EXHIBIT 99.2
FINANCIAL STATEMENTS
Financial Guaranty Insurance Company and Subsidiaries
March 31, 2006
Financial Guaranty Insurance Company and Subsidiaries
Financial Statements
March 31, 2006
Contents
Balance Sheets at March 31, 2006 (Unaudited) and December 31, 2005.... 1
Statements of Income for the Three Months Ended March 31, 2006
and 2005 (Unaudited)............................................... 2
Statements of Cash Flows for the Three Months Ended March 31, 2006
and 2005 (Unaudited)............................................... 3
Notes to Financial Statements (Unaudited)............................. 4
Financial Guaranty Insurance Company and Subsidiaries
Balance Sheets
(Dollars in thousands, except per share amounts)
March 31 December 31
2006 2005
--------------------------------------
(Unaudited)
Assets
Fixed maturity securities, available for sale, at fair value
(amortized cost of $3,355,155 in 2006 and $3,277,291 in 2005) $ 3,302,181 $ 3,258,738
Variable interest entity fixed maturity securities, held to maturity
at amortized cost 750,000 -
Short-term investments 151,806 159,334
--------------------------------------
Total investments 4,203,987 3,418,072
Cash and cash equivalents 70,719 45,077
Accrued investment income 46,465 42,576
Reinsurance recoverable on losses 2,341 3,271
Prepaid reinsurance premiums 112,546 110,636
Deferred policy acquisition costs 72,754 63,330
Receivable from related parties - 9,539
Property and equipment, net of accumulated depreciation of $1,151 in
2006 and $885 in 2005 2,850 3,092
Prepaid expenses and other assets 17,637 10,354
Federal income taxes - 2,158
--------------------------------------
Total assets $4,529,300 $ 3,708,105
======================================
Liabilities and stockholder's equity
Liabilities:
Unearned premiums $1,226,597 $ 1,201,163
Losses and loss adjustment expenses 50,228 54,812
Ceded reinsurance balances payable 3,968 1,615
Accounts payable and accrued expenses and other liabilities 20,229 36,359
Payable for securities purchased 19,366 -
Capital lease obligations 4,328 4,262
Variable interest entity floating rate notes 750,000 -
Accrued investment income - variable interest entity 1,176 -
Federal income taxes payable 16,585 -
Deferred income taxes 29,350 42,463
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Total liabilities 2,121,826 1,340,674
--------------------------------------
Stockholder's equity:
Common stock, par value $1,500 per share; 10,000 shares authorized,
issued and outstanding 15,000 15,000
Additional paid-in capital 1,896,460 1,894,983
Accumulated other comprehensive loss, net of tax (33,750) (13,597)
Retained earnings 529,763 471,045
--------------------------------------
Total stockholder's equity 2,407,473 $2,367,431
--------------------------------------
Total liabilities and stockholder's equity $4,529,300 $ 3,708,105
======================================
See accompanying notes to unaudited interim financial statements.
1
Financial Guaranty Insurance Company and Subsidiaries
Statements of Income
(Unaudited)
(Dollars in thousands)
Three months ended
March 31,
2006 2005
---------------------------
Revenues:
Gross premiums written $ 89,281 $ 84,404
Ceded premiums written (6,423) (1,795)
------------------------
Net premiums written 82,858 82,609
Increase in net unearned premiums (23,394) (29,976)
------------------------
Net premiums earned 59,464 52,633
Net investment income 32,319 27,440
Net realized gains - 118
Net mark to market losses on credit derivative
contracts (228) -
Other income 536 426
------------------------
Total revenues 92,091 80,617
------------------------
Expenses:
Losses and loss adjustment expenses (1,933) (2,611)
Underwriting expenses 24,117 20,650
Policy acquisition cost deferred (12,513) (10,671)
Amortization of deferred policy acquisition costs 3,192 2,149
Other operating expenses 1,655 -
------------------------
Total expenses 14,518 9,517
------------------------
Income before income taxes 77,573 71,100
Income tax expense 18,862 17,794
------------------------
Net income $58,711 $ 53,306
========================
See accompanying notes to unaudited interim financial statements.
2
Financial Guaranty Insurance Company and Subsidiaries
Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
Three months ended
March 31,
2006 2005
--------------------------------------
Operating activities
Net income $58,711 $ 53,306
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of deferred policy acquisition costs 3,192 2,149
Policy acquisition costs deferred (12,513) (10,671)
Depreciation of property and equipment 266 143
Amortization of fixed maturity securities 8,314 9,600
Amortization of short-term investments 28
Net realized gains on investments - (118)
Amortization of stock compensation expense 1,476
Change in accrued investment income, prepaid expenses and
other assets (11,251) (6,716)
Change in mark-to-market losses on credit derivative contracts 228
Change in reinsurance receivable 931 265
Change in prepaid reinsurance premiums (1,910) 4,378
Change in unearned premiums 25,434 25,593
Change in losses and loss adjustment expenses (4,584) (3,183)
Change in receivable from related parties 9,539 802
Change in ceded reinsurance balances payable and accounts
payable and accrued expenses and other liabilities (12,763) (10,936)
Change in current federal income taxes receivable 2,158 -
Change in current federal income taxes payable 16,585 12,676
Change in deferred federal income taxes 110 4,907
--------------------------------------
Net cash provided by operating activities 83,951 82,195
--------------------------------------
Investing activities
Sales and maturities of fixed maturity securities 34,741 68,181
Purchases of fixed maturity securities (120,095) (166,715)
Purchases, sales and maturities of short-term investments, net 7,528 22
Receivable for securities sold (171)
Payable for securities purchased 19,366 9,320
Purchases of fixed assets (24) (86)
--------------------------------------
Net cash used in investing activities (58,484) (89,449)
--------------------------------------
--------------------------------------
Financing activities
Capital contribution - 8,049
--------------------------------------
Net cash provided by financing activities - 8,049
--------------------------------------
--------------------------------------
Effect of exchange rate changes on cash 175
--------------------------------------
Net increase (decrease) in cash and cash equivalents 25,642 795
Cash and cash equivalents at beginning of period 45,077 69,292
--------------------------------------
Cash and cash equivalents at end of period $70,719 $ 70,087
======================================
See accompanying notes to unaudited interim financial statements.
3
Financial Guaranty Insurance Company and Subsidiaries
Notes to Financial Statements
(Unaudited) (continued)
(Dollars in thousands)
1. Business and Organization
Financial Guaranty Insurance Company (the "Company") is a wholly owned
subsidiary of FGIC Corporation ("FGIC Corp."). The Company provides financial
guaranty insurance and other forms of credit enhancement for public finance and
structured finance obligations. The Company began insuring public finance
obligations in 1984 and structured finance obligations in 1988. The Company's
financial strength is rated "Aaa" by Moody's Investors Service, Inc., "AAA" by
Standard & Poor's Rating Services, a division of The McGraw-Hill Companies,
Inc., and "AAA" by Fitch Ratings, Inc. The Company is licensed to engage in
writing financial guaranty insurance in all 50 states, the District of Columbia,
the Commonwealth of Puerto Rico, the U.S. Virgin Islands, and, through a branch,
the United Kingdom. In addition, a United Kingdom subsidiary of the Company is
authorized to write financial guaranty business in the United Kingdom and has
passport rights to write business in other European Union member countries.
2. Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany balances have been eliminated.
The accompanying unaudited interim consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States ("GAAP) for interim financial information. Accordingly, they do
not include all of the information and footnotes required by GAAP for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for fair presentation have
been included. Operating results for the three-month period ended March 31, 2006
are not necessarily indicative of results that may be expected for the year
ending December 31, 2006. These unaudited interim consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements for the year ended December 31, 2005, including accompanying notes.
Certain 2005 amounts have been reclassified to conform to the 2006 presentation.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and the accompanying notes. Actual results could differ
from those estimates.
4
Financial Guaranty Insurance Company and Subsidiaries
Notes to Financial Statements
(Unaudited) (continued)
(Dollars in thousands)
3. Review of Financial Guaranty Industry Accounting Practices
The Financial Accounting Standards Board ("FASB") staff is considering whether
additional accounting guidance is necessary to address loss reserving and
certain other practices in the financial guaranty industry. Statement of
Financial Accounting Standards ("SFAS") No. 60, Accounting and Reporting by
Insurance Enterprises, was developed prior to the emergence of the financial
guaranty industry. As it does not specifically address financial guaranty
contracts, there has been diversity in the accounting for these contracts. In
2005, the FASB added a project to consider accounting by providers of financial
guaranty insurance. The objective of the project is to develop an accounting
model for financial guaranty contracts issued by insurance companies that are
not accounted for as derivative contracts under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. The goal of this project is to
develop a single model for all industry participants to apply.
The FASB is expected to issue proposed and final pronouncements on this matter
in 2006. When the FASB issues a final pronouncement, the Company, along with
other companies in the financial guaranty industry, may be required to change
certain aspects of accounting for loss reserves, premium income and deferred
acquisition costs. It is not possible to predict the impact the FASB's review
may have on the Company's accounting practices.
5. Premium Refundings
When an obligation insured by the Company is refunded prior to the end of the
expected policy coverage period, any remaining unearned premium is recognized. A
refunding occurs when an insured obligation is called or legally defeased prior
to the stated maturity. Premiums earned for the three months ended March 31,
2006 and 2005 include $7,311 and $15,539, respectively, related to the
accelerated recognition of unearned premiums in connection with refundings.
6. Loss and Loss Adjustment Expense Reserves
Loss reserves and loss adjustment expenses are regularly reviewed and updated
based on claim payments and the results of ongoing surveillance. The Company's
insured portfolio surveillance is designed to identify impaired obligations and
thereby provide a materially complete recognition of losses for each accounting
period. The reserves are necessarily based upon estimates and subjective
judgments about the outcome of future events, and actual results will likely
differ from these estimates. At March 31, 2006, the Company had case reserves of
$30,278, credit watchlist reserves of $18,603 and an unallocated loss adjustment
expense reserve of $1,347.
5
Financial Guaranty Insurance Company and Subsidiaries
Notes to Financial Statements
(Unaudited) (continued)
(Dollars in thousands)
6. Loss and Loss Adjustment Expense Reserves (continued)
At December 31, 2005, the Company had case reserves of $31,981, credit watchlist
reserves of $21,484 and a loss adjustment expense reserve of $1,347.
Case reserves and credit watchlist reserves at March 31, 2006 included $6,855
and $12,672, respectively, of estimated losses related to obligations impacted
by Hurricane Katrina. Case reserves and credit watchlist reserves at December
31, 2005 included $8,511 and $13,322, respectively, of estimated losses related
to obligations impacted by Hurricane Katrina. Given the unprecedented nature of
the events and magnitude of damage in the affected areas, the loss reserves were
necessarily based upon estimates and subjective judgments about the outcome of
future events, including without limitation the amount and timing of any future
federal and state aid. The loss reserves will likely be adjusted as additional
information becomes available, and such adjustments may have a material impact
on future results of operations. However, the Company believes that the losses
ultimately incurred as result of Hurricane Katrina will not have a material
impact on the Company's consolidated financial position.
7. Income Taxes
The Company's effective federal corporate tax rates of 24.3% and 25.0% for the
three months ended March 31, 2006 and 2005, respectively, were less than the
statutory corporate tax rate (35%) on income due to permanent differences
between financial and taxable income, principally tax-exempt interest.
8. Reinsurance
Net premiums earned are shown net of ceded premiums earned of $4,868 and $6,200
for the three months ended March 31, 2006 and 2005, respectively.
9. Variable Interest Entities
Financial Interpretation No. 46, Consolidation of Variable Interest Entities
("FIN 46-R"), provides accounting and disclosure rules for determining whether
certain entities should be consolidated in the Company's consolidated financial
statements. An entity is subject to FIN 46-R, and is called a variable interest
entity ("VIE"), if it has (i) equity that is insufficient to permit the entity
to finance its activities without additional subordinated financial support or
(ii) equity investors that cannot make significant decisions about the entity's
operations or that do not absorb the majority of expected losses or receive the
majority of expected residual returns of the entity. A VIE is consolidated by
its
6
Financial Guaranty Insurance Company and Subsidiaries
Notes to Financial Statements
(Unaudited) (continued)
(Dollars in thousands)
9. Variable Interest Entities (continued)
primary beneficiary, which is the party that has a majority of the VIE's
expected losses or a majority of its expected residual returns, or both.
Additionally, FIN 46-R requires disclosures for companies that have either a
primary or significant variable interest in a VIE. All other entities not
considered VIEs are evaluated for consolidation under SFAS No. 94, Consolidation
of all Majority-Owned Subsidiaries.
As part of its structured finance business, the Company insures debt obligations
or certificates issued by special purpose entities. During the first quarter of
2006, the Company consolidated a third party VIE as a result of financial
guarantees provided by the Company on one transaction related to the
securitization of life insurance reserves. This third party VIE had assets of
$750,000 and an equal amount of liabilities at March 31, 2006, which are shown
under "Assets - Variable interest entity fixed maturity securities, held to
maturity at amortized cost" and "Liabilities - Variable interest entity floating
rate notes," respectively, on the Company's consolidated balance sheet at March
31, 2006. In addition, accrued investment income includes $1,176 related to the
variable interest entity fixed income maturity securities and the corresponding
liability is shown under "Accrued investment expense-variable interest entity"
on the Company's consolidated balance sheet at March 31, 2006. Although the
third party VIE is included in the consolidated financial statements, its
creditors do not have recourse to the general assets of the Company outside of
the financial guaranty policy provided to the VIE. The Company has evaluated its
other structured finance transactions and does not believe any of the third
party entities involved in these transactions requires consolidation or
disclosure under FIN 46-R.
FGIC has arranged the issuance of contingent preferred trust securities by a
group of special purpose trusts. Each Trust is solely responsible for its
obligations, and has been established for the purpose of entering into a put
agreement with FGIC that obligates the Trusts, at FGIC's discretion, to purchase
Perpetual Preferred Stock of FGIC. The purpose of this arrangement is to provide
capital support to FGIC by allowing it to obtain immediate access to new capital
at its sole discretion at any time through the exercise of the put options.
These trusts are considered VIEs under FIN 46-R. However, the Company is not
considered a primary beneficiary and therefore is not required to consolidate
the trusts.
9. Derivative Instruments
The Company provides credit default swaps ("CDSs") to certain buyers of credit
protection by entering into contracts that reference collateralized debt
obligations from cash and synthetic structures backed by pools of corporate,
consumer or structured finance debt. It also offers credit protection on public
finance and structured finance obligations in CDS form. The Company considers
these agreements to be a normal extension of its financial guaranty insurance
business,
7
Financial Guaranty Insurance Company and Subsidiaries
Notes to Financial Statements
(Unaudited) (continued)
(Dollars in thousands)
9. Derivative Instruments (continued)
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, and to record losses and
loss adjustment expenses and changes in fair value as incurred. The Company
recorded $4,235 of net earned premium, $0 in losses and loss adjustment
expenses, and net mark-to-market losses of $228 in changes in fair value under
these agreements for the three months ended March 31, 2006. The gains or losses
recognized by recording these contracts at fair value are determined each
quarter based on quoted market prices, if available. If quoted market prices are
not available, the determination of fair value is based on internally developed
estimates. The inception-to-date mark-to-market gain and (loss) on the CDS
portfolio were $890 and $(1,831) at March 31, 2006 and $545 and ($712) at
December 31, 2005, recorded in other assets and in other liabilities,
respectively. The Company did not enter into any CDS contracts during the three
months ended March 31, 2005.
10. Stock Compensation Plan
Employees of the Company participate in a stock incentive plan that provides for
stock-based compensation, including stock options, restricted stock awards and
restricted stock units of FGIC Corp. Stock options are granted for a fixed
number of shares with an exercise price equal to or greater than the fair value
of the shares at the date of the grant. Restricted stock awards and restricted
stock units are valued at the fair value of the stock on the grant date, with no
cost to the grantee. Prior to January 1, 2006, FGIC Corp. and the Company
accounted for those plans under the recognition and measurement provisions of
APB Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations, as permitted by SFAS No. 123, Accounting for Stock-Based
Compensation. No stock-based employee compensation cost related to stock options
was allocated to the Company by FGIC Corp. for the three-month period ended
March 31, 2005, as all options granted through that date had an exercise price
equal to the market value of the underlying common stock on the date of grant.
For grants of restricted stock and restricted stock units to employees of the
Company, unearned compensation, equivalent to the fair value of the shares at
the date of grant, is allocated to the Company.
Effective January 1, 2006, the FGIC Corp. and the Company adopted the fair value
recognition provisions of SFAS No. 123(R), Share-Based Payment, using the
modified-prospective-transition method. Under that transition method,
compensation cost allocated to the Company for the three-month period ended
March 31, 2006 included compensation cost for all share-based payments granted
prior to, but not yet vested as of, January 1, 2006, based on the grant date
fair value estimated in accordance with SFAS No. 123(R). Results for prior
periods have not been
8
Financial Guaranty Insurance Company and Subsidiaries
Notes to Financial Statements
(Unaudited) (continued)
(Dollars in thousands)
10. Stock Compensation Plan (continued)
restated. As a result of adopting SFAS No. 123(R) effective January 1, 2006, the
Company's income before income taxes and net income for the three-month period
ended March 31, 2006 were reduced by $1,308 and $850, respectively, than if it
had continued to account for share-based compensation under Opinion 25.
The following table illustrates the effect on net income of the Company if the
Company had applied the fair value recognition provisions of SFAS No. 123 to
options granted under the Company's plan for all periods presented. For purposes
of this pro forma disclosure, the value of the options is estimated using a
Black-Scholes-Merton option pricing formula and amortized to expense over the
options' vesting periods.
March 31, 2005
--------------
Net Income, as reported $ 53,306
Add: Stock-based director compensation expense included in reported net
income, net of related tax effects 20
Deduct: Total stock-based employee compensation expense determined under
fair value-based method for all awards, net of related tax
effects (443)
---------------
$ 52,883
Pro Forma Net Income
===============
12. Comprehensive Income
Accumulated other comprehensive loss of the Company consists of net unrealized
gains (losses) on investment securities, foreign currency translation
adjustments and a cash flow hedge. The components of total comprehensive income
for the three-month period ended March 31, 2006 and 2005 were as follows:
Three Months Ended
March 31,
2006 2005
-------------------- ---------------
Net Income $ 58,711 $ 53,306
Other comprehensive loss (20,153) (32,222)
-------------------- ---------------
Total comprehensive income $ 38,558 $ 21,804
==================== ===============
9
Financial Guaranty Insurance Company and Subsidiaries
Notes to Financial Statements
(Unaudited) (continued)
(Dollars in thousands)
12. Comprehensive Income (continued)
The components of other comprehensive loss for the three-month period ended
March 31, 2006 and 20045 were as follows:
Three Months Ended March 31, 2006
-----------------------------------------------------
Before Net of
Tax Tax
Amount Tax Amount
----------------- ---------------- ------------------
Unrealized holding losses arising during the period $ (31,497) $11,022 $ (20,475)
Foreign currency translation adjustment 494 (172) 322
----------------- ---------------- ------------------
Total other comprehensive loss $ (31,003) $10,850 $ (20.153)
================= ================ ==================
Three Months Ended March 31, 2005
-----------------------------------------------------
Before Net of
Tax Tax
Amount Tax Amount
----------------- ---------------- ------------------
Unrealized holding losses arising during the period $ (48,536) $ 16,988 $ (31,548)
Less reclassification adjustment for gains realized
in net income (118) 41 (77)
----------------- ---------------- ------------------
----------------- ---------------- ------------------
Unrealized losses on investments (48,654) 17,029 (31,625)
Foreign currency translation adjustment (918) 321 (597)
----------------- ---------------- ------------------
Total other comprehensive loss $ (49,572) $ 17,350 $ (32,222)
================= ================ ==================
10