EXHIBIT 99.1
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
Condensed Consolidated Financial Statements
June 30, 2003
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Six Months Ended June 30, 2003 and 2002
INDEX
The New York State Insurance Department recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under the New York Insurance Law, and for determining whether its financial condition warrants the payment of a dividend to its stockholders. No consideration is given by the New York State Insurance Department to financial statements prepared in accordance with accounting principles generally accepted in the United States of America in making such determinations.
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
| | June 30,
2003 | | December 31,
2002 | |
ASSETS | | | | | |
| | | | | |
Bonds at market value (amortized cost of $2,990,157 and $2,597,599) | | $ | 3,259,781 | | $ | 2,811,747 | |
Short-term investments | | 235,592 | | 364,565 | |
| | | | | |
Total investments | | 3,495,373 | | 3,176,312 | |
Cash | | 9,443 | | 27,560 | |
Securitized loans at cost | | 408,475 | | 431,718 | |
Deferred acquisition costs | | 261,249 | | 253,777 | |
Prepaid reinsurance premiums | | 630,799 | | 557,659 | |
Reinsurance recoverable on unpaid losses | | 78,459 | | 75,950 | |
Investment in unconsolidated affiliate | | 59,848 | | 52,206 | |
Other assets | | 247,006 | | 206,458 | |
| | | | | |
TOTAL ASSETS | | $ | 5,190,652 | | $ | 4,781,640 | |
| | | | | |
LIABILITIES AND MINORITY INTEREST AND SHAREHOLDER’S EQUITY | | | | | |
| | | | | |
Deferred premium revenue | | $ | 1,641,271 | | $ | 1,450,211 | |
Losses and loss adjustment expenses | | 237,885 | | 223,618 | |
Deferred federal income taxes | | 181,024 | | 153,333 | |
Ceded reinsurance balances payable | | 64,178 | | 79,870 | |
Notes payable to affiliate | | 407,613 | | 431,360 | |
Surplus notes | | 200,350 | | 212,850 | |
Minority interest | | 57,561 | | 52,841 | |
Accrued expenses and other liabilities | | 248,223 | | 206,232 | |
| | | | | |
TOTAL LIABILITIES AND MINORITY INTEREST | | 3,038,105 | | 2,810,315 | |
| | | | | |
Preferred stock (5,000.1 and 0 shares authorized; 0 shares issued and outstanding; par value of $1,000 per share) | | | | | |
Common stock (400 shares authorized, issued and outstanding; par value of $37,500 per share) | | 15,000 | | 15,000 | |
Additional paid-in capital | | 814,818 | | 813,002 | |
Accumulated other comprehensive income (net of deferred income taxes of $89,489 and $70,889) | | 180,135 | | 143,260 | |
Accumulated earnings | | 1,142,594 | | 1,000,063 | |
| | | | | |
TOTAL SHAREHOLDER’S EQUITY | | 2,152,547 | | 1,971,325 | |
| | | | | |
TOTAL LIABILITIES AND MINORITY INTEREST AND SHAREHOLDER’S EQUITY | | $ | 5,190,652 | | $ | 4,781,640 | |
See notes to condensed consolidated financial statements.
1
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(Dollars in thousands)
| | Six Months Ended June 30, | |
| | 2003 | | 2002 | |
REVENUES: | | | | | |
Net premiums written | | $ | 282,985 | | $ | 220,427 | |
Net premiums earned | | 171,164 | | 146,751 | |
Net investment income | | 74,006 | | 67,644 | |
Net realized gains | | 4,615 | | 24,077 | |
Net realized and unrealized gains (losses) on derivative instruments | | 4,195 | | (24,698 | ) |
Other income | | 10,554 | | 532 | |
TOTAL REVENUES | | 264,534 | | 214,306 | |
| | | | | |
EXPENSES: | | | | | |
Losses and loss adjustment expenses | | 12,895 | | 42,119 | |
Interest expense | | 14,946 | | 3,604 | |
Policy acquisition costs | | 26,936 | | 25,877 | |
Other operating expenses | | 26,756 | | 19,914 | |
TOTAL EXPENSES | | 81,533 | | 91,514 | |
| | | | | |
Minority interest | | (4,720 | ) | (4,216 | ) |
Equity in earnings of unconsolidated affiliate | | 7,641 | | 3,522 | |
INCOME BEFORE INCOME TAXES | | 185,922 | | 122,098 | |
Provision for income taxes | | 43,391 | | 25,293 | |
NET INCOME | | 142,531 | | 96,805 | |
| | | | | |
Other comprehensive income, net of tax: | | | | | |
Unrealized gains on securities: | | | | | |
Holding gains arising during period | | 39,936 | | 36,307 | |
Less: reclassification adjustment for gains included in net income | | 3,061 | | 17,630 | |
Other comprehensive income | | 36,875 | | 18,677 | |
COMPREHENSIVE INCOME | | $ | 179,406 | | $ | 115,482 | |
See notes to condensed consolidated financial statements.
2
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
| | Six Months Ended June 30, | |
| | 2003 | | 2002 | |
Cash flows from operating activities: | | | | | |
Premiums received, net | | $ | 270,567 | | $ | 221,449 | |
Policy acquisition and other operating expenses paid, net | | (98,969 | ) | (89,958 | ) |
Recoverable advances recovered | | 683 | | 3,341 | |
Loss and loss adjustment expenses paid, net | | (1,490 | ) | (4,018 | ) |
Net investment income received | | 68,497 | | 64,055 | |
Federal income taxes paid | | (40,645 | ) | (45,477 | ) |
Interest paid | | (14,393 | ) | (4,562 | ) |
Other, net | | 9,300 | | (3,856 | ) |
Net cash provided by operating activities | | 193,550 | | 140,974 | |
| | | | | |
Cash flows from investing activities: | | | | | |
Proceeds from sales of bonds | | 502,385 | | 525,741 | |
Purchases of bonds | | (828,076 | ) | (651,050 | ) |
Purchases of property and equipment | | (348 | ) | (4,440 | ) |
Net decrease in short-term securities | | 129,366 | | 5,752 | |
Other investments, net | | 516 | | 295 | |
Net cash used for investing activities | | (196,157 | ) | (123,702 | ) |
| | | | | |
Cash flows from financing activities: | | | | | |
Repayment of surplus notes | | (12,500 | ) | | |
Capital issuance cost | | (3,010 | ) | | |
Net cash used for financing activities | | (15,510 | ) | | |
Net increase (decrease) in cash | | (18,117 | ) | 17,272 | |
| | | | | |
Cash at beginning of period | | 27,560 | | 5,882 | |
| | | | | |
Cash at end of period | | $ | 9,443 | | $ | 23,154 | |
(a) In the first six months of 2003 and 2002, the Company received a tax benefit of $4,826 and $2,859, respectively, by utilizing its Parent’s losses. These amounts were recorded as capital contributions.
See notes to condensed consolidated financial statements.
3
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Six Months Ended June 30, 2003 and 2002
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Inc. (the Company), a wholly owned subsidiary of Financial Security Assurance Holdings Ltd. (the Parent), is an insurance company domiciled in the State of New York. The Company and its subsidiaries are primarily engaged in the business of providing financial guaranty insurance on asset-backed and municipal obligations. In addition, the Company insures guaranteed investment contracts (GICs) issued by FSA Capital Markets Services LLC and FSA Capital Management Services LLC (collectively, CMS), wholly owned subsidiaries of the Parent.
2. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been prepared by the Company and are unaudited. In the opinion of management, all adjustments, which include only normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows at June 30, 2003 and for all periods presented, have been made.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These statements should be read in conjunction with the Company’s December 31, 2002 consolidated financial statements and notes thereto. The year-end condensed balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The results of operations for the periods ended June 30, 2003 and 2002 are not necessarily indicative of the operating results for the full year. Certain prior-year balances have been reclassified to conform to the 2003 presentation.
3. LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company establishes a case basis reserve for unpaid losses and loss adjustment expenses for the present value of the estimated loss when, in management’s opinion, the likelihood of a future loss on a particular insured obligation is probable and determinable at the balance sheet date. The estimated loss on a transaction is discounted using the then current risk-free rates ranging from 4.77% to 6.1%. For collateralized debt obligations, a case basis reserve is recorded to the extent that the overcollateralization ratio (non-defaulted collateral at par value divided by the debt insured) has fallen below 100%.
The Company also maintains a non-specific general reserve, which is available to be applied against future additions or accretions to existing case basis reserves or to new case basis reserves to be established in the future. The general reserve is calculated by applying a loss factor to the Company’s total net par underwritten and discounting the result at the then current risk-free rates. The loss factor used for this purpose has been determined based upon an independent rating agency study of bond defaults and the Company’s portfolio characteristics and history.
Management of the Company periodically evaluates its estimates for losses and loss adjustment expenses and establishes reserves that management believes are adequate to cover the net present value of the ultimate net cost of claims.
4
4. STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 133
The Company has insured a number of credit default swaps that it intends, in each case, to insure for the full term of the swap agreements. It considers these agreements to be a normal extension of its financial guaranty insurance business, although they are considered derivatives for accounting purposes. These agreements are recorded at fair value. The Company believes that the most meaningful presentation of the financial statement impact of these derivatives is to reflect premiums as installments are received, to record losses and loss adjustment expenses as incurred and to record changes in fair value as incurred. The Company recorded $23.7 million and $15.3 million in net earned premium under these agreements for the first half of 2003 and 2002, respectively. The changes in fair value, which were gains of $4.1 million and losses of $4.9 million for the first half of 2003 and 2002, respectively, were recorded in net realized and unrealized losses on derivative instruments in the consolidated statements of operations and comprehensive income and in other assets or liabilities. The losses or gains recognized by recording these contracts at fair value will be determined each quarter based upon market pricing of Super Triple-A (defined as having first-loss protection of 1.3 times the level required for a Triple-A rating) swap guarantees. The Company does not believe the fair value adjustments are an indication of potential claims under FSA’s guarantees.
5. SECURITIZED LOANS AND NOTES PAYABLE TO AFFILIATE
In 2002, the Company exercised certain rights available under its financial guaranty policies and the indentures relating to certain loan-backed notes issued by trusts. Those rights allowed the Company to accelerate the insured notes and pay claims under its insurance policies on an accelerated basis. Refinancing vehicles reimbursed the Company in whole for its claims payment in exchange for an assignment of certain of the Company’s rights against the capital of the trusts. The refinancing vehicles secured the funds to purchase the notes by issuing refinanced notes, with interest rates ranging from 2.898% to 5.718%. These notes were purchased by FSA Asset Management LLC (AMC), a wholly owned subsidiary of the Parent. The Company maintains significant reinsurance, first loss and quota share, in respect of these transactions.
Principal payments due under these refinanced notes for the remainder of 2003 and each of the next five years ending December 31 and thereafter, are as follows (in millions):
Year | | Principal
Amount | |
2003 | | $ | — | |
2004 | | 40.8 | |
2005 | | 37.1 | |
2006 | | 35.0 | |
2007 | | 33.0 | |
2008 | | 32.2 | |
Thereafter | | 229.5 | |
Total | | $ | 407.6 | |
6. OUTSTANDING EXPOSURE
The Company limits its exposure to losses from writing financial guaranties by underwriting investment-grade obligations, diversifying its portfolio and maintaining rigorous collateral requirements on asset-backed obligations, as well as through reinsurance. The principal amounts of insured obligations in the asset-backed insured portfolio are backed by the following types of collateral (in millions) at June 30, 2003 and December 31, 2002:
5
| | Net of Amounts Ceded | | Ceded | |
| | 2003 | | 2002 | | 2003 | | 2002 | |
Residential mortgages | | $ | 19,609 | | $ | 23,379 | | $ | 4,607 | | $ | 5,480 | |
Consumer receivables | | 15,593 | | 19,454 | | 5,108 | | 5,954 | |
Pooled corporate obligations | | 79,871 | | 78,113 | | 12,572 | | 13,007 | |
Investor-owned utility obligations | | 545 | | 619 | | 312 | | 348 | |
Other asset-backed obligations(1) | | 7,493 | | 6,958 | | 3,662 | | 3,225 | |
| | | | | | | | | |
Total asset-backed obligations | | $ | 123,111 | | $ | 128,523 | | $ | 26,261 | | $ | 28,014 | |
(1) Includes $3,010 million and $2,430 million, in 2003 and 2002, respectively, in “Net of Amounts Ceded” relating to FSA-insured GICs issued by CMS.
Net of amount ceded and ceded amounts are not necessarily reflective of the risk retained by FSA since FSA employs first loss reinsurance on a material portion of its asset-backed business.
The principal amount of insured obligations in the municipal insured portfolio includes the following types of issues (in millions) at June 30, 2003 and December 31, 2002:
| | Net of Amounts Ceded | | Ceded | |
Types of Issues | | 2003 | | 2002 | | 2003 | | 2002 | |
General obligation bonds | | $ | 61,127 | | $ | 54,563 | | $ | 18,986 | | $ | 18,388 | |
Housing revenue bonds | | 6,934 | | 5,833 | | 1,848 | | 1,687 | |
Municipal utility revenue bonds | | 27,431 | | 23,442 | | 13,827 | | 13,468 | |
Health care revenue bonds | | 6,005 | | 5,970 | | 6,625 | | 6,683 | |
Tax-supported bonds (non-general obligation) | | 30,203 | | 27,556 | | 12,773 | | 12,391 | |
Transportation revenue bonds | | 9,622 | | 7,640 | | 6,865 | | 5,748 | |
Other municipal bonds | | 13,559 | | 12,173 | | 6,755 | | 5,761 | |
| | | | | | | | | |
Total municipal obligations | | $ | 154,881 | | $ | 137,177 | | $ | 67,679 | | $ | 64,126 | |
7. CAPITAL RESOURCES
In June 2003, $200.0 million of money market committed preferred trust securities (the CPS Securities) were issued by trusts created for the primary purpose of issuing the CPS Securities, investing the proceeds in high quality commercial paper and providing the Company with a put option for selling to the trust non-cumulative redeemable perpetual preferred stock (the Preferred Stock) of the Company. If a put option were to be exercised by the Company, the applicable trust would use the portion of the proceeds attributable to principal received upon maturity of its assets, net of expenses, and transfer such proceeds to the Company in exchange for Preferred Stock of the Company. The Company pays a floating put premium to the trusts. The cost of the structure was $3.0 million in the second quarter of 2003 and was recorded in equity. The trusts are vehicles for providing the Company access to new capital at its sole discretion through the exercise of the put option.
The Company does not consider itself to be the primary beneficiary of the trusts under Financial Accounting Standards Board (FASB) Interpretation No. 46 “Consolidation of Variable Interest Entities” (FIN No. 46) because it does not retain the majority of the residual benefits or expected losses.
8. RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued FIN No. 46, which is an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements”. FIN No. 46 addresses consolidation of VIEs which have one or both of the following characteristics: (i) 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 (ii) the equity investors lack the
6
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. The provisions of FIN No. 46 will be effective immediately for VIEs created after January 31, 2003 and for VIEs in which an enterprise obtains an interest after that date. For VIEs in which an enterprise holds a variable interest that it acquired prior to February 1, 2003, the interpretation is effective in the first fiscal year or interim period beginning after June 15, 2003. The implementation of FIN No. 46, will require the Company to consolidate for financial reporting purposes, for the first time, FSA Global Funding Limited (FSA Global) and Canadian Global Funding Corporation (Canadian Global). FIN No. 46 requires that, upon consolidation, the Company shall initially measure the VIE’s assets, liabilities and minority interest at their carrying amounts under existing GAAP as if the entity had been consolidated from the time the Company was considered its primary beneficiary (or parent). Any differences upon consolidation will be reflected as a cumulative effect of a change in accounting principle. The cumulative effect of a change in accounting principle is not expected to have a material impact on the results of operations of the Company. In addition, on July 1, 2003, the Company obtained control provisions of another VIE, Premier International Funding Co. (Premier), which will require the Company to consolidate Premier beginning July 1, 2003. At June 30, 2003, FSA Global had total assets and total liabilities of approximately $9.6 billion and $9.6 billion, respectively. The foregoing assets and liabilities include assets and liabilities of $7.2 billion that will be eliminated with assets and liabilities of Premier, when consolidated. FSA Global had a net loss of approximately $0.1 million for the first half of 2003. FSA Global’s net income is determined net of FSA Global’s premium expense to FSA. For the six months ended June 30, 2003, FSA Global paid premiums to FSA of approximately $2.4 million. All amounts insured by FSA relating to FSA Global are included in the Company’s outstanding exposure, included in the Notes to the Condensed Consolidated Financial Statements for June 30, 2003. As of June 30, 2003, there were no case basis reserves required for any transactions related to FSA Global. At June 30, 2003, Canadian Global had total assets of approximately $198.5 million, of which $97.6 million has been invested in GICs issued by CMS. As of June 30, 2003, the Company was carrying gross and net case basis reserves of $17.2 million and $4.3 million, respectively, against transactions refinanced by Canadian Global. The Company will continue to analyze the effects of FIN No. 46, considering the complexity of practical application to the Company’s transactions.
9. SUBSEQUENT EVENT
On August 12, 2003, the Company, with the approval of the Superintendent of Insurance of the State of New York, repaid $37.5 million of surplus notes to the Parent.
7
