EXHIBIT 99.2
XL FINANCIAL ASSURANCE LTD.
(Incorporated in Bermuda)
CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
FOR THE NINE MONTH PERIODS ENDED
SEPTEMBER 30, 2004 AND 2003
XL FINANCIAL ASSURANCE LTD.
CONDENSED BALANCE SHEET
AS AT SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
(UNAUDITED)
(U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
2004 2003
------------------------
ASSETS:
Investments :
Fixed maturities, at fair value
(amortized cost: 2004 - $698,525; 2003 - $542,600) $ 698,945 $ 543,748
Short-term investments, at fair value
(amortized cost: 2004 - $26,097; 2003 - $40,286) 26,139 40,312
------------------------
Total investments available for sale 725,084 584,060
Cash and cash equivalents 6,071 26,346
Accrued investment income 5,189 7,420
Deferred acquisition costs 70,383 51,477
Prepaid reinsurance premiums 71,216 98,048
Reinsurance balances receivable 13,808 33,446
Unpaid losses and loss expenses recoverable 53,803 7,745
Amounts due from parent and affiliates 21,819 18,342
Net receivable for investments sold 2,142 --
Derivative assets 6,295 4,826
Other assets 128 52
------------------------
TOTAL ASSETS $ 975,938 $ 831,762
========================
LIABILITIES, REDEEMABLE PREFERRED SHARES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Unpaid losses and loss expenses $ 92,236 $ 35,899
Deferred premium revenue 399,810 348,719
Reinsurance premiums payable 5,287 6,275
Net payable for investments purchased -- 13
Accounts payable and accrued liabilities 719 1,249
Derivative liabilities 2,851 7,018
Dividend payable on preferred shares 1,458 1,950
------------------------
TOTAL LIABILITIES $ 502,361 $ 401,123
------------------------
REDEEMABLE PREFERRED SHARES:
Redeemable preferred shares (par value of $120 per share;
10,000 shares authorized; 363 issued and outstanding as at
September 30, 2004 and December 31, 2003, respectively) $ 44 $ 44
Additional paid-in capital 38,956 38,956
------------------------
TOTAL REDEEMABLE PREFERRED SHARES $ 39,000 $ 39,000
------------------------
SHAREHOLDERS' EQUITY:
Common shares (par value of $120 per share; 10,000 shares
authorized; 2,057 issued and outstanding as at
September 30, 2004 and December 31, 2003, respectively) $ 247 $ 247
Additional paid-in capital 220,653 220,653
Accumulated other comprehensive income 462 1,174
Retained earnings 213,215 169,565
------------------------
TOTAL SHAREHOLDERS' EQUITY $ 434,577 $ 391,639
------------------------
TOTAL LIABILITIES, REDEEMABLE PREFERRED SHARES AND SHAREHOLDERS' EQUITY $ 975,938 $ 831,762
========================
The accompanying notes are an integral part of these condensed
financial statements.
XL FINANCIAL ASSURANCE LTD.
CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME FOR THE THREE AND NINE
MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
(U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
--------------------------------------------------------
REVENUES:
Net premiums earned $ 17,790 $ 19,964 $ 57,448 $ 52,076
Net investment income 6,225 3,904 17,102 11,378
Net realized gains (losses) on investments (793) (609) 726 1,825
Net realized and unrealized gains on derivative instruments 705 5,480 20,525 27,009
---------------------------------------------------------
Total revenues $ 23,927 $ 28,739 $ 95,801 $ 92,288
---------------------------------------------------------
EXPENSES:
Losses and loss expenses 7,013 $ 2,031 $ 13,215 $ 12,907
Acquisition costs 7,637 7,905 21,874 21,668
Operating expenses 1,366 1,550 5,551 5,140
---------------------------------------------------------
Total expenses $ 16,016 $ 11,486 $ 40,640 $ 39,715
---------------------------------------------------------
NET INCOME $ 7,911 $ 17,253 $ 55,161 $ 52,573
=========================================================
COMPREHENSIVE INCOME
Net income $ 7,911 $ 17,253 $ 55,161 $ 52,573
Unrealized gains (losses) 12,927 (2,447) 14 567
Less: reclassification for gains (losses) realized
in income (793) (609) 726 1,825
---------------------------------------------------------
Other comprehensive gain (loss) $ 13,720 $ (1,838) $ (712) $ (1,258)
---------------------------------------------------------
COMPREHENSIVE INCOME $ 21,631 $ 15,415 $ 54,449 $ 51,315
=========================================================
The accompanying notes are an integral part of these condensed
financial statements.
XL FINANCIAL ASSURANCE LTD.
CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2004 AND FOR THE
YEAR ENDED DECEMBER 31, 2003
(UNAUDITED)
(U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
2004 2003
----------------------------------
COMMON SHARES - AUTHORIZED
Number of shares, beginning of year and period 2,057 2,057
----------------------------------
Number of shares, end of year and period 2,057 2,057
==================================
COMMON SHARES - ISSUED
Balance - beginning of year and period $ 247 $ 247
----------------------------------
Balance - end of year and period $ 247 $ 247
==================================
ADDITIONAL PAID-IN CAPITAL
Balance - beginning of year and period $ 220,653 $ 220,653
----------------------------------
Balance - end of year and period $ 220,653 $ 220,653
==================================
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance - beginning of year and period $ 1,174 $ 6,095
Other comprehensive loss (712) (4,921)
----------------------------------
Balance - end of year and period $ 462 $ 1,174
==================================
RETAINED EARNINGS
Balance - beginning of year and period $ 169,565 $ 100,046
Net income 55,161 76,161
Dividends on preferred shares (11,511) (6,642)
----------------------------------
Balance - end of year and period $ 213,215 $ 169,565
==================================
TOTAL SHAREHOLDERS' EQUITY $ 434,577 $ 391,639
==================================
The accompanying notes are an integral part of these condensed
financial statements.
XL FINANCIAL ASSURANCE LTD.
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
(U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
2004 2003
----------------------------------
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net income for the period $ 55,161 $ 52,573
Adjustments to reconcile net income to net cash provided by operating activities:
Realized gains on investments (726) (1,825)
Amortization of discount on fixed maturities 3,648 (429)
Net realized gains on investment derivatives (19) (3,267)
Net realized and unrealized gains on credit derivatives
excluding cash received and paid (5,636) (13,439)
Accrued investment income 2,231 (1,269)
Reinsurance premiums receivable 19,638 (13,139)
Deferred acquisition costs (18,906) (27,083)
Prepaid reinsurance premiums 26,832 (21,102)
Unpaid losses and loss expenses recoverable (46,058) (2,766)
Amounts due from parent and affiliates (3,477) 3,813
Accounts payable and accrued liabilities (530) (434)
Reinsurance premiums payable (988) (14,824)
Deferred premium revenue 51,091 135,619
Unpaid losses and loss expenses 56,337 14,018
Other assets and liabilities (76) (9)
------------------------------------
Total adjustments 83,361 53,864
------------------------------------
Net cash provided by operating activities 138,522 106,437
------------------------------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Proceeds from sale of fixed maturities and short-term investments 2,299,403 238,602
Proceeds from redemption of fixed maturities and short-term investments 512,150 4,111,110
Purchase of fixed maturities and short-term investments (2,958,347) (4,552,957)
------------------------------------
Net cash used in investing activities (146,794) (203,245)
------------------------------------
CASH FLOWS USED IN FINANCING ACTIVITIES:
Dividends paid on preferred shares (12,003) (6,640)
------------------------------------
DECREASE IN CASH AND CASH EQUIVALENTS (20,275) (103,448)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 26,346 125,073
------------------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 6,071 $ 21,625
====================================
The accompanying notes are an integral part of these condensed
financial statements.
XL FINANCIAL ASSURANCE LTD.
NOTES TO CONDENSED FINANCIAL STATEMENTS
FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
1. ORGANIZATION AND BUSINESS
XL Financial Assurance Ltd. (the "Company") was incorporated with limited
liability under the Bermuda Companies Act 1981 on October 14, 1998 and is
registered as a Class 3 insurer under The Insurance Act 1978, amendments thereto
and related regulations ("The Act"). At September 30, 2004 and December 31,
2003, the Company was approximately 85% owned by XL Insurance (Bermuda) Ltd (a
wholly-owned subsidiary of XL Capital Ltd); 6% by Financial Security Assurance
Inc. (a wholly-owned subsidiary of Financial Security Assurance Holdings Ltd.)
and 9% by Financial Security Assurance International Ltd. (owned 20% by XL
Insurance (Bermuda) Ltd and 80% by Financial Security Assurance Inc.). The
Company is an integral part of a joint venture agreement between XL Capital Ltd
and Financial Security Assurance Holdings Ltd.
The Company is primarily engaged in the business of providing reinsurance of
financial guaranties on asset-backed and municipal obligations underwritten by
XL Insurance (Bermuda) Ltd, Financial Security Assurance Inc. and XL Capital
Assurance Inc. (a wholly-owned subsidiary of XL Capital Ltd) and other monoline
and multiline insurance companies. This may be in the form of traditional
financial guaranty insurance or via a credit derivative execution. The Company's
underwriting policy is to provide reinsurance of asset-backed and municipal
obligations that would be of a lower investment-grade quality without the
benefit of the Company's reinsurance. The asset-backed obligations reinsured by
the Company are generally issued in structured transactions and are backed by
pools of assets such as residential mortgage loans, consumer or trade
receivables, securities or other assets having ascertainable cash flows or
market value. The municipal obligations reinsured by the Company consist
primarily of general obligation bonds that are supported by the issuers' taxing
power and of special revenue bonds and other special obligations of states and
local governments that are supported by the issuers' ability to impose and
collect fees and charges for public services or specific projects. The Company's
reinsurance guarantees payments when due of scheduled payments on an insured
obligation. In the case of a payment default on an insured obligation, the
Company is generally required to pay the principal, interest or other such
amounts due in accordance with the obligations' original payment schedule or, at
its option, to pay such amounts on an accelerated basis. The Company conducts
surveillance on its exposures to try and ensure early identification of any loss
events. In addition, in the normal course of business, the Company seeks to
reduce the loss that may arise from such events by reinsuring certain levels of
risks in various areas of exposure with other insurance enterprises or
reinsurers.
On October 6, 1999, the Company entered into a Facultative Quota Share
Reinsurance Treaty ("Treaty") with XL Capital Assurance Inc. ("XLCA"). The
Treaty was amended and restated on June 22, 2001 and May 1, 2004. Under the
terms of this Treaty, the Company agrees to reinsure up to 90% of XLCA's
compliant risks. The Company is subject to ceding commissions of up to 30% on
business assumed under the terms of this Treaty.
On December 6, 2000, the Company entered into an excess of loss agreement, which
reinsures 100% of net incurred losses in excess of $250 million up to a limit of
liability of $100 million. On June 30, 2003, the Company terminated the
agreement. On October 3, 2001, the Company entered into an excess of loss
reinsurance agreement with XL Insurance (Bermuda) Ltd, which indemnifies the
Company up to an aggregate limit of liability of $500 million in excess of
defined obligor losses.
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PREPARATION
The accompanying condensed 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 September 30, 2004
and for all periods presented, have been made.
XL FINANCIAL ASSURANCE LTD.
NOTES TO CONDENSED FINANCIAL STATEMENTS
FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
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 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 September 30, 2004 and 2003 are not
necessarily indicative of the operating results for the full year.
The preparation of condensed financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Any such adjustments are reflected in income in the period in which the
adjustments are made. The financial statement estimates subject to most
uncertainty are estimates for loss reserves and calculation of the fair value of
credit default swap instruments.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, FASB issued Interpretation No. 46, "Consolidation of Variable
Interest Entities", ("FIN 46"). The objective of FIN 46 is to improve financial
reporting by companies involved with variable interest entities. This new model
for consolidation applies to an entity which either (1) the powers or rights of
the equity holders do not give them sufficient decision making powers or (2) the
equity investment at risk is insufficient to finance that entity's activities
without receiving additional subordinated financial support from other parties.
FIN 46 requires a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both.
In December 2003, FASB issued a revision to FIN 46 (FIN 46-R) which clarified
several provisions of FIN 46, superceded the related FASB Staff Positions
(FSPs), and amended the effective date and transition of the pronouncement,
except for certain types of entities. However, the Company has applied the
provisions of FIN 46 or FIN 46-R to those entities that are considered to be
special-purpose entities as at September 30, 2004. The adoption of FIN 46 did
not have a material effect on the Company's financial condition and results of
operations.
3. DERIVATIVE INSTRUMENTS
Credit derivatives issued by the Company meet the definition of a derivative
under FAS 133. The Company has recorded these products at fair value, modeled on
prevailing market conditions and certain other factors relating to the structure
of the transaction. The Company considers credit derivatives to be financial
guaranty contracts, in substance, as the Company intends to hold them to
maturity. The Company determines fair value using a model which calculates the
difference between the actual remaining present value of installment premiums
and an estimated remaining present value of installment premiums under current
market conditions. In essence, the model estimates the cost of an offsetting
position to the original credit derivatives from other comparable counterparties
under the current market environment. The model is dependent upon a number of
factors including changes in credit spreads, changes in credit quality, foreign
exchange and other market factors.
The Company's credit derivatives portfolio generally requires the Company to
meet payment obligations for referenced credits within the portfolio in the
event of specific credit events after erosion or exhaustion of various first
loss protection levels. These credit events are contract specific, but generally
cover bankruptcy, failure to pay and repudiation. The notional exposure of the
credit derivatives portfolio as of September 30, 2004 was $4.6 billion.
XL FINANCIAL ASSURANCE LTD.
NOTES TO CONDENSED FINANCIAL STATEMENTS
FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
Approximately 96% of the portfolio is rated AAA, with the remainder being split
amongst AA, A and BBB respectively. The weighted average term of the contracts
in force was 5.11 years. The net fair value adjustment for the periods ended
September 30, 2004 and 2003 was an unrealized gain of $5,636 and $13,439,
respectively. At September 30, 2004 and 2003, the Company had a net derivatives
asset (liability) of $3,444 and ($2,829), respectively.
4. VARIABLE INTEREST ENTITIES
The Company primarily provides financial guaranty reinsurance or enters into a
credit derivative on the senior interests, which would otherwise be rated
investment grade. The obligations related to these transactions are often
securitized through variable interest entities. The Company does not hold any
equity positions or subordinated debt in these arrangements. Accordingly, the
Company's interest in these variable interest entities is not significant and
therefore, not consolidated.
5. LOSS RESERVE
The Company assumed a loss of approximately $18.4 million, net of certain
adjustments, representing the present value of losses expected to be incurred in
the future with respect to an insured project financing transaction underwritten
by an affiliate. The portion of the reinsured exposure to which this loss
relates was retroceded by the Company, on a first loss basis, to an affiliate
and, accordingly, there was no impact on the Company's results of operations
from this loss provision. The total remaining par reinsured by the Company in
connection with this transaction aggregated approximately $133.33 million at
September 30, 2004. Such par exposure amortizes over many years into the future.
The estimate of losses was necessarily based on assumptions and estimates
extending over many years into the future. There is currently no payment default
with respect to this transaction. Management continues to monitor the exposure
and will revise its loss estimate as necessary, as information becomes
available. Pursuant to the assumptions upon which the estimate was based,
approximately 51.25% of any additional loss provision in excess of the amount
currently provided will be retained by the Company
6. REINSURANCE
The effect of reinsurance on premiums written and earned for the three and nine
month periods ended September 30, 2004 and 2003 is shown below:
ASSUMED CEDED NET
---------------------------------------------------
Three months ended September 30, 2004
Premium written $ 51,690 $ (9,765) $ 41,925
Premium earned 54,057 (36,267) 17,790
Losses and loss adjustment expenses 51,538 (44,525) 7,013
Three months ended September 30, 2003
Premium written $ 78,863 $ (12,442) $ 66,421
Premium earned 26,053 (6,089) 19,964
Losses and loss adjustment expenses 1,695 336 2,031
XL FINANCIAL ASSURANCE LTD.
NOTES TO CONDENSED FINANCIAL STATEMENTS
FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- --------------------------------------------------------------------------------
Nine months ended September 30, 2004
Premium written $ 159,187 $ (23,816) $ 135,371
Premium earned 108,096 (50,648) 57,448
Losses and loss adjustment expenses 59,273 (46,058) 13,215
Nine months ended September 30, 2003
Premium written $ 206,412 $ (39,820) $ 166,592
Premium earned 70,794 (18,718) 52,076
Losses and loss adjustment expenses 15,672 (2,765) 12,907