EXHIBIT 99.1
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
Condensed Consolidated Financial Statements
March 31, 2004
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended March 31, 2004 and 2003
INDEX
The New York State Insurance Department recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under the New York Insurance Law, and for determining whether its financial condition warrants the payment of a dividend to its stockholders. No consideration is given by the New York State Insurance Department to financial statements prepared in accordance with accounting principles generally accepted in the United States of America in making such determinations.
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(in thousands, except share data)
| | March 31,
2004 | | December 31,
2003 | |
ASSETS | | | | | |
Bonds at fair value (amortized cost of $3,331,193 and $3,254,503) | | $ | 3,595,175 | | $ | 3,487,380 | |
Short-term investments | | 189,885 | | 222,391 | |
Variable interest entities’ bonds at fair value (amortized cost of $1,357,488 and $1,361,332) | | 1,356,825 | | 1,360,151 | |
Variable interest entities’ guaranteed investment contracts at fair value (amortized cost approximates fair value) | | 559,853 | | 559,853 | |
Variable interest entities’ short-term investments | | 15,157 | | 11,102 | |
Total investment portfolio | | 5,716,895 | | 5,640,877 | |
Cash | | 10,406 | | 11,640 | |
Securitized loans | | 420,219 | | 433,948 | |
Deferred acquisition costs | | 277,701 | | 273,646 | |
Prepaid reinsurance premiums | | 727,723 | | 695,398 | |
Investment in unconsolidated affiliate | | 70,123 | | 64,440 | |
Reinsurance recoverable on unpaid losses | | 55,797 | | 59,235 | |
Other assets | | 948,057 | | 909,614 | |
| | | | | |
TOTAL ASSETS | | $ | 8,226,921 | | $ | 8,088,798 | |
| | | | | |
LIABILITIES AND MINORITY INTEREST AND SHAREHOLDER’S EQUITY | | | | | |
Deferred premium revenue | | 1,918,569 | | $ | 1,861,960 | |
Losses and loss adjustment expenses | | 236,667 | | 233,408 | |
Variable interest entities’ debt | | 2,542,202 | | 2,537,466 | |
Deferred federal income taxes | | 194,441 | | 180,687 | |
Notes payable to affiliate | | 420,586 | | 434,723 | |
Surplus notes | | 152,850 | | 152,850 | |
Accrued expenses and other liabilities | | 331,342 | | 380,058 | |
| | | | | |
TOTAL LIABILITIES AND MINORITY INTEREST | | 5,796,657 | | 5,781,152 | |
| | | | | |
Preferred stock (5,000.1 and 0 shares authorized; 0 shares issued and outstanding; par value of $1,000 per share) | | | | | |
Common stock (400 shares authorized, issued and outstanding; par value of $37,500 per share) | | 15,000 | | 15,000 | |
Additional paid-in capital | | 821,271 | | 819,918 | |
Accumulated other comprehensive income (net of deferred income taxes of $88,648 and $78,340) | | 173,786 | | 151,725 | |
Accumulated earnings | | 1,420,207 | | 1,321,003 | |
| | | | | |
TOTAL SHAREHOLDER’S EQUITY | | 2,430,264 | | 2,307,646 | |
| | | | | |
TOTAL LIABILITIES AND MINORITY INTEREST AND SHAREHOLDER’S EQUITY | | $ | 8,226,921 | | $ | 8,088,798 | |
See notes to condensed consolidated financial statements.
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FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (unaudited)
(in thousands)
| | Three Months Ended March 31, | |
| | 2004 | | 2003 | |
REVENUES: | | | | | |
Net premiums written | | $ | 119,489 | | $ | 92,185 | |
| | | | | |
Net premiums earned | | 95,205 | | 80,090 | |
Net investment income | | 40,808 | | 36,406 | |
Net realized gains | | 437 | | 1,037 | |
Variable interest entities’ net interest income | | 29,254 | | | |
Net realized and unrealized gains on derivative instruments | | 14,723 | | 1,915 | |
Other income | | 7,497 | | 5,198 | |
TOTAL REVENUES | | 187,924 | | 124,646 | |
EXPENSES: | | | | | |
Losses and loss adjustment expenses | | 7,700 | | 6,300 | |
Interest expense | | 6,879 | | 7,475 | |
Variable interest entities’ net interest expense | | 27,908 | | | |
Policy acquisition costs | | 14,798 | | 13,399 | |
Other operating expenses | | 13,680 | | 12,403 | |
TOTAL EXPENSES | | 70,965 | | 39,577 | |
Minority interest | | (4,534 | ) | (2,427 | ) |
Equity in earnings of unconsolidated affiliate | | 4,686 | | 5,900 | |
INCOME BEFORE INCOME TAXES | | 117,111 | | 88,542 | |
Provision for income taxes: | | 28,166 | | 20,436 | |
NET INCOME | | 88,945 | | 68,106 | |
Other comprehensive income, net of tax: | | | | | |
Unrealized gains on securities: | | | | | |
Holding gains arising during period | | 22,443 | | 3,088 | |
Less: reclassification adjustment for gains included in net income | | 382 | | 277 | |
Other comprehensive income | | 22,061 | | 2,811 | |
COMPREHENSIVE INCOME | | $ | 111,006 | | $ | 70,917 | |
See notes to condensed consolidated financial statements.
2
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(in thousands)
| | Three Months Ended March 31, | |
| | 2004 | | 2003 | |
Cash flows from operating activities: | | | | | |
Premiums received, net | | $ | 103,384 | | $ | 54,763 | |
Policy acquisition and other operating expenses paid, net | | (114,403 | ) | (97,280 | ) |
Recoverable advances (paid) recovered | | (325 | ) | 717 | |
Loss and loss adjustment expenses paid, net | | (1,091 | ) | (1,329 | ) |
Net investment income received | | 41,967 | | 34,994 | |
Federal income taxes paid | | (7,651 | ) | (1,020 | ) |
Interest paid | | (6,875 | ) | (6,830 | ) |
Variable interest entities’ net interest income received | | 11,044 | | | |
Variable interest entities’ interest paid | | (7,312 | ) | | |
Other, net | | 5,382 | | 7,949 | |
Net cash provided by (used for) operating activities | | 24,120 | | (8,036 | ) |
Cash flows from investing activities: | | | | | |
Proceeds from sales of bonds | | 163,331 | | 304,682 | |
Purchases of bonds | | (217,839 | ) | (378,616 | ) |
Net decrease in short-term investments | | 32,628 | | 79,344 | |
Net decrease in variable interest entities’ short-term investments | | (4,055 | ) | | |
Purchases of property and equipment | | (279 | ) | (129 | ) |
Other investments, net | | 15,258 | | (388 | ) |
Net cash (used for) provided by investing activities | | (10,956 | ) | 4,893 | |
| | | | | |
Cash flows from financing activities: | | | | | |
Repayment of notes payable to affiliate | | (14,137 | ) | (7,660 | ) |
Capital issuance cost | | (261 | ) | | |
Net cash used for financing activities | | (14,398 | ) | (7,660 | ) |
Net decrease in cash | | (1,234 | ) | (10,803 | ) |
Cash at beginning of period | | 11,640 | | 27,560 | |
Cash at end of period | | $ | 10,406 | | $ | 16,757 | |
(a) In the first three months of 2004 and 2003, the Company received a tax benefit of $1,614 and $861, respectively, by utilizing its Parent’s losses. These amounts were recorded as capital contributions.
See notes to condensed consolidated financial statements.
3
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
For the Three Months Ended March 31, 2004 and 2003
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Inc. (the Company), a wholly owned subsidiary of Financial Security Assurance Holdings Ltd. (the Parent), is an insurance company domiciled in the State of New York. The Company and its subsidiaries are primarily engaged in the business of providing financial guaranty insurance on asset-backed and municipal obligations. In addition, the Company insures guaranteed investment contracts (GICs) issued by wholly-owned subsidiaries of the Parent (collectively, the GIC Subsidiaries).
In the third quarter of 2003, the Company consolidated FSA Global Funding Limited (FSA Global) and Canadian Global Funding Corporation (Canadian Global) as a result of Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51” (FIN 46). The Company also consolidated Premier International Funding Co. (Premier) in the third quarter as a result of obtaining control rights.
2. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been prepared by the Company and are unaudited. In the opinion of management, all adjustments, which include only normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows at March 31, 2004 and for all periods presented, have been made.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These statements should be read in conjunction with the Company’s December 31, 2003 consolidated financial statements and notes thereto. The December 31, 2003 condensed consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The results of operations for the periods ended March 31, 2004 and 2003 are not necessarily indicative of the operating results for the full year. Certain prior-year balances have been reclassified to conform to the 2004 presentation.
3. LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company establishes a case reserve for unpaid losses and loss adjustment expenses for the present value of the estimated loss, net of subrogation recoveries, when, in management’s opinion, the likelihood of a future loss on a particular insured obligation is probable and determinable at the balance sheet date. The estimated loss on a transaction is discounted using the risk-free rate at the time the case reserve is established, which ranged from 4.94% to 6.1% at March 31, 2004. For insured collateralized debt obligations (CDOs), a case reserve is recorded to the extent that the overcollateralization ratio (non-defaulted collateral at par value divided by the debt insured) has fallen below 100% and there is a projected loss when calculating the present value of cash flows.
The Company also maintains a non-specific general reserve, which is available to be applied against future additions or accretions to existing case reserves or to new case reserves to be established on particular insured obligations in the future. The general reserve is derived from two separate steps. The first step is to multiply loss factors by the Company’s total net par underwritten and to discount the result at the risk-free rate at the date the reserve is established, which ranged from 1.2% to 7.953% at March 31, 2004. The loss factors used for this purpose are obtained from an independent rating agency study of bond defaults and have been adjusted by the Company’s portfolio characteristics and history. The second step pertains to the Company’s insured CDOs, where a present value “deterministic” approach is utilized to calculate the general reserve for insured CDOs.
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Management of the Company periodically evaluates its estimates for losses and loss adjustment expenses and establishes reserves that management believes are adequate to cover the net present value of the ultimate net cost of claims. However, because of the uncertainty involved in developing these estimates, the ultimate liability may differ from current estimates.
4. DERIVATIVE INSTRUMENTS
FSA has insured a number of credit default swaps (CDS) with the expectation that these transactions will not be subject to a market value termination for which the Company would be liable. It considers these agreements to be a normal extension of its financial guaranty insurance business, although they are considered derivatives for accounting purposes. These agreements are recorded at fair value. The Company believes that the most meaningful presentation of the financial statement impact of these derivatives is to reflect premiums as installments are received, to record losses and loss adjustment expenses as incurred and to record changes in fair value as incurred. The Company recorded $16.0 million and $11.2 million in net earned premium under these agreements for the three months ended March 31, 2004 and 2003, respectively. The changes in fair value, which were gains of $15.1 million and $1.5 million for the three months ended March 31, 2004 and 2003, respectively, were recorded in net realized and unrealized gains on derivative instruments in the condensed consolidated statements of operations and comprehensive income. The Company included the net par outstanding of $66.7 billion relating to these CDS transactions at March 31, 2004 in the asset-backed balances in Note 6. The losses or gains recognized by recording these contracts at fair value will be determined each quarter based upon quoted market prices, if available. If quoted market prices are not available, as is the case primarily with CDS on pools of assets, then the determination of fair value is based on internally developed estimates. 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 FSA’s ability to obtain reinsurance for its insured obligations. The Company does not believe the fair value adjustments are an indication of potential claims under FSA’s guarantees. The inception-to-date net unrealized gain of $5.7 million at March 31, 2004 was recorded in other assets and the net unrealized loss of $9.4 million at December 31, 2003 was recorded in accrued expenses and other liabilities.
Derivative instruments, which are designated as fair-value hedges, are entered into to manage the interest rate and currency exchange rate exposure on FSA Global and Canadian Global’s debt and investments. The derivatives are recorded at fair value. These derivatives generally include interest rate and foreign currency swap agreements, which are utilized to convert FSA Global and Canadian Global’s debt and investments into U.S. dollar floating-rate debt and investments. The gains and losses relating to these fair-value hedges are included in variable interest entities’ net interest income and net interest expense, as appropriate, along with the offsetting change in fair value of the hedged item attributable to the risk being hedged, in the condensed consolidated statements of operations and comprehensive income.
5. SECURITIZED LOANS AND NOTES PAYABLE TO AFFILIATE
In 2003 and in 2002, the Company exercised certain rights available under its financial guaranty policies and the indentures relating to certain loan-backed notes issued by trusts. Those rights allowed the Company to accelerate the insured notes and pay claims under its insurance policies on an accelerated basis. Refinancing vehicles reimbursed the Company in whole for its claims payment in exchange for an assignment of certain of the Company’s rights against the capital of the trusts. The refinancing vehicles secured the funds to purchase the notes by issuing refinanced notes, with interest rates ranging from 1.84% to 5.718%. These notes were purchased by FSA Asset Management LLC, a wholly owned subsidiary of the Parent. The Company maintains significant reinsurance, first loss and quota share, in respect of these transactions.
5
Principal payments due under these refinanced notes for the remainder of 2004 and each of the next five years ending December 31 and thereafter, are as follows (in millions):
Year | | Principal
Amount | |
2004 | | $ | 35.0 | |
2005 | | 64.4 | |
2006 | | 58.7 | |
2007 | | 53.3 | |
2008 | | 49.7 | |
2009 | | 46.7 | |
Thereafter | | 112.8 | |
Total | | $ | 420.6 | |
6. OUTSTANDING EXPOSURE
The Company limits its exposure to losses from writing financial guaranties by underwriting investment-grade obligations, diversifying its portfolio and maintaining rigorous collateral requirements on asset-backed obligations, as well as through reinsurance. The net and ceded par outstanding of insured obligations (including FSA-insured CDS) in the asset-backed insured portfolio are backed by the following types of collateral (in millions) at March 31, 2004 and December 31, 2003:
| | Net Par Outstanding | | Ceded Par Outstanding | |
| | 2004 | | 2003 | | 2004 | | 2003 | |
Residential mortgages | | $ | 22,427 | | $ | 20,682 | | $ | 3,554 | | $ | 4,031 | |
Consumer receivables | | 12,702 | | 14,039 | | 4,964 | | 5,033 | |
Pooled corporate obligations | | 77,191 | | 78,147 | | 11,756 | | 11,936 | |
Other asset-backed obligations(1) | | 10,643 | | 10,134 | | 3,562 | | 4,200 | |
Total asset-backed obligations | | $ | 122,963 | | $ | 123,002 | | $ | 23,836 | | $ | 25,200 | |
(1) Includes $4,944 million and $4,474 million, in 2004 and 2003, respectively, in “Net Par Outstanding” relating to FSA-insured GICs issued by the GIC Subsidiaries.
The net and ceded par outstanding of insured obligations in the municipal insured portfolio includes the following amounts by type of issues (in millions) at March 31, 2004 and December 31, 2003:
| | Net Par Outstanding | | Ceded Par Outstanding | |
| | 2004 | | 2003 | | 2004 | | 2003 | |
General obligation bonds | | $ | 69,902 | | $ | 67,212 | | $ | 21,055 | | $ | 20,184 | |
Housing revenue bonds | | 7,136 | | 7,597 | | 1,900 | | 2,074 | |
Municipal utility revenue bonds | | 30,304 | | 30,024 | | 14,345 | | 14,270 | |
Health care revenue bonds | | 7,483 | | 7,051 | | 7,501 | | 6,971 | |
Tax-supported bonds (non-general obligation) | | 34,912 | | 33,835 | | 13,858 | | 13,526 | |
Transportation revenue bonds | | 11,000 | | 10,744 | | 7,602 | | 7,376 | |
Other municipal bonds | | 15,331 | | 14,475 | | 8,325 | | 7,223 | |
Total municipal obligations | | $ | 176,068 | | $ | 170,938 | | $ | 74,586 | | $ | 71,624 | |
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7. VARIABLE INTEREST ENTITIES
Following is a summary of the impact on the condensed consolidated balance sheet of consolidating FSA Global, Canadian Global and Premier (in thousands) at March 31, 2004:
| | Premier/
FSA Global | | Canadian
Global | | Intercompany
Eliminations | | VIE
Total | |
Bonds | | $ | 1,321,825 | | $ | 35,000 | | $ | | | $ | 1,356,825 | |
GIC assets | | 430,103 | | 129,750 | | | | 559,853 | |
Short-term investments | | 8,877 | | 6,280 | | | | 15,157 | |
Other assets | | 657,458 | | 43,658 | | (632 | ) | 700,484 | |
Total Assets | | $ | 2,418,263 | | $ | 214,688 | | $ | (632 | ) | $ | 2,632,319 | |
| | | | | | | | | |
Debt | | $ | 2,345,771 | | $ | 196,431 | | $ | | | $ | 2,542,202 | |
Other financial guaranty liabilities | | 72,492 | | 18,257 | | (632 | ) | 90,117 | |
Total Liabilities | | $ | 2,418,263 | | $ | 214,688 | | $ | (632 | ) | $ | 2,632,319 | |
Following is a summary of the impact in the consolidated statement of operations and comprehensive income of consolidating FSA Global, Canadian Global and Premier for the three months ended March 31, 2004 (in thousands):
| | Premier/
FSA Global | | Canadian
Global | | Intercompany
Eliminations | | VIE
Total | |
VIE net interest income | | $ | 28,253 | | $ | 1,001 | | $ | | | $ | 29,254 | |
Other income | | 77 | | 359 | | (351 | ) | 85 | |
Net premiums written | | | | | | (1,532 | ) | (1,532 | ) |
Total revenues | | $ | 28,330 | | $ | 1,360 | | $ | (1,883 | ) | $ | 27,807 | |
| | | | | | | | | |
VIE net interest expense | | $ | 28,491 | | $ | 1,300 | | $ | (1,883 | ) | $ | 27,908 | |
Other expenses | | 28 | | 9 | | | | 37 | |
Total expenses | | $ | 28,519 | | $ | 1,309 | | $ | (1,883 | ) | $ | 27,945 | |
At March 31, 2004, the interest rates on variable interest entities’ (VIE) debt were between 1.12% and 10.0% per annum.
Payments due under the VIE debt (including $1,253.6 million of future interest accretion on zero coupon obligations and excluding $190.8 million of hedge accounting adjustments) in the remainder of 2004 and each of the next five years ending December 31 and thereafter, are as follows (in millions):
Year | | Principal
Amount | |
2004 | | $ | 206.8 | |
2005 | | 208.6 | |
2006 | | 87.7 | |
2007 | | 188.1 | |
2008 | | 39.8 | |
2009 | | 20.4 | |
Thereafter | | 2,853.6 | |
Total | | $ | 3,605.0 | |
The Canadian Global debt of $180.6 million will mature in August 2004 and Canadian Global will be liquidated. The amount of the debt payment for 2004 is included in the above debt repayment schedule.
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8. OTHER ASSETS
The detailed balances that comprise other assets at March 31, 2004 and December 31, 2003 are as follows (in thousands):
| | 2004 | | 2003 | |
Other Assets: | | | | | |
Fair value of VIE swaps | | $ | 407,293 | | $ | 407,742 | |
Tax and loss bonds | | 86,377 | | 85,512 | |
Accrued interest on VIE swaps | | 97,065 | | 59,100 | |
Accrued interest income | | 14,261 | | 27,635 | |
Other assets | | 343,061 | | 329,625 | |
Total Other Assets | | $ | 948,057 | | $ | 909,614 | |
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