(a)Prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP").
In the FP segment, the Company generally intends to hold its investments to maturity, consistent with its normal investment policy. Adverse loss developments surrounding subprime RMBS may lead to earlier than anticipated withdrawals on its GICs issued in connection with CDOs of ABS. As of the end of February 2008, $280 million of CDO of ABS GICs had been unwound due to an event of default in the underlying CDO of ABS. Beginning in the fourth quarter of 2007, the Company has been enhancing the liquidity available to its FP Investment Portfolio by investing newly originated GIC proceeds in short-term investments. As a result, the NIM on new business originations in the FP segment has been eliminated and, in some cases, negative NIM is generated. Overall, NIM remained positive through December 31, 2007.
As of December 31, 2007, unrealized portfolio gains and losses and CDS fair-value adjustments had no effect on insurance company statutory equity or claims-paying resources, and rating agencies generally do not take these unrealized gains or losses into account for evaluating FSA's capital adequacy.
PV premiums originated is a measure of gross origination activity and does not reflect premiums ceded to reinsurers or the cost of CDS or other credit protection, which may be considerable, employed by the Company to manage its credit exposures.
The financial guaranty segment includes the results of operations of the insurance subsidiaries as well as the results of operations related to holding company activities. The primary components of financial guaranty segment earnings are premiums, net investment income from the General Investment Portfolio, income on assets acquired in refinancing transactions, loss and loss adjustment expenses ("LAE"), interest expense on corporate debt and other operating expenses. Management analyzes segment results on a pre-tax operating earnings basis.
The Company's insured portfolio includes contracts accounted for as derivatives, namely, FSA-insured CDS, insured interest rate swaps entered into in connection with the issuance of certain public finance obligations and insured NIM securitizations issued in connection with certain RMBS financings. The Company considers all such agreements to be a normal part of its financial guaranty insurance business but, for accounting purposes, these contracts are deemed to be derivative instruments and therefore must be recorded at fair value, with changes in fair value recorded in the consolidated statements of operations and comprehensive income in the line item "realized and unrealized gains (losses) on derivative instruments," along with the results of other derivatives held at FSA Holdings. The Company receives a premium in return for its obligation to make payment in the event of an insured loss (default or non-payment by the obligor), which is recorded in the consolidated statements of operations and comprehensive income as earned premium. See "-Premiums Earned."
The components of net realized and unrealized gains (losses) on derivative instruments in the financial guaranty segment are shown in the table below.
It is unrealistic to believe that all variables behave independently and management reported in the third quarter that, under a reasonably possible but more stressful than expected scenario, HELOC losses should not exceed $125 million. This amount was calculated using internally developed cash flow models and assumed that conditional default rates and draw rates for each transaction would remain at what was then (September 2007) their most recent three-month average for the life of the transaction. However, should Countrywide or any successor drastically curtail or altogether discontinue funding draws, HELOC losses could materially exceed $125 million.
Alt-A First-Lien Mortgages: Alt-A first-lien mortgage securitizations represent 1% of total asset-backed par outstanding. In a typical Alt-A transaction, FSA is protected by approximately 8% subordination plus 3% of future spread, for total protection of 11%. At the time of origination FSA typically expects pool losses to equal 3%, which assumes a 35% severity rate and 8.5% foreclosure frequency. Holding severity constant, foreclosures would need to exceed 31% before FSA experienced a loss on its policies. All of the FSA-insured Alt-A first lien exposure is rated Triple-A.
Credit ratings are also an important component of a financial institutions' ability to compete in the derivative, investment agreement and structured transaction markets. If FSA were downgraded, the Company might be required to post incremental collateral to its investment agreement and derivative counterparties, introducing additional liquidity risk. Most FSA-insured GICs allow for withdrawal of GIC funds in the event of a downgrade of FSA, typically below AA- by S&P or Aa3 by Moody's, unless the GIC provider posts collateral or otherwise enhances its credit. Such a downgrade could result in a significant amount of collateral to be posted. Some FSA-insured GICs also allow for withdrawal of GIC funds in the event of a downgrade of FSA, typically below A3 by Moody's or A- by S&P, with no right of the GIC provider to avoid such withdrawal by posting collateral or otherwise enhancing its credit.
Investing activities consist primarily of purchases and sales of assets in the Company's various investment portfolio. The Company invests proceeds from the issuance of GICs and VIE debt in assets held within the FP Segment Investment Portfolio. Premium receipts are invested in the General Investment Portfolio. Proceeds from issuance of debt are classified as financing activities while the investment of those proceeds are classified as investing activities in the cash flow statement.
II. Notes to Condensed Financial Statements of Financial Security Assurance Holdings Ltd.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Financial Security Assurance Holdings Ltd. and Subsidiaries (the "Company") at December 31, 2007 and December 31, 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
On July 5, 2000, the Company completed a merger in which FSA Holdings became a direct subsidiary of Dexia Holdings, Inc. ("Dexia Holdings"), which, in turn, is owned 90% by Dexia Crédit Local S.A. ("Dexia Crédit Local") and 10% by Dexia S.A. ("Dexia"). Dexia is a Belgian corporation whose shares are traded on the Euronext Brussels and Euronext Paris markets, as well as on the Luxembourg Stock Exchange. Dexia Crédit Local is a wholly owned subsidiary of Dexia. At December 31, 2007, Dexia Holdings owned over 99% of outstanding FSA Holdings shares; the only other holders of FSA Holdings common stock were certain current and former directors of FSA Holdings who owned shares of FSA Holdings common stock or economic interests therein under the Director Share Purchase Program (see Note 12). During 2006, Dexia purchased all the shares previously owned by an affiliate of White Mountains Insurance Group, Ltd. ("White Mountains").
consideration of the issuance by FSA of its insurance policy, with the SPE's assets typically serving as the source of such premium, thereby 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.
(1)The majority of foreign securities are government issues and corporate securities that are denominated primarily in British pounds or euros.
(2)Stated maturities for asset-backed and other securities of four to 44 years as of December 31, 2007 and of one to 49 years as of December 31, 2006. Proceeds from sales of available-for-sale bonds held in the FP Investment Portfolio during 2007, 2006 and 2005 were $2,971.7 million, $4,512.5 million and $5,635.3 million, respectively. Proceeds from maturities of bonds for the FP Investment Portfolio during 2007, 2006 and 2005 were $3,299.0 million, $4,485.1 million and $1,422.0 million, respectively. Gross gains were realized on sales during 2007 and
(1)Stated maturities for asset-backed securities of two to 24 years as of December 31, 2007 and of three to 25 years as of December 31, 2006. Proceeds from maturities of bonds for the VIE Investment Portfolio during 2007, 2006 and 2005 were $165.9 million, $24.7 million and $183.2 million, respectively.
Acquisition costs deferred and the related amortization charged to expense are as follows:
Since case and non-specific reserves are based on estimates, there can be no assurance that the ultimate liability will not differ from such estimates. The Company will continue, on an ongoing basis, to monitor these reserves and may periodically adjust such reserves, upward or downward, based on the Company's actual loss experience, its mix of business and economic conditions.
The Company adopted FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109" ("FIN 48") as of January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes in an entity's financial statements pursuant to FASB Statement No. 109, "Accounting for Income Taxes" and provides thresholds for recognizing and measuring benefits of a tax position taken or expected to be taken in a tax return. Consequently, the Company recognizes tax benefits only on tax positions where it is "more likely than not" to prevail. Adoption of FIN 48 had no effect on the Company's statements of operations and comprehensive income.
In connection with Dexia's acquisition of the Company in July 2000, the Company became the successor, for tax purposes, to White Mountains Holdings, Inc. ("WMH"). WMH had previously sold an insurance subsidiary to a third party that was indemnified by White Mountains for certain future adverse loss development up to $50.0 million. In 2004, the Company made an indemnity payment of $47.0 million to the third party with funds provided for such purpose by White Mountains. While the Company had no legal liability in connection with the indemnity payment, the payment was treated for tax purposes as a $47.0 million loss deduction to the Company, as successor to WMH. The Company therefore recorded a deferred tax asset with a corresponding deferred tax benefit of $16.5 million. There can be no assurance that the deferred tax benefit will not be reversed in the future. In addition, the Company has agreed to share 50% of the deferred tax benefit with White Mountains under certain circumstances, but did not satisfy the standards for recording a liability for accounting purposes as of December 31, 2007.
•The liquidity risk present in most non-insured CDS contracts is not present in most FSA-insured CDS contracts, since the terms of the insured CDS contract are designed to replicate the payment provisions of financial guaranty contracts in that (a) losses, if any, are generally paid
•For deferred premium revenue, the fair value is based on the estimated cost of entering into a cession of the outstanding insured portfolio with third-party reinsurers under current market conditions.
In February 2008, Dexia contributed $500 million of additional capital to the Company to provide additional capacity to insure new financial guaranty business.