Assured Guaranty Municipal 10Q 2007 Q1 Quarterly report

QuickLinks -- Click here to rapidly navigate through this document

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2007
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission File Number: 1-12644

Financial Security Assurance Holdings Ltd.
(Exact name of registrant as specified in its charter)

New York (State or other jurisdiction of incorporation or organization)		13-3261323 (I.R.S. Employer Identification No.)
31 West 52^nd Street New York, New York 10019 (Address of principal executive offices)
(212) 826-0100 (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. Yes ý No o

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 o Accelerated filer o Non-accelerated filer ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý

At May 10, 2007, there were 33,276,017 outstanding shares of Common Stock of the registrant (excludes 241,978 shares of treasury stock).

INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Financial Statements (unaudited)
	Financial Security Assurance Holdings Ltd. and Subsidiaries
	Consolidated Balance Sheets (unaudited)	1
	Consolidated Statements of Operations and Comprehensive Income (unaudited)	2
	Consolidated Statement of Changes in Shareholders' Equity (unaudited)	3
	Consolidated Statements of Cash Flows (unaudited)	4
	Notes to Consolidated Financial Statements (unaudited)	5
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4T.	Controls and Procedures	34
PART II. OTHER INFORMATION
Item 6.	Exhibits	35
SIGNATURES		36

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (unaudited)
(in thousands, except share data)

			March 31, 2007			December 31, 2006
ASSETS
General investment portfolio:
	Bonds at fair value (amortized cost of $4,537,183 and $4,546,147)		$	4,699,463		$	4,721,512
	Equity securities at fair value (cost of $39,275 and $54,291)			39,321			54,325
	Short-term investments (cost of $89,414 and $96,055)			90,537			96,578
Financial products segment investment portfolio:
	Bonds at fair value (amortized cost of $17,341,154 and $16,692,183)			17,382,956			16,757,979
	Short-term investments			702,496			659,704
	Trading portfolio at fair value			214,028			119,424
Assets acquired in refinancing transactions:
	Bonds at fair value (amortized cost of $40,533 and $40,133)			41,699			41,051
	Securitized loans			229,661			241,785
	Other			53,608			55,036

		Total investment portfolio		23,453,769			22,747,394

Cash				37,529			32,471
Deferred acquisition costs				344,793			340,673
Prepaid reinsurance premiums				1,006,277			1,004,987
Reinsurance recoverable on unpaid losses				39,126			37,342
Other assets				1,485,714			1,610,759

	TOTAL ASSETS		$	26,367,208		$	25,773,626

LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY
Deferred premium revenue			$	2,655,801		$	2,653,321
Losses and loss adjustment expenses				233,500			228,122
Financial products segment debt				18,814,436			18,349,665
Deferred federal income taxes				297,255			298,542
Notes payable				730,000			730,000
Accrued expenses, other liabilities and minority interest				882,733			791,664

	TOTAL LIABILITIES AND MINORITY INTEREST			23,613,725			23,051,314

COMMITMENTS AND CONTINGENCIES
Common stock (200,000,000 shares authorized; 33,517,995 issued; par value of $.01 per share)				335			335
Additional paid-in capital—common				906,687			906,687
Accumulated other comprehensive income (net of deferred income taxes of $73,452 and $86,119)				136,514			160,038
Accumulated earnings				1,709,947			1,655,252
Deferred equity compensation				19,225			19,225
Less treasury stock at cost (241,978 shares held)				(19,225	)		(19,225	)

	TOTAL SHAREHOLDERS' EQUITY			2,753,483			2,722,312

	TOTAL LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY		$	26,367,208		$	25,773,626

The accompanying Notes are an integral part of the Consolidated Financial Statements (unaudited).

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (unaudited)
(in thousands)

			Three Months Ended March 31,
			2007			2006
REVENUES
	Net premiums written		$	100,200		$	88,732

	Net premiums earned		$	99,012		$	94,496
	Net investment income			57,709			53,046
	Net realized gains (losses)			(155	)		(918	)
	Net interest income from financial products segment			247,678			176,289
	Net realized gains (losses) from financial products segment			534			77
	Net realized and unrealized gains (losses) on derivative instruments			18,371			57,825
	Income from assets acquired in refinancing transactions			5,852			6,981
	Net realized gains (losses) from assets acquired in refinancing transactions			269			712
	Other income			5,559			7,348

TOTAL REVENUES				434,829			395,856

EXPENSES
	Losses and loss adjustment expenses			4,390			3,285
	Interest expense			11,584			6,748
	Policy acquisition costs			15,951			16,210
	Foreign exchange (gains) losses from financial products segment			17,504			36,185
	Net interest expense from financial products segment			241,683			155,660
	Other operating expenses			30,262			31,304

TOTAL EXPENSES				321,374			249,392

INCOME BEFORE INCOME TAXES AND MINORITY INTEREST				113,455			146,464
Provision (benefit) for income taxes:
		Current		16,879			11,779
		Deferred		11,380			42,005

		Total provision		28,259			53,784

NET INCOME BEFORE MINORITY INTEREST				85,196			92,680
	Less: Minority interest			—			(37,525	)

NET INCOME				85,196			130,205
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX
Unrealized gains (losses) arising during the period, net of deferred income tax provision (benefit) of $(12,339) and $(34,286)				(22,914	)		(64,179	)
Less: reclassification adjustment for gains (losses) included in net income, net of deferred income tax provision (benefit) of $328 and $(312)				610			(579	)

Other comprehensive income (loss)				(23,524	)		(63,600	)

COMPREHENSIVE INCOME			$	61,672		$	66,605

The accompanying Notes are an integral part of the Consolidated Financial Statements (unaudited).

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited)
(in thousands)

	Common Stock		Additional Paid-In Capital- Common		Accumulated Other Comprehensive Income			Accumulated Earnings			Deferred Equity Compensation		Treasury Stock			Total
BALANCE, December 31, 2006	$	335	$	906,687	$	160,038		$	1,655,252		$	19,225	$	(19,225	)	$	2,722,312
Net income for the year									85,196								85,196
Net change in accumulated other comprehensive income (net of deferred income tax provision (benefit) of ($12,667)						(23,524	)										(23,524	)
Dividends paid on common stock									(30,501	)							(30,501	)

BALANCE, March 31, 2007	$	335	$	906,687	$	136,514		$	1,709,947		$	19,225	$	(19,225	)	$	2,753,483

The accompanying Notes are an integral part of the Consolidated Financial Statements (unaudited).

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(in thousands)

			Three Months Ended March 31,
			2007			2006
Cash flows from operating activities:
	Premiums received, net		$	77,982		$	36,073
	Policy acquisition and other operating expenses paid, net			(158,287	)		(132,000	)
	Salvage and subrogation			5			267
	Losses and loss adjustment expenses paid, net			(850	)		(1,464	)
	Net investment income received			58,324			51,900
	Federal income taxes paid			(6,914	)		(1,624	)
	Interest paid on notes payable			(6,758	)		(6,658	)
	Interest paid on financial products segment			(162,000	)		(130,176	)
	Interest received on financial products segment			227,438			153,235
	Financial products segment net derivative payments			14,096			14,220
	Income received from refinanced assets			4,132			5,829
	Purchases of trading portfolio securities			(98,772	)		—
	Other			7,126			4,990

		Net cash provided by (used for) operating activities		(44,478	)		(5,408	)

Cash flows from investing activities:
	Proceeds from sales of bonds in general investment portfolio			738,856			420,218
	Proceeds from maturities of bonds			60,132			36,706
	Purchases of bonds			(783,307	)		(451,712	)
	Net (increase) decrease in short-term investments			6,959			49,630
	Proceeds from sales of bonds in financial products segment			1,766,598			1,374,077
	Proceeds from maturities of bonds in financial products segment			830,183			218,592
	Purchases of bonds in financial products segment			(3,087,109	)		(1,582,351	)
	Securities purchased under agreements to resell			150,000			330,000
	Net (increase) decrease in financial products segment short-term investments			(42,792	)		(115,300	)
	Purchases of property, plant and equipment			(212	)		(1,018	)
	Paydowns of assets acquired in refinancing transactions			15,374			51,875
	Proceeds from sales of assets acquired in refinancing transactions			286			4,995
	Other investments			14,732			529

		Net cash provided by (used for) investing activities		(330,300	)		336,241

Cash flows from financing activities:
	Dividends paid			(30,501	)		(32,466	)
	Proceeds from issuance of financial products segment debt			1,236,509			713,362
	Repayment of financial products segment debt			(826,192	)		(1,028,242	)
	Capital issuance costs			(220	)		(233	)

		Net cash provided by (used for) financing activities		379,596			(347,579	)

Effect of changes in foreign exchange rates on cash balances				240			772

Net (decrease) increase in cash				5,058			(15,974	)
Cash at beginning of period				32,471			43,629

Cash at end of period			$	37,529		$	27,655

The accompanying Notes are an integral part of the Consolidated Financial Statements (unaudited).

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

1. ORGANIZATION AND OWNERSHIP

Financial Security Assurance Holdings Ltd. ("FSA Holdings" or, together with its consolidated entities, the "Company") is a holding company incorporated in the State of New York. The Company operates in two business segments: the Financial Guaranty Segment and the Financial Products ("FP") Segment. In the Financial Guaranty Segment, the principal segment, the Company provides financial guaranty insurance on public finance and asset-backed obligations through its primary insurance company subsidiary, Financial Security Assurance Inc. ("FSA"), and other domestic and foreign insurance subsidiaries. The Company's underwriting policy is to insure public finance and asset-backed obligations that it determines would be investment-grade quality without the benefit of the Company's insurance. Public finance obligations insured by the Company consist primarily of general obligation bonds supported by the issuers' taxing powers and special revenue bonds and other special obligations of states and local governments supported by the issuers' abilities to impose and collect fees and charges for public services or specific projects. Public finance obligations include obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including government office buildings, toll roads, health care facilities and utilities. Asset-backed obligations insured by the Company are generally issued in structured transactions and are backed by pools of assets, such as residential mortgage loans, consumer receivables, securities or other assets having an ascertainable cash flow or market value. The Company also insures synthetic asset-backed obligations that generally take the form of credit default swap ("CDS") obligations or credit-linked notes that reference specific asset-backed securities or pools of securities or loans, with a defined deductible to cover credit risks associated with the referenced securities or loans. The Company has refinanced certain defaulted transactions by employing refinancing vehicles to raise funds for the refinancings. These refinancing vehicles are consolidated. The Company's management believes that the assets held by the refinancing vehicles are beyond the reach of the Company and its creditors, even in bankruptcy or other receivership.

In the FP Segment, the Company issues guaranteed investment contracts ("GICs") in the municipal GIC and other markets through several consolidated affiliates ("GIC Affiliates"). The GIC Affiliates lend the proceeds from their sales of GICs to FSA Asset Management LLC ("FSAM"), which invests the funds, generally in obligations that qualify for FSA insurance. FSAM wholly owns FSA Portfolio Asset Limited, a U.K. Company that invests in non-U.S. securities. The FP Segment also includes the results of certain variable interest entities ("VIEs"), including FSA Global Funding Limited ("FSA Global") and Premier International Funding Co. ("Premier"). FSA Global issues FSA- insured medium term notes and generally invests the proceeds from the sale of its notes in FSA-insured GICs or other FSA-insured obligations with a view to realizing the yield difference between the notes issued and the obligations purchased with the note proceeds. Substantially all the assets of FSA Global are pledged to secure the repayment, on a pro rata basis, of FSA Global's notes and its other obligations. Premier is principally engaged in debt defeasance for lease transactions. The FP Segment debt is issued at or converted into LIBOR-based floating-rate obligations and the proceeds are invested in or converted into LIBOR-based floating-rate investments intended to result in profits from a higher investment rate than borrowing rate. The Company's management believes that the assets held by the consolidated VIEs, including those that are eliminated in consolidation, are beyond the reach of the Company and its creditors, even in bankruptcy or other receivership.

The Company is a direct subsidiary of Dexia Holdings, Inc. ("DHI"), which in turn is owned 10% by Dexia S.A. ("Dexia"), a publicly held Belgian corporation, and 90% by Dexia Credit Local S.A., a wholly owned subsidiary of Dexia.

2. BASIS OF PRESENTATION

The accompanying Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments necessary for a fair statement of the financial position, results of operations and cash flows as of and for the period ended March 31, 2007 and for all periods presented. These Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2006. The accompanying Consolidated Financial Statements have not been audited by an independent registered public accounting firm in accordance with the standards of the Public Company Accounting Oversight Board (United States). The December 31, 2006 consolidated balance sheet was derived from audited financial statements. The results of operations for the periods ended March 31, 2007 and 2006 are not necessarily indicative of the operating results for the full year. Certain prior-year balances have been reclassified to conform to the 2007 presentation.

Revisions

The statement of cash flows for the period ended March 31, 2007 appropriately segregates the effect of changes in foreign exchange rates on cash balances into a separate line item. The effect of foreign exchange rates on cash balances has historically been included in cash flows from operations. The statements of cash flows for the period ended March 31, 2006 has been revised to conform to the 2007 presentation. The 2006 statement of cash flows also reflects the reclassification of certain accounts. The amount revised for 2006 from cash to short-term investments was $27.6 million.

3. LOSSES AND LOSS ADJUSTMENT EXPENSES

The Company establishes loss liabilities based on its estimate of specific and non-specific losses. The Company also establishes liabilities for loss adjustment expenses ("LAE"), consisting of the estimated cost of settling claims, including legal and other fees and expenses associated with administering the claims process.

The Company calculates a loss and LAE liability based upon identified risks inherent in its insured portfolio. If an individual policy risk has a reasonably estimable and probable loss as of the balance sheet date, a case reserve is established. For the remaining policy risks in the portfolio, a non-specific reserve is established to account for the inherent credit losses that can be statistically estimated.

The following table presents the activity in non-specific and case reserves for the three months ended March 31, 2007. Adjustments to reserves represent management's estimate of the amount required to cover the present value of the net cost of claims, based on statistical provisions for new originations. Transfers between non-specific and case reserves represent a reallocation of existing loss reserves and have no impact on earnings.

Reconciliation of Net Losses and Loss Adjustment Expenses

	Non- Specific			Case			Total
	(in millions)
December 31, 2006	$	137.8		$	53.0		$	190.8
Incurred		4.4			—			4.4
Transfers		(3.1	)		3.1			—
Payments and other decreases		—			(0.8	)		(0.8	)

March 31, 2007 balance	$	139.1		$	55.3		$	194.4

Management of the Company periodically evaluates its estimates for losses and LAE and establishes reserves that management believes are adequate to cover the present value of the ultimate net cost of claims. However, because of the uncertainty involved in developing these estimates, the ultimate liability may differ from current estimates.

The gross and net par amounts outstanding on transactions with case reserves were $456.1 million and $375.6 million, respectively, at March 31, 2007. The net case reserves consisted primarily of five collateralized debt obligation ("CDO") risks and two municipal risks, which collectively accounted for approximately 94.8% of total net case reserves. The remaining eight exposures were in non-municipal sectors.

Management is aware that there are differences regarding the method of defining and measuring both case reserves and non-specific reserves among participants in the financial guaranty industry. Other financial guarantors may establish case reserves only after a default and use different techniques to estimate probable loss. Other financial guarantors may establish the equivalent of non-specific reserves, but refer to these reserves by various terms, such as, but not limited to, "unallocated losses," "active credit reserves" and "portfolio reserves," or may use different statistical techniques from those used by the Company to determine loss at a given point in time. In April 2007, the Financial Accounting Standards Board (the "FASB") published an exposure draft proposing new guidance for financial guaranty insurance accounting. This exposure draft proposes, among other things, changes to reserving and premium earnings methodologies. Based on management's current understanding of this exposure draft, the effect of these changes would be material to the financial statements if adopted.

4. FINANCIAL PRODUCTS SEGMENT DEBT

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 March 31, 2007, interest rates were between 1.91% and 6.07% per annum on outstanding GICs and between 1.98% and 6.20% per annum on VIE debt. Payments due under GICs are based on expected withdrawal dates and exclude negative hedge accounting adjustments and prepaid interest of $82.3 million and include accretion of $936.6 million. VIE debt excludes fair-value adjustments of $136.0 million and includes $1,036.6 million of future interest accretion on zero-coupon obligations. The following table presents the combined principal

amounts due under GIC and VIE debt for the remainder of 2007, each of the next four calendar years ending December 31, and thereafter:

		Principal Amount
		(in millions)
2007		$	3,341.1
2008			1,699.1
2009			2,420.1
2010			2,571.6
2011			1,274.9
Thereafter			9,427.1

	Total	$	20,733.9

5. OUTSTANDING EXPOSURE

The Company's policies insure the scheduled payments of principal and interest on public finance and asset-backed (including FSA-insured derivatives) obligations. The gross amount of financial guaranties in force (principal and interest) was $744.8 billion at March 31, 2007 and $743.9 billion at December 31, 2006. The net amount of financial guaranties in force was $542.3 billion at March 31, 2007 and $531.4 billion at December 31, 2006. 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 net and ceded par outstanding of insured obligations in the public finance insured portfolio included the following amounts:

			Net Par Outstanding				Ceded Par Outstanding
			March 31, 2007		December 31, 2006		March 31, 2007		December 31, 2006
			(in millions)
Domestic obligations
	General obligation		$	106,685	$	103,112	$	28,668	$	28,143
	Tax-supported			47,159		46,479		18,730		18,733
	Municipal utility revenue			41,561		40,495		13,656		13,367
	Health care revenue			13,303		13,155		10,462		10,144
	Housing revenue			7,441		7,576		1,954		2,039
	Transportation revenue			16,253		16,164		10,322		10,337
	Education			4,754		4,378		1,606		1,027
	Other domestic public finance			1,615		1,628		506		509
International obligations				18,576		18,306		15,034		14,554

		Total public finance obligations	$	257,347	$	251,293	$	100,938	$	98,853

The net and ceded par outstanding of insured obligations in the asset-backed insured portfolio (including FSA-insured CDS) included the following amounts:

		Net Par Outstanding				Ceded Par Outstanding
		March 31, 2007		December 31, 2006		March 31, 2007		December 31, 2006
		(in millions)
Domestic obligations
	Residential mortgages	$	17,921	$	15,666	$	2,906	$	2,555
	Consumer receivables		10,086		10,599		592		664
	Pooled corporate obligations		51,493		45,914		6,377		8,729
	Other domestic asset-backed obligations(1)		7,076		6,793		3,288		2,952
International obligations			29,892		29,295		6,166		8,077

	Total asset-backed obligations	$	116,468	$	108,267	$	19,329	$	22,977

(1): Excludes net par outstanding of $16,892 million as of March 31, 2007 and $16,558 million as of December 31, 2006 relating to FSA-insured GICs issued by the GIC Affiliates.

6. TAXES

The Company adopted FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes—an Interpretation of SFAS 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. There was no impact to the Company's financial statements from adopting FIN 48.

The total amount of unrecognized tax benefits at January 1, 2007 and March 31, 2007 were $22.8 million and $23.4 million, respectively. If recognized, the entire amount would favorably influence the effective tax rate. Further, the Company recognizes interest and penalties related to unrecognized tax benefits as part of income taxes. For the quarter ended March 31, 2007, the Company accrued $0.3 million of expenses related to interest and penalties. Cumulative interest and penalties of $2.3 million had been accrued on the Company's balance sheet at March 31, 2007.

The Company files consolidated income tax returns in the United States as well as separate tax returns for certain of its subsidiaries or branches in various state and local and foreign jurisdictions, including the United Kingdom, Japan, Australia, and Singapore. With limited exceptions, the Company is no longer subject to income tax examinations for its 2002 and prior tax years for U.S. federal, state and local, or non-U.S. jurisdictions.

Within the next 12 months, it is reasonably possible that unrecognized tax benefits for tax positions taken on previously filed tax returns will become recognized as a result of the expiration of the statute of limitations for the 2003 tax year, which, absent any extension, will close in September 2007.

7. DERIVATIVE INSTRUMENTS

Insured Derivatives

Included in the Company's insured portfolio are certain contracts for which fair-value adjustments are recorded through the statements of operations and comprehensive income because they qualify as derivatives under Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") or SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments" ("SFAS 155"). These contracts include FSA-insured CDS, insured interest rate swaps entered into in connection with the issuance of certain public finance obligations and insured net interest margin ("NIM") securitizations issued in connection with certain mortgage-backed security ("MBS") financings. The Company considers all such agreements to be a normal extension of its financial guaranty insurance business, although they are considered derivatives for accounting purposes and therefore recorded at fair value.

With respect to insured derivatives, FSA expects that these transactions will not be subject to a market value termination for which the Company would be liable. The Company recorded net earned premium under these agreements of $22.2 million for the three months ended March 31, 2007 and $22.5 million for the three months ended March 31, 2006.

The Company's net par outstanding of $74.3 billion and $72.8 billion relating to CDS transactions at March 31, 2007 and December 31, 2006, respectively, are included in the asset-backed balances in Note 5. The Company believes that the most meaningful presentation of the financial statement impact of these derivatives is to record earned premiums over the installment period and to record changes in fair value as incurred. Changes in fair value are recorded in net realized and unrealized gains (losses) on derivative instruments and in either other assets or other liabilities, as appropriate. The Company uses quoted market prices, when available, to determine fair value. If quoted market prices are not available, as is generally the case, the Company uses internally developed estimates of fair value. Management applies judgment when developing these estimates and considers factors such as current prices charged for similar agreements, performance of underlying assets, changes in internal shadow ratings, the level at which the deductible has been set and the Company's ability to obtain reinsurance for its insured obligations. Due to the lack of a quoted market for the CDS obligations written by the Company, estimates generated from the Company's valuation process may differ materially from values that may be realized in market transactions. The Company does not believe that the fair value adjustments are an indication of potential claims under FSA's guarantees or an indication of potential gains or losses to be realized from the derivative transactions. The average remaining life of these contracts as of March 31, 2007 was 3.4 years. The inception-to-date gain on the balance sheet was $76.8 million at March 31, 2007 and $88.5 million at December 31, 2006 and is recorded in other assets.

As of January 1, 2007, the Company implemented SFAS 155, which resulted in a mark-to-market loss of $1.2 million related to insured NIM securitizations. The change in fair value was a function of the market's adverse perception of mortgage-backed products. The Company does not believe that the fair value adjustments are an indication of potential claims under FSA's guarantees or an indication of potential gains or losses to be realized from the derivative transactions.

The table below shows the changes in fair value of insured derivatives that are recorded in net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income:

		Three Months Ended March 31,
		2007			2006
		(in millions)
Insured derivatives:
CDS		$	(11.7	)	$	29.0
Interest rate swaps			(0.3	)		0.2
NIM securitizations			(1.2	)		—

	Total	$	(13.2	)	$	29.2

Interest Rate and Foreign Exchange Rate Derivatives

The Company enters into derivative contracts to manage interest rate and foreign currency exposure in its FP Segment investment portfolio and FP Segment debt. All gains and losses from changes in the fair value of derivatives are recognized immediately in the consolidated statements of operations and comprehensive income. These derivatives generally include interest rate and currency swap agreements, which are primarily utilized to convert fixed-rate debt and investments into U.S. dollar floating-rate debt and investments. Hedge accounting is applied in a fair-value hedge, provided certain criteria are met.

In order for a derivative to qualify for hedge accounting, it must be highly effective at reducing the risk associated with the exposure being hedged. An effective hedge is defined as one whose periodic fair value change is 80% to 125% correlated with the fair value of the hedged item. The difference between a perfect hedge (i.e., one that is 100% correlated) and the actual correlation within the 80% to 125% range is the ineffective portion of the hedge. A failed hedge is one whose correlation falls outside of the 80% to 125% range. The table below presents the net gain (loss) related to the ineffective portion of the Company's fair value hedges and net gain (loss) related to failed hedges.

	Three Months Ended March 31,
	2007			2006
	(in millions)
Ineffective portion of fair value hedges(1)	$	0.9		$	4.4
Failed hedges		(0.4	)		0.3

(1): Includes the changes in value of hedging instruments related to the passage of time, which have been excluded from the assessment of hedge effectiveness.

The inception-to-date net unrealized gain on derivatives in the FP Segment of $485.8 million and $493.8 million at March 31, 2007 and December 31, 2006, respectively, is recorded in other assets or accrued expenses, other liabilities and minority interest, as applicable.

Other Derivatives

The Company enters into various other derivative contracts that do not qualify for hedge accounting treatment under SFAS 133. These derivatives may include swaptions, caps and other derivatives which are used principally as protection against large interest rate movements in certain assets and liabilities. Gains and losses on these derivatives are reflected in net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income.

8. OTHER ASSETS AND LIABILITIES

The detailed balances that comprise other assets and accrued expenses, other liabilities and minority interest at March 31, 2007 and December 31, 2006 are as follows:

		March 31, 2007		December 31, 2006
		(in thousands)
Other assets:
	Fair value of VIE swaps	$	513,675	$	516,762
	Fair-value adjustment of insured derivatives		75,989		89,195
	VIE other invested assets		161,740		157,810
	Securities purchased under agreements to resell		—		150,000
	Deferred compensation trust		121,388		114,181
	Tax and loss bonds		128,917		127,150
	Accrued interest on VIE swaps		156,533		136,975
	Accrued interest income		95,721		92,951
	Other assets		231,751		225,735

Total other assets		$	1,485,714	$	1,610,759

		March 31, 2007		December 31, 2006
		(in thousands)
Accrued expenses, other liabilities and minority interest:
	Payable for securities purchased	$	178,254	$	33,046
	Deferred compensation trust		121,388		114,181
	Equity participation plan		62,398		112,688
	Accrued interest on FP GICs		122,919		124,856
	Fair-value adjustment of derivatives		49,031		33,230
	Other liabilities		348,493		373,413
	Minority interest in VIE's		250		250

Total accrued expenses, other liabilities and minority interest		$	882,733	$	791,664

9. SEGMENT REPORTING

The Company operates in two business segments: financial guaranty and financial products. The Financial Guaranty Segment is primarily in the business of providing financial guaranty insurance on

public finance and asset-backed obligations. The FP Segment includes the GIC operations of the Company, which issues GICs to municipalities and other market participants. GICs provide for the return of principal and the payment of interest at pre-specified rates. Reflecting the manner in which the VIEs' operations are managed, the results of the VIEs have been included in the FP Segment beginning in the fourth quarter of 2006. The March 31, 2006 disclosures have been reclassified to conform to the 2007 presentation.

The following tables summarize the financial information by segment as of and for the three months ended March 31, 2007 and 2006. The exclusions from pretax operating earnings are the fair value adjustments on insured derivatives and economic interest rate hedges.

		Three Months Ended March 31, 2007
		Financial Guaranty			Financial Products			Intersegment Eliminations			Total
		(in thousands)
Revenues:
	External	$	155,595		$	279,234			—		$	434,829
	Intersegment		909			4,239		$	(5,148	)		—
Expenses:
	External		(56,677	)		(264,697	)		—			(321,374	)
	Intersegment		(4,239	)		(909	)		5,148			—
Less:
	SFAS 133 fair-value adjustments for insured derivatives and economic interest rate hedges		(13,206	)		12			—			(13,194	)

Pre-tax segment operating earnings			108,794			17,855			—			126,649

Segment assets		$	7,109,500		$	19,564,959		$	(307,251	)	$	26,367,208

		Three Months Ended March 31, 2006
		Financial Guaranty			Financial Products			Intersegment Eliminations			Total
		(in thousands)
Revenues:
	External	$	191,174		$	204,682			—		$	395,856
	Intersegment		894			5,386		$	(6,280	)		—
Expenses:
	External		(52,642	)		(196,750	)		—			(249,392	)
	Intersegment		(5,386	)		(894	)		6,280			—
Less:
	SFAS 133 fair-value adjustments for insured derivatives and economic interest rate hedges		29,164			(1,081	)		—			28,083

Pre-tax segment operating earnings		$	104,876		$	13,505		$	—		$	118,381

The following tables present reconciliations of the segments' pre-tax operating earnings to net income.

	Three Months Ended March 31, 2007
	Financial Guaranty			Financial Products		Intersegment Eliminations	Total
	(in thousands)
Pretax operating earnings	$	108,794		$	17,855	—	$	126,649
SFAS 133 fair-value adjustments for insured derivatives and economic interest rate hedges		(13,206	)		12	—		(13,194	)
Taxes								(28,259	)

Net income							$	85,196

	Three Months Ended March 31, 2006
	Financial Guaranty		Financial Products			Intersegment Eliminations	Total
	(in thousands)
Pretax operating earnings	$	104,876	$	13,505		—	$	118,381
SFAS 133 fair-value adjustments for insured derivatives and economic interest rate hedges		29,164		(1,081	)	—		28,083
Taxes								(53,784	)
Minority interest								37,525

Net income							$	130,205

The intersegment assets consist of intercompany notes issued by FSA and held within the FP Segment investment portfolio. The intersegment revenues and expenses relate to interest income and interest expense on intercompany notes and premiums paid by FSA Global on FSA-insured notes.

The amount of SFAS 133 fair-value adjustments for insured derivatives is a reconciling item between pre-tax segment operating earnings and net income. In addition, management subtracts the impact of economic interest rate hedges when analyzing the segments. Marking the derivatives to fair value but not marking the hedged assets or liabilities causes one-sided accounting. By removing its effect, the measure will more closely reflect the underlying economic performance of segment operations.

10. VARIABLE INTEREST ENTITIES

On April 28, 2006, the Company increased its ownership of the ordinary shares of FSA Global from 29% to 49% through an acquisition of shares from an unaffiliated third party. Immediately thereafter, FSA Global's charter documents were amended to create a new class of nonvoting preference shares, which was issued to the Company. Holders of such preference shares have exclusive rights to any future dividends and, upon any winding up of FSA Global, all net assets available for distribution to shareholders (after a distribution of $250,000 to the ordinary shares). As a result of the issuance of such preference shares, (a) a substantive sale and purchase of an interest took place between the ordinary shareholders of FSA Global and the Company, resulting in an assessment and recording of the fair value of the assets and liabilities sold and purchased at the time of such

transaction, and (b) the Company's minority interest liability associated with FSA Global being eliminated. In the second quarter of 2006, the Company realized a pre-tax gain of $1.8 million as a result of this transaction.

11. RECENTLY ISSUED ACCOUNTING STANDARDS

On September 15, 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), which addresses how companies should measure fair value when required to use fair value measures for recognition or disclosure purposes under GAAP. SFAS 157 adopted an "exit price" approach to determining fair value and set forth a three-level fair value hierarchy to prioritize the inputs used in valuation techniques. Level 1 is the highest priority and is defined as observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 is defined as inputs other than quoted prices included in Level 1 that are observable for the asset or liability through corroboration with observable market data. Level 3 is the lowest priority and is defined as a valuation based on unobservable inputs such as a company's own data. Prioritization of inputs, as well as other considerations, determine the level of disclosure required. SFAS 157 is applicable to financial statements issued for fiscal years beginning after November 15, 2007 and for interim periods within those fiscal years. The Company is in the process of evaluating the impact of SFAS 157 on its financial statements.

In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"), which permits reporting entities to choose to measure at fair value many financial instruments and certain other items that are not currently required to be measured at fair value. The fair value option may be applied instrument by instrument, is applied only to entire instruments and not to portions of instruments and the election is irrevocable. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted, under certain circumstances, provided the provisions of SFAS 157 are also applied. The Company is currently evaluating SFAS 159 and the implications for the Company's financial statements.

12. COMMITMENTS AND CONTINGENCIES

In the ordinary course of business, the Company and certain Subsidiaries are parties to litigation. The Company is not a party to any material pending litigation.

On November 15, 2006, the Company received a subpoena from the Antitrust Division of the U.S. Department of Justice ("DOJ") issued in connection with an ongoing criminal investigation of bid rigging of awards of municipal GICs. On November 16, 2006, FSA received a subpoena from the Securities and Exchange Commission ("SEC") related to an ongoing industry-wide civil investigation of brokers of municipal GICs. The Company issues municipal GICs through the FP Segment, but does not serve as a GIC broker. The subpoenas request that the Company furnish to the DOJ and SEC records and other information with respect to the Company's municipal GIC business. The Company is cooperating with the investigations by the DOJ and SEC.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

Management's principal business objective is to grow the intrinsic value of the Company over the long term. To this end, it seeks to accumulate an insured portfolio of conservatively underwritten public finance and asset-backed obligations and attractively priced GICs in order to produce a reliable, predictable earnings stream. Strategically, the Company seeks to maintain balanced capabilities across domestic and international public finance and asset-backed markets in order to allow the flexibility to pursue the most attractive opportunities available at any point in the business cycle.

To reflect accurately how management evaluates the Company's operations and progress toward long-term goals, this discussion employs both measures promulgated in accordance with accounting principles generally accepted in the United States of America ("GAAP measures") and measures not so promulgated ("non-GAAP measures"). Although the measures identified as non-GAAP in this discussion should not be considered substitutes for GAAP measures, management considers them key performance indicators and employs them in determining compensation. Non-GAAP measures therefore provide investors with important information about the way management analyzes its business and rewards performance.

Unless otherwise noted, percentage changes in this discussion and analysis compare the period named with the comparable period of the prior year.

For the first quarter of 2007, net income decreased 34.6% from $130.2 million to $85.2 million. Gross premiums written for the first quarter increased 18.5% to $149.4 million. Shareholders' equity increased 1.1% to $2.8 billion from December 31, 2006 after dividends of $30.5 million.

Results of Operations

Premiums

Net Earned and Written Premiums

	Three Months Ended March 31,
	2007		2006
	(in millions)
Premiums written, net of reinsurance	$	100.2	$	88.7
Premiums earned, net of reinsurance		99.0		94.5
Net premiums earned excluding refundings and accelerations		84.0		85.4

New Business Production

For each accounting period, the Company estimates the present value of originations ("PV originations"). This non-GAAP measure consists of the total present value of premiums originated ("PV premiums originated") by FSA and its subsidiaries and the present value of net interest margin originated ("PV NIM originated") by the FP Segment. The Company generated PV originations of $197.5 million in the three months ended March 31, 2007 and $126.5 million in the three months ended March 31, 2006. Management believes that, by disclosing the components of PV originations in addition to premiums written, the Company provides investors with a more comprehensive description of its new business activity in a given period.

Present Value of Premiums Originated

The GAAP measure "gross premiums written" captures premiums collected and accrued in the period, whether collected for business originated in the period, or in installments for business

originated in prior periods. It is not a precise measure of current period originations because a significant portion of the Company's premiums are collected in installments. Therefore, to measure current period premium production, management calculates the gross present value of premium installments with respect to business originated in the accounting period and combines it with premiums received upfront with respect to business originated in the accounting period, which produces the non-GAAP measure "PV premiums originated."

The Company's insurance policies, including insured derivatives, are generally non-cancelable and remain outstanding for years from date of inception, in some cases 30 years or longer. Accordingly, PV premiums originated, as distinct from earned premiums, represents premiums to be earned in the future.

Viewed at a policy level, installment premiums are generally calculated as a fixed premium rate multiplied by the estimated or expected insured debt outstanding as of dates established by the terms of the policy. Because the actual installment premiums received could vary from the amount estimated at the time of origination based on variances in the actual versus estimated outstanding debt balances and foreign exchange rate fluctuations, the realization of PV premiums originated could be greater or less than the amount reported.

Installment premiums are not recorded in the financial statements until due, which is a function of the terms of each insurance policy. Future installment premiums are not captured in premiums earned or premiums written, the most comparable GAAP measures. Management therefore uses PV premiums originated to measure current business production.

PV premiums originated is a measure of gross origination activity, and does not reflect premiums ceded to reinsurers or the cost of insured derivatives or other credit protection, which may be considerable, employed by the Company to manage its credit exposures. PV premiums originated reflects estimated future installment premiums discounted to their present value, as well as upfront premiums, with respect to business originated during the period. To calculate PV premiums originated, management discounts an estimate of all future installment premium receipts. The Company calculates the discount rate for PV premiums originated as the average pre-tax yield on its insurance investment portfolio for the previous three years. This rate serves as a proxy for the return that could be achieved if the premiums had been received upfront. The estimated installment premium receipts are determined based on each installment policy's projected par balance outstanding multiplied by its premium rate. The Company's Transaction Oversight Groups estimate the relevant schedule of future par balances outstanding for each insurance policy with installment premiums. At the time of origination, projected debt schedules are generally based on good faith estimates developed and used by the parties negotiating the transaction.

Year-to-year comparisons of PV premiums originated are affected by the application of a different discount rate applied to each vintage year. The discount rate employed by the Company for this purpose was 4.86% for 2007 originations and 5.07% for 2006 originations. Management intends to revise the discount rate in future years according to the same methodology, in order to reflect specific return results realized by the Company.

Reconciliation of Gross Premiums Written to Non-GAAP PV Premiums Originated

	Three Months Ended March 31,
	2007			2006
	(in millions)
Gross premiums written	$	149.4		$	126.1
Gross installment premiums received		(61.9	)		(55.3	)

Gross upfront premiums originated		87.5			70.8
Gross PV estimated installment premiums originated		83.2			40.7

Gross PV premiums originated	$	170.7		$	111.5

Financial Guaranty Insurance Originations

The tables below show the gross par amount insured and PV premiums originated in the Company's major business sectors for the periods indicated.

U.S. Public Finance Originations

	Three Months Ended March 31,
	2007		2006
United States:
Gross par insured (in billions)	$	14.3	$	7.3
Gross PV premiums originated (in millions)		74.0		54.3
International:
Gross par insured (in billions)	$	0.9	$	1.6
Gross PV premiums originated (in millions)		16.7		28.2

Total issuance in the U.S. municipal bond market reached approximately $107.0 billion in the first quarter, up 53% over first-quarter volume last year. Refundings nearly doubled and new-money issuance also increased substantially. Insurance penetration was approximately 52%, compared with 53% in the first quarter of 2006 and 49% for all of 2006. FSA insured approximately 25% of the par amount of insured new municipal bond issues sold in the first quarter of 2007 compared with 20% in the first quarter of 2006.

Including both primary and secondary U.S. municipal obligations with closing dates in the first quarter, the par amount insured by FSA increased 94.1%, and PV premiums originated increased 36.2%. FSA maintained its focus on high-quality issues in core sectors that provide greater relative value, including general obligations, tax-supported bonds and water and sewer utility issues, and also insured an increased volume of education revenue bonds with primarily Double-A shadow ratings.

In international public finance, first-quarter par insured decreased 42.7% and PV premiums decreased 40.9%. This was a modest quarter, following an exceptionally strong performance in 2006, and FSA has mandates for significant infrastructure transactions scheduled to close during 2007. Business closed in the quarter included utility, health care and municipal issues in the United Kingdom, Canada and Japan.

U.S. Asset-Backed Originations

	Three Months Ended March 31,
	2007		2006
United States:
Gross par insured (in billions)	$	12.4	$	4.3
Gross PV premiums originated (in millions)		64.4		25.9
International:
Gross par insured (in billions)	$	2.1	$	3.6
Gross PV premiums originated (in millions)		15.6		3.1

FSA's first-quarter U.S. asset-backed originations increased 191.6% in par insured and 149.1% in PV premiums originated. The majority of this business consisted of pooled corporate and residential mortgage-backed securities, where FSA began to see better opportunities due to a more credit-sensitive market. Writings in the mortgage sector included home equity line of credit securitizations, net interest margin (NIM) securitizations and Triple-A tranches of prime and subprime mortgage securitizations.

Outside the United States, asset-backed PV premiums increased 414.9% despite a 42.2% decline in par volume originated. Although FSA insured a lower par volume of collateralized debt obligations, longer average lives resulted in increased CDO PV premium production. FSA also insured transactions in higher premium sectors, including insurance-linked and aircraft lease securitizations.

Financial Products Originations

The FP Segment produces net interest margin ("FP NIM") rather than insurance premiums. Like installment premiums, the present value of FP NIM originated in a given period ("PV NIM originated") is expected to be earned and collected in future periods.

FP Segment debt is issued at or converted into LIBOR-based floating-rate obligations, with proceeds invested in or converted into LIBOR-based floating-rate investments intended to result in profits from a higher investment rate than borrowing rate. The difference between the current period investment revenue and borrowing cost, net of the economic effect of derivatives used to hedge interest rate and currency risk, is the FP NIM.

PV NIM originated represents the difference between the present value of estimated interest to be received on actual investments and the present value of estimated interest to be paid on liabilities issued by the FP Segment, net of transaction expenses and the expected results of derivatives used to hedge interest rate risk. In the first quarter of 2007, based on experience, management reduced its estimate of the adverse effect of transaction and hedging costs. The Company's future positive interest rate spread estimate generally relates to contracts or security instruments that extend for multiple years.

Net interest income and net interest expense are reflected in the consolidated statements of operations and comprehensive income but are limited to current period earnings. As the GICs and the assets they fund extend beyond the current period, management considers the non-GAAP measure PV NIM originated to be a useful indicator of future FP NIM to be earned. PV of future NIM is also included in the non-GAAP measure adjusted book value ("ABV") as an element of intrinsic value that is not found in GAAP book value.

GIC Affiliates issue GICs mainly to municipal issuers and for structured transactions. The majority of municipal GICs issued relate to debt service reserve funds and construction funds in support of municipal bond transactions. The majority of structured GICs serve as collateral for synthetic CDO transactions. The actual timing and amount of repayments may differ from the original estimates, which in turn would affect the realization of the estimate of PV NIM originated in a given accounting period.

Financial Products PV NIM Originated

	Three Months Ended March 31,
	2007		2006
	(in millions)
PV NIM originated	$	26.8	$	15.0

First-quarter PV NIM originated in the FP Segment increased 78.3% compared with the result in the first quarter of last year. The increase reflected the growth trend of the GIC portfolio, attractive investment opportunities arising from spread widening in the residential mortgage market and a change in the estimate of transaction and hedging costs reflected in the 2007 PV NIM estimate.

Operating Earnings and Adjusted Book Value

In addition to evaluating the Company's GAAP financial information, management evaluates the Company's business under certain non-GAAP performance measures that management refers to as operating earnings and ABV. Management uses these two metrics to measure the Company's performance and to calculate long-term incentive compensation and the annual bonus pool. Management refers to this information in its presentations with rating agencies and the Board of Directors. While these metrics are not substitutes for reported results under GAAP, management regards operating earnings and ABV as meaningful indicators of operational performance that supplement the information available from GAAP measures.

While GAAP provides a uniform comprehensive basis of accounting, management believes that operating earnings is an important additional measure for providing a more complete understanding of the Company's results of operations. The Company defines operating earnings as net income before the effects of fair-value adjustments for two items:

1.: Economic interest rate hedges, defined as interest rate derivatives that are intended to hedge fixed rate assets and liabilities but do not meet the criteria for hedge accounting treatment under SFAS 133, adjusted so that the impact of any residual hedge ineffectiveness remains in operating earnings; and
2.: Insured investment-grade derivatives, which refer to contracts that qualify as derivatives under SFAS 133 or SFAS 155 and therefore require changes in fair value to be recorded in the income statement. These contracts include FSA-insured CDS, insured interest rate swaps in certain public finance obligations and insured net interest margin ("NIM") securitizations.

Periodic unrealized gains and losses related to economic interest rate hedges arise primarily in the FP Segment, caused primarily by marking derivatives to fair value without also marking the corresponding risks being hedged, as prescribed by SFAS 133 for derivatives that do not qualify for "hedge accounting treatment." Under the Company's definition of operating earnings, the economic effect of these hedges is recognized, which, for interest rate swaps, generally results in any cash paid or received being recognized ratably as an expense or revenue over the hedged item's life. Futures contracts used to hedge interest rate risk include both the embedded current net interest paid or received, as well as the value of the future net interest cash flow. Therefore, to reflect the equivalent of any cash paid or received being recognized ratably as an expense or revenue over the hedged item's life, the current interest accretion amounts embedded in the marks to fair value of open futures positions are added back to operating earnings.

Insured derivatives are transactions that are entered into by the Company in the normal course of business and, for accounting purposes, qualify as derivatives under SFAS 133 and SFAS 155. A large majority of these derivatives are CDS, which are generally non-cancelable prior to maturity, and the Company views insured CDS risks as comparable to other insured risks. CDS transactions insured by

the Company generally reference either a specific security otherwise qualifying for FSA insurance or a pool of corporate or consumer debt securities or bank loans, structured such that the risk insured is investment grade without the benefit of the credit protection provided by the Company. In a typical CDS transaction, the Company, in exchange for an upfront or periodic premium, indemnifies the insured party for economic losses (in excess, in some cases, of an agreed-upon deductible) related to debt obligations of specified obligors, structured such that the risk insured is investment grade without the benefit of the credit protection provided by the Company. In the event a CDS were to migrate below investment grade, the fair-value impact would be fully reflected in operating earnings. Given the high credit quality of the CDS insured by FSA, management believes it is probable that the financial impact of the fair-value adjustments for the insured CDS will sum to zero over the finite terms of the exposures, which are typically five to ten years at inception. Notwithstanding this eventual outcome, sharp swings in the estimated fair value of the CDS portfolio may occur from quarter to quarter, as the credit spreads that drive the fair-value estimates are volatile.

Operating earnings are subject to certain general and specific limitations that investors should carefully consider. For example, there is no comprehensive, authoritative guidance for management reporting. The Company's operating earnings is not a defined term within GAAP and may not be comparable to similarly titled measures reported by other companies. Unlike GAAP, the Company's operating earnings presentation does not represent a comprehensive basis of accounting. Investors, therefore, should not compare the Company's performance with that of other financial guaranty companies based upon operating earnings. Operating earnings results are meant only to supplement GAAP results by providing additional information regarding the operational and performance indicators management, the Company's Board of Directors and rating agencies follow to assess performance.

Other limitations arise from the specific adjustments that management makes to GAAP results to derive operating earnings results. For example, in reversing the unrealized gains and losses that result from application of SFAS 133 to derivatives that do not qualify for hedge accounting, management focuses on the long-term economic effectiveness of those instruments relative to the underlying hedged item and isolates the effects of interest rate volatility and changing credit spreads on the fair value of such instruments during the period. Under GAAP, the effects of these factors on the fair value of the derivative instruments (but not the underlying hedged item) tend to show more volatility in the short term. While the Company believes that its presentation reflects the economic substance of its FP Segment, the presentation understates GAAP earnings volatility.

Operating earnings also do not reflect earnings volatility related to insured derivative fair-value adjustments. A significant percentage of the Company's insured derivative exposures subject to fair-value adjustments are considered Triple-A or Super Triple-A (defined as credit quality based on loss protection greater than the Triple-A standard), and the Company does not intend to trade these highly rated, highly structured contracts. Accordingly, management believes it is probable that the financial impact of the fair-value adjustments for the insured derivative will sum to zero over the finite terms of the exposures, which are typically five to ten years at inception. For this reason, management believes that the market volatility of credit-spread pricing, the primary driver of the changes in insured derivative fair-value results, should not influence a measure of the Company's operating performance and therefore excludes insured derivative fair-value adjustments from operating earnings.

For the first quarter of 2007, the Company's operating earnings increased 7.1% to $93.8 million. The following table reconciles net income to non-GAAP operating earnings:

Reconciliation of Net Income to Non-GAAP Operating Earnings

		Three Months Ended March 31,
		2007			2006
		(in millions)
Net income		$	85.2		$	130.2
Less fair-value adjustments for economic interest rate hedges, net of taxes(1)(2)			0.0			23.6
Less fair value adjustments for investment-grade insured derivatives, net of taxes			(8.6	)		19.0

	Operating earnings	$	93.8		$	87.6

(1): Hedge ineffectiveness remains in operating earnings. Also, see following table for a more detailed presentation of fair-value adjustments for economic interest rate hedges.
(2): Balance for the first quarter of 2007 was less than $0.05 million.

Fair-Value Adjustments for Economic Interest Rate Hedges

		Three Months Ended March 31,
		2007		2006
		(in millions)
Fair-value adjustment for economic interest rate hedges		$	0.0	$	(1.1	)
VIE minority interest			—		37.5
Tax effect			0.0		(12.8	)

	Total fair-value adjustments for economic interest rate hedges	$	0.0	$	23.6

Adjusted Book Value

To calculate ABV, the following adjustments, on an after-tax basis, are made to shareholders' equity (GAAP "book value"):

1.: addition of unearned premium revenues, net of amounts ceded to reinsurers;
2.: addition of the present value of future installment premiums, net of amounts ceded to reinsurers;
3.: addition of the present value of future FP net interest margin ("PV future NIM");
4.: subtraction of the deferred costs of acquiring policies;
5.: elimination of fair-value adjustments for investment grade insured derivatives;
6.: elimination of the fair-value adjustments for economic interest rate hedges;
7.: elimination of unrealized gains or losses on investments; and
8.: International Financial Reporting Standards ("IFRS") adjustments.

Management considers ABV an operating measure of the Company's intrinsic value. Book value includes an estimate of loss for all insured risks made at the time of contract origination. ABV adds

back certain GAAP liabilities and deducts certain GAAP assets (adjustments 1, 4, 5, 6 and 7 in the calculation above), and also captures the estimated value of future contractual cash flows related to transactions in force as of the balance sheet date (adjustments 2 and 3 in the calculation above) because installment payment contracts, whether in the form of future premiums or future NIM, are generally non-cancelable and represent a claim to future cash flows. Beginning in 2006, ABV also reflects certain IFRS adjustments in order to better align the interests of employees with the interests of Dexia S.A., the Company's principal shareholder, whose accounts are maintained under IFRS. An investor attempting to evaluate the Company using GAAP measures alone would not have the benefit of this information. In addition, investors may consider the growth of ABV to be a performance measure indicating the degree to which management has succeeded in building a reliable source of future earnings. Certain of the Company's compensation formulas are based, in part, on the ABV growth rate or ABV growth rate before IFRS adjustments.

The limitations of the ABV metric are that it reflects the accelerated realization of certain assets and liabilities through equity and relies on an estimate of the amount and timing of the receipt of installment premiums and future net interest margin. Actual installment premium receipts could vary from the amount estimated due to differences between actual and estimated insured debt balances outstanding. Actual net interest margin results could vary from the amount estimated based on sales of investments prior to maturity and variances in the actual timing and amount of repayment associated with flexible-draw GICs that the Company issues. ABV excludes the fair-value adjustments for investment-grade insured derivatives and the effective portion of fair-value adjustments for derivatives that hedge interest rate risk but do not qualify for hedge accounting under SFAS 133.

Adjustments 1, 2 and 3 above represent the sum of cumulative years' reported PV premiums originated and PV NIM originated, less what has been earned or adjusted due to changes in estimates as described above. PV of future net interest margin is adjusted for management's estimate of transaction and hedging related costs. In the first quarter of 2007, based on recent experience, management reduced its estimate of the adverse effect of such costs. Such change in estimates resulted in an increase to ABV of approximately $25 million at March 31, 2007. Adjustments 1 and 2 in the calculation of ABV represent unearned premiums that have been collected and the Company's best estimate of the present value of its future premium installments (comprising current- and prior-period originations that have not yet been earned). Debt schedules related to installment transactions can change from time to time. Critical assumptions underlying adjustment 2 are discussed above under "New Business Production—Financial Guaranty Insurance Originations."

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 consolidated statements of operations and comprehensive income are limited to current period earnings. The Company's future positive interest rate spread from outstanding FP Segment 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 of costs deferred and associated with premium origination.

Through adjustments 5 and 6, the effect of certain items excluded from operating earnings is also excluded from ABV. As explained in the preceding discussion of operating earnings, management expects the financial impact of the insured derivative fair-value adjustments, reflected in adjustment 5, to sum to zero over the finite terms of the related exposures. Derivatives reflected in adjustment 6 reduce, on an economic basis, the interest rate risk of fixed rate assets and liabilities held in the FP Segment, which includes the FSA Global portfolio, although they do not meet SFAS 133 hedge-accounting requirements. The Company uses such derivatives to hedge against interest rate volatility, rather than to speculate on the direction of interest rates. The intent of management is to hold the derivatives to expected maturity along with the related hedged fixed-rate assets or liabilities. In

addition, through adjustment 7, ABV excludes the effect of fair-value adjustments made to investments and reflected in other comprehensive income. As the objective is to optimize long-term stable earnings, management generally seeks to minimize turnover and therefore any unrealized investment gain or loss is subtracted from book value to exclude it from the ABV metric. In the event that an investment is liquidated prior to its maturity, any related gain or loss is reflected in both earnings and ABV without further adjustment. Adjustment 8 reflects IFRS accounting treatment of items for which GAAP and IFRS treatments differ. These accounting differences relate primarily to foreign exchange, contingencies and fair-value adjustments.

Shareholders' equity ("book value") was $2.8 billion and ABV was $4.0 billion at March 31, 2007. During the twelve month period ended March 31, 2007, after taking dividends into account, ABV (IFRS basis) grew 16.0%. The ABV growth rate would have been 15.3% without a change in the estimate of transaction and hedging costs that increased PV future NIM by approximately $25.0 million.

The following table reconciles book value to non-GAAP ABV:

Reconciliation of Book Value to Non-GAAP Adjusted Book Value

			March 31, 2007		December 31, 2006
			(in millions)
Shareholders' equity (U.S. GAAP)			$	2,753.5	$	2,722.3
After-tax adjustments:
	Plus net unearned premium revenues			1,072.2		1,071.4
	Plus PV future net installment premiums and PV future NIM			675.2		627.2
	Less net deferred acquisition costs			224.1		221.4
	Less fair-value adjustments for insured derivatives			49.4		58.0
	Less fair-value of economic interest rate hedges			66.4		72.6
	Less unrealized gains on investments			133.6		154.9

Adjusted book value before IFRS adjustments				4,027.4		3,914.0
	IFRS adjustments			2.1		4.8

		Adjusted book value (IFRS basis)	$	4,029.5	$	3,918.8

Net Investment Income and Realized Gains

Net investment income increased 8.8% to $57.7 million in the first quarter of 2007 over the prior year's first quarter results. The increase primarily reflects higher invested balances in the Company's investment portfolios. The Company's effective income tax rate on investment income (excluding the effects of realized gains and losses, FP Segment and assets acquired in refinancing transactions) for the first quarter was 12.2%, versus 13.2% for the comparable prior-year period.

The Company has an investment in XL Financial Assurance Ltd ("XLFA") in the form of preferred shares. XLFA is a financial guaranty insurance subsidiary of XL Capital Ltd ("XL"). The Company accounts for its investment in XLFA as available-for-sale securities with changes in fair value reflected in OCI and with dividends declared or paid included in investment income. The fair value of the investment at March 31, 2007 was $39.0 million. In March 2006, the XLFA Board of Directors approved a by-law amendment changing the coupon on XLFA's preferred shares from a participating dividend based on an internal rate of return up to 19% to a fixed dividend of 8.25% per annum, effective January 1, 2006. Quarterly dividends were declared at this new rate commencing with the first quarter of 2006. Dividend income was $1.1 million for the three months ended March 31, 2007 and March 31, 2006. In addition, the Company received a $15.0 million dividend on March 30, 2007, which was recorded as a return of capital and therefore, reduced the carrying amount of the investment.

Losses and Loss Adjustment Expenses

The Company recorded losses and LAE incurred of $4.4 million in the first quarter of 2007, compared with $3.3 million in the first quarter of 2006. The increase is primarily related to an increase in originations, which produce higher reserves, compared to that of the prior year's first quarter. Adjustments to reserves represent management's estimate of the amount required to cover the present value of the net cost of claims, based on statistical provisions in the case of new originations.

Reconciliation of Net Losses and Loss Adjustment Expenses

	Non-Specific			Case			Total
	(in millions)
December 31, 2006	$	137.8		$	53.0		$	190.8
Incurred		4.4			—			4.4
Transfers		(3.1	)		3.1			—
Payments and other decreases		—			(0.8	)		(0.8	)

March 31, 2007 balance	$	139.1		$	55.3		$	194.4

The gross and net par amounts outstanding on transactions with case reserves were $456.1 million and $375.6 million, respectively, at March 31, 2007. The net case reserves consisted primarily of five CDO risks and two municipal risks, which collectively accounted for approximately 94.8% of total net case reserves. The remaining eight case reserve exposures were in non-municipal sectors.

Since case and non-specific reserves are based on estimates, there can be no assurance that the ultimate liabilities 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 revised estimated loss, actual loss experience, its mix of business and economic conditions.

Policy Acquisition Cost and Other Operating Expense

For the first quarter, policy acquisition and other operating expenses decreased to $46.2 million from $47.5 million for the previous year's first quarter. These expenses include certain compensation expenses related primarily to the Company's deferred compensation plan and supplemental executive retirement plan, which are based on changes in the fair value of related investments and are perfectly offset by amounts in other income arising from marking to fair value the assets held to economically defease such obligations. Excluding such expenses, policy acquisition and other operating expenses were $44.0 million in the first quarter of 2007, compared with $41.6 million in last year's comparable period. The increase related primarily to lower deferral rates.

Financial Products Spread Portfolio Net Interest Margin

FP spread portfolio NIM, a non-GAAP measure, is defined as the FP Segment net interest margin excluding variable interest entities net interest margin ("VIE NIM") and fair-value adjustments for economic interest rate hedges. FP spread portfolio NIM was $23.7 million for the first quarter of 2007 and $18.4 million for the first quarter of 2006. The increases in FP spread portfolio NIM were related primarily to growth in the GIC portfolio. FP spread portfolio NIM is comparable to FP operating NIM, which the Company reported for periods prior to December 31, 2006. Beginning in the fourth quarter of 2006, FP Segment reporting includes the results of VIEs, which formerly were reported in the financial guaranty segment.

NIM shown in accordance with classifications required under GAAP on the consolidated statements of operations and comprehensive income ("Total NIM") is calculated as net interest income from the FP Segment, plus FP net realized gains (losses), less net interest expense from the FP Segment. Total NIM was $6.5 million for the first quarter of 2007 and $20.7 million for the first quarter of 2006 and primarily represents fixed rate liabilities (which are swapped to floating rate obligations) funding floating rate assets.

The table below reconciles Total NIM with FP Segment NIM and FP spread portfolio NIM:

Reconciliation of Total NIM to Non-GAAP FP Spread Portfolio NIM

		Three Months Ended March 31,
		2007		2006
		(in millions)
Total NIM		$	6.5	$	20.7
Realized interest income from and ineffectiveness on economic interest rate hedges			13.9		(6.6	)
Intersegment income related to refinanced transactions			4.2		5.4

	FP Segment NIM		24.6		19.5
Less: VIE NIM(1)			0.9		1.1

	FP spread portfolio NIM	$	23.7	$	18.4

(1): VIE NIM represents the impact of consolidation of the VIEs on the Total NIM.

Net realized interest income and expense associated with derivatives in hedging relationships that do not qualify for hedge accounting are recorded in realized and unrealized gains and losses on derivative instruments and are added back to calculate FP spread portfolio NIM. Ineffectiveness related to derivatives that do not qualify for hedge accounting is added back to calculate FP spread portfolio NIM. Ineffectiveness is the difference between the unrealized gains and losses on derivatives and the unrealized gains and losses on hedged items. Unrealized gains and losses on derivatives that do not qualify for hedge accounting are shown under the caption net realized and unrealized gains (losses) on derivative instruments. Unrealized gains and losses on risks hedged with derivatives that do not qualify for hedge accounting are not recorded in income.

Derivatives that qualify for hedge accounting are classified in the consolidated statements of operations and comprehensive income with the underlying item being hedged.

Intersegment income relates primarily to intercompany notes held in the FP Segment investment portfolio, which are the assets supporting the GIC and VIE debt. In connection with the Company's refinancing transactions, FSA obtains funds from FP operations to fund claim payments, creating an interest bearing intercompany note. This intercompany note is included in the assets of the

FP Segment, with the related net interest income added to FP Segment NIM, but is eliminated from the consolidated Total NIM.

VIE and FP net interest income are combined on the consolidated statements of operations and comprehensive income, as are VIE and FP net interest expense. VIE NIM pertains to the net interest margin derived from transactions executed by FSA Global and Premier. The VIE NIM relates to a passively managed portfolio, while the growing GIC portfolio is actively managed. Accordingly, the VIE NIM is shown separately from the FP spread portfolio NIM.

Net Realized and Unrealized Gains (Losses) on Derivative Instruments

The components of net realized and unrealized gains (losses) on derivative instruments are shown in the table below:

		Three Months Ended March 31,
		2007			2006
		(in millions)
Net realized and unrealized gains (losses) on:
FP Segment derivatives		$	31.3		$	28.3
Insured derivatives			(13.2	)		29.2
Other			0.3			0.3

	Net realized and unrealized gains (losses) on derivative instruments	$	18.4		$	57.8

Insured Derivatives

Included in the Company's insured portfolio are certain contracts for which fair-value adjustments are recorded through the statement of operations and comprehensive income because they qualify as derivatives under SFAS 133 or SFAS 155. These contracts include FSA-insured CDS, insured interest rate swaps entered into in connection with the issuance of certain public finance obligations and NIM securitizations issued in connection with certain MBS financings. The Company considers all such agreements to be a normal extension of its financial guaranty insurance business, although they are considered derivatives for accounting purposes and therefore recorded at fair value.

The Company's net par outstanding of $74.3 billion and $72.8 billion relating to CDS transactions at March 31, 2007 and December 31, 2006, respectively, are included in the asset-backed balances in Note 5 to the Consolidated Financial Statements in Item 1. The Company believes that the most meaningful presentation of the financial statement impact of these derivatives is to record earned premiums over the installment period and to record changes in fair value as incurred. Changes in fair value are recorded in net realized and unrealized gains (losses) on derivative instruments and in either other assets or other liabilities, as appropriate. The Company uses quoted market prices, when available, to determine fair value. If quoted market prices are not available, as is generally the case, the Company uses internally developed estimates of fair value. Management applies judgment when developing these estimates and considers factors such as current prices charged for similar agreements, performance of underlying assets, changes in internal shadow ratings, the level at which the deductible has been set and the Company's ability to obtain reinsurance for its insured obligations. Due to the

lack of a quoted market for the CDS obligations written by the Company, estimates generated from the Company's valuation process may differ materially from values that may be realized in market transactions. The Company does not believe that the fair value adjustments are an indication of potential claims under FSA's guarantees or an indication of potential gains or losses to be realized from the derivative transactions. The average remaining life of these contracts as of March 31, 2007 was 3.4 years. The inception-to-date gain on the balance sheet was $76.8 million at March 31, 2007 and $88.5 million at December 31, 2006 and is recorded in other assets.

		Three Months Ended March 31,
		2007			2006
		(in millions)
Insured derivatives:
CDS		$	(11.7	)	$	29.0
Interest rate swaps			(0.3	)		0.2
NIM securitizations			(1.2	)		—

	Total	$	(13.2	)	$	29.2

Income from Assets Acquired in Refinancing Transactions

Income from assets acquired in refinancing transactions, excluding realized gains and losses, was $5.9 million for the three month period ended March 31, 2007 and $7.0 million for the three month period ended March 31, 2006. The decrease relates primarily to lower investment balances. The Company recorded $0.3 million in realized gains for the three month period ended March 31, 2007 and $0.7 million in realized gains for the three month period ended March 31, 2006. Realized gains and losses are generally a by-product of the investment management process for these refinancing transactions and may vary substantially from period to period. Any other-than-temporary impairments are also included in realized gains (losses) from assets acquired in refinancing transactions.

Taxes

For the first three months of 2007 and 2006, the Company's effective tax rates were 24.9% and 29.2%, respectively. The prior year effective tax rate was higher that the current year due to higher fair value adjustments in income which were taxed at 35.0%. The 2007 and 2006 rates differ from the statutory rate of 35% primarily due to tax-exempt interest income. The Company adopted 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. There was no impact on the Company's financial statements from adopting FIN 48. See Note 6 to the Consolidated Financial Statements in Item 1.

Liquidity and Capital Resources

The Company's consolidated invested assets and cash at March 31, 2007, net of unsettled security transactions, were $21,851.7 million, compared with the December 31, 2006 balance of $21,261.4 million. These balances include the change in the fair value of the Company's various investment portfolios, which had an aggregate unrealized gain position of $202.3 million at March 31, 2007 and $333.1 million at December 31, 2006. These balances exclude assets in the VIE Investment Portfolio and assets acquired under refinancing transactions that management believes are beyond the reach of the Company and its creditors.

Cash flow from operations was a cash outflow of $44.5 million for the three months ended March 31, 2007, compared to an outflow of $5.4 million for the three months ended March 31, 2006. The decrease in cash flows from operations was primarily attributable to purchases of trading portfolio assets, partially offset by higher premiums and net interest income from the FP Segment.

At March 31, 2007, Financial Security Assurance Holdings Ltd. (as a separate holding company, "FSA Holdings") had cash and investments of $38.5 million available to fund the liquidity needs of its non-insurance operations. Because the majority of the Company's operations are conducted through FSA, the long-term ability of FSA Holdings to service its debt will largely depend on its receipt of dividends from, payment on surplus notes by, or repurchase of shares by, FSA.

In its financial guaranty business, premiums and investment income are the Company's primary sources of funds to pay its operating expenses, insured losses and taxes. In its FP Segment, the Company relies on net interest income to fund its net interest expense and operating expenses. Management believes that the Company's operations provide sufficient liquidity to pay its obligations. If additional liquidity is needed or cash flow from operations significantly decreases, the Company can liquidate or utilize its investment portfolio as a source of funds in addition to its alternative liquidity arrangements, as discussed further below. The Company's cash flows from operations are heavily dependent on market conditions, the competitive environment and the mix of business originated. In addition, payments made in settlement of the Company's obligations in its insured portfolio may, and often do, vary significantly from year to year depending primarily on the frequency and severity of payment defaults and its decisions regarding whether to exercise its right to accelerate troubled insured transactions in order to mitigate future losses. In each of the two years reported, the Company has not drawn on alternative sources of liquidity to meet its obligations, except that the Company has refinanced certain transactions using funds raised through its GIC Affiliates and VIEs.

FSA Holdings paid dividends of $30.5 million in the three month period ended March 31, 2007 and $32.5 million during the comparable period of 2006.

FSA's ability to pay dividends depends, among other things, upon FSA's financial condition, results of operations, cash requirements and compliance with rating agency requirements for maintaining its Triple-A ratings, and is also subject to restrictions contained in the insurance laws and related regulations of New York and other states. Under the insurance laws of the State of New York (the "New York Insurance Law"), FSA may pay dividends out of earned surplus, provided that, together with all dividends declared or distributed by FSA during the preceding 12 months, the dividends do not exceed the lesser of (a) 10% of policyholders' surplus as of its last statement filed with the Superintendent of Insurance of the State of New York ("The New York Superintendent") or (b) adjusted net investment income during this period. FSA did not pay any dividends in the first three months of 2007 and paid $40.0 million of dividends in the first three months of 2006. Based on FSA's statutory statements for March 31, 2007, and considering dividends that can be paid by its subsidiary, the maximum amount normally available for payment of dividends by FSA without regulatory approval over the 12 months following March 31, 2007 is approximately $154.0 million.

FSA may repurchase shares of its common stock from FSA Holdings subject to the New York Superintendent's approval. The New York Superintendent has approved the repurchase by FSA of up to $500.0 million of its shares from FSA Holdings through December 31, 2008. In 2006, FSA repurchased $100 million of shares of its common stock from FSA Holdings and in the first quarter of 2007, FSA repurchased $35 million of shares of its common stock and, in each case, it retired such shares.

At March 31, 2007, FSA Holdings held $108.9 million of FSA surplus notes. Payments of principal and interest on such notes may be made only with the approval of the New York Superintendent. FSA paid $1.4 million in both the three months ended March 31, 2007 and March 31, 2006 in surplus note interest, and did not pay any principal. As of March 31, 2007 FSA has not sought or received permission to pay any further principal or interest on its surplus notes.

FSA's primary uses of funds are to pay operating expenses and to pay dividends to, or pay interest or principal on surplus notes held by, or repurchase shares held by, its parent. FSA's funds are also required to satisfy claims under insurance policies in the event of default by an issuer of an insured obligation and the unavailability or exhaustion of other payment sources in the transaction, such as the cash flow or collateral underlying the obligations. FSA seeks to structure asset-backed transactions to address liquidity risks by matching insured payments with available cash flow or other payment sources. Insurance policies issued by FSA guaranteeing payments under bonds and other securities provide, in general, that payments of principal, interest and other amounts insured by FSA may not be accelerated by the holder of the obligation but are paid by FSA in accordance with the obligation's original payment schedule or, at FSA's option, on an accelerated basis. Insurance policies issued by FSA guaranteeing payments under CDS may provide for acceleration of amounts due upon the occurrence of certain credit events subject to single-risk limits specified in the New York insurance law. These policy provisions prohibiting or limiting acceleration of certain claims are mandatory under Article 69 of the New York Insurance Law and serve to reduce FSA's liquidity requirements.

FSA has a credit arrangement aggregating $150.0 million, provided by commercial banks and intended for general application to transactions insured by FSA. If FSA is downgraded below Aa3 and AA-, the lenders may terminate the commitment and the commitment commission becomes due and payable. If FSA is downgraded below Baa3 and BBB-, any outstanding loans become due and payable. At March 31, 2007, there were no borrowings under this arrangement, which expires on April 21, 2011, if not extended.

FSA has a standby line of credit in the amount of $350.0 million with a group of international banks to provide loans to FSA after it has incurred, during the term of the facility, cumulative municipal losses (net of any recoveries) in excess of the greater of $350.0 million or the average annual debt service of the covered portfolio multiplied by 5.00%, which amounted to $1,367.1 million at March 31, 2007. The obligation to repay loans under this agreement is a limited recourse obligation payable solely from, and collateralized by, a pledge of recoveries realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. This commitment has a ten-year term expiring on April 30, 2015 and contains an annual renewal provision, commencing April 30, 2008, subject to approval by the banks. A ratings downgrade of FSA would result in an increase in the commitment fee. No amounts have been utilized under this commitment as of March 31, 2007.

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 FSA with put options for issuing to the trusts non-cumulative redeemable perpetual preferred stock (the "Preferred Stock") of FSA. If FSA were to exercise a put option, the applicable trust would transfer the portion of the proceeds attributable to principal received upon maturity of its assets, net of expenses, to FSA in exchange for

Preferred Stock of FSA. FSA pays a floating put premium to the trusts. The cost of the puts were $0.2 million in the three months ended March 31, 2007 and 2006, and was recorded as other operating expense in the Company's Consolidated Financial Statements. The trusts are vehicles that provide FSA access to new capital at its sole discretion through the exercise of the put options. The Company does not consider itself to be the primary beneficiary of the trusts under Financial Accounting Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" (revised December 2003) ("FIN 46-R") because it does not retain the majority of the residual benefits or expected losses.

FSA-insured GICs subject the Company to risk associated with unexpected withdrawals of principal allowed by the terms of the GICs. The majority of municipal GICs insured by FSA relate to debt service reserve funds and construction funds in support of municipal bond transactions. Debt service reserve fund GICs may be drawn unexpectedly upon a payment default by the municipal issuer. Construction fund GICs may be drawn unexpectedly when construction of the underlying municipal project does not proceed as expected. In addition, most FSA-insured GICs allow for withdrawal of GIC funds in the event of a downgrade of FSA, typically below Aa3 by Moody's or AA- by S&P, unless the GIC provider posts collateral or otherwise enhances its credit. 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 Investors Service, Inc. ("Moody's") or A- by Standard & Poor's Ratings Services ("S&P"), with no right of the GIC provider to avoid such withdrawal by posting collateral or otherwise enhancing its credit. The Company manages this risk through the maintenance of liquid collateral and bank liquidity facilities.

FSA Asset Management LLC ("FSAM") has a $100.0 million line of credit with UBS Loan Finance LLC, which expires December 7, 2007, unless extended. This line of credit provides an additional source of liquidity should there be unexpected draws on GICs issued by the GIC Affiliates. There were no borrowings under this arrangement at March 31, 2007. Borrowings under this agreement are conditioned on FSA having a Triple-A rating by either Moody's or S&P, and on neither Moody's nor S&P having issued a rating to FSA below Aa1 or AA+, respectively.

Certain FSA Global debt issuances contain provisions that could extend the stated maturities of those notes. To ensure FSA Global will have sufficient cash flow to repay its funding requirements, it entered into four liquidity facilities with Dexia for amounts totaling $419.4 million.

Capital Adequacy

S&P, Moody's and Fitch Ratings periodically make an assessment of FSA, which may include an assessment of the credits insured by FSA and of the reinsurers and other providers of capital support to FSA, to confirm that FSA continues to satisfy the rating agencies' capital adequacy criteria necessary to maintain FSA's Triple-A ratings. Capital adequacy assessments by the rating agencies are generally based on FSA's qualified statutory capital, which is the aggregate of policyholders' surplus and contingency reserves determined in accordance with statutory accounting principles.

In the case of S&P, assessments of the credits insured by FSA are reflected in defined "capital charges," which are reduced by reinsurance and collateral to the extent "credit" is allowed for such reinsurance and collateral. Credit provided for reinsurance under the S&P capital adequacy model is generally a function of the S&P rating of the reinsurer and the qualification of the reinsurer as a "monoline" or "multi-line" company, as well as any collateral provided by the reinsurer. Capital charges on outstanding insured transactions and reinsurer ratings are subject to change by S&P at any time. The downgrade of a reinsurer by S&P from the Triple-A to the Double-A category results in a decline in the credit allowed for reinsurance by S&P from 100% or 95% to 70% or 65%, while a downgrade to the Single-A category results in 50% or 45% credit under present criteria. A downgrade by S&P of FSA's reinsurers would reduce the "margin of safety" by which FSA would survive a theoretical catastrophic depression modeled by S&P. A reduction by S&P in credit for reinsurance used

by FSA would also be expected ultimately to reduce the Company's return on equity to the extent that ceding commissions paid to FSA by such reinsurers were not increased to compensate for such reduction. FSA employs considerable reinsurance in its business to manage its single-risk exposures on insured credits. Any material increase in capital charges by S&P on FSA's insured portfolio would likewise be expected to have an adverse effect on FSA's margin of safety under the S&P capital adequacy model and, ultimately, the Company's return on equity. The Company may seek to raise additional capital to replenish capital eliminated by any of the rating agencies in their assessment of FSA's capital adequacy.

Capital adequacy is one of the financial strength measures under Moody's financial guarantor model. The model uses a Monte Carlo distribution methodology and includes a penalty for risk concentration and recognizes a benefit for diversification. Moody's assesses capital adequacy by comparing FSA's claims-paying resources to a Moody's-derived probability of potential credit losses. Moody's loss distribution reflects FSA's current distribution of risk by sector, the credit quality of insured exposures, correlations that exist between transactions, the credit quality of FSA's reinsurers and the term to maturity of FSA's insured portfolio. The published results compare levels of theoretical loss in the tail of this distribution to various measures of FSA's claims-paying resources. Like S&P, Moody's allows FSA "credit" for reinsurance based upon Moody's rating of the reinsurer. Generally, 100% credit is allowed for Triple-A reinsurance, 80% to 90% credit is allowed for Double-A reinsurance and 40% to 60% credit is allowed for Single-A reinsurance.

Fitch's Matrix model also uses a Monte Carlo distribution methodology, employing correlation factors and concentration factors. Its primary measure is the "Core Capital Adequacy Ratio," which is the ratio of claims paying resources adjusted by Fitch to reflect its view of their availability to the amount that it calculates (to a AAA level of confidence) would be required to pay claims. Fitch's Matrix model applies reinsurance credit on a transaction level based on Fitch's ratings of the provider, Fitch's correlation factor and the probability of a dispute over the claims, which probability varies depending on whether or not the reinsurer is a monoline.

Forward-Looking Statements

The Company relies on the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. This safe harbor requires that the Company specify important factors that could cause actual results to differ materially from those contained in forward-looking statements made by or on behalf of the Company. Accordingly, forward-looking statements by the Company and its affiliates are qualified by reference to the following cautionary statements.

In its filings with the Securities and Exchange Commission ("SEC"), reports to shareholders, press releases and other written and oral communications, the Company from time to time makes forward-looking statements. Such forward-looking statements include, but are not limited to:

•: projections of revenues, income (or loss), earnings (or loss) per share, dividends, market share or other financial forecasts;
•: statements of plans, objectives or goals of the Company or its management, including those related to growth in adjusted book value or return on equity; and
•: expected losses on, and adequacy of loss reserves for, insured transactions.

Words such as "believes," "anticipates," "expects," "intends" and "plans" and similar expressions are intended to identify forward looking statements but are not the exclusive means of identifying such statements.

The Company cautions that a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in forward-looking statements made by the Company. These factors include:

•: changes in capital requirements or other criteria of securities rating agencies applicable to FSA;
•: competitive forces, including the conduct of other financial guaranty insurers;
•: changes in domestic or foreign laws or regulations applicable to the Company, its competitors or its clients;
•: changes in accounting principles or practices that may result in a decline in securitization transactions or effect the Company's reported financial results;
•: an economic downturn or other economic conditions (such as a rising interest rate environment) adversely affecting transactions insured by FSA or its General Investment Portfolio;
•: inadequacy of reserves established by the Company for losses and loss adjustment expenses;
•: disruptions in cash flow on FSA-insured structured transactions attributable to legal challenges to such structures;
•: downgrade or default of one or more of FSA's reinsurers;
•: market conditions, including the credit quality and market pricing of securities issued;
•: capacity limitations that may impair investor appetite for FSA-insured obligations;
•: market spreads and pricing on insured CDS exposures, which may result in gain or loss due to mark-to-market accounting requirements;
•: prepayment speeds on FSA-insured asset-backed securities and other factors that may influence the amount of installment premiums paid to FSA;
•: the risks discussed in "Item 1A. Risk Factors" of the Company's annual report on Form 10-K for the year ended December 31, 2006; and
•: other factors, most of which are beyond the Company's control.

The Company cautions that the foregoing list of important factors is not exhaustive. In any event, such forward-looking statements made by the Company speak only as of the date on which they are made, and the Company does not undertake any obligation to update or revise such statements as a result of new information, future events or otherwise.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

There has been no material change in the Company's market risk since December 31, 2006.

Item 4T. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, completed an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended) as of March 31, 2007. Based on that evaluation, the Company's management, including the Chief Executive Officer and the Chief Financial Officer, have concluded that as of such date the Company's disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the SEC and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, in a manner that allows timely decisions regarding required disclosure.

PART II—OTHER INFORMATION

Item 6. Exhibits.

(a): Exhibits

Exhibit No.		Exhibit
31.1		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1		Consolidated Financial Statements of Financial Security Assurance Inc. for the periods ended March 31, 2007 and 2006.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
Date: May 14, 2007	By:	/s/ LAURA A. BIELING
	Name:	Laura A. Bieling
	Title:	Managing Director & Controller (Chief Accounting Officer)

Exhibit Index

Exhibit No.		Exhibit
31.1		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1		Consolidated Financial Statements of Financial Security Assurance Inc. for the period ended March 31, 2007 and 2006.

QuickLinks

INDEX
PART I—FINANCIAL INFORMATION
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (unaudited) (in thousands, except share data)
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (unaudited) (in thousands)
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited) (in thousands)
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (in thousands)
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Reconciliation of Net Losses and Loss Adjustment Expenses
PART II—OTHER INFORMATION
SIGNATURE
Exhibit Index

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	H.S. freshman Avg

Assured Guaranty Municipal 10-Q2007 Q1 Quarterly report

Content analysis