The Company’s insurance policies and insured credit derivative contracts are generally non-cancelable and remain outstanding for years from date of inception, in some cases 30 years or longer. Accordingly, current-period premium production, as distinct from earned premium, represents premiums to be earned in the future.
The tables below show the PV premiums originated and gross par amount insured by FSA in its three major business sectors for transactions closed in the period.
1. Interest-rate derivatives that are intended to hedge fixed-rate assets and liabilities but do not meet the criteria for hedge accounting treatment under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) (“economic interest-rate hedges”); and
2. addition of the present value of future installment premiums, net of amounts ceded to reinsurers;
As discussed above under “New Business Production-Financial Products Originations,” the Company calculates PV NIM originated (adjustment 3) because net interest income and net interest expense reflected in the statements of operations and comprehensive income are limited to current-year earnings. The Company’s future positive interest-rate spread from outstanding GIC business can be estimated and generally relates to contracts or security instruments that extend for multiple years. Management therefore includes it in ABV as another element of intrinsic value not found in GAAP book value.
Adjustment 4 reflects the realization in equity of deferred costs associated with the origination of premiums.
Asset-backed obligations insured by FSA are secured by pools of assets. While the assets in a given transaction are generally of one type (such as automobile loans, residential mortgage loans, etc.), they are
Management believes that a material adverse change to the loss estimate in its municipal risk sectors, excluding the health care category, would not occur under any reasonably possible scenario. While the Company has not experienced a loss in the health care sector, the potential severity of health care losses is comparatively high. Hospital facilities are single-purpose assets and a failing health care issuer is likely to be liquidated or acquired. If there is collateral associated with a health care credit, it is generally in the form of a hospital facility, the value of which is primarily driven by the community’s need for that facility. The more hospitals competing in a community, the more fragile the value of the hospital collateral is likely to be in a stress scenario. FSA addresses the severity risk in this sector through internal policies that limit exposure to any single credit.
As of December 31, 2004, the Company owned 34.1% of the SPS Holding Corp. (“SPS”), formerly Fairbanks Capital Holding Corp., and the Company’s interest in SPS had a book value of $49.6 million. As of December 31, 2003, the Company’s interest in SPS had a book value of $46.4 million, of which $7.6 million represented goodwill. In the third quarter of 2004, the Company determined that its $7.6 million of goodwill associated with its investment in SPS was impaired as a result of challenges encountered by SPS in acquiring new business. The Company’s equity in earnings from SPS was a pre-tax gain of $1.2 million in 2005, a pre-tax loss of $7.1 million in 2004 and a pre-tax loss of $13.5 million in 2003.
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” (“FIN 46”). FIN 46 addresses consolidation of VIEs that have one or both of the following characteristics: (a) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity; and (b) the equity investors lack the direct or indirect ability to make decisions about the entity’s activities through voting rights or similar rights, the obligation to absorb the expected losses of the entity if they occur or the right to receive the expected residual returns of the entity if they occur. In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities, an interpretation of ARB 51” (“FIN 46R”). FIN 46R replaced FIN 46 and is effective for public companies for periods after December 15, 2003.
The Company consolidates the results of certain variable interest entities (“VIEs”), including FSA Global Funding Limited (“FSA Global”), Premier International Funding Co. (“Premier”) and Canadian Global Funding Corporation (“Canadian Global”). The Company consolidated FSA Global and Canadian Global beginning in the third quarter of 2003 in accordance with Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” (“FIN 46”). The Company also began to consolidate Premier in the third quarter of 2003 as a result of
Through 2004, performance shares were awarded under the 1993 Equity Participation Plan (the “1993 Equity Plan”). The 1993 Equity Plan authorized the discretionary grant of performance shares by the Human Resources Committee to key employees. The amount earned for each performance share depends on the attainment of certain growth rates of adjusted book value and book value per outstanding share over a three-year period.
Awards of Dexia restricted stock remain restricted for an additional six months after the end of the vesting periods. In 2005, the Company awarded 194,202 Dexia restricted shares valued at $22.69 on the award date. As of December 31, 2005, 5,150 shares had been forfeited and 8,756 shares had vested.
During 2005, the Company charged $25.4 million to loss expense, consisting of $20.4 million for originations of new business and $5.0 million related to accretion on in-force business. Case reserves increased $8.3 million primarily due to deterioration of specific CDO risks.
The obligations under GICs issued by the GIC Affiliates may be called at various times prior to maturity based on certain agreed-upon events. As of December 31, 2005, interest rates were between 0.81% and 5.95% per annum on outstanding GICs and between 1.12% and 6.61% per annum on VIE debt. Payments due under GICs are based on expected withdrawal dates and exclude hedge accounting adjustments and prepaid interest of $20.4 million, and include accretion of $868.0 million. VIE debt includes $1,081.8 million of future interest accretion on zero-coupon obligations. The following table presents (in millions) the combined principal amounts due under GICs and VIE debt for 2006 and each of the next four years ending December 31, and thereafter:
Securitized loans are carried at cost, net of losses at the date of purchase. Income is recorded based on the effective yield method. The accretable yield on the securitized loans at December 31, 2005, 2004 and 2003 was $142.3 million, $145.7 million and $147.2 million, respectively. The cash flows on the securitized loans, net of reinsurance, are monitored and the effective yield modified to reflect any change in the cash flow estimate on a prospective basis. Since the notes represent 100% of the debt capitalization of the trusts and since FSA maintains all the risk of further asset decline (except as provided by reinsurance) and maintains control over key decisions regarding the trusts (such as removal of the servicer, sale of the assets and liquidation of the entity), the trusts were consolidated with the Company for accounting purposes. The Company also consolidated the refinancing vehicles.
The intersegment assets consist of (1) intercompany notes issued by FSA and held within the FP Investment Portfolio and (2) GICs issued by the GIC Affiliates and held within the VIE Portfolio. The intersegment revenues and expenses relate to interest income and interest expense on intercompany notes and GICs.
portfolio that have not been recognized as other-than-temporary impairments. The requirements under FSP 115-1 are effective for reporting periods beginning after December 15, 2005. The Company believes that the adoption of FSP 115-1 will not have a material effect on the Company’s financial position or results of operations. See Note 3 for disclosures required by EITF 03-1.