The Company's 2001 net income was $209.5 million, compared with $63.3 million ($138.8 million excluding merger-related costs) for 2000, an increase of 231.1%. Core net income was $212.9 million for 2001, compared with $176.0 million for 2000, an increase of 20.9%. Total core revenues increased by $50.8 million in 2001, to $354.5 million from $303.7 million for 2000, while total core expenses increased only $9.8 million in 2001. Operating net income was $217.3 million for 2001 versus $181.5 million for 2000, an increase of $35.8 million, or 19.7%.
The Company employs two measures of gross premiums originated for a given period. GROSS PREMIUMS WRITTEN captures premiums collected in the period, whether collected up front for business originated in the period, or in installments for business originated in prior periods. An alternative measure, GROSS PV PREMIUMS WRITTEN, reflects future installment premiums discounted to their present value, as well as upfront premiums, but only for business originated in the period. Business ceded through reinsurance placed by a third party is excluded from gross PV premiums written. The Company considers gross PV premiums written to be the better indicator of a given period's origination activity because a substantial portion of the Company's premiums is collected in installments, a practice typical of the asset-backed business. To calculate gross PV premiums written, management estimates the life of each transaction that has installment premiums and discounts the future installment premium payments. The Company calculates the discount rate as the average pre-tax yield on its investment portfolio for the previous three years. Accordingly, year-to-year comparisons of gross PV premiums written are affected by the application of different discount factors. The rates for 2001, 2000 and 1999 were 5.79%, 5.77% and 5.93%, respectively. Management intends to revise the discount rate in future years according to the same formula, in order to reflect interest rate changes.
Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The market risks related to financial instruments of the Company relate primarily to its investment portfolio, of which over 99.6% (excluding the GIC bond portfolio) was invested in fixed-income securities at December 31, 2001. Changes in interest rates affect the value of the Company's fixed-income portfolio. As interest rates rise, the fair value of fixed-income securities decreases. Sensitivity to interest rate movements can be estimated by projecting a hypothetical increase in interest rates of 1.0%. Based on market values and interest rates at year-end 2001, this
Interest expense in 1999 and 2000 was $16.6 million each year. For further discussion, see "Liquidity and Capital Resources" below.
In the second quarter of 2000, in connection with the merger of the Company with a Dexia subsidiary, FSA repurchased $55.0 million of its stock from the Company, and the Company sold 511,031 of its shares held in a rabbi trust to Dexia for $38.6 million. The proceeds from these transactions were used to fund the Company's obligations under certain of its long-term, equity-based compensation programs.
Asset-backed and, to a lesser extent, municipal transactions insured by FSA may employ special purpose entities (SPEs) for a variety of purposes. A typical asset-backed transaction, for example, employs an SPE as the purchaser of the securitized assets and as the issuer of the obligations insured by FSA. FSA's participation is typically requested by the sponsor of the SPE or the underwriter, either via a bid process or on a sole source basis. SPEs are typically owned by transaction sponsors or charitable trusts, although FSA may have an ownership interest in some cases. FSA maintains certain contractual rights and exercises varying degrees of influence over SPE issuers of FSA-insured obligations. FSA also bears some of the "risks and rewards" associated with the performance of the SPE's assets. Specifically, as issuer of a financial guaranty insurance policy insuring the SPE's obligations, FSA bears the risk of asset performance (typically, but not always, after a significant depletion of overcollateralization, excess spread, a deductible or other credit protection). FSA's underwriting policy is to insure only obligations that are otherwise investment grade. In addition, the SPE typically pays a periodic premium to FSA in consideration of the issuance by FSA of its insurance policy, with the SPE's assets typically serving as the source of such premium, thus providing some of the "rewards" of the SPE's assets to FSA. SPEs are also employed by FSA in connection with "repackaging" of outstanding securities into new securities insured by FSA and with refinancing underperforming non- investment-grade transactions insured by FSA. The degree of influence exercised by FSA over these SPEs varies from transaction to transaction, as does the degree to which "risks and rewards" associated with asset performance are assumed by FSA. While all transactions insured by FSA are included in the Company's outstanding exposure, and losses under these obligations are reflected in the Notes to Consolidated Financial Statements for December 31, 2001, the assets and liabilities of these SPEs have not been consolidated with those of the Company for financial reporting purposes and are considered "off-balance sheet" obligations. Two such SPEs, Canadian Global Funding Corporation (Canadian Global) and FSA Global Funding Limited (FSA Global), are discussed in more detail below.
The credit quality of bonds, excluding the GIC bond portfolio, at December 31, 2001 were as follows:
The Company held open positions in U.S. Treasury bond futures contracts, Eurodollar futures contracts, and municipal bond index futures during 2000 and 1999. Such positions were marked to market on a daily basis and, for the years ended December 31, 2000 and 1999, resulted in net realized gains (losses) of $480,000 and $(5,490,000), respectively.
The credit quality of bonds held in the GIC bond portfolio, at December 31, 2001 were as follows:
On November 3, 1998, the Company and XL Capital Ltd (XL) closed a transaction to create two new Bermuda-based financial guaranty insurance companies. Each of the new companies was initially capitalized with approximately $100,000,000. One company, International, is an indirect subsidiary of FSA, and the other company, XL Financial Assurance Ltd, is a subsidiary of XL. The Company has a minority interest in the XL subsidiary, and XL has a minority interest in the FSA indirect subsidiary. In conjunction with forming the new companies, the Company and XL exchanged $80,000,000 of their respective common shares, with the Company delivering to XL 1,632,653 common shares out of treasury. Prior to the closing of the transaction with XL, the Company had entered into an agreement with an unrelated third party to sell for cash, at no gain or loss, $60,000,000 of the XL shares. This $60,000,000 was used to fund, in part, the Company's investment in International. In 2000, the Company sold its remaining investment in XL.
The Company applies APB Opinion 25 and related Interpretations in accounting for its performance shares. The Company estimates the final cost of these performance shares and accrues for this expense over the performance period. The accrued expense for the performance shares was $48,238,000, $50,076,000, which includes $26,177,000 of merger-related costs, and $33,442,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Prior to the merger, in tandem with this accrued expense, the Company estimated those performance shares that it expected to settle in stock and recorded this amount in shareholders' equity as deferred compensation. The remainder of the accrual, which represented the amount of performance shares that the Company estimated it would settle in cash, was recorded in accrued expenses and other liabilities. As a result of the merger, the Company revised its assumption by assuming that all future payments would be settled in cash and recharacterized $39,599,000 from shareholders' equity to a liability. Had the compensation cost for the Company's performance shares been determined based upon the provisions of SFAS No. 123, there would have been no effect on the Company's reported net income.
The Company does not currently provide post-retirement benefits, other than under its defined contribution plans, to its employees, nor does it provide post-employment benefits to former employees other than under its severance plans or employment agreements with members of senior management.
The Company's policies insure the scheduled payments of principal and interest on asset-backed and municipal obligations. The principal amount insured (in millions) as of December 31, 2001 and 2000 (net of amounts ceded to other insurers) and the terms to maturity are as follows: