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EXHIBIT 99.1
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
Condensed Consolidated Financial Statements
June 30, 2002
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FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
INDEX
<Table>
<Caption>
FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets 1
Condensed Consolidated Statements of Operations and
Comprehensive Income 2
Condensed Consolidated Statements of Cash Flows 3
Notes to Condensed Consolidated Financial Statements 4
</Table>
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.
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FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<Table>
<Caption>
JUNE 30, DECEMBER 31,
2002 2001
------------ ------------
ASSETS
Bonds at market value (amortized cost of $2,386,469 and
$2,211,247) $ 2,509,810 $ 2,303,431
Equity investments at market value (cost of $10,006) 10,076 10,076
Short-term investments 208,059 213,212
------------ ------------
Total investments 2,727,945 2,526,719
Cash 23,154 5,882
Deferred acquisition costs 256,728 240,492
Prepaid reinsurance premiums 452,738 420,798
Reinsurance recoverable on unpaid losses 50,851 28,880
Investment in unconsolidated affiliate 53,248 49,726
Other assets 155,223 165,782
------------ ------------
TOTAL ASSETS $ 3,719,887 $ 3,438,279
============ ============
LIABILITIES AND MINORITY INTEREST AND SHAREHOLDER'S EQUITY
Deferred premium revenue $ 1,197,237 $ 1,090,332
Losses and loss adjustment expenses 177,069 114,428
Deferred federal income taxes 139,938 133,877
Ceded reinsurance balances payable 36,283 34,961
Surplus notes 144,000 144,000
Minority interest 50,372 46,157
Accrued expenses and other liabilities 157,975 175,852
------------ ------------
TOTAL LIABILITIES AND MINORITY INTEREST 1,902,874 1,739,607
------------ ------------
Common stock (400 shares authorized, issued and outstanding;
par value of $37,500 per share) 15,000 15,000
Additional paid-in capital 797,656 794,797
Accumulated other comprehensive income (net of deferred
income tax provision of $41,814 and $29,334) 81,597 62,920
Accumulated earnings 922,760 825,955
------------ ------------
TOTAL SHAREHOLDER'S EQUITY 1,817,013 1,698,672
------------ ------------
TOTAL LIABILITIES AND MINORITY INTEREST
AND SHAREHOLDER'S EQUITY $ 3,719,887 $ 3,438,279
============ ============
</Table>
See notes to condensed consolidated financial statements.
1
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FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS)
<Table>
<Caption>
SIX MONTHS ENDED JUNE 30,
----------------------------
2002 2001
------------ ------------
REVENUES:
Net premiums written (net of premiums ceded of $95,002 and $75,496) $ 220,427 $ 161,355
------------ ------------
Premiums earned (net of premiums ceded of $65,716 and $46,500) 146,751 107,760
Net investment income 67,644 62,523
Net realized gains 24,077 3,676
Net realized and unrealized gains (losses) on derivative instruments (24,698) 3,737
Other income 532 415
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TOTAL REVENUES 214,306 178,111
------------ ------------
EXPENSES:
Losses and loss adjustment expenses 42,119 5,973
Policy acquisition costs 25,877 19,700
Other operating expenses 23,518 21,353
------------ ------------
TOTAL EXPENSES 91,514 47,026
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Minority interest and equity in earnings of unconsolidated affiliate (694) 322
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INCOME BEFORE INCOME TAXES 122,098 131,407
Provision for income taxes 25,293 29,033
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NET INCOME 96,805 102,374
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Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities:
Holding gains (losses) arising during period 36,307 (1,049)
Less: reclassification adjustment for gains
included in net income 17,630 2,498
------------ ------------
Other comprehensive income (loss) 18,677 (3,547)
------------ ------------
COMPREHENSIVE INCOME $ 115,482 $ 98,827
============ ============
</Table>
See notes to condensed consolidated financial statements.
2
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FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<Table>
<Caption>
SIX MONTHS ENDED JUNE 30,
----------------------------
2002 2001
------------ ------------
Cash flows from operating activities:
Premiums received, net $ 221,449 $ 173,983
Policy acquisition and other operating expenses paid, net (89,958) (75,846)
Recoverable advances recovered (paid) 3,341 (281)
Loss and LAE paid, net (4,018) (16,513)
Net investment income received 64,055 59,590
Federal income taxes paid (45,477) (35,116)
Interest paid (4,562) (3,000)
Other, net (3,856) 1,855
------------ ------------
Net cash provided by operating activities 140,974 104,672
------------ ------------
Cash flows from investing activities:
Proceeds from sales of bonds 525,741 252,709
Purchases of bonds (651,050) (348,843)
Purchases of property and equipment (4,440) (936)
Net decrease (increase) in short-term securities 5,752 (2,541)
Other investments, net 295 (127)
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Net cash used for investing activities (123,702) (99,738)
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Net increase in cash 17,272 4,934
Cash at beginning of period 5,882 7,053
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Cash at end of period $ 23,154 $ 11,987
============ ============
</Table>
(a) In the first six months of 2002 and 2001, the Company received a tax
benefit of $2,859 and $1,717, respectively, by utilizing its Parent's
losses. These amounts were recorded as capital contributions.
See notes to condensed consolidated financial statements.
3
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FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001
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.
2. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been
prepared by the Company and are unaudited. In the opinion of management, all
adjustments, which include only normal recurring adjustments necessary to
present fairly the financial position, results of operations and cash flows at
June 30, 2002 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, 2001 consolidated
financial statements and notes thereto. The year-end condensed balance sheet was
derived from audited financial statements, but does not include all disclosures
required by accounting principles generally accepted in the United States of
America. The results of operations for the periods ended June 30, 2002 and 2001
are not necessarily indicative of the operating results for the full year.
Certain prior-year balances have been reclassified to conform to the 2002
presentation.
3. LOSS AND LOSS ADJUSTMENT EXPENSES
In the second quarter of 2002, as part of the Company's ongoing credit review
process, management identified certain transactions not performing as expected
in its portfolio of insured collateralized debt obligations ("CDOs"). As a
result, management analyzed all CDO transactions in its insured portfolio that
breached over-collateralization triggers, which were included in such
transactions as one measure of adverse performance. A "deterministic" approach
was utilized as a basis to estimate the loss inherent in this portfolio. The
deterministic model applies a run of the collateral portfolio for each
transaction considering each CDO transaction's unique attributes (such as
reinsurance, individual collateral ratings and status, derivatives purchased,
premiums due to the guarantor, etc.) utilizing a Moody's default pattern for
frequency of defaults, an estimate of collateral recovery values for severity,
and a risk-free rate of interest. Management assumed that current default rates
on CDO collateral would improve in a manner consistent with an economic recovery
following a period of significant credit deterioration similar to that
experienced in 1991/1992 and, as a result, management selected Moody's 1992
idealized default curve as a predictor of future defaults on the CDO collateral.
The per period default rate is calculated based on the Moody's weighted average
rating factor for each piece of surviving collateral. Recovery rates are
judgmentally established by the Company. In considering the recovery rates to be
utilized, management adjusted Moody's average recovery rates (observed since
1982) downward to reflect more recent and more adverse observations. This
analysis produced a present value of expected losses of $51.5 million, net of
reinsurance recoveries and net of unearned premiums and future ceding
commissions. As described in more detail below, management addressed this net
present value of expected loss ($51.5 million) through (i) an increase in the
Company's general reserve ($31.0 million) and (b) current amounts in its general
reserve ($20.5 million), including general reserve amounts reallocated to case
basis reserves ($11.3 million). The $31.0 million increase in the Company's
general reserve resulted in a corresponding increase to loss and loss adjustment
expense in the income statement of $31.0 million. At June 30, 2002, the general
reserve totaled $99.6 million and the total loss and loss adjustment expense
liability totaled $177.1 million. Management has established a methodology of
recording case basis reserves on CDO transactions to the extent that the
over-collateralization ratio (non-defaulted collateral at par value divided by
the debt insured) has fallen below
4
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100%, since management believes that claims on such transactions are probable
and that the amount of the undercollateralization is a reasonable estimate of
such claims. Such transactions may benefit from excess cash flow attributable in
part to higher interest rates on the underlying collateral than on the insured
securities. In addition, such transactions generally require insured payments of
principal only at the ultimate maturity of such transactions. As a result, the
Company does not expect to be required to pay claims in respect of these
transactions until 2010, but may elect to do so at an earlier date in its
discretion. Over time, management expects to reallocate amounts in its general
reserve (including accretions thereto) to case basis reserves as specific losses
on its insured CDO portfolio become probable and estimable in accordance with
the undercollateralization methodology described above. Application of this
methodology resulted in recording $34.5 million in gross case basis reserves and
$23.2 million in reinsurance recoverable on unpaid losses, resulting in a $11.3
million increase in net case basis reserves. Management, beginning in the second
quarter of 2002, has refined the loss factor it applies to its net par
underwritten when calculating the general reserve in order to reflect its recent
adverse experience. As a result, the general reserve accrual for the second
quarter of 2002 was $8.2 million, rather than the approximate $4.1 million that
would have been accrued using the prior assumptions. Management expects future
reserve contributions to be approximately double the amounts under the prior
practice. Since the reserves are based upon estimates, there can be no assurance
that the ultimate liability 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
actual loss experience, its future mix of business and future economic
conditions.
4. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
141, "Business Combinations" (SFAS No. 141) and No. 142, "Goodwill and Other
Intangible Assets" (SFAS No. 142). SFAS No. 141 requires the purchase method of
accounting be used for all business combinations initiated after June 30, 2001,
establishes specific criteria for the recognition of intangible assets
separately from goodwill, and requires unallocated negative goodwill to be
written off immediately as an extraordinary gain (instead of being deferred and
amortized). These provisions are effective for business combinations accounted
for by the purchase method for which the date of acquisition is after June 30,
2001. Certain SFAS No. 141 provisions also apply to purchase business
combinations for which the acquisition date was before July 1, 2001. SFAS No.
142 addresses how intangible assets acquired individually or with a group of
other assets (but not those acquired in a business combination) should be
accounted for in the financial statements. This statement requires that goodwill
no longer be amortized and instead be subject to an impairment test performed at
least annually. The provisions of SFAS No. 142 will be effective for fiscal
years beginning after December 31, 2001. The implementation of these standards,
on January 1, 2002, did not have a material effect on the Company's financial
position, results of operations or cash flows.
5. SUBSEQUENT EVENT
Subsequent to June 30, 2002, the single corporate name credit default swap
program was terminated in exchange for a fee of $43.0 millon, $38.0 million
of which was related to the Company's exposure. This will result in the
Company recognizing a third quarter 2002 pre-tax charge of $17.2 million.
Through the second quarter, the Company had already recognized aggregate
charges of $20.8 million related to the program in accordance with the
mark-to-market requirements of Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities".
5