid in advance through a refunding accomplished by placing U.S. Government
  securities in escrow, the remaining deferred premium revenue is earned at that time. While reinsurance premiums assumed are earned based on reports from the reinsured companies, we believe that
  the underlying reinsured companies generally follow the revenue recognition policies and practices discussed above.
40

The following table presents, for the periods indicated, the amount of earned premiums attributable to upfront and installment policies:
(U.S dollars in thousands)
    
    Six Months EndedJune 30,2007
    
    2006Net premiums earnedUpfront policies/contracts
    
    
    $
    
    38,116
    
    
    
    $
    
    39,554Installment policies/contracts
    
    
    
    62,455
    
    
    
    
    53,800Total
    
    
    $
    
    100,571
    
    
    
    $
    
    93,354Net premiums earned were $100.6 million for the six months ended June 30, 2007, an increase of $7.2 million or 7.7%, as compared to $93.4 million in the comparable period in 2006. The
  increase in earned premiums was primarily attributable to higher earned premiums in the financial guarantee insurance segment of $6.7 million, which was primarily attributable to growth in earned
  premiums in our global infrastructure and CDO lines of business, as well as lower reinsurance cessions to XLI, partially offset by a period over period decrease of $18.8 million in earnings from
  refundings.
Net Investment Income
Net investment income was $56.4 million for the six months ended June 30, 2007, an increase of $25.2 million or 80.8% as compared to $31.2 million in the comparable period in 2006. The increase in
  net investment income was due primarily to higher average invested assets and higher new money yields. The increase in average invested assets resulted primarily from the net proceeds from our IPO of
  $341.3 million, cash capital contributions from XL Capital at the effective date of our IPO of $15.0 million, cash received in connection with the commutation and reinsurance agreement referred to
  above of approximately $22.1 million, the net proceeds from our offerings of the Series A Perpetual Non-Cumulative Preference Shares of $247.3 million, and operating cash flows. See Investments for
  information regarding the credit quality of our debt securities.
The following tables present net investment income, average invested assets, and the effective yield on our average invested assets for the six months ended June 30, 2007 and 2006, and the
  average duration of our invested assets as of June 30, 2007 and 2006:
(U.S dollars in thousands, except percentages)
    
    Six Months EndedJune 30,2007
    
    2006Net investment income
    
    
    $
    
    56,388
    
    
    
    $
    
    31,191Average invested assets(1)
    
    
    $
    
    2,340,912
    
    
    
    $
    
    1,477,765Effective yield(2)
    
    
    
    4.8
    %
    
    
    
    
    4.2
    %

(1)
    
    
    
    Represents the quarterly average of the amortized cost of debt securities, short-term investments and cash and cash equivalents for the respective periods.(2)
    
    
    
    Effective yield represents net investment income, on an annualized basis, as a percentage of average invested assets during the period. The increase in the effective yield was due to the investment of operating, financing and investing cash flows
      at higher interest rates.As of June 30,2007
    
    2006Average duration in years
    
    
    
    3.4
    
    
    
    
    3.441

Net Realized Gains (Losses) on Investments
Net realized losses on investments were $1.5 million for the six months ended June 30, 2007 as compared to a net realized loss of $16.4 million in the comparable period in 2006. Net realized
  losses during the six months ended June 30, 2007 included approximately $1.0 million of net realized losses relating to sales of certain securities which were made to lengthen the duration of our
  investment portfolio and an other than temporary impairment charge of $0.3 million relating to two securities. As a result of the aforementioned sales during the six months ended June 30, 2007, the
  weighted average duration of our investment portfolio increased to 3.4 years at June 30, 2007 from approximately 3.1 at December 31, 2006. During the six months ended June 30, 2006, net realized
  losses on investments included a $14.0 million impairment charge on certain investments acquired in satisfaction of a claim.
Net Realized and Unrealized Gains (Losses) on Derivative Financial Instruments
The Companys derivative financial instruments principally include credit default swaps issued to its customers and guarantees of interest rate swap contracts in connection with its guarantees of
  certain debt obligations. Changes in the fair value of credit default swaps attributable to earnings from premiums received by us from the issuance of such contracts are recorded in net premiums
  earned in the consolidated statement of operations. In addition, changes in the fair value of credit default swaps attributable to losses from actual and expected payments to counterparties under such
  contracts are recorded in losses and loss adjustment expense in the consolidated statement of operations, and the remaining components of the change in fair value of credit default swaps, which are
  attributable to changes in interest rates, credit spreads, credit quality, expected recovery rates and other market factors, are recorded in net realized and unrealized gains (losses) on derivative
  financial instruments. The Companys credit default swap portfolio consists of structured pools of corporate obligations that were awarded investment-grade ratings at the deals inception. At June 30,
  2007, on a net par basis, approximately 97% of the portfolio was rated AAA with the remaining 3% rated at or above investment-grade and the weighted average term of the contracts in-force was
  8.4 years.
Net realized and unrealized losses on derivative financial instruments, which consisted only of unrealized amounts, were $29.1 million for the six months ended June 30, 2007, an increase of
  $25.6 million, as compared to net realized and unrealized losses of $3.5 million in the comparable period in 2006. The net unrealized loss on derivative financial instruments reported during the six
  months ended June 30, 2007 primarily consisted of unrealized losses aggregating $30.0 million on investment grade credit default swaps, partially offset by unrealized gains on insured interest rate
  swaps aggregating $1.8 million. The unrealized loss on credit default swaps principally resulted from widening credit spreads across most sectors, particularly Senior AAA High-Grade Structured
  Finance CDOs, which generated $13.8 million of unrealized losses on approximately $14.7 billion of par exposure during the second quarter. The reference spread used to mark these deals increased
  from 23 bps to 30 bps during the quarter. In addition, our credit default swaps on CDOs of CDOs (CDOs of CDOs are securitizations of CDOs), generated unrealized losses of $5.1 million during
  the second quarter due to widening credit spreads in the specific sectors underlying these instruments. We have four such credit default swaps in-force covering $1.2 billion of such notional exposure as
  of June 30, 2007. In regard to insured interest rate swaps, the $1.8 million of unrealized gains resulted from an increase in the LIBOR benchmark interest rate during the six months ended June 30,
  2007.
Net Losses and Loss Adjustment Expenses
Net losses and loss adjustment expenses include current year net losses incurred and adverse or favorable development of prior year net loss and loss adjustment expenses reserves.
42

The following table presents, for the periods indicated, the activity in our reserves for losses and loss adjustment expenses, net of reinsurance:
(U.S. dollars in thousands)
    
    FinancialGuaranteeInsurance
    
    FinancialGuaranteeReinsurance
    
    ConsolidatedTotalBeginning balance, January 1, 2007
    
    
    $
    
    71,574
    
    
    
    $
    
    18,327
    
    
    
    $
    
    89,901Case reserve provision
    
    
    
    (3,304
    )
    
    
    
    
    (364
    )
    
    
    
    
    (3,668
    )Loss adjustment expense reserve provision
    
    
    
    (5
    )
    
    
    
    
    9
    
    
    
    
    4Unallocated reserve provision
    
    
    
    5,052
    
    
    
    
    839
    
    
    
    
    5,891Net losses and loss adjustment expenses
    
    
    
    1,743
    
    
    
    
    484
    
    
    
    
    2,227Paid losses and loss adjustment expenses
    
    
    
    (366
    )
    
    
    
    
    (9
    )
    
    
    
    
    (375
    )Ending balance, June 30, 2007
    
    
    $
    
    72,951
    
    
    
    $
    
    18,802
    
    
    
    $
    
    91,753Beginning balance, January 1, 2006
    
    
    $
    
    60,811
    
    
    
    $
    
    17,340
    
    
    
    $
    
    78,151Case reserve provision
    
    
    
    
    
    
    
    
    646
    
    
    
    
    646Loss adjustment expense reserve provision
    
    
    
    462
    
    
    
    
    144
    
    
    
    
    606Unallocated reserve provision
    
    
    
    4,385
    
    
    
    
    692
    
    
    
    
    5,077Net losses and loss adjustment expenses
    
    
    
    4,847
    
    
    
    
    1,482
    
    
    
    
    6,329Paid losses and loss adjustment expenses
    
    
    
    (1,419
    )
    
    
    
    
    (144
    )
    
    
    
    
    (1,563
    )Ending balance, June 30, 2006
    
    
    $
    
    64,239
    
    
    
    $
    
    18,678
    
    
    
    $
    
    82,917For the six months ended June 30, 2007, net losses and loss adjustment expenses were $2.2 million, a decrease of $4.1 million or 65.1%, as compared to $6.3 million reported in the comparable
  period in 2006. The decrease consisted of lower losses and loss adjustment expenses in our financial guarantee insurance and reinsurance segments of $3.1 million and $1.0 million, respectively.
Lower net losses and loss adjustment expenses in the financial guarantee insurance segment during the six months ended June 30, 2007 resulted primarily from favorable development of case
  basis reserves of $3.8 million, offset in part by an increase in unallocated reserves of $0.7 million resulting from the growth of our in-force business. The favorable development of case basis reserves
  was primarily attributable to a case basis reserve relating to an insured obligation supported by subprime mortgage loans which was accelerated, fully paid, and defeased pursuant to the exercise of a
  clean-up call by the sponsor of the securitization in late March of 2007 (See Note 9 (c) to the Unaudited Interim Consolidated Financial Statements elsewhere herein for details).
Lower net losses and loss adjustment expenses in the financial guarantee reinsurance segment during the six months ended June 30, 2007 resulted primarily from favorable development of case
  basis reserves of $1.1 million, offset in part by an increase in unallocated reserves of $0.1 million resulting from the growth of our in-force business.
43

Acquisition Costs, Net
The following table presents the components of acquisition costs, net, during the periods indicated:
(U.S dollars in thousands)
    
    Six Months EndedJune 30,2007
    
    2006Amortization of deferred acquisition costs and ceding commissionsFinancial Guarantee Insurance:Acquisition costs
    
    
    $
    
    7,579
    
    
    
    $
    
    9,232Ceding commissions
    
    
    
    (2,472
    )
    
    
    
    
    (4,903
    )Net acquisition costs
    
    
    
    5,107
    
    
    
    
    4,329Financial Guarantee Reinsurance:Acquisition costs
    
    
    
    2,642
    
    
    
    
    2,895Acquisition costs, net
    
    
    $
    
    7,749
    
    
    
    $
    
    7,224Acquisition costs, net, increased $0.5 million, or 7% in the six months ended June 30, 2007 as compared to the six months ended June 30, 2006, primarily driven by a decrease in ceding
  commission revenue in the financial gurantee insurance segment of $2.4 million, partially offset by decreased acquisition costs in the financial guarantee insurance segment of $1.7 million due to a
  decrease in refunding activity from the year ago period. Accelerated amortization due to refundings was $0.9 million in the current period compared to $2.1 million in the year ago period. Excluding
  the impact of refundings, the decrease of $0.5 million was due to a decrease in the amortization rate from the prior year resulting from a lengthening of the remaining life of the portfolio. The
  decrease in ceding commission revenue in the financial gurantee insurance segment was driven by lower ceded reinsurance. Business previously ceded to XLI was commuted back to the Company
  coincident with the IPO in the third quarter of 2006. As such, we retain more business written as compared to 2006, which resulted in a decrease of ceding commission revenue of 50%, from $4.9
  million in 2006 to $2.5 million in 2007, consistent with the significant decrease in ceded premium earned observed from 2006 to 2007 ($18.2 million vs. $9.1 million).
Acquisition costs in the financial guarantee reinsurance segment represent commissions paid to acquire assumed business. Amortization of acquisition costs in the financial guarantee reinsurance
  segment was $2.6 million in the six months ended June 30, 2007, decreasing $0.3 million versus the comparable period in 2006, due to higher letter of credit fees in the year ago period. Excluding the
  impact of the letter of credit fees, acquisition costs in the financial guarantee reinsurance segment were relatively flat quarter over quarter, consistent with only a slight increase in reinsurance net
  premiums earned ($14.2 million in 2007 versus $13.7 million in 2006).
Operating Expenses
Operating expenses were $50.6 million for the six months ended June 30, 2007, an increase of $16.0 million or 46.2%, as compared to $34.6 million in the comparable period in 2006. Operating
  expenses for the six months ended June 30, 2007 are comprised of operating expenses of our financial guarantee insurance and reinsurance segments, as well as corporate operating expenses, which
  consist of costs associated with SCA being a stand-alone public company. Operating expenses of our financial guarantee insurance and reinsurance segments aggregated $42.0 million for the six
  months ended June 30, 2007, an increase of 7.4 million, as compared to $34.6 million in the same period in 2006. The increase in operating expenses of our financial guarantee insurance and
  reinsurance segments resulted primarily from increased compensation related to a net increase in the number of our employees, an increase in the volume of our credit default swap business (the
  costs of which cannot be deferred), and continued investment in our infrastructure. During the six months ended June 30, 2007, we reported corporate operating expenses of $8.7 million, which
  included approximately $1.0 million of expense incurred by the Company in connection with the secondary offering of SCA common shares by XL Capital. See
44

Managements Discussion and Analysis of Financial Condition and Results of Operations  Organization Background, Initial Public Offering, and Ownership by XL Capital and Note 6 to the
  Unaudited Interim Consolidated Financial Statements included elsewhere herein.
Income tax expense
Income tax expense was $0.7 million for the six months ended June 30, 2007, an increase of $0.9 million, as compared to a benefit of $0.2 million recorded in the comparable period in 2006. See
  Note 7 to the Unaudited Interim Consolidated Financial Statements included elsewhere herein.
Minority Interest  Dividends on Redeemable Preferred Shares
Dividends on redeemable preferred shares were $1.9 million for the six months ended June 30, 2007, a decrease of $3.8 million, as compared to $5.7 million recorded during the same period in
  2006.
The decrease in dividends on the redeemable preferred shares of XLFA during the six months ended June 30, 2007, as compared to the comparable period in 2006 was due to an amendment of
  the terms of the preferred shares pursuant to an agreement with the holders of such securities in April 2006 and a change in the stated value of such securities in connection with the payment of an
  extraordinary dividend on March 30, 2007 of $15.0 million.
In accordance with the aforementioned amendment: (i) the participating dividend of the preferred shares, which was in effect prior to 2006, was eliminated, (ii) the stated value of the redeemable
  preferred shares held by FSAH was increased to $54.0 million, and (iii) the fixed dividend rate, which was in effect prior to 2006, was changed to a fixed rate of 81/4%. As a result of the
  aforementioned amendments to the dividend provisions of the preferred shares, dividends on the preference shares will be $1.1 million quarterly subsequent to March 31, 2006.
In connection with the extraordinary dividend the stated value of the redeemable preferred shares was reduced by $15.0 million. As a result of the reduction in stated value, dividends on the
  redeemable preferred shares will be $0.8 million quarterly subsequent to March 31, 2007. See Liquidity and Capital ResourcesXLFA Redeemable Preferred Shares Extraordinary Dividend.
Dividends on SCA Series A Preference Shares
Because dividends on our SCA Series A Preference Shares are non-cumulative and the declaration of such dividends are subject to the discretion of the Companys Board of Directors, under
  GAAP such dividends can only be recognized when declared by the board and may not be accreted ratably over the each fiscal year. In addition, because the governing documents underlying the
  SCA Series A Preference Shares provide for semi-annual dividends, dividends will only be recognized during the third and first quarters of each fiscal year, if declared by the Board of Directors.
  During the three and six months ended June 30, 2007 no dividends on our SCA Series A Preference Shares were declared by our Board of Directors. See Managements Discussion and Analysis of
  Financial Condition and Results of Operations  Offering of Series A Perpetual Non-Cumulative Preference Shares and Notes 13 and 14 to the unaudited interim consolidated financial statements.
Investments
The finance and risk oversight committee of our Board of Directors approves our general investment objectives and policies. Independent investment managers manage all of our consolidated
  investment portfolios.
Our primary investment objective is the preservation of capital, subject to an appropriate degree of liquidity, and a steady stream of investment income. A secondary objective is to optimize long-
  term returns.
45

We select our investment managers on the basis of various criteria, including investment style, historical performance, internal controls, operational risk, and the ability to contribute to the
  diversification of our portfolio.
Changes in the valuation of our invested assets reflect changes in interest rates (for example, changes in the level, slope and curvature of yield curves, volatility of interest rates, mortgage
  prepayment speeds and credit spreads) and credit quality. Market risk therefore arises due to the uncertainty surrounding the future valuations of these different assets, the factors that impact their
  values and the impact that this could have on our earnings.
We seek to manage the risks of our investment portfolio through a combination of asset class, industry and security level diversification. In addition, individual security and issuer exposures are
  controlled and monitored at the investment portfolio level via specific investment constraints outlined in our investment guidelines and agreed with the external investment professionals. Additional
  constraints are generally agreed upon with the external investment professionals and may address exposures to eligible securities, prohibited investments/transactions, credit quality and concentrations
  limits. We also have a policy not to invest in any securities that we guarantee.
As of June 30, 2007, our consolidated fixed-income portfolio consisted of debt securities, short-term investments and cash and cash equivalents with a carrying value of $2.2 billion, $0.1 million
  and $0.2 million, respectively. Our debt securities are designated as available for sale in accordance with SFAS 115, Accounting for Certain Investments in Debt and Equity Securities. The fixed-
  income portfolio is reported at fair value in accordance with SFAS 115, and the change in fair value is reported as part of accumulated other comprehensive income. Short-term investments consist of
  securities with maturities equal to or greater than 90 days but less than one year at time of purchase.
The average duration of our investment portfolio was 3.4 years as of June 30, 2007, as compared to 3.1 years as of December 31, 2006.
Our fixed-income portfolio is exposed to credit and interest rate risk. As of June 30, 2007, the fair value of our fixed-income portfolio was approximately $2.5 billion, as compared to
  approximately $2.0 billion as of December 31, 2006.
The table below shows the percentage of our fixed-income portfolio (excluding cash and cash equivalents) by credit rating as of June 30, 2007:
Credit Rating(1):
    
    TotalAAA
    
    
    
    76.9AA
    
    
    
    10.5A
    
    
    
    12.4BBB
    
    
    
    .2Total
    
    
    
    100.0%

(1)
    
    
    
    As of June 30, 2007 the average credit quality of our fixed-income portfolio was AA+.As of June 30, 2007, the top 10 corporate holdings, which exclude government guaranteed and government sponsored enterprises, represented 6.9% of the total fixed-income portfolio and
  approximately 33.2% of all corporate holdings. As of June 30, 2007, none of our corporate holdings exceeded 1.0% of our total fixed-income portfolio.
Our fixed-income portfolio is exposed to interest rate risk. Interest rate risk is the price sensitivity of a fixed-income security to changes in interest rates. We manage interest rate risk by setting
  duration targets for our investment portfolio, thus mitigating the overall economic effect of interest rate risk. We remain nevertheless exposed to accounting interest rate risk since the assets are
  marked-to-market, thus subject to market conditions, while liabilities are accrued at a static rate. The hypothetical case of an
46

immediate 100 basis point adverse parallel shift in global bond curves as of June 30, 2007 would have decreased the fair value of our fixed-income portfolio by approximately 3.4%, or $83.2 million.
The following table summarizes our consolidated investment portfolio as of June 30, 2007:
(U.S. dollars in thousands)
    
    AmortizedCost
    
    As of June 30, 2007
    
    Fair ValueGrossUnrealizedGains
    
    GrossUnrealizedLossesDebt securitiesMortgage-backed and asset-backed securities
    
    
    $
    
    1,435,308
    
    
    
    $
    
    891
    
    
    
    $
    
    (24,123
    )
    
    
    
    $
    
    1,412,076U.S. Government and government agencies
    
    
    
    296,472
    
    
    
    
    306
    
    
    
    
    (10,015
    )
    
    
    
    
    286,763Corporate
    
    
    
    516,455
    
    
    
    
    641
    
    
    
    
    (9,128
    )
    
    
    
    
    507,968Non-U.S. sovereign government
    
    
    
    11,065
    
    
    
    
    65
    
    
    
    
    (174
    )
    
    
    
    
    10,956U.S. states and political subdivisions of the states
    
    
    
    373
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    368Total debt securities
    
    
    $
    
    2,259,673
    
    
    
    $
    
    1,903
    
    
    
    $
    
    (43,445
    )
    
    
    
    $
    
    2,218,131Short-term investmentsTotal short-term investments
    
    
    $
    
    57,501
    
    
    
    $
    
    4
    
    
    
    $
    
    (226
    )
    
    
    
    $
    
    57,279The amortized cost and estimated fair value of debt securities and short-term investments available for sale as of June 30, 2007, by contractual maturity, are presented 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.
(U.S. dollars in thousands)
    
    As of June 30, 2007Amortized Cost
    
    Fair ValueDue within one year
    
    
    $
    
    57,501
    
    
    
    $
    
    57,279Due after one through five years
    
    
    
    453,392
    
    
    
    
    447,329Due after five through ten years
    
    
    
    327,575
    
    
    
    
    316,498Due after ten years
    
    
    
    43,398
    
    
    
    
    42,228Mortgage-backed and asset-backed securities
    
    
    
    1,435,308
    
    
    
    
    1,412,076Total
    
    
    $
    
    2,317,174
    
    
    
    $
    
    2,275,410The following table presents the aggregate gross unrealized losses and fair values by investment category and length of time that individual securities have been in a continuous unrealized loss
  position at June 30, 2007.
(U.S. dollars in thousands)
    
    As of June 30, 2007Less than 12 months
    
    12 months or more
    
    TotalFair Value
    
    UnrealizedLoss
    
    Fair Value
    
    UnrealizedLoss
    
    Fair Value
    
    UnrealizedLossDescription of securitiesMortgage and asset-backed securities.
    
    
    $
    
    755,688
    
    
    
    $
    
    (12,340
    )
    
    
    
    $
    
    336,971
    
    
    
    $
    
    (11,783
    )
    
    
    
    $
    
    1,092,659
    
    
    
    $
    
    (24,123
    )U.S. Government and government agencies
    
    
    
    84,163
    
    
    
    
    (2,122
    )
    
    
    
    
    177,936
    
    
    
    
    (7,995
    )
    
    
    
    
    262,099
    
    
    
    
    (10,117
    )Corporate
    
    
    
    226,311
    
    
    
    
    (3,047
    )
    
    
    
    
    205,511
    
    
    
    
    (6,205
    )
    
    
    
    
    431,822
    
    
    
    
    (9,252
    )U.S. States and political subdivisions
    
    
    
    367
    
    
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    367
    
    
    
    
    (5
    )Non-U.S. sovereign government
    
    
    
    495
    
    
    
    
    (10
    )
    
    
    
    
    8,433
    
    
    
    
    (164
    )
    
    
    
    
    8,928
    
    
    
    
    (174
    )Total debt securities and short-term investments
    
    
    $
    
    1,067,024
    
    
    
    $
    
    (17,524
    )
    
    
    
    $
    
    728,851
    
    
    
    $
    
    (26,147
    )
    
    
    
    $
    
    1,795,875
    
    
    
    $
    
    (43,671
    )Securities in a continuous unrealized loss position for 12 months or more consist of U.S. Government and Agency securities, including mortgage-backed securities issued by U.S. Government
  agencies,
47

aggregating $10.7 million and corporate, mortgage-backed, and asset-backed securities (non-government securities) aggregating $15.4 million. Of the non-government securities 57.9%, 78.7%, 98.2%
  and 100% are rated AAA, AA- or better, A- or better and BBB+ or better, respectively. In addition, of the non-government securities in a continuous unrealized loss position for 12 months
  or more, securities aggregating 62% of the total unrealized loss in such category have a price decline of less than 6% from their amortized cost and 38% have a price decline greater than 6% but less
  than 10% of their amortized cost as of June 30, 2007.
Liquidity and Capital Resources
Liquidity Resources
We define liquidity resources to include: our total investments in debt securities, short-term investments, cash and cash equivalents, accrued investment income, the capacity for revolving credit
  loans under our Letter of Credit and Liquidity Facility (see  Letter of Credit and Liquidity Facility below for details), and with respect to XLFA, our soft capital credit facility (see  XLFA Soft
  Capital Facility below for details). At June 30, 2007 and December 31, 2006 our total liquidity resources on a consolidated basis were $2.9 billion and $2.6 billion, respectively.
Our total consolidated net cash inflows for the six months ended June 30, 2007 were $328.8 million, which consisted of $101.1 million in net cash flow generated by operations and $227.7 million
  of net cash flow generated by financing activities, which is net of $19.5 million used to pay dividends to holders of our common shares and the redeemable preferred shares of our subsidiary (see
  XLFA Redeemable Preferred Shares Extraordinary Dividend below for details). Net cash inflow from operations was driven by new business written and investment income and net cash inflow
  from financing activities was driven from our issuance of Series A Perpetual Non-Cumulative Preference Shares discussed below. Net cash used in investing activities was $346.9 million, reflective of
  the investment of cash from operations and the preference share offering.
Capital Resources
We manage our capital resources to maintain appropriate claims-paying resources to sustain the Triple-A claims-paying ratings of our insurance subsidiaries, while minimizing our cost of capital.
  To the extent that the existing capital resources of our operating subsidiaries are insufficient to meet regulatory or rating agency requirements or cover losses, we may need to raise additional funds
  through financings or curtail our insurance subsidiaries growth and reduce their insured exposure. In addition, any equity or debt financing, if available, may be on terms that are not favorable to us.
  If we cannot obtain adequate capital on favorable terms or at all, our business, operating results, and financial condition could be adversely affected.
On
    April 5, 2007, we consummated the sale of $250 million of our SCA Series
    A Preference Shares which were offered for sale
  pursuant to a private placement. Gross proceeds from the offering were $250.0
    million, offering costs were $3.4 million, and net proceeds were $247.2 million.
    The SCA Series A Preference Shares are perpetual securities with no fixed
    maturity date and, if declared by the Board of SCA, will pay a fixed dividend,
    on a semi-annual basis during the first and third quarters of each fiscal
    year, at the annualized rate of 6.88% until September 30, 2017. After such
    date, the Series A Preference Shares, if declared by the Board of SCA, will
    pay dividends, on a quarterly basis, at a floating rate based on three-month
    LIBOR plus 2.715%. Dividends on the SCA Series A Preference Shares are non-cumulative
    and the SCA Series A Preference Shares have a liquidation preference
    of $1,000 per preference share.
In connection with the sale of the SCA Series A Preference Shares, we entered into a Replacement Capital Covenant (the Replacement Capital Covenant), whereby we agreed for the benefit
  of holders of one or more designated series of our long-term debt securities that we may issue in the future that (i) we will not redeem, exchange or purchase the SCA Series A Preference Shares and
  (ii) none of our
48

subsidiaries will purchase or exchange the SCA Series A Preference Shares, except, subject to certain limitations, to the extent that the applicable redemption, exchange or purchase price does not
  exceed a specified amount of cash proceeds from the sale of certain specified qualifying replacement capital securities raised during the period commencing on the 180th calendar day prior to the date
  of notice of the redemption or the date of purchase. We have made no decision as to whether, or when, we would issue debt securities that would have the benefit of that covenant. While such
  provisions are in effect, there could be circumstances where we would wish to redeem, exchange or purchase some or all of the SCA Series A Preference Shares but be restricted from doing so. The
  Replacement Capital Covenant may be terminated if (i) holders of at least a majority by principal amount of the then-effective series of covered debt consent or agree in writing to terminate the
  Replacement Capital Covenant, (ii) we no longer have outstanding any indebtedness that qualifies as covered debt or (iii) we no longer have any outstanding SCA Series A Preference Shares. In
  addition, if not earlier terminated, the Replacement Capital Covenant will terminate on September 30, 2047; provided, however, that the September 30, 2047 termination date may be extended at our
  option.
SCA Liquidity
As a holding company, our cash flow consists of dividends from our insurance subsidiaries (XLCA and XLFA), if declared and paid, and investment income on our invested assets, offset by
  expenses incurred for employee compensation and other expenses consisting primarily of costs incurred as a stand-alone public company, including: board of directors fees, directors and officers
  liability insurance, independent auditor fees, stock registrar and listing fees, legal fees, and annual report and proxy production and distribution costs. The payment of dividends or advances from our
  insurance subsidiaries is subject to regulatory restrictions. In addition, the ability of our insurance subsidiaries to conduct business depends upon ratings from independent rating agencies and,
  consequently, they are subject to rating agency imposed restrictions which also may affect their ability to pay dividends or make advances. As a result of the aforementioned regulatory and rating
  agency restrictions, there can be no assurance that our insurance subsidiaries will be able to pay dividends or make advances, or that any dividends or advances paid by our insurance subsidiaries will
  be sufficient to fund our cash requirements or that we will not be required to seek external debt or equity financing to meet our operating expenses.
In
    the ordinary course of business, we evaluate our liquidity resource needs
    in light of our expenses, our dividend policy, and the dividend paying ability
    of our insurance subsidiaries. Based on our liquidity resources (see definition
    above) as of June 30, 2007, which aggregated $281.2 million, the income we
    expect to receive from such liquidity resources, we believe that our holding
    company will have sufficient liquidity to pay its operating expenses and
    anticipated dividends over the next twelve months. During the six months
    ended June 20, 2007, our board of directors declared quarterly dividends
    on our common shares which were paid on March 30, 2007 and June 29, 2007,
    respectively, and which aggregated approximately $2.6 million. In addition,
    on July 31, 2007 our board of directors declared a quarterly dividend of
    $.02 per common share payable on September 28, 2007 to shareholders of record
    on September 14, 2007. Also, on July 31, 2007 our board of directors declared
    a semi-annual dividend on the SCA Series A Preference Shares aggregating
    $8.4 million, which is payable on October 1, 2007 to shareholders of record
    of the SCA Series A Preference Shares on September 28, 2007. Any future dividends
    will be subject to the discretion and approval of the Board of Directors.
In connection with our IPO, our operating subsidiaries have each agreed that, until the second anniversary of the IPO each will not declare or pay dividends on its common stock other than to
  fund certain parent holding company operating expenses and debt service requirements and to fund nominal dividends on our common stock. In addition, New York Insurance law contains a test
  governing the amount of dividends that XLCA can pay in any year and, as a result of the application of such test, XLCA cannot currently pay dividends, without notice to, and prior approval from,
  the New York Superintendent. As a U.S. company paying dividends to a Bermuda holding company, XLCAs dividends are subject to a 30% withholding tax rate.
49

Operating Subsidiaries Liquidity
Liquidity resources at our operating subsidiaries are primarily used to pay their operating expenses, claims, payment obligations with respect to credit derivatives, reinsurance premiums, support in
  force business, and pay dividends to us, as well as in the case of XLCA to make investments from time to time in its subsidiary, XLCA-UK. Our operating subsidiaries principal sources of liquidity
  resources are their portfolio of liquid assets and their net operating cash flow, as well as, in the case of XLFA, the soft capital facility described under  XLFA Soft Capital Facility below. Liquidity
  resources can be affected by changes in interest rates and the amount and timing of loss payments as well as the other factors described under  Managements Discussion and Analysis of Financial
  Condition and Results of Operations  Key Factors Affecting Profitability.
Our operating subsidiaries liquid assets include substantial U.S. Treasury holdings, short-term investments and readily marketable debt securities. These liquidity resources are subject to market
  conditions, regulation and rating agency requirements and we cannot guarantee that they will have sufficient liquidity resources in the future or that they will not have to seek alternative sources of
  liquidity, which may be more expensive than their current liquidity resource options. We believe, however, that our operating subsidiaries sources of liquidity are adequate to meet their anticipated
  needs for at least the next twelve months.
XLCA
Cash Flows.XLCA reported net cash (used in) operating activities of ($13.7) million for the six months ended June 30, 2007 compared to $33.8 million of net cash provided by operating
  activities in the comparable period in 2006. Net cash provided by operating activities decreased by $47.5 million. The decrease in XLCAs cash flow from operations is primarily due to: (i) slightly
  lower business production (particularly in the public finance sector), as compared to the comparable prior year period, and (ii) a higher proportion of installment business, as compared to upfront
  business, during the six months ended June 30, 2007, as compared to the comparable period in 2006, offset in part by (iii) XLCAs higher retention of business resulting from the change in its quota
  share arrangement with XLFA, whereby effective July 1, 2006 XLCA began ceding up to 75% of its business to XLFA, as compared with 90% prior thereto.
XLCA reported net cash provided by used in investing activities was $20.8 million and $19.8 million for the six months ended June 30, 2007 and 2006, respectively. Cash used in investing
  activities is primarily a result of investing cash generated from operating activitiessee Liquidity Resources above.
As of June 30, 2007 and December 31, 2006, XLCA had readily marketable debt securities and short-term investments with a carrying value of $358.7 million and $347.2 million, respectively. In
  addition, at those dates, approximately 99.9% of XLCAs fixed income portfolio was rated A or higher.
XLFA
Cash Flows.XLFA reported net cash provided by operating activities of $128.8 million for the six months ended June 30, 2007 compared to $125.4 million in the comparable period in 2006. Net
  cash provided by operating activities increased by $3.4 million, driven by new business written and investment income.
XLFA reported net cash provided by (used in) financing activities was $208.1 million and ($2.6 million) for the six months ended June 30, 2007 and 2006, respectively. The current year net inflow
  reflects the contribution of $225.0 million of net proceeds of our Series A perpetual non-cumulative preference shares, partially offset by dividends paid to holders of the redeemable preferred shares of
  XLFA.
XLFA reported net cash provided used in investing activities was $323.8 million and $99.1 million for the six months ended June 30, 2007 and 2006, respectively. Cash used in investing activities
  is primarily a result of investing cash generated from operating activities and financing activities  see Liquidity Resources above.
As of June 30, 2007 and December 31, 2006, XLFA had readily marketable debt securities and short-term investments with a carrying value of $1.9 billion and $1.6 billion, respectively. In
  addition, at those dates, approximately 99.7% of XLFAs fixed income portfolio was rated A or higher.
50

Letter of Credit and Liquidity Facility
On August 4, 2006, we and certain of our subsidiaries entered into an aggregate $500.0 million, five-year letter of credit and revolving credit facility (the $500.0 million credit facility) with a
  syndicate of banks, for which Citibank N.A. is the administrative agent. The letter of credit and liquidity facility provides for letters of credit of up to $250 million and up to $250 million of revolving
  credit loans with the aggregate amount of outstanding letters of credit and revolving credit loans thereunder not to exceed $500 million.
Interest and fees payable under the letter of credit and liquidity facility shall be determined based upon certain spreads over defined benchmarks, principally LIBOR. The commitments under the
  letter of credit and liquidity facility will expire on, and amounts borrowed under the letter of credit and liquidity facility may be borrowed, repaid and reborrowed from time to time until, the earlier
  of (i) the date that is five years after the closing date of the letter of credit and liquidity facility and (ii) the date of termination in whole of the commitments upon an optional termination or
  reduction of the commitments by the Account Parties or upon an event of default.
The credit and liquidity facility contains financial covenants that require that SCA at any time (a) prior to August 4, 2008, maintain a minimum net worth of $857.4 million, (b) after August 4,
  2008, maintain a minimum net worth equal to the greater of (1) $857.4 million (our net worth, defined as total shareholders equity before accumulated other comprehensive income, was
  approximately $1,696.0 million as of June 30, 2007) or (2) an amount equal to 65% of the consolidated net worth as of the end of the then most recent fiscal year or fiscal quarter of SCA for which
  financial statements shall have been delivered, and (c) maintain a maximum total funded debt-to-total capitalization ratio of 30% (as of June 30, 2007, we had no debt outstanding). The letter of
  credit and liquidity facility also contains certain covenants, including restrictions on mergers, acquisitions and other business consolidations; the sale of assets; incurrence of indebtedness; liens on our
  assets; and transactions with affiliates. In addition, the letter of credit and liquidity facility contains certain customary provisions regarding events of default, including payment defaults, breaches of
  representations and warranties, covenant defaults, cross-default and cross-acceleration to certain other indebtedness, certain events of bankruptcy and insolvency, material judgments, certain events
  under the Employee Retirement Income Security Act of 1974, as amended, and changes of control.
As of June 30, 2007, the Company had letters of credit outstanding under the Facility of $176.7 million, which were established for the benefit of primary insurance companies reinsured by the
  Company, as explained below. No revolving loans have been drawn by the Company under the Facility since its inception. For the three and six months ended June 30, 2007, the Company incurred
  expenses of $0.2 million and $0.3 million under the Facility. In the comparable prior period in 2006, XL Capital had drawn letters of credit under its credit facility with a syndicate of commercial
  banks for the benefit of primary companies reinsured by the Company. For the three and six months ended June 30, 2006, the Company incurred expenses of $0.1 million and $0.3 million related to
  letters of credit drawn by XL Capital for the benefit of primary companies reinsured by the Company.
Primary insurers may require collateral or letters of credit so that they can receive reinsurance credit under certain U.S. state laws. In addition, under certain of the Companys reinsurance
  treaties, the Company may be required to provide collateral or letters of credit in favor of its ceding insurers in the event of a downgrade of the Companys credit ratings or other event which would
  diminish the credit provided by the Companys reinsurance to such ceding insurers.
Ceded Reinsurance Recoverables
We manage our in-force portfolio of guaranteed obligations based on, and to comply with, regulatory and rating agency single-risk limits and internal credit guidelines. Single-risk limits are
  designed to avoid concentration in single names and to mitigate event risk and are calculated as a percentage of capital. For transactions that exceed these limits or guidelines, we will cede the excess
  to XLI, XL RE AM, or other third-party reinsurers. Generally, all such reinsurance is structured as facultative quota share reinsurance in which the reinsurer is liable to us for its quota share of the
  applicable policies that we issue, regardless of when the loss occurs. Accordingly, related loss reserves, including unallocated loss reserves, are ceded in accordance with such contracts. Through these
  facultative cessions, we gain greater flexibility to manage large single risks and reduce concentration in specific bond sectors and geographic regions. Part of our strategy is to reduce reinsurance to
  XLI and XL RE AM, and increase our third-party reinsurance relationships. To the extent that we cede a portion of our exposure to one or more reinsurance
51

companies, we can reduce our concentration to particular issuers and help to control the diversification of our credit portfolio. In addition, use of reinsurance can increase our capacity to write new
  business and strengthen our capital adequacy ratios.
As of June 30, 2007 and December 31, 2006, we had $65.8 million and $70.8 million in reinsurance recoverables from our reinsurers relating to specific case reserves. The following table presents,
  by reinsurer, the amount of our in-force principal exposure ceded to reinsurers as of June 30, 2007 and December 31, 2006:
(U.S. dollars in billions, except percentages)
    
    As of June 30 2007
    
    As of December 31, 2006Ceded ParOutstanding
    
    % of GrossOutstanding
    
    Ceded ParOutstanding
    
    % of GrossOutstandingXL RE AM
    
    
    $
    
    2.1
    
    
    
    
    1.4
    %
    
    
    
    $
    
    0.9
    
    
    
    
    0.7
    %XLI(1)
    
    
    
    0.7
    
    
    
    
    0.5
    %
    
    
    
    
    0.7
    
    
    
    
    0.5
    %AAA Companies(2)
    
    
    
    4.0
    
    
    
    
    2.6
    %
    
    
    
    
    2.5
    
    
    
    
    2.0
    %AA Companies & others(3)
    
    
    
    4.5
    
    
    
    
    2.8
    %
    
    
    
    
    3.2
    
    
    
    
    2.5
    %Total
    
    
    $
    
    11.3
    
    
    
    
    7.3
    %
    
    
    
    $
    
    7.3
    
    
    
    
    5.7
    %

(1)
    
    
    
    In connection with the transfer of business from XLI to us as described under Formation Transactions in our Annual Report on Form 10-K the amount of our in-force principal exposure ceded to XLI was reduced by approximately $3.9
      billion.(2)
    
    
    
    AAA Companies means those firms that have both an AAA rating from S&P and/or an Aaa rating from Moodys.(3)
    
    
    
    AA Companies and others means those firms (other than XLI) that have either an AA category rating from S&P and/or an Aa category rating from Moodys or have an investment grade rating but do not have a financial enhancement
      rating from S&P.XLFA Soft Capital Facility
In December 2004, XLFA entered into a put option agreement and an expense reimbursement agreement (the Asset Trust Expense Reimbursement Agreement) with Twin Reefs Asset Trust
  (the Asset Trust). The put option agreement provides XLFA with the irrevocable right to require the Asset Trust at any time and from time to time to purchase XLFAs non-cumulative perpetual
  Series B preferred shares with an aggregate liquidation preference of up to $200 million. There is no limit to the number of times that XLFA may exercise the put option, redeem the Series B
  preferred shares from the Asset Trust and exercise the put option again. XLFA is obligated to reimburse the Asset Trust for certain fees and ordinary expenses. To the extent that any Series B
  preferred shares are put to the Asset Trust and remain outstanding, a corresponding portion of such fees and ordinary expenses will be payable by XLFA pursuant to the asset trust expense
  reimbursement agreement. The put option agreement is perpetual but would terminate on delivery of notice by XLFA on or after December 9, 2009, or under certain defined circumstances, such as
  the failure of XLFA to pay the put option premium when due or bankruptcy. The premium payable by XLFA is the sum of certain trustee and investment managers expenses, the distribution of
  income paid to holders of the pass-through trust securities, less the investment yield on the eligible assets purchased using the proceeds originally raised from the issuance of the pass-through
  securities. The eligible securities (which are generally high-grade investment securities) are effectively held in trust to be used to fund the purchase of any Series B preferred shares upon exercise of
  the put. The put option has not been exercised since the inception of the facility.
XLFA Redeemable Preferred Shares Extraordinary Dividend
On February 27, 2007, the board of directors of XLFA approved: (i) an extraordinary dividend of $15.0 million on its Series A Redeemable Preferred Shares, and (ii) a reduction in the stated
  value of the remaining outstanding Series A Redeemable Preferred Shares by a corresponding amount. Payment of the extraordinary dividend and the reduction in the stated value of the Series A
  Redeemable Preferred Shares occurred on March 30, 2007. This transaction was accounted for as a redemption of the preferred shares. As a result of the reduction in stated value, dividends on the
  Series A Redeemable Preferred Shares will be $0.8 million quarterly subsequent to March 31, 2007.
52

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 (PSLRA) provides a safe harbor for forward-looking statements. Any prospectus, prospectus supplement, our annual report to ordinary
  shareholders, any proxy statement, any other Form 10-K, Form 10Q, or Form 8-K of ours, or any other written or oral statements made by or on behalf of us may include forward-looking statements
  that reflect our current views with respect to future events and financial performance. Statements that include the words expect, intend, plan, believe, project, anticipate, will, may
  and similar statements of a future or forward-looking nature identify forward-looking statements. All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there
  are or will be important factors that could cause actual results to differ materially from those indicated in such statements.
We believe that these factors include, but are not limited to, the following:

    
    
    
    changes in rating agency policies or practices, including adverse changes to the financial strength or financial enhancement ratings of any or all of our operating subsidiaries;
    
    
    
    ineffectiveness or obsolescence of our business strategy, due to changes in current or future market conditions or other factors;
    
    
    
    the performance of our invested assets or losses on credit derivatives;
    
    
    
    availability of capital (whether in the form of debt or equity) and liquidity (including letter of credit facilities);
    
    
    
    the timing of claims payments being faster or the receipt of reinsurance recoverables being slower than anticipated by us;
    
    
    
    increased competition on the basis of pricing, capacity, terms or other factors;
    
    
    
    greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events, than our underwriting, reserving or investment practices anticipate
      based on historical experience or industry data;
    
    
    
    developments in the worlds financial and capital markets that adversely affect the performance of our investments and our access to such markets;
    
    
    
    changes in, or termination of, our ongoing reinsurance agreements with XL Capital or FSA;
    
    
    
    changes in regulation or tax laws applicable to us or our customers or suppliers such as our reinsurers;
    
    
    
    changes in the rating agencies views on third-party inward reinsurance;
    
    
    
    changes in the availability, cost or quality of reinsurance or retrocessions, including a material adverse change in the ratings of our reinsurers or retrocessionaires;
    
    
    
    changes with respect to XL Capital (including changes in its ownership percentage in us) or our relationship with XL Capital;
    
    
    
    changes that may occur in our operations as we begin operations as a public company;
    
    
    
    changes in accounting policies or practices or the application thereof;
    
    
    
    changes in the officers of our company or our subsidiaries;
    
    
    
    legislative or regulatory developments;
    
    
    
    changes in general economic conditions, including inflation, interest rates, foreign currency exchange rates and other factors; and
    
    
    
    the effects of business disruption or economic contraction due to war, terrorism or natural or other catastrophic events.The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included herein or elsewhere.
  We undertake no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.
53

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative disclosure regarding our exposures to market risk, as well as our objectives, policies and strategies relating to the management of such risks, is set forth in our Annual
  Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 15, 2007. Our relative sensitivity to changes in fair value from interest rates and equity prices at June
  30, 2007 is not materially different from that presented in such report.
ITEM
        4. CONTROLS AND PROCEDURES
Not
    Applicable. See Item 4T. Controls and Procedures below.
ITEM 4T. CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
The Company carried out an evaluation, under the supervision and with the participation of the Companys management, including the Chief Executive Officer and Chief Financial Officer, of the
  effectiveness of disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of the end of the period covered
  by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective to provide reasonable assurance
  that all material information relating to the Company required to be filed in this report has been made known to them in a timely fashion.
Changes in internal control over financial reporting
There was no change in the Companys internal control over financial reporting, that occurred during the period covered by this quarterly report that materially affected, or is reasonably likely to
  materially affect, the Companys internal control over financial reporting.
54

PART IIOTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company believes that the ultimate outcome of all outstanding litigation and arbitration will not have a material adverse effect on its consolidated financial condition, future operating results
  and/or liquidity, although an adverse resolution of a number of these items could have a material adverse effect on the Companys results of operations in a particular fiscal quarter or year.
ITEM 1A. RISK FACTORS
Risk Associated with a Recently Proposed Statement of Financial Accounting Standards (SFAS) Pertaining to Accounting for Financial Guarantee Insurance Contracts. On April 18, 2007, the
  Financial Accounting Standards Board (FASB) issued Proposed SFAS, Accounting for Financial Guarantee Insurance Contractsan interpretation of FASB Statement No. 60. This proposed
  Statement would clarify how FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises, applies to financial guarantee insurance contracts. This proposed Statement, among other
  things, would change current industry practices with respect to the recognition of premium revenue and claim liabilities. In addition, this proposed Statement would require that the measurement of
  the initial deferred premium revenue (liability) be the present value of the contractual premium due pursuant to the terms of the financial guarantee insurance contract, thereby changing current
  industry accounting practice with respect to insurance contracts priced on an installment basis by requiring that the present value of all contractual premiums due under such contracts, currently or in
  the future, be recorded on the companys balance sheet as premiums receivable. Under current industry practice such premiums are not reflected on the balance sheet. We expect that the initial effect
  of applying the revenue recognition provisions of the Statement as currently proposed will be material to the Companys financial statements and that implementation of the proposed guidance in
  regard to the recognition of claim liabilities will cause the Company to de-recognize its reserves for unallocated losses and loss adjustment expenses and preclude it from providing such reserves in the
  future. The comment period for the proposed Statement expired on June 18, 2007. A round table discussion between the FASB and interested parties who provided comments on the proposed
  Statement has been rescheduled to early September 2007 from mid-July of 2007. Currently the proposed Statement is due to be effective for fiscal years beginning after December 15, 2007. The
  Company is continuing to evaluate the effect of the proposed Statement on its financial statements. See Note 4 to the Unaudited Interim Consolidated Financial Statements for further information.
The costs of services, leasing, reinsurance, and other arrangements provided by XL Capital may increase. Effective upon our IPO, we and XL Capital entered into a series of service agreements
  pursuant to which XL Capital provides us, for a period of up to two years, transitional services, including treasury, payroll and other financial services, human resources and employee benefit services,
  legal services, information systems and network services, tax and treasury services, investment management and procurement and sourcing support. We also entered into a transition agreement with
  XL Capital, which governs the relationship between us and XL Capital and reinsurance agreements with subsidiaries of XL Capital.
Each service agreement provides that, on or before August 15, 2007, SCA shall submit to XL Capital a list of the types of services required from XL Capital for the period from January 1, 2008
  through August 4, 2008. Pursuant to the service agreements, costs and services will be determined no later than September 15, 2007. There can be no assurance that our costs under the service
  agreements will not materially increase as a result of this process.
Refer to Risk Factors in our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 15, 2007, for information in regard to the Companys other
  Risk Factors.
ITEM
        2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
See
    information contained in Companys Current Reports on Form 8-K filed
    on March 30, 2007 and April 10, 2007.
55

ITEM
        3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Annual General Meeting of holders (the Shareholders) of Common Shares held on May 4, 2007 at the Fairmont Hamilton Princess, 76 Pitts Bay Road, Pembroke HM 11 Bermuda, the
  Shareholders approved the following:
1. The election of three Class II Directors to hold office until 2010:
Votes in Favor
    
    Votes WithheldPaul S. Giordano
    
    
    
    58,795,222
    
    
    
    
    438,189Robert M. Lichten
    
    
    
    58,792,722
    
    
    
    
    440,689Alan Z. Senter
    
    
    
    58,792,822
    
    
    
    
    440,589In addition, the terms of the following Directors continued after the Annual General Meeting: Michael P. Esposito, Jr., Brian OHara, E. Grant Gibbons, Bruce G. Hannon, Mary R. Hennessy,
  and Coleman Ross.
2. The appointment of PricewaterhouseCoopers LLP, New York, New York, to act as the registered independent public accounting firm for the Company for the year ending December 31, 2007:
Votes In Favor
    
    Votes Against
    
    Abstentions59,228,568
    
    4,753
    
    1003. The Amended and Restated 2006 Long Term Incentive and Share Award Plan was approved.
Votes In Favor
    
    Votes Against
    
    Abstentions56,142,862
    
    406,930
    
    961,3124. The Amended and Restated Annual Incentive Compensation Plan was approved.
Votes In Favor
    
    Votes Against
    
    Abstentions57,844,655
    
    470,417
    
    918,339ITEM
        5. OTHER INFORMATION.
None.
56

ITEM 6. EXHIBITS
ExhibitNumber
    
    Description of Document4.1
    
    Replacement Capital Covenant, dated April 5, 2007, incorporated by reference
            to Exhibit 4.5 to the Companys Current Report on Form 8-K filed
            on April 10, 2007 (File No. 001-32950).4.2
    
    Registration Rights Agreement, dated April 5, 2007, incorporated by reference
            to Exhibit 4.6 to the Companys Current Report on Form 8-K filed
            on April 10, 2007 (File No. 001-32950).4.3
    
    Extract of the Minutes
        of a Meeting of a Subcommittee of the Finance and Risk Oversight Committee,
        incorporated by reference to Exhibit 4.1 to the Companys Current
        Report on Form 8-K filed on April 10, 2007 (File No. 001-32950).10.1
    
    Amended and Restated Annual Incentive Compensation Plan, adopted as of
            May 4, 2007, incorporated by reference to Exhibit 10.1 to the Companys
            Current Report on Form 8-K filed on May 10, 2007 (File No. 001-32950).10.2
    
    Amended and Restated 2006 Long-Term Incentive and Share Award Plan, adopted
            as of May 4, 2007, incorporated by reference to Exhibit 10.2 to the
            Companys Current Report on
      Form 8-K filed on May 10, 2007 (File No. 001-32950).31
    
    Rule 13a-14(a)/15d-14(a) Certifications.32
    
    Section 1350 Certification.99.1
    
    XL Capital Assurance Inc. and Subsidiary interim consolidated financial statements (unaudited) as of June 30, 2007 and December 31, 2006 and for the three and six month periods
      ended June 30, 2007 and 2006.99.2
    
    XL Financial Assurance Ltd interim financial statements (unaudited) as of June 30, 2007 and December 31, 2006 and for the three and six month periods ended June 30, 2007 and 2006.57

SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SECURITY CAPITAL ASSURANCE LTD(Registrant)Date: August 10, 2007
    
    /s/ PAUL S. GIORDANOPaul S. GiordanoPresident, Chief Executive Officer and Director(Principal Executive Officer)Date: August 10, 2007
    
    /s/ DAVID P. SHEADavid P. SheaExecutive Vice President and Chief Financial Officer(Principal Financial Officer)58