FINANCIAL SECURITY ASSURANCE HOLDINGS LTD/NY/ - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2001

OR

|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-12644

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
(Exact name of registrant as specified in its charter)

NEW YORK 13-3261323
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

350 PARK AVENUE, NEW YORK, NEW YORK 10022
(Address of principal executive offices, including zip code)

(212) 826-0100
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:
NONE

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 |X| No |_|

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|

The aggregate market value of common equity, excluding treasury shares,
held by non-affiliates of the registrant at March 25, 2002 was $27.1 million.
For purposes of the foregoing, directors are deemed to be affiliates of the
registrant and the dollar amount shown is based on the price at which shares of
the Company's common stock were valued under the Company's director share
purchase program on January 31, 2002. The common stock of the Company ceased to
be publicly traded in July 2000.

At March 25, 2002, there were outstanding 33,216,900 shares of Common
Stock, par value $0.01 per share, of the registrant (excludes 301,095 shares of
treasury stock).

DOCUMENTS INCORPORATED BY REFERENCE

None

TABLE OF CONTENTS

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ITEM 1. BUSINESS.

GENERAL

Financial Security Assurance Holdings Ltd. (the "Company"), through its
wholly owned subsidiary, Financial Security Assurance Inc. ("FSA"), is primarily
engaged in the business of providing financial guaranty insurance on
asset-backed and municipal obligations. The claims-paying ability of FSA is
rated "Triple-A" by the major securities rating agencies and obligations insured
by FSA are generally awarded "Triple-A" ratings by reason of such insurance. FSA
was the first insurance company organized to insure asset-backed obligations and
has been a leading insurer of asset-backed obligations (based on number of
transactions insured) since its inception in 1985. FSA expanded the focus of its
business in 1990 to include financial guaranty insurance of municipal
obligations. For the year ended December 31, 2001, FSA had gross premiums
written of $485.6 million, of which 52% related to insurance of asset-backed
obligations and 48% related to insurance of municipal obligations. At December
31, 2001, FSA had net par outstanding of $217.1 billion, of which 51%
represented insurance of asset-backed obligations and 49% represented insurance
of municipal obligations. FSA is licensed to engage in the financial guaranty
insurance business in all 50 states, the District of Columbia, Guam, Puerto Rico
and the U.S. Virgin Islands. In the fourth quarter of 2001, the Company began
offering FSA-insured guaranteed investment contracts ("GICs") through its newly
formed subsidiaries, FSA Capital Markets Services LLC and FSA Capital Management
Services LLC (collectively, "CMS").

FSA owns FSA Insurance Company ("FSAIC"), which in turn owns Financial
Security Assurance International Ltd. ("FSA International") and Financial
Security Assurance (U.K.) Limited ("FSA-UK"). FSA International is a Bermuda
domiciled insurance company that primarily provides financial guaranty insurance
for transactions outside United States and European markets as well as
reinsurance to FSA. FSA-UK is a United Kingdom domiciled insurance company that
primarily provides financial guaranty insurance for transactions in the United
Kingdom and other European markets. FSAIC is an Oklahoma domiciled insurance
company that primarily provides reinsurance to FSA. All such insurance company
subsidiaries are wholly-owned, except that XL Capital Ltd ("XL") owns a minority
interest in FSA International, as described below.

FSA Portfolio Management Inc. ("FSA Portfolio Management"), a wholly owned
subsidiary of the Company, is engaged in the business of managing the investment
portfolios of the Company and its affiliates and holding various investments of
the Company.

Transaction Services Corporation ("TSC"), a wholly owned subsidiary of the
Company, is engaged in the business of managing workout transactions within the
insured portfolios of the Company and its subsidiaries.

FSA Services (Australia) Pty Limited, a wholly owned subsidiary of the
Company, provides representative services with respect to financial guaranties
issued by FSA and its subsidiaries in connection with financial transactions
that have obligors or assets located in Australia.

The Company is a subsidiary of Dexia Holdings Inc., which, in turn, is a
subsidiary of Dexia Credit Local. Dexia Credit Local is a subsidiary of Dexia
S.A. ("Dexia"), a publicly held Belgian corporation. Dexia, through its bank
subsidiaries, is primarily engaged in the business of public finance, banking
and investment management in France, Belgium, Luxembourg and other European
countries.

When the Company commenced operations in 1985, it was owned by a number of
large insurance companies and other institutional investors. In 1989, the
Company was acquired by U S WEST Capital Corporation ("U S WEST"), which
subsequently changed its name to MediaOne Capital Corporation ("MediaOne").
MediaOne was a subsidiary of MediaOne Group, Inc., with operations and
investments in domestic cable and broadband communications and international
broadband and wireless communication. In 1990, the Company established a
strategic relationship with The Tokio Marine and Fire Insurance Co. Ltd. ("Tokio
Marine"), which acquired a minority interest in the Company. Tokio Marine is a
major Japanese property and casualty insurance company.

In 1994, the Company completed an initial public offering of common
shares, at which time White Mountains Insurance Group, Ltd. ("White Mountains")
(formerly known as Fund American Enterprises Holdings, Inc.) made an investment
in the Company and entered into certain agreements providing, among other
things, White Mountains options to acquire additional shares of the Company from
MediaOne. In 1994, pursuant to these agreements, the

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Company issued to White Mountains shares of Series A non-dividend paying voting
convertible redeemable preferred stock. In 1999, White Mountains exercised its
stock options and acquired additional shares of common stock from MediaOne.
White Mountains is an insurance holding company.

In 1998, the Company and XL entered into a joint venture, establishing two
Bermuda domiciled financial guaranty insurance companies--FSA International and
XL Financial Assurance Ltd ("XLFA"). XL owns a minority interest in FSA
International and the Company owns a minority interest in XLFA. XL is a major
Bermuda-based insurance holding company. In connection with the joint venture,
XL acquired common shares of the Company and the Company acquired common shares
of XL. Both the Company and XL subsequently sold the shares of stock acquired in
the transaction.

On July 5, 2000, the Company completed a merger in which the Company
became a direct subsidiary of Dexia Holdings, Inc., which is an indirect, wholly
owned subsidiary of Dexia. At the merger date, each outstanding share of the
Company's common stock was converted into the right to receive $76.00 in cash.
Dexia also indirectly acquired the Company's redeemable preferred stock, which
was then contributed to the Company's capital. At December 31, 2001, the only
holders of the Company's common stock were Dexia Holdings, Inc., White Mountains
and certain directors of the Company who own shares of the Company's common
stock or economic interests therein as described under the caption "Director
Share Purchase Program" in Item 11.

The principal executive offices of the Company are located at 350 Park
Avenue, New York, New York 10022. Subsidiaries of the Company maintain offices
domestically in San Francisco and Dallas and abroad in London, Singapore,
Bermuda, Tokyo, Sydney, Paris and Madrid.

INDUSTRY OVERVIEW

Financial guaranty insurance written by FSA typically guarantees scheduled
payments on an issuer's obligations. Upon a payment default on an insured
obligation, FSA is generally required to pay the principal, interest or other
amounts due in accordance with the obligation's original payment schedule or, at
its option, to pay such amounts on an accelerated basis. FSA's underwriting
policy is to insure asset-backed and municipal obligations that would otherwise
be investment grade without the benefit of FSA's insurance. Asset-backed
obligations insured by FSA are generally issued in structured transactions
backed by pools of assets such as residential mortgage loans, consumer or trade
receivables, securities or other assets having an ascertainable cash flow or
market value. Asset-backed obligations insured by FSA also include payment
obligations of counterparties and issuers under synthetic obligations such as
credit default swaps and credit-linked notes. Municipal obligations insured by
FSA consist primarily of general obligation bonds supported by the issuers'
taxing power and special revenue bonds and other special obligations of state
and local governments supported by the issuers' ability to impose and collect
fees and charges for public services or specific projects.

The Company's business objective is to remain a leading insurer of
asset-backed and municipal obligations employing transactional and financial
skills to generate increased premium volume at attractive returns while
minimizing the occurrence and severity of credit losses in its insured
portfolio. The Company believes that the demand for financial guaranty insurance
will remain strong over the long term as a result of the anticipated
continuation of three trends: (i) expansion of asset securitization outside the
residential mortgage sector; (ii) substantial volume of new domestic municipal
bonds that are insured, due, in part, to the continued use of municipal bonds to
finance repairs and improvements to the nation's infrastructure and municipal
bond purchases by individuals who generally purchase insured obligations; and
(iii) growing use of asset securitization and financial guaranty insurance in
non-U.S. markets, due, in part, to a trend towards private financing initiatives
for projects that have essential public purposes and regulatory changes
encouraging or facilitating credit-enhanced transactions.

The Company expects to continue to emphasize a diversified insured
portfolio characterized by insurance of both asset-backed and municipal
obligations, with a broad geographic distribution and a variety of revenue
sources and transaction structures. In addition to its domestic business, the
Company selectively pursues international opportunities primarily in Western
European and Asia Pacific markets.

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BUSINESS OF FSA

GENERAL

The business of FSA is managed by the Company's Management Committee,
comprised of FSA's Chairman, President, General Counsel, Chief Underwriting
Officer, Chief Financial Officer and Managing Director in charge of its Asset
Finance Group. FSA is primarily engaged in the business of writing financial
guaranty insurance on asset-backed and municipal obligations. In 2001, FSA
commenced insuring GICs issued by its affiliates.

ASSET-BACKED OBLIGATIONS

Asset-backed obligations are typically issued in connection with
structured financings or securitizations, in which the securities being issued
are secured by or payable from a specific pool of assets having an ascertainable
cash flow or market value and held by a special purpose issuing entity. While
most asset-backed obligations are secured by or represent interests in diverse
pools of assets, such as residential mortgage loans, auto loans, credit card
receivables, other consumer receivables, corporate bonds, government debt, bank
loans and multi-family mortgage loans, monoline financial guarantors also insure
asset-backed obligations secured by less diverse payment sources, such as
multifamily real estate.

Asset-backed obligations include funded and synthetic transactions. Funded
asset-backed obligations are typically payable from cash flow generated by a
pool of assets and take the form of either "pass-through" obligations, which
represent interests in the related assets, or "pay-through" obligations, which
generally are debt obligations collateralized by the related assets. Both types
of funded asset-backed obligations generally have the benefit of
overcollateralization, excess cash flow or one or more other forms of credit
enhancement to cover credit risks associated with the related assets. Synthetic
asset-backed obligations generally take the form of credit default swap
obligations or credit-linked notes that reference a pool of securities or loans,
with a defined deductible to cover credit risks associated with the referenced
securities or loans.

According to industry sources, the par volume of funded U.S. public
asset-backed securities, including securities distributed under Rule 144A, and
the total par volume of insured funded U.S. asset-backed obligations, since
1997, were as follows:

(1) Information is from ASSET-BACKED ALERT, January 11, 2002, and includes
corporate and consumer receivable-backed issues (including home equity
loan issues) but excludes private-label mortgage-backed securities,
collateralized debt obligations, commercial paper, synthetic transactions
and non-Rule 144A private placements.

(2) Information is from a news release distributed by the Association of
Financial Guaranty Insurors, April 23, 2001, and includes all
primary-market and secondary-market U.S. insured transactions, except
municipal obligations.

(3) Not available.

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According to industry sources, par volumes in certain other asset-backed
markets from 2000 through 2001 were as follows:

(1) Information in the table above is from ASSET-BACKED ALERT, January 11,
2002.

Asset securitization often represents an efficient way for commercial
banks to comply with capital requirements and for corporations to access the
capital markets at more attractive rates and, frequently, with different
accounting treatment. Banks have responded to increased capital requirements by
selling certain of their assets, such as credit card receivables and automobile
loans, in securitized structures to the financial markets. In addition, many
corporations have found securitization of their assets to be a less costly
funding alternative to traditional forms of borrowing or otherwise important in
diversifying funding sources. Also, some finance companies fund consumer finance
and home equity lending through securitization. In recent years, there has been
substantial consolidation and contraction among finance companies, particularly
in the subprime mortgage and auto loan finance sectors in which FSA operates.

Since the late 1990s, there has been significant growth in the market for
funded and synthetic collateralized debt obligations ("CDOs"), which are
securitizations of bonds, loans or other securities. CDOs are used by financial
institutions to manage their risk profiles, optimize capital utilization and
improve returns on equity. CDOs are also used by dealers or portfolio managers
to provide leveraged investments in bond and loan portfolios tailored to conform
to differing risk appetites of investors. The data with respect to funded CDOs
in the table above excludes synthetic transactions, and fails to reflect the
substantial growth in this sector perceived by FSA.

Worldwide, the volume of asset-backed securities insured by monoline
guarantors exceeded the volume of municipal securities insured by monoline
guarantors for the first time in 1999 and again in 2000, according to the
Association of Financial Guaranty Insurors. This was due to the expansion of the
asset-backed market primarily in the international and CDO sectors, high demand
for credit enhancement on complex asset-backed issues, the attraction of higher
returns available in the asset-backed market, and, during those two years, an
interest-rate-related volume decline in the U.S. municipal bond market.

MUNICIPAL OBLIGATIONS

Municipal obligations include bonds, notes and other evidences of
indebtedness issued by states and their political subdivisions (such as
counties, cities or towns), utility districts, public universities and
hospitals, public housing and transportation authorities and other public and
quasi-public entities. Municipal obligations are supported by the issuer's
taxing power in the case of general obligation bonds, or by the issuer's ability
to impose and collect fees and charges for public services or specific projects
in the case of most special revenue bonds.

Until 1999, insurance of municipal obligations represented the largest
portion of the financial guaranty insurance business. Both total issuance and
refundings of municipal obligations increased in 1996, 1997 and 1998, primarily
because of lower interest rates. In 1999, rising interest rates caused a steep
decline in refundings, which was responsible for much of the decline in total
issuance that year. The year 2000 saw a further decline in both total municipal
issuance and percentage of municipal par insured benefiting from bond insurance,
attributable in part to budget surpluses reducing borrowing needs, with
strengthened municipal issuers having less need to employ bond insurance. In
2001, new issue volume grew substantially due, in part, to a declining interest
rate environment, and insurance penetration returned to the same level as in
1999.

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The following table sets forth certain information regarding long-term
municipal obligations, issued during the periods indicated:

INSURED MUNICIPAL OBLIGATIONS(1)

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(1) Information is based on data provided in THE BOND BUYER, JANUARY 7, 2002.
Volume is expressed in terms of principal insured.

GICS/MEDIUM TERM NOTES

The Company's GIC business, conducted through CMS, provides GICs primarily
to municipalities. GICs written by CMS are insured by FSA. GICs are primarily
used by holders to invest bond proceeds required to be maintained in a debt
service reserve fund or construction fund for a bond issue. GICs provide for the
return of principal and the payment of interest at a guaranteed rate. Amounts
raised through the issuance of GICs are generally raised at or converted into
LIBOR-based floating rate obligations, with proceeds invested in LIBOR-based
floating rate investments intended to result in profits from the positive
difference between the borrowing rate (the floating rate on the GICs) and the
floating rate interest on the investments. These investments are owned, and the
related risk management function is performed, by FSA Asset Management LLC
("AMC"), a subsidiary of the Company.

FSA-insured GICs subject the Company to risk associated with early
withdrawal 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 AA- by S&P or Aa3 by Moody's,
unless the GIC provider posts collateral or otherwise enhances its credit. The
Company manages this risk through the maintenance of liquid collateral and
liquidity agreements now being implemented. At December 31, 2001, the CMS
subsidiaries had approximately $601.0 million of GICs outstanding.

The Company owns 29% of the equity of an off-balance sheet special purpose
entity, FSA Global Funding Limited ("FSA Global"), a Cayman Islands domiciled
issuer of FSA-insured notes and other obligations in international markets
(generally referred to as medium term notes or "MTNs"). FSA Global generally
issues securities at the request of interested purchasers in a process known as
"reverse inquiry", which generally results in lower interest rates and borrowing
costs than would apply to direct borrowings. Funds raised by FSA Global are
raised at or converted to U.S. dollars and LIBOR-based floating rates and are
generally invested in obligations that are insured by FSA and, in some cases,
another financial guaranty insurer and that mature prior to the maturity of the
related FSA Global notes and pay a higher interest rate than the interest rate
on the related FSA Global notes. FSA Global is managed as a "matched funding
vehicle" in which the proceeds from the sale of the FSA Global notes are
generally invested in obligations chosen to provide cash flows substantially
matched to those of the FSA Global notes. The matched funding structure
minimizes the market risks borne by FSA Global and FSA. In contrast,
non-matched funding vehicles, such as the CMS subsidiaries, use various dynamic
hedging techniques to address such risks. At December 31, 2001, FSA Global had
total assets and total liabilities of $3.5 billion and $3.5 billion,
respectively, and for the year ended December 31, 2001, FSA Global had net
income of $0.6 million. All amounts insured by FSA relating to FSA Global are
included in the Company's outstanding exposure, included in the Notes to the
Financial Statements for

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December 31, 2001. As of December 31, 2001, there were no case basis reserves
required for any FSA Global related transactions.

TYPES OF PRODUCTS

FSA's insurance is employed in both the new issue and secondary markets.
Insurance premium rates take into account the projected return to and risk
assumed by FSA. Critical factors in assessing risk include the credit quality of
the issuer, type of issue, sources of repayment, transaction structure and term
to maturity. Each obligation is evaluated on the basis of such factors and
subject to FSA's underwriting guidelines. The final premium rate is generally a
function of market factors, including, in the case of funded transactions, the
interest rate savings to the issuer from the use of insurance. In transactions
under the Company's GIC and MTN programs, transactions involving "repackaging"
of outstanding securities and other cases, FSA's premium may be arbitrage-based,
equaling the difference between the effective borrowing cost at a Triple-A rate
and the interest rate on the underlying securities.

In the case of new issues, the insured obligations are sold with FSA
insurance at the time the obligations are issued. For both municipal and
asset-backed obligations, FSA participates in negotiated offerings, where the
investment banker and often the insurer have been selected by the sponsor or
issuer. In addition, FSA participates in competitive offerings, where
underwriting syndicates bid for securities and submit bids that may include
insurance.

In the secondary market, FSA's Triple-A Guaranteed Secondary Securities
(TAGSS(R)) Program provides insurance for uninsured asset-backed obligations
trading in the secondary market. Likewise, FSA's Custody Receipt Program
provides insurance for uninsured municipal obligations trading in the secondary
market. The insurance of obligations outstanding in the secondary market
generally affords a wider secondary market and therefore greater marketability
to a given issue of previously issued obligations. FSA's underwriting guidelines
require the same underwriting standards on secondary market issues as on new
security issues, although the evaluation procedures are typically abbreviated.

FSA insures payment obligations of counterparties and issuers under GICs,
GIC equivalents, credit-linked notes and obligations under interest rate,
currency and credit default swaps. FSA also issues surety bonds under its
Sure-Bid(R) program, which provides an alternative to traditional types of good
faith deposits on competitive municipal bond transactions.

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The following table indicates the percentages of par amount (net of
reinsurance) outstanding at December 31, 2001 and 2000 with respect to each type
of asset-backed and municipal program:

NET PAR AMOUNT AND PERCENTAGE OUTSTANDING BY PROGRAM TYPE

- ----------
(1) Excludes $1,253 million and $327 million net par amount outstanding
assumed by FSA under reinsurance agreements at December 31, 2001 and 2000,
respectively.
(2) Excludes $803 million and $823 million net par amount outstanding assumed
by FSA under reinsurance agreements at December 31, 2001 and 2000,
respectively.

INSURANCE IN FORCE

FSA insures a variety of asset-backed obligations, including obligations
backed by residential mortgage loans, consumer or trade receivables, corporate
bonds, government debt and multifamily mortgage loans. Asset-backed obligations
insured by FSA include payment obligations of counterparties and issuers under
synthetic obligations such as credit default swaps and credit-linked notes
structured to have risks similar to more traditional forms of asset-backed
structures. FSA has insured a broad array of municipal obligations. FSA has also
insured investor-owned utility first mortgage bonds and sale/leaseback
obligation bonds. In 1990, FSA ceased writing insurance backed by commercial
mortgage loans, and today retains only minor net insurance in force in that
sector. FSA has also insured obligations of financial institutions and, on a
short-term basis, obligations of highly rated corporate obligors. In recent
years, FSA has insured obligations in connection with various cross-border and
municipal leases. In 2001, FSA implemented a program of insured credit default
swaps, up to a maximum notional amount of $1.0 billion, on a diversified pool of
individual investment grade corporate obligors, with first loss credit
protection provided by a combination of (a) fees generated by issuing credit
default swaps and (b) a first loss credit default swap provided by the Company.
This program represented an expansion by the Company into a business similar to
traditional insurance, in which fee/premium income is intended to cover expected
losses. The Company expects to explore similar opportunities on a selective
basis, when premiums and related fees are sufficient to provide an investment
grade level of protection to FSA.

FSA has selectively expanded its insured portfolio in a manner intended to
achieve diversification. At December 31, 2001, FSA and its subsidiaries had in
force policies relating to 795 issues insuring approximately $133.2 billion in
gross direct par amount outstanding of asset-backed obligations and 6,642 issues
insuring approximately $157.1 billion in gross direct par amount outstanding of
municipal obligations. In addition, at December 31, 2001 FSA had assumed
pursuant to certain reinsurance contracts approximately $1.3 billion and $0.9
billion in par amount outstanding on asset-backed and municipal obligations,
respectively, resulting in a total gross par amount outstanding of approximately
$292.5 billion. At such date, the total net par amount outstanding,

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determined by reducing the gross par amount outstanding to reflect reinsurance
ceded of approximately $75.4 billion, was approximately $217.1 billion. Net par
data does not distinguish between quota share and first loss reinsurance. In
light of FSA's substantial use of first loss reinsurance in the asset-backed
sector, net par data tends to overstate FSA's net risk exposure. At December 31,
2001, the weighted average life of the direct principal insured on these
policies was approximately 4 and 13 years, respectively, for asset-backed and
municipal obligations.

ASSET-BACKED OBLIGATIONS

FSA's insured portfolio of asset-backed obligations is divided into six
major categories:

DOMESTIC RESIDENTIAL MORTGAGE LOANS. Obligations primarily backed by
residential mortgage loans generally take the form of conventional pass-through
certificates or pay-through debt securities, but also include other structured
products. Residential mortgage loans backing these insured obligations include
closed-end first mortgage loans and closed- and open-end second mortgage loans
or home equity loans on one-to-four family residential properties, including
condominiums and cooperative apartments. Domestic residential mortgage loan
obligations insured by FSA have tended to be concentrated in the "sub-prime"
sector, featuring lower quality borrowers mitigated by higher levels of
subordination and/or excess spread. FSA has generally declined to participate in
securitizations of so-called "high cost mortgage loans," characterized by very
high interest rates and subject to restrictive federal and state regulations.

DOMESTIC CONSUMER RECEIVABLES. Obligations primarily backed by consumer
receivables include conventional pass-through and pay-through securities as well
as more highly structured transactions. Consumer receivables backing these
insured obligations include automobile loans and leases, manufactured housing
loans and credit card receivables. Consumer receivable transactions insured by
FSA have tended to be concentrated in the sub-prime auto loan and credit card
receivable sectors.

DOMESTIC POOLED CORPORATE OBLIGATIONS. Obligations primarily backed by
pooled corporate obligations include funded and synthetic obligations
collateralized by corporate debt securities or corporate loans and obligations
backed by cash flow or market value of non-consumer indebtedness, and include
"collateralized bond obligations", "collateralized loan obligations"
(collectively, "collateralized debt obligations" or "CDOs") and comparable risks
under credit default swap obligations. Corporate obligations include corporate
bonds, bank loan participations, trade receivables, franchise loans and equity
securities. Obligations under credit default swaps represent a growing
percentage of this sector, comprising approximately 58% of this sector at
December 31, 2001 on the basis of net par outstanding. Credit default swap
obligations expose FSA to elements of market value risk arising from obligations
to pay the difference between par and market value upon the occurrence of a
payment default or other defined "credit event" specified in the credit default
swap. FSA generally addresses these risks by requiring large "deductibles" as a
condition to payment under credit default swaps insured by FSA.

DOMESTIC INVESTOR-OWNED UTILITY OBLIGATIONS. Obligations primarily backed
by investor-owned utilities include, most commonly, first mortgage bond
obligations of for-profit electric or water utilities providing retail,
industrial and commercial service, and also include sale-leaseback obligation
bonds supported by such entities. In each case, these bonds are secured by a
mortgage on property owned by or leased to an investor-owned utility.

OTHER DOMESTIC ASSET-BACKED OBLIGATIONS. Other domestic asset-backed
obligations insured by FSA include bonds or other securities backed by
government securities, letters of credit or repurchase agreements collateralized
by government securities, securities backed by a combination of assets that
include elements of more than one of the categories set forth above and
unsecured corporate obligations satisfying FSA's underwriting criteria.

INTERNATIONAL ASSET-BACKED OBLIGATIONS. International asset-backed
obligations include obligations of non-domestic funded and synthetic
collateralized debt obligations, securitizations of perpetual floating rate
notes of non-domestic banks, obligations of non-domestic investor owned
utilities and other obligations having international aspects but otherwise
within the asset-backed categories described above.

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MUNICIPAL OBLIGATIONS

FSA's insured portfolio of municipal obligations is divided into eight
major categories:

DOMESTIC GENERAL OBLIGATION BONDS. General obligation bonds are issued by
states, their political subdivisions and other municipal issuers, and are
supported by the general obligation of the issuer to pay from available funds
and by a pledge of the issuer to levy taxes sufficient in an amount to provide
for the full payment of the bonds to the extent other available funds are
insufficient.

DOMESTIC HOUSING REVENUE BONDS. Housing revenue bonds include both
multifamily and single family housing bonds, with multi-tiered security
structures based on the underlying mortgages, reserve funds, and various other
features such as Federal Housing Administration or private mortgage insurance,
bank letters of credit, first loss guaranties, and, in some cases, the general
obligation of the issuing housing agency or a state's "moral obligation" (that
is, not a legally binding commitment) to make up deficiencies.

DOMESTIC MUNICIPAL UTILITY REVENUE BONDS. Municipal utility revenue bonds
include obligations of all forms of municipal utilities, including electric,
water and sewer utilities. Insurable utilities may be organized as municipal
enterprise systems, authorities or joint-action agencies.

DOMESTIC HEALTH CARE REVENUE BONDS. Health care revenue bonds include both
long-term maturities for capital construction or improvements of health care
facilities and medium-term maturities for equipment purchase, and include both
secured and unsecured obligations of individual hospitals and health care
systems.

DOMESTIC TAX-SUPPORTED (NON-GENERAL OBLIGATION) BONDS. Tax-supported
(non-general obligation) bonds include a variety of bonds that, though not
general obligations, are supported by the taxing ability of the issuer, such as
tax-backed revenue bonds and lease revenue bonds. Tax-backed revenue bonds may
be secured by a first lien on pledged tax revenues, such as those from special
taxes, including those on retail sales and gasoline, or from tax increments (or
tax allocations) generated by growth in property values within a district. FSA
also insures bonds secured by special assessments, levied against property
owners, which benefit from covenants by the district to levy, collect and
enforce collections and to foreclose on delinquent properties. Lease revenue
bonds or certificates of participation (COPs) may be secured by long-term
obligations or by lease obligations subject to annual appropriation. The
financed project is generally real property or equipment that, in the case of
annual appropriation leases, FSA deems to serve an essential public purpose
(e.g., schools, prisons, courts) or, in the case of long-term leases, is
insulated from the risk of abatement resulting from nontenantability.

DOMESTIC TRANSPORTATION REVENUE BONDS. Transportation revenue bonds
include a wide variety of revenue-supported bonds, such as bonds for airports,
ports, tunnels, parking facilities, toll roads and toll bridges.

OTHER DOMESTIC MUNICIPAL BONDS. Other domestic municipal bonds insured by
FSA include college and university revenue bonds, moral obligation bonds,
financings for stadiums, resource recovery bonds and debt issued, guarantied or
otherwise supported by domestic national or local governmental entities.

INTERNATIONAL MUNICIPAL OBLIGATIONS. International municipal obligations
include obligations of sovereign and sub-sovereign non-domestic municipal
issuers, project finance transactions involving projects leased to or supported
by payments from non-domestic governmental or quasi-governmental entities,
obligations arising under leases of equipment or facilities by non-domestic
municipal obligors, non-domestic municipal utility revenue bonds and other
obligations having international aspects but otherwise within the municipal
categories described above.

10

A summary of FSA's insured portfolio at December 31, 2001 is shown below.
Please note that exposure amounts are expressed net of reinsurance but do not
distinguish between quota share reinsurance and first loss reinsurance. In
recent years, FSA has tended to employ quota share reinsurance in the municipal
sector and first loss reinsurance in the asset-backed sector.

SUMMARY OF INSURED PORTFOLIO AT DECEMBER 31, 2001

(1) Includes 795 asset-backed issues and 6,642 municipal issues directly insured
by FSA with the balance having been assumed by FSA under reinsurance contracts.

11

OBLIGATION TYPE

The table below sets forth the relative percentages of net par amount
written of obligations insured by FSA by obligation type during each of the last
five years:

ANNUAL NEW BUSINESS INSURED BY OBLIGATION TYPE

(1) Percentages of 0 represent amounts that are less than .5% of the total.

TERMS TO MATURITY

The table below sets forth the estimated terms to maturity of FSA's
policies at December 31, 2001 and 2000:

ESTIMATED TERMS TO MATURITY OF NET PAR OF INSURED OBLIGATIONS(1)

- ----------
(1) Based on estimates made by the issuers of the insured obligations as of
the original issuance dates of such obligations. Actual maturities could
differ from contractual maturities because borrowers have the right to
call or prepay certain obligations with or without call or prepayment
penalties.

12

ISSUE SIZE

The tables below set forth information with respect to the original net
par amount of insurance written per issue insured by FSA at December 31, 2001:

ASSET-BACKED -- ORIGINAL NET PAR AMOUNT PER ISSUE(1)

- ----------
(1) Excludes $1,253 million net par amount outstanding assumed by FSA and its
subsidiaries under reinsurance agreements.

MUNICIPAL -- ORIGINAL NET PAR AMOUNT PER ISSUE(1)

- ----------
(1) Excludes $803 million net par amount outstanding assumed by FSA and its
subsidiaries under reinsurance agreements.

GEOGRAPHIC CONCENTRATION

In its asset-backed business, FSA considers geographic concentration as a
factor in underwriting insurance covering securitizations of asset pools such as
residential mortgage loans or consumer receivables. However, after the initial
issuance of an insurance policy relating to such securitizations, the geographic
concentration of the underlying assets may change over the life of the policy.
In addition, in writing insurance for other types of asset-backed obligations,
such as securities primarily backed by government or corporate debt, geographic
concentration is not considered to be a significant credit factor given other
more relevant measures of diversification such as issuer or industry
diversification.

13

FSA seeks to maintain a diversified portfolio of insured municipal
obligations designed to spread its risk across a number of geographic areas. The
table below sets forth those jurisdictions in which municipalities issued an
aggregate of 2% or more of FSA's net par amount outstanding of insured municipal
securities:

MUNICIPAL INSURED PORTFOLIO BY JURISDICTION
AT DECEMBER 31, 2001

ISSUER CONCENTRATION

FSA has adopted underwriting and exposure management policies designed to
limit the net par insured or net retained credit gap for any one credit. Credit
gap is a concept employed by Standard & Poor's Ratings Services ("S&P") to
measure the at-risk amount (worst case risk) on an insured exposure. FSA has
also established procedures to ensure compliance with regulatory single-risk
limits applicable to bonds insured by it. In many cases, FSA uses reinsurance to
limit net exposure to any one credit. At December 31, 2001, insurance of
asset-backed obligations constituted 51.4% of FSA's net par outstanding and
insurance of municipal obligations constituted 48.6% of FSA's net par
outstanding. At such date, FSA's ten largest net insured asset-backed
transactions represented $16.2 billion, or 7.5%, of its total net par amount
outstanding, and FSA's ten largest net insured municipal credits represented
$6.8 billion, or 3.1%, of its total net par amount outstanding. In light of
FSA's substantial use of first loss reinsurance in the asset-backed sector, net
par data tends to overstate FSA's net risk exposure. For purposes of the
foregoing, different issues of asset-backed securities by the same sponsor have
not been aggregated. FSA has, however, adopted underwriting policies
establishing single risk guidelines applicable to asset-backed securities of the
same sponsor. In addition, individual corporate names appear in FSA-insured CDO
transactions, but such exposures are not aggregated for purposes of identifying
FSA's largest exposures. Instead, FSA addresses these risks by limiting its
exposure to the CDO sector in the aggregate. FSA is also subject to regulatory
limits and rating agency guidelines on exposures to single credits.

CREDIT UNDERWRITING GUIDELINES, STANDARDS AND PROCEDURES

Financial guaranty insurance written by FSA generally relies on an
assessment of the adequacy of various payment sources to meet debt service or
other obligations in a specific transaction without regard to premiums paid or
income from investment of premiums. FSA's underwriting policy is to insure
asset-backed and municipal obligations that it determines are investment grade
without the benefit of FSA's insurance. To this end, each policy written or
reinsured by FSA is designed to meet the general underwriting guidelines and
specific standards for particular types of obligations approved by its Board of
Directors. In addition, the Company's Board of Directors

14

has established an Underwriting Committee which periodically reviews completed
transactions to ensure conformity with underwriting guidelines and standards.

FSA's underwriting guidelines for asset-backed obligations are premised on
the concept of multiple layers of protection, and vary by obligation type in
order to reflect different structures and credit support. In this regard,
asset-backed obligations insured by FSA are generally issued in structured
transactions and backed by pools of assets such as consumer or trade
receivables, residential mortgage loans, securities or other assets having an
ascertainable cash flow or market value. In addition, FSA seeks to insure
asset-backed obligations that generally provide for one or more forms of
overcollateralization (such as excess collateral value, excess cash flow or
"spread," reserves or, in the case of credit default swaps, a deductible) or
third-party protection (such as bank letters of credit, guarantees, net worth
maintenance agreements, indemnity agreements or reinsurance agreements). This
overcollateralization or third-party protection need not indemnify FSA against
all loss, but is generally intended to assume the primary risk of financial
loss. Asset-backed obligations insured by FSA also often benefit from
self-adjusting mechanisms, such as cash traps or accelerated amortization that
take effect upon a failure of the transaction to satisfy performance based
triggers. Overcollateralization or third-party protection may not be required in
transactions in which FSA is insuring the obligations of certain highly rated
issuers that typically are regulated, have implied or explicit government
support, or are short term, or in transactions in which FSA is insuring bonds
issued to refinance other bonds insured by FSA as to which the issuer is or may
be in default. FSA's general policy has been to insure 100% of the principal,
interest and other amounts due in respect of funded asset-backed obligations
rather than providing partial or first loss coverage sufficient to confer a
Triple-A rating on the insured obligations.

FSA's underwriting guidelines for municipal obligations require that the
transaction be rated investment grade by Moody's Investors Service, Inc.
("Moody's") or S&P or, in the alternative, such obligor is considered by FSA to
be the equivalent of investment grade. Where the municipal obligor is a
governmental entity with taxing power or providing an essential public service
paid by taxes, assessments or other charges, supplemental protections may be
required if such taxes, assessments or other charges are not projected to
provide sufficient debt service coverage. Where appropriate, the municipal
obligor may be required to provide a rate covenant and a pledge of additional
security (e.g., mortgages on real property, liens on equipment or revenue
pledges) to secure the obligation.

The rating agencies participate to varying degrees in the underwriting
process. Each asset-backed obligation insured by FSA is reviewed prior to
issuance by both S&P and Moody's to evaluate the risk proposed to be insured. In
the case of municipal obligations, prior rating agency review is a function of
the type of insured obligation and the risk elements involved. In addition,
transactions insured by FSA are generally reviewed by at least one of the major
rating agencies after issuance to confirm continuing compliance with rating
agency standards. The independent review of FSA's underwriting practices
performed by the rating agencies further strengthens the underwriting process.

The underwriting process that implements these underwriting guidelines and
standards is supported by FSA's professional staff of analysts, underwriting
officers, credit officers and attorneys. Moreover, the approval of senior
management is required for all transactions.

Each underwriting group in the Financial Guaranty Department has a senior
underwriting officer responsible for confirming that each transaction proposed
by the Financial Guaranty Department conforms to the underwriting guidelines and
standards. This evaluation is reviewed by the chief underwriting officer for the
particular sector. This review may take place while the transaction is in its
formative stages, thus facilitating the introduction of further enhancements at
a stage when the transaction is more receptive to change.

Final transaction approval is obtained from FSA's Management Review
Committee (the "MRC") for asset-backed transactions and from FSA's Municipal
Underwriting Committee (the "MUNC") for municipal transactions. Approval is
usually based upon both a written and an oral presentation by the underwriting
group to the respective committee. The MRC is comprised of FSA's Chairman,
President, Chief Underwriting Officer, Chief International Underwriting Officer,
General Counsel, Associate General Counsel for Asset-Backed Transactions and a
senior underwriting officer. The Chairman, President and General Counsel do not
participate in MRC meetings for transactions not classified as presenting new
issues. The MUNC is comprised of FSA's Chairman, President, Chief Municipal
Underwriting Officer, Managing Director of Public Finance, Associate General
Counsel for Municipal Transactions and Managing Director for Municipal
Oversight. Following approval, minor transaction modifications

15

may be approved by the Chairs of the underwriting groups. Major changes require
the concurrence of the appropriate underwriting committee. Subject to applicable
limits, secondary market and portions of senior classes of asset-backed
transactions that meet certain credit and return criteria may be approved by one
member of FSA's Risk Management Group and the head of the department involved,
with a third signature required from a member of the Risk Management Group for
larger transactions. Subject to applicable limits, municipal transactions that
meet certain credit and return criteria may be approved by a committee comprised
of the Chief Municipal Underwriting Officer or the Managing Director for
Municipal Oversight, or Associate General Counsel for Municipal Transactions and
any one of certain managing directors and directors designated by the MUNC.

Corporate Research

FSA's Corporate Research Department is comprised of a professional staff
under the direction of the Chief Underwriting Officer. The Corporate Research
Department is responsible for evaluating the credit of entities participating or
providing recourse on obligations insured by FSA. The Corporate Research
Department also provides analysis of industry segments. Members of the Corporate
Research Department generally report their findings directly to the appropriate
underwriting committee in the context of transaction review and approval.

Transaction Oversight and Transaction Services

FSA's Transaction Oversight Departments and TSC are independent of the
analysts and credit officers involved in the underwriting process. The
Asset-Backed and Municipal Transaction Oversight Departments are responsible for
monitoring the performance of outstanding transactions. TSC, together with the
Transaction Oversight Departments, is responsible for taking remedial actions as
appropriate. The managing directors responsible for the transaction oversight
and transaction services functions report to the Chief Underwriting Officer and
Chief Municipal Underwriting Officer. This function also reports to a Risk
Management Committee comprised of FSA's Chief Underwriting Officer, Chief
Municipal Underwriting Officer, Chief International Underwriting Officer and a
senior underwriting officer, with FSA's Chairman, President, General Counsel and
Chief Financial Officer as ex officio members. The Transaction Oversight
Departments review insured transactions to confirm compliance with transaction
covenants, monitor credit and other developments affecting transaction
participants and collateral, and determine the steps, if any, required to
protect the interests of FSA and the holders of FSA-insured obligations. Reviews
for asset-backed transactions typically include an examination of reports
provided by, and (as circumstances warrant) discussions with, issuers,
servicers, trustees and other transaction participants. Reviews of asset-backed
transactions often include servicer audits, site visits or evaluations by
third-party appraisers, engineers or other experts retained by FSA. The
Transaction Oversight Departments review each transaction to determine the level
of ongoing attention it will require. These judgments relate to current credit
quality and other factors, including compliance with reporting or other
requirements, legal or regulatory actions involving transaction participants and
liquidity or other concerns that may not have a direct bearing on credit
quality. Transactions with the highest risk profile are generally subject to
more intensive review and, if appropriate, remedial action. The Transaction
Oversight Departments and TSC work together with the Legal Department and the
Corporate Research Department in monitoring these transactions, negotiating
restructurings and pursuing appropriate legal remedies.

Legal

FSA's Legal Department is comprised of a professional staff of attorneys
and legal assistants under the direction of the General Counsel. FSA's Legal
Department is divided into three sectors (asset-backed transactions, municipal
transactions and regulatory/reinsurance/corporate), each managed by an Associate
General Counsel. The Legal Department plays a major role in establishing and
implementing legal requirements and procedures applicable to obligations insured
by FSA. Members of the Legal Department serve on the MRC and the MUNC, which
provide final underwriting approval for transactions. An attorney in the Legal
Department works together with a counterpart in the Financial Guaranty
Department in determining the legal and credit elements of each obligation
proposed for insurance and in overseeing the execution of approved transactions.
Asset-backed obligations insured by FSA are ordinarily executed with the
assistance of outside counsel working closely with the Legal Department.
Municipal obligations insured by FSA are ordinarily executed without employment
of outside counsel. The Legal Department works closely with the transaction
oversight and transaction services functions in addressing legal issues, rights
and remedies, as well as proposed amendments, waivers and consents, in
connection with obligations insured by FSA.

16

The Legal Department is also responsible for domestic and international
regulatory compliance, reinsurance, secondary market transactions, litigation
and other matters.

LOSS RESERVES

FSA establishes a case basis reserve for the net present value of an
estimated loss 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. A case basis reserve represents FSA's estimate of the present value
of the anticipated shortfall, net of reinsurance, between (i) scheduled payments
on the insured obligations plus anticipated loss adjustment expenses and (ii)
anticipated cash flow from and proceeds to be received on sales of any
collateral supporting the obligation and other anticipated recoveries. FSA
maintains reserves in an amount believed by its management to be sufficient to
pay the net present value of its estimated ultimate liability for losses and
loss adjustment expenses with respect to obligations it has insured.

In addition to its case basis reserves, FSA maintains a non-specific
general reserve in order to account for unidentified risks inherent in its
overall portfolio, that is, when the loss cannot be attributed to a particular
insured obligation. FSA does not consider traditional actuarial approaches used
in the property/casualty insurance industry to be applicable to the
determination of its loss reserves because of the absence of a sufficient number
of losses in its financial guaranty insurance activities and in the financial
guaranty industry generally to establish a meaningful statistical base. The
general reserve amount is calculated by applying a loss factor to the total net
par amount of FSA's insured obligations outstanding over the term of such
insured obligations and discounting the result at the then current risk-free
rate. The loss factor used for this purpose has been determined based upon an
independent rating agency study of bond defaults and FSA's portfolio
characteristics and history. FSA monitors the general reserve on an ongoing
basis, and may periodically adjust such reserve based on FSA's actual loss
experience, its future mix of business and future economic conditions. The
general reserve is available to be applied against future additions or
accretions to existing case basis reserves or to new case basis reserves to be
established in the future. To the extent that any such future additions to case
basis reserves are applied from the available general reserve, there will be no
impact on the Company's earnings for that period. To the extent that additions
to case basis reserves for any period exceed the remaining available general
reserve or are not applied from the general reserve, the excess will be charged
against the Company's earnings for that period. Any addition to the general
reserve which results from applying the loss factor to new par written will
result in a charge to earnings at that time.

Activity in the liability for losses and loss adjustment expenses,
consisting of case basis and general reserves, is summarized as follows:

During 1999, the Company increased its general reserve by $8.8 million,
of which $8.6 million was for originations of new business and $0.2 million was
for the replenishment of the general reserve. Also during 1999, the Company
transferred to the general reserve $3.5 million representing recoveries received
on prior year

17

transactions and transferred $4.6 million from the general reserve to the case
basis reserves. Giving effect to these transfers, the general reserve totaled
$55.0 million at December 31, 1999.

During 2000, the Company increased its general reserve by $9.4 million, of
which $6.7 million was for originations of new business and $2.7 million was for
the accretion of the discount on prior years' reserves. Also during 2000, the
Company transferred to the general reserve $2.0 million representing recoveries
received on prior-year transactions and transferred $1.2 million from the
general reserve to case basis reserves. Giving effect to these transfers, the
general reserve totaled $65.2 million at December 31, 2000.

During 2001, the Company increased its general reserve by $12.5 million,
of which $8.2 million was for originations of new business and $4.3 million was
for the accretion of the discount on prior years' reserves. Also during 2001,
the Company transferred to the general reserve $0.1 million representing
recoveries received on prior-year transactions and transferred $8.7 million from
the general reserve to case basis reserves. Giving effect to these transfers,
the general reserve totaled $69.1 million at December 31, 2001.

Reserves for losses and loss adjustment expenses are discounted at the
then current risk-free rates for the general reserve and at rates between 5.79%
and 6.1% for case basis reserves. The amount of discount taken was approximately
$29.6 million, $28.7 million and $31.1 million at December 31, 2001, 2000 and
1999, respectively.

Since reserves are necessarily based on estimates and because of the
absence of a sufficient number of losses in its financial guaranty insurance
activities and in the financial guaranty insurance industry generally to
establish a meaningful statistical base, there can be no assurance that the case
basis reserves or the general reserve will be adequate to cover losses in FSA's
insured portfolio.

COMPETITION AND INDUSTRY CONCENTRATION

FSA faces competition from both other providers of third party credit
enhancement and alternatives to third party credit enhancement. The majority of
asset-backed and municipal obligations are sold without third party credit
enhancement. Accordingly, each transaction proposed to be insured by FSA must
generally compete against an alternative execution which does not employ third
party credit enhancement. FSA also faces competition from other monoline
financial guaranty insurers, primarily Ambac Assurance Corp. ("Ambac"),
Financial Guaranty Insurance Company ("FGIC"), MBIA Insurance Corp. ("MBIA") and
XL Capital Assurance Inc. Potential new entrants to the market, including
CDC-IXIS Financial Guaranty, that may provide significant competition to FSA are
in the planning stages. Traditional credit enhancers such as bank letter of
credit providers and mortgage pool insurers also provide significant competition
to FSA as providers of credit enhancement for asset-backed obligations. While
actions by securities rating agencies in recent years have significantly reduced
the number of Triple-A rated financial institutions that can offer a product
directly competitive with FSA's Triple-A guaranty, and risk-based capital
guidelines applicable to banks have generally increased costs associated with
letters of credit that compete directly with financial guaranty insurance, bank
sponsored commercial paper conduits, bank letter of credit providers and other
credit enhancement, such as cash collateral accounts, provided by banks,
continue to provide significant competition to FSA. In addition, credit default
swaps, credit-linked notes and other synthetic products provide coverage
directly competitive with financial guaranty insurance, and expand the universe
of participants in the financial risk market. Recent legislation may facilitate
the direct participation by bank affiliates in the U.S. insurance business,
including the financial guaranty insurance business. In addition, government
sponsored entities, including FNMA and Freddie Mac, compete with the monoline
financial guaranty insurers, on a limited basis, in the mortgage-backed and
multifamily sectors.

Insurance law generally restricts multiline insurance companies, such as
large property/casualty insurers and life insurers, from engaging in the
financial guaranty insurance business other than through separately capitalized
affiliates. Entry requirements include (i) assembling the group of experts
required to operate a financial guaranty insurance business, (ii) establishing
the Triple-A claims-paying ability ratings with the credit rating agencies,
(iii) complying with substantial capital requirements, (iv) developing name
recognition and market acceptance with issuers, investment bankers and investors
and (v) organizing a monoline insurance company and obtaining insurance licenses
to do business in the applicable jurisdictions.

18

FSA's net insurance in force is the outstanding principal, interest and
other amounts to be paid over the remaining life of all obligations insured by
FSA, net of ceded reinsurance and refunded bonds secured by United States
government securities held in escrow or other qualified collateral. Qualified
statutory capital, determined in accordance with statutory accounting practices,
is the aggregate of policyholders' surplus and contingency reserves calculated
in accordance with statutory accounting practices. Set forth below are FSA's
aggregate gross insurance in force, net insurance in force, qualified statutory
capital and leverage ratio (represented by the ratio of its net insurance in
force to qualified statutory capital) and the average industry leverage ratio at
the dates indicated. Net insurance data does not distinguish between quota share
reinsurance and first loss reinsurance. In light of FSA's substantial use of
first loss reinsurance in the asset-backed sector, the data below tends to
overstate FSA's risk leverage in comparison to its industry counterparts.

- ----------
(1) Financial guaranty primary insurers for which data is included in this
table are Ambac, FGIC and MBIA. Information relating to the financial
guaranty primary insurers is derived from data from statutory accounting
financial information publicly available from each insurer at December 31,
2000 and 1999.
(2) Not available.

REINSURANCE

Reinsurance is the commitment by one insurance company, the "reinsurer,"
to reimburse another insurance company, the "ceding company," for a specified
portion of the insurance risks underwritten by the ceding company in
consideration for a portion of the premiums received. The ceding company
typically but not always receives ceding commissions to cover costs of business
generation. Because the insured party contracts for coverage solely with the
ceding company, the failure of the reinsurer to perform does not relieve the
ceding company of its obligation to the insured party under the terms of the
insurance contract.

FSA obtains reinsurance to increase its policy writing capacity, both on
an aggregate-risk and a single-risk basis, to meet rating agency, internal and
state insurance regulatory limits; to diversify risks; to reduce the need for
additional capital; and to strengthen financial ratios. At December 31, 2001,
FSA had reinsured approximately 26.0% of its direct principal amount
outstanding. Most of FSA's reinsurance is on a quota share or first-loss basis,
with a small portion being provided on an excess of loss basis. Reinsurance
arrangements typically require FSA to retain a minimum portion of the risks
reinsured.

FSA arranges reinsurance on both a facultative
(transaction-by-transaction) and treaty basis. Treaty reinsurance provides
coverage for a portion of the exposure from all qualifying policies issued
during the term of the treaty. In addition, FSA employs "automatic facultative"
reinsurance which permits FSA to apply reinsurance to transactions selected by
it subject to certain limitations. The reinsurer's participation in a treaty is
either cancelable annually upon 90 days' prior notice by either FSA or the
reinsurer or has a one-year term. Treaties generally provide coverage for the
full term of the policies reinsured during the annual treaty period, except
that, upon a financial deterioration of the reinsurer and the occurrence of
certain other conditions, FSA generally has the right to reassume all of the
business reinsured. As required by applicable state law, reinsurance agreements
may be subject to certain other termination conditions.

Primary insurers, such as FSA, are required to fulfill their obligations
to policyholders if reinsurers fail to meet their obligations. The financial
condition of reinsurers is important to FSA, and FSA endeavors to place its

19

reinsurance with financially strong reinsurers. FSA's treaty reinsurers at
December 31, 2001 were American Re-insurance Company, AXA Reassurance S.A., ACE
Guaranty Re Inc., Radian Reinsurance Inc. (formerly Enhance Reinsurance
Company), RAM Reinsurance Co. Ltd., Swiss Reinsurance Company, Tokio Marine and
XLFA.

FSA, FSAIC and FSA International are party to a quota share reinsurance
pooling agreement pursuant to which, after reinsurance cessions to other
reinsurers, the FSA companies share in the net retained risk insured by each of
these companies. Under the pooling agreement, FSA, FSAIC and FSA International
share the net retained risk in proportion to their policyholders' surplus and
contingency reserve ("Statutory Capital") at the end of the prior calendar
quarter. FSA-UK and FSA are party to a quota share and stop loss reinsurance
agreement pursuant to which (i) FSA-UK reinsures with FSA its retention under
its policies after third party reinsurance based on an agreed-upon percentage
that is substantially in proportion to the Statutory Capital of FSA-UK to the
total Statutory Capital of FSA and its subsidiary insurers (including FSA-UK)
and (ii) subject to certain limits, FSA is required to make payments to FSA-UK
when FSA-UK's combined loss and expense ratio exceeds 100%. Under this
agreement, FSA-UK ceded to FSA approximately 98% of its retention after other
reinsurance of its policies issued in 2001.

RATING AGENCIES

The value of the insurance product sold by FSA is generally a function of
the "rating" applied to obligations insured by FSA. The insurance financial
strength, insurer financial strength and claims-paying ability, as the case may
be, of FSA and its operating insurance company subsidiaries is rated "Aaa" by
Moody's and "AAA" by S&P, Fitch Ratings and Rating and Investment Information,
Inc. Such ratings reflect only the views of the respective rating agencies, are
not recommendations to buy, sell or hold securities and are subject to revision
or withdrawal at any time by such rating agencies. These rating agencies
periodically review the business and financial condition of FSA, focusing on the
insurer's underwriting policies and procedures and the quality of the
obligations insured. Each rating agency performs periodic assessments of the
credits insured by FSA, and the reinsurers and other providers of capital
support to FSA, to confirm that FSA continues to satisfy such rating agency's
capital adequacy criteria necessary to maintain FSA's Triple-A rating. See
"Credit Underwriting Guidelines, Standards and Procedures" above. FSA's ability
to compete with other Triple-A rated financial guarantors, and its results of
operations and financial condition, would be materially adversely affected by
any reduction in its ratings.

INSURANCE REGULATORY MATTERS

General

FSA is licensed to engage in insurance business in all 50 states, the
District of Columbia, Guam, Puerto Rico and the U.S. Virgin Islands. FSA is
subject to the insurance laws of the State of New York (the "New York Insurance
Law"), and is also subject to the insurance laws of the other states in which it
is licensed to transact insurance business. FSAIC is an Oklahoma domiciled
insurance company also licensed in New York and subject to the New York
Insurance Law. FSA and its domestic insurance company subsidiary are required to
file quarterly and annual statutory financial statements in each jurisdiction in
which they are licensed, and are subject to statutory restrictions concerning
the types and quality of investments and the filing and use of policy forms and
premium rates. FSA's accounts and operations are subject to periodic examination
by the Superintendent of Insurance of the State of New York (the "New York
Superintendent") (the last such examination having been conducted in 2000 for
the period ended December 31, 1999) and other state insurance regulatory
authorities.

FSA International is a Bermuda domiciled insurance company subject to
applicable requirements of Bermuda law. FSA International maintains its
principal executive offices in Hamilton, Bermuda. FSA International does not
intend to transact business or establish a permanent place of business in the
United States or Europe. FSA-UK is a United Kingdom domiciled insurance company
subject to applicable requirements of English law. FSA-UK maintains its
principal executive offices in London, England. Pursuant to European Union
Directives, FSA-UK is generally authorized to write business out of its London
office in other member countries of the European Union subject to the
satisfaction of perfunctory registration requirements. FSA has a Singapore
branch authorized to transact insurance business in Singapore and subject to
regulation by Singapore authorities.

20

Domestic Insurance Holding Company Laws

The Company and its domestic insurance company subsidiaries (FSA and
FSAIC) are subject to regulation under insurance holding company statutes of New
York and Oklahoma, where these insurers are domiciled, as well as other
jurisdictions where these insurers are licensed to do insurance business. The
requirements of holding company statutes vary from jurisdiction to jurisdiction
but generally require insurance holding companies and their insurance company
subsidiaries to register and file certain reports describing, among other
information, their capital structure, ownership and financial condition. The
holding company statutes also require prior approval of changes in control,
certain dividends and other intercorporate transfers of assets and transactions
between insurance companies and their affiliates. The holding company statutes
generally require that all transactions with affiliates be fair and reasonable
and that those exceeding specified limits require prior notice to or approval by
insurance regulators.

Under the insurance holding company laws in effect in New York and
Oklahoma, any acquisition of control of the Company, and thereby indirect
control of FSA and FSAIC, requires the prior approval of the New York
Superintendent and the Oklahoma Insurance Commissioner. "Control" is defined as
the direct or indirect power to direct or cause the direction of the management
and policies of a person, whether through the ownership of voting securities, by
contract or otherwise. Any purchaser of 10% or more of the outstanding voting
securities of a corporation is presumed to have acquired control of that
corporation and its subsidiaries, although the insurance regulator may find that
"control" in fact does or does not exist when a person owns or controls either a
lesser or greater amount of voting securities.

New York Financial Guaranty Insurance Law

Article 69 of the New York Insurance Law ("Article 69"), a comprehensive
financial guaranty insurance statute, governs all financial guaranty insurers
licensed to do business in New York, including FSA. This statute limits the
business of financial guaranty insurers to financial guaranty insurance and
related lines (such as surety).

Article 69 requires that financial guaranty insurers maintain a special
statutory accounting reserve called the "contingency reserve" to protect
policyholders against the impact of excessive losses occurring during adverse
economic cycles. Article 69 requires a financial guaranty insurer to provide a
contingency reserve (i) with respect to policies written prior to July 1, 1989
in an amount equal to 50% of earned premiums and (ii) with respect to policies
written on and after July 1, 1989, quarterly on a pro rata basis over a period
of 20 years for municipal bonds and 15 years for all other obligations, in an
amount equal to the greater of 50% of premiums written for the relevant category
of insurance or a percentage of the principal guarantied, varying from 0.55% to
2.50%, depending upon the type of obligation guarantied, until the contingency
reserve amount for the category equals the applicable percentage of net unpaid
principal. This reserve must be maintained for the periods specified above,
except that reductions by the insurer may be permitted under specified
circumstances in the event that actual loss experience exceeds certain
thresholds or if the reserve accumulated is deemed excessive in relation to the
insurer's outstanding insured obligations. Financial guaranty insurers are also
required to maintain reserves for losses and loss adjustment expenses on a
case-by-case basis and reserves against unearned premiums.

Article 69 establishes single risk limits for financial guaranty insurers
applicable to all obligations issued by a single entity and backed by a single
revenue source. For example, under the limit applicable to qualifying
asset-backed securities, the lesser of (i) the insured average annual debt
service for a single risk or (ii) the insured unpaid principal (reduced by the
extent to which the unpaid principal of the supporting assets exceeds the
insured unpaid principal) divided by nine, net of qualifying reinsurance and
collateral, may not exceed 10% of the sum of the insurer's policyholders'
surplus and contingency reserve, subject to certain conditions. Under the limit
applicable to municipal obligations, the insured average annual debt service for
a single risk, net of qualifying reinsurance and collateral, may not exceed 10%
of the sum of the insurer's policyholders' surplus and contingency reserve. In
addition, insured principal of municipal obligations attributable to any single
risk, net of qualifying reinsurance and collateral, is limited to 75% of the
insurer's policyholders' surplus and contingency reserve. Single risk limits are
also specified for other categories of insured obligations, and generally are
more restrictive than those listed for asset-backed or municipal obligations.

Article 69 also establishes aggregate risk limits on the basis of
aggregate net liability insured as compared to statutory capital. "Aggregate net
liability" is defined as outstanding principal and interest of guarantied
obligations

21

insured, net of qualifying reinsurance and collateral. Under these limits,
policyholders' surplus and contingency reserves must not be less than a
percentage of aggregate net liability equal to the sum of various percentages of
aggregate net liability for various categories of specified obligations. The
percentage varies from 0.33% for certain municipal obligations to 4% for certain
non-investment grade obligations.

Dividend Restrictions

FSA's ability to pay dividends is dependent upon FSA's financial
condition, results of operations, cash requirements, rating agency approval and
other related factors and is also subject to restrictions contained in the
Insurance Laws and related regulations of New York and other states. Under New
York Insurance Law, FSA may pay dividends out of statutory 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 (i) 10% of
policyholders' surplus as of its last statement filed with the New York
Superintendent or (ii) adjusted net investment income during this period. Based
upon FSA's statutory statements for the year ended December 31, 2001, the
maximum amount available for payment of dividends by FSA without regulatory
approval over the following 12 months is approximately $77.1 million. However,
as a customary condition for approving the application of Dexia for a change in
control of FSA, the prior approval of the New York Superintendent is required
for any payment of dividends by FSA to the Company for a period of two years
following such change in control, which occurred on July 5, 2000. In 2001, FSA
International paid a preferred dividend of $1.6 million to its minority interest
owner.

Financial Guaranty Insurance Regulation in Other Jurisdictions

FSA is subject to laws and regulations of jurisdictions other than the
State of New York concerning the transaction of financial guaranty insurance.
The laws and regulations of these other jurisdictions are generally not more
stringent in any material respect than the New York Insurance Law.

The Bermuda Ministry of Finance regulates FSA International. The United
Kingdom Financial Services Authority regulates FSA-UK. Pursuant to European
Union Directives, FSA-UK has been authorized to provide financial guaranty
insurance for transactions in France, Germany, Ireland, Italy, Luxembourg, the
Netherlands, Portugal and Spain from its home office in the United Kingdom. FSA
has received a determination from the Australian Insurance and Superannuation
Commissioner that the financial guaranties issued by it with respect to
Australian transactions do not constitute insurance for which a license is
required. The Monetary Authority of Singapore regulates activities of FSA's
Singapore branch.

Investment Portfolio

FSA's primary objective in managing its investment portfolio is generation
of an optimal level of after-tax investment income while preserving capital and
maintaining adequate liquidity. FSA's investment portfolio, excluding the
investments of the proceeds of FSA-insured GIC's managed by the AMC (the "GIC
Portfolio"), is managed primarily by unaffiliated professional investment
managers, with a portion of its municipal portfolio managed by its affiliate,
FSA Portfolio Management. FSA's investment management is overseen by an
Investment Committee comprised of FSA's Chairman, Chief Financial Officer, Chief
Underwriting Officer and Treasurer. To accomplish its objectives, the Company
has established guidelines for eligible fixed income investments by FSA,
requiring that at least 95% of such investments be rated at least "Single-A" at
acquisition and the overall portfolio be rated "Double-A" on average. Fixed
income investments falling below the minimum quality level are disposed of at
such time as management deems appropriate. For liquidity purposes, the Company's
policy is to invest FSA assets in investments which are readily marketable with
no legal or contractual restrictions on resale. Eligible fixed income
investments include U.S. Treasury and agency obligations, corporate bonds,
tax-exempt bonds and mortgage pass-through instruments. Formerly, the Company
and its subsidiaries also invested a small portion of their portfolios in equity
securities and/or convertible debt securities. In late 1999, the Company
disposed of a majority of such investments due in part to adverse credit for
such investments under rating agency capital adequacy models. The Company has
investments in various strategic partners, including (i) XLFA; (ii) Fairbanks
Capital Holding Corp., which owns a residential mortgage loan servicer; (iii)
creditex, Inc., which operates an exchange for credit-derivative products; and
(iv) TheMuniCenter, L.L.C., which operates an on-line exchange for municipal
bonds. In addition, the Company has from time to time invested in sponsors of,
or interests in, transactions insured or proposed to be insured by FSA, none of
which investments is material to the Company.

22

The weighted average maturity of the Company's investment portfolio,
excluding the GIC Portfolio, at December 31, 2001 was approximately 11.4 years.
The Company's current investment strategy is to invest in quality, readily
marketable instruments of intermediate average duration so as to generate stable
investment earnings with minimal market value or credit risk.

The following tables set forth certain information concerning the
investment portfolio of the Company, excluding the GIC Portfolio:

INVESTMENT PORTFOLIO BY RATING
AT DECEMBER 31, 2001(1)

- ----------
(1) Ratings are for the long-term fixed income portfolio (91.1% of the
investment portfolio, excluding the GIC Portfolio, as of December 31,
2001) and are based on the higher of Moody's or S&P ratings available at
December 31, 2001.
(2) Includes U.S. Treasury and agency obligations, which comprised 3.6% of the
portfolio at December 31, 2001.

SUMMARY OF INVESTMENTS

- ----------
(1) Yields are stated on a pre-tax basis.
(2) Includes taxable and tax-exempt investments and excludes cash equivalents
of $52.5 million, $45.8 million and $58.7 million for the years ended
December 31, 2001, 2000 and 1999, respectively.
(3) Excludes stocks at cost of $10.0 million, $10.0 million and $30.1 million
for 2001, 2000 and 1999, respectively.

23

INVESTMENT PORTFOLIO BY SECURITY TYPE

- ----------
(1) Includes short-term investments in the amount of $166.2 million, $76.0
million and $205.1 million at December 31, 2001, 2000 and 1999,
respectively, but excludes cash equivalents of $52.5 million, $45.8
million, and $58.7 million, respectively.
(2) Excludes stocks at cost of $10.0 million, $10.0 million and $30.1 million
for 2001, 2000 and 1999, respectively.

MORTGAGE-BACKED SECURITIES
COST AND MARKET VALUE BY INVESTMENT CATEGORY

The Company's investments in mortgage-backed securities consisted of
pass-through certificates and collateralized mortgage obligations ("CMO's"),
which are secured by mortgage loans guarantied or insured by agencies of, or
sponsored by, the federal government. These securities are highly liquid with
readily determinable

24

market prices. The Company also held Triple-A rated CMO's, which are not
guaranteed by government agencies. Secondary market quotations are available for
these securities, although they are not as liquid as the government
agency-backed securities.

The CMO's held at December 31, 2001 have stated maturities ranging from 2
to 30 years, and expected average lives ranging from 1 to 29 years based on
anticipated prepayments of principal. None of the Company's holdings of CMO's is
subject to extraordinary interest rate sensitivity. At December 31, 2001, the
Company did not own any interest-only stripped mortgage securities or inverse
floating rate CMO tranches.

Mortgage-backed securities differ from traditional fixed income bonds
because they are subject to prepayments at par value without penalty at the
borrower's option. Prepayment rates on mortgage-backed securities are influenced
primarily by the general level of prevailing interest rates, with prepayments
increasing when prevailing interest rates are lower than the rates on the
underlying mortgages. When prepayments occur, the proceeds must be re-invested
at then current market rates, which are generally below the yield on the prepaid
securities. Prepayments on mortgage-backed securities purchased at a premium to
par will result in a loss to the Company to the extent of the unamortized
premium.

GIC PORTFOLIO

The following tables set forth certain information concerning the GIC
Portfolio:

INVESTMENT PORTFOLIO BY RATING
AT DECEMBER 31, 2001(1)

- ----------
(1) Ratings are for the long-term fixed income portfolio (65.2% of the
investment portfolio) as of December 31, 2001, and are based on the higher
of Moody's or S&P ratings available at December 31, 2001.

SUMMARY OF INVESTMENTS

- ----------
(1) Yields are stated on a pre-tax basis.
(2) Excludes cash equivalents of $47.0 million.

25

INVESTMENT PORTFOLIO BY SECURITY TYPE

- ----------
(1) Yields are stated on a pre-tax basis.
(2) Excludes cash equivalents of $47.0 million

DISTRIBUTION OF INVESTMENTS BY MATURITY

- ----------
(1) Includes short-term investments in the amount of $181.0 million and
excludes cash equivalents of $47.0 million.

The mortgage-backed securities included in the GIC Portfolio consisted of
pass-through certificates of $95.1 million and $95.7 million at amortized cost
and market value, respectively. These securities are rated Triple-A and are
highly liquid with readily determinable market prices.

EMPLOYEES

At December 31, 2001, the Company and its subsidiaries had 283 employees.
None of its employees are covered by collective bargaining agreements. The
Company considers its employee relations to be satisfactory.

FORWARD-LOOKING STATEMENTS

The Company relies upon 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 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, (i) projections of revenues, income (or loss), earnings (or loss)
per share, dividends, market share or other financial forecasts, (ii) statements
of plans, objectives or goals of the Company or its management, including those
related to growth in adjusted book value per share or return on equity, and
(iii) 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.

26

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: (i) changes in capital requirements or other criteria of
securities rating agencies applicable to financial guaranty insurers in general
or to FSA specifically; (ii) competitive forces, including the conduct of other
financial guaranty insurers in general; (iii) changes in domestic or foreign
laws or regulations applicable to the Company, its competitors or its clients;
(iv) changes in accounting principles or practices that may result in a decline
in securitization transactions; (v) an economic downturn or other economic
conditions (such as a rising interest rate environment) adversely affecting
transactions insured by FSA or its investment portfolio; (vi) inadequacy of loss
reserves established by the Company; (vii) temporary or permanent disruptions in
cash flow on FSA-insured structured transactions attributable to legal
challenges to such structures; and (viii) downgrade or default of one or more of
FSA's reinsurers. 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 2. PROPERTIES.

The principal executive offices of the Company and FSA are located at 350
Park Avenue, New York, New York 10022. The principal executive offices, which
consist of approximately 75,700 square feet of office space, are under lease
agreements which generally expire in 2005. The Company's telephone number at its
principal executive offices is (212) 826-0100. FSA or its subsidiaries also
maintain leased office space in San Francisco, Dallas, Hamilton (Bermuda),
London (England), Madrid (Spain), Paris (France), Singapore, Sydney (Australia)
and Tokyo (Japan). The Company and its subsidiaries do not own any real
property.

ITEM 3. LEGAL PROCEEDINGS.

In the ordinary course of business, the Company and certain subsidiaries
have become party to certain litigation. The Company believes that none of these
matters, if decided against the Company, would have a material impact on the
Company's consolidated financial position, results of operations or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 2001.

27

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

On July 5, 2000, the Company completed a merger (the "Merger") in which
the Company became an indirect wholly owned subsidiary of Dexia S.A., a publicly
held Belgian corporation. Dexia S.A. also indirectly acquired the Company's
redeemable preferred stock and caused such stock to be contributed to the
Company's capital. As a consequence of these actions, there is no longer an
established public trading market for the Company's common stock, and bid
quotations are not reported or otherwise available. As of March 2002, the only
holders of the Company's common stock were Dexia Holdings, Inc.; an affiliate of
White Mountains Insurance Group Ltd. (a major shareholder of the Company prior
to the Merger); and certain directors of the Company who own shares of the
Company's common stock or economic interests therein as described under the
caption "Director Share Purchase Program" in Item 11.

Information relating to the high and low sales prices per share for each
quarterly period for the past two years until the Merger, and the frequency and
amount of any cash dividends declared in the past two years, is set forth below:

The Company did not pay any dividends during the year following the
Merger. The Company paid a dividend on its Common Stock of $0.76125 per share
(comprised of a regular quarterly dividend of $0.17625 per share and a special
dividend of $0.585 per share intended as a "catch-up" for regular quarterly
dividends omitted for the four prior quarters) for the quarter ended September
30, 2001, and of $0.17625 per share for the quarter ended December 31, 2001.
Information concerning restrictions on the payment of dividends is set forth in
Item 1 above under the caption "Insurance Regulatory Matters -- Dividend
Restrictions."

28

ITEM 6. SELECTED FINANCIAL DATA

This following Selected Consolidated Financial Data should be read in
conjunction with the Consolidated Financial Statements and accompanying notes
included elsewhere herein.

- ----------
(a) Prepared in accordance with accounting principles generally accepted in
the United States of America. Deferred premium revenue shown above is
shown net of prepaid reinsurance premiums. Losses and loss adjustment
expenses are shown net of reinsurance recoverables on unpaid losses.
(b) The sum of statutory capital, statutory unearned premium reserve, present
value of future net installment premiums, statutory loss reserve, and
credit available under standby line of credit ("soft capital") facility.
(c) $138.8 million of net income excluding merger-related costs.

29

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

Management and investors consider the following measures important in
analyzing the financial results of the Company: adjusted book value, core net
income, operating net income, core revenue, core expenses and gross present
value of premiums written (gross PV premiums written). However, none of these
measures are promulgated in accordance with accounting principles generally
accepted in the United States of America and should not be considered as
substitutes for shareholders' equity, net income, revenues, expenses and gross
premiums written.

YEAR ENDED DECEMBER 31, 2001 VERSUS YEAR ENDED DECEMBER 31, 2000

Adjusted book value per common share of the Company was $69.08 at December
31, 2001, up 17.7% including dividends since year-end 2000. Excluding realized
and unrealized capital gains and losses, adjusted book value per share rose
18.4% including dividends. Management and some equity analysts use adjusted book
value per common share as a proxy for the Company's intrinsic value, exclusive
of franchise value. It is defined as book value plus the after-tax present value
of all net deferred premium revenue less deferred expenses.

The Company discusses its financial results by breaking out various levels
of its income statement in order to present a better analysis of underlying
trends. OPERATING NET INCOME is net income less the after-tax effect of net
realized capital gains or losses, the cost of equity-based compensation
programs, changes in fair value of certain insurance products accounted for as
derivatives as required by Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133)
and other non-operating items. CORE NET INCOME represents operating net income
less the after-tax effects of refundings and prepayments. Core net income
therefore represents the Company's normal operating results on a basis
comparable to that of its industry peers. The distinction between core and
operating net income is important because higher than normal volumes of
refundings and prepayments disproportionately increase earned premiums and could
suggest a stronger earnings trend than the pace of originations would warrant.

The Company's 2001 net income was $209.5 million, compared with $63.3
million ($138.8 million excluding merger-related costs) for 2000, an increase of
231.1%. Core net income was $212.9 million for 2001, compared with $176.0
million for 2000, an increase of 20.9%. Total core revenues increased by $50.8
million in 2001, to $354.5 million from $303.7 million for 2000, while total
core expenses increased only $9.8 million in 2001. Operating net income was
$217.3 million for 2001 versus $181.5 million for 2000, an increase of $35.8
million, or 19.7%.

The Company employs two measures of gross premiums originated for a given
period. GROSS PREMIUMS WRITTEN captures premiums collected in the period,
whether collected up front for business originated in the period, or in
installments for business originated in prior periods. An alternative measure,
GROSS PV PREMIUMS WRITTEN, reflects future installment premiums discounted to
their present value, as well as upfront premiums, but only for business
originated in the period. Business ceded through reinsurance placed by a third
party is excluded from gross PV premiums written. The Company considers gross PV
premiums written to be the better indicator of a given period's origination
activity because a substantial portion of the Company's premiums is collected in
installments, a practice typical of the asset-backed business. To calculate
gross PV premiums written, management estimates the life of each transaction
that has installment premiums and discounts the future installment premium
payments. The Company calculates the discount rate as the average pre-tax yield
on its investment portfolio for the previous three years. Accordingly,
year-to-year comparisons of gross PV premiums written are affected by the
application of different discount factors. The rates for 2001, 2000 and 1999
were 5.79%, 5.77% and 5.93%, respectively. Management intends to revise the
discount rate in future years according to the same formula, in order to reflect
interest rate changes.

The Company's principal operating subsidiary, FSA, had an exceptional year
in 2001, with strong results across

30

its three core businesses -- U.S. municipal, U.S. asset-backed and
international. Asset-backed business was particularly strong, in both the United
States and Europe, due to market uncertainty, widening credit spreads and demand
for liquidity. FSA issued insurance policies generating $696.5 million of gross
PV premiums written in 2001, 55.4% higher than the $448.3 million in 2000. In
2001, the annual gross par value of obligations insured by FSA rose 82.4%, to
$114.2 billion.

In the U.S. asset-backed market, FSA achieved record results, with
business well balanced across the consumer, residential mortgage and structured
finance sectors. In consumer finance, the Company enjoyed steady transaction
flow from repeat issuers of asset-backed securities backed by automobile loans
and credit card receivables. In the residential mortgage market, FSA developed
new applications for its guaranty and, late in the year, saw increased demand
for the guaranty as a way to enhance liquidity of mortgage-backed issues already
rated Triple-A. In addition, funded and synthetic CDO business was strong
because of a favorable credit spread environment. Fourth quarter 2001 gross PV
premiums written were amplified by an unusually large residential mortgage
transaction and a complex, high-premium structured financial institution
obligation, which together contributed $90.0 million in gross PV premiums
written. For the year, par value reached $56.7 billion and gross PV premiums
written totaled $353.9 million, compared with $28.0 billion and $198.9 million,
respectively, for 2000. Par insured increased more than gross PV premiums
written primarily because of increased originations in the Triple-A shadow-rated
CDO sector, which carries a low premium rate relative to par insured.

During 2001, new issue volume in the U.S. municipal bond market reached
$286.3 billion, the second highest level in history, due in part to a decline in
interest rates that encouraged municipal borrowing, and insurance penetration
increased to 46% from 40% in the prior year. In this positive environment, FSA
held the leading market share for the first time, insuring approximately 27% of
the insured new issues that were sold during the year. FSA's market share
leadership does not reflect any change in business strategy, which is for FSA to
insure all the transactions meeting its underwriting criteria that it can insure
at appropriate returns. The U.S. municipal business contributed $222.3 million
in gross PV premiums written in 2001, compared with $140.1 million in 2000.
FSA's U.S. municipal par insured increased to $36.5 billion in 2001 from $21.5
billion in 2000.

In international markets, FSA's asset-backed business continued to grow
during 2001, led by European synthetic and funded CDOs and other structured
finance transactions. The Asia Pacific group also closed a number of synthetic
CDOs and consumer asset securitizations during the year. In addition, FSA made
progress in global public infrastructure markets, where transactions generally
have long lead times, and ended the year with mandates for a number of
transactions scheduled to close in 2002. During 2001, FSA insured $21.1 billion
of international par, compared with $13.2 billion in 2000, to generate gross PV
premiums written of $120.3 million, compared with $109.3 million in 2000.

FSA's gross premiums written increased 30.4% to $485.6 million for 2001
from $372.3 million for 2000. Net premiums written were $319.6 million during
2001, an increase of 46.5% compared with the 2000 result. Reinsurance cessions
totaled 34.2% of 2001 gross premiums written, compared with 41.4% in 2000. The
amount ceded decreased in 2001 primarily due to some large facultative cessions
on health care business in 2000 to comply with new internal single-risk limits.
Net premiums earned in 2001 were $237.7 million, compared with $192.1 million in
2000, an increase of 23.7%. Premiums earned from refundings and prepayments were
$9.1 million for 2001 and $11.7 million for 2000, contributing $4.4 million and
$5.5 million, respectively, to after-tax earnings. Excluding the effects of
refundings, net premiums earned grew 23.0% over the comparable 2000 result. No
assurance can be given that refundings and prepayments will continue at the
level experienced in 2001 or 2000.

Net investment income was $128.9 million for 2001 and $121.1 million for
2000, an increase of 6.4%. This increase was due primarily to higher invested
balances arising from new business writings. For further discussion, see
"Liquidity and Capital Resources" below. The Company's effective tax rate on
investment income was 11.0% for 2001, compared with 13.1% for 2000. In 2001, the
Company realized $7.2 million in net capital gains, compared with $36.8 million
of net capital losses in 2000. Capital losses in 2000 were affected by losses
purposely incurred to take advantage of expiring tax loss carry-back
opportunities against previously realized capital gains. Capital gains and
losses are generally a by-product of the normal investment management process
and can vary substantially from period to period.

31

Interest expense in 2001 and 2000 was $16.9 million and $16.6 million,
respectively. For further discussion, see "Liquidity and Capital Resources"
below.

The provision for losses and loss adjustment expenses in 2001 was $12.5
million, compared with $9.4 million in 2000, representing additions to the
Company's general reserve. The additions to the general reserve represent
management's estimate of the amount required to cover the present value of the
net cost of future claims. The Company will, on an ongoing basis, 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. The Company evaluated its insured portfolio to assess the
potential impact of the events of September 11, 2001, and does not expect to
incur any losses as a direct result of the tragedy. The Company's insured
portfolio, at the time of the event, included approximately $131.0 million of
gross exposure (approximately $76.0 million after reinsurance) to Port Authority
of New York and New Jersey Consolidated Revenue Bonds, which were backed by the
Authority's general revenues, including those from bridges and tunnels, and not
directly secured by lease payments or other payments related to the World Trade
Center. In addition, the Company assessed the effects of several high-profile
bankruptcies on its insured portfolio and does not expect to incur losses
attributable to these bankruptcies. At December 31, 2001, the general reserve
totaled $69.1 million.

Total policy acquisition and other operating expenses (excluding the cost
of equity-based compensation programs, which was $25.2 million for 2001 and
$27.1 million for 2000) were $56.9 million in 2001, compared with $51.2 million
in 2000, an increase of $5.7 million. Further excluding the effect of
refundings, total policy acquisition and other operating expenses were $54.5
million in 2001, compared with $47.9 million in 2000, an increase of $6.6
million. The increase resulted from higher personnel costs. The Company's core
expense ratio (policy acquisition costs plus core other operating expenses
divided by core earned premiums) fell to 24.5% from 26.5% in 2000 due to higher
core premiums earned. In 2000, the Company recognized $105.5 million in
merger-related expenses, of which $85.8 million represented an increase in
equity-based compensation and $19.7 million was for various fees.

In the fourth quarter of 2001, the Company's newly formed asset management
group began issuing FSA-insured GICs and had recorded $601.0 million of GICs as
of December 31, 2001. These transactions resulted in a net interest margin of
$0.1 million and a net capital loss of $0.3 million for the year ended December
31, 2001.

Income before income taxes for 2001 and 2000 was $269.5 million and $67.4
million ($172.9 million excluding merger-related costs), respectively.

The Company's effective tax rate for 2001 was 22.3%, compared with 6.1%
for 2000. The effective tax rate increased because, in 2000, merger-related
expenses reduced net income, resulting in a higher than normal proportion of
income derived from the Company's tax-exempt investment securities. The increase
was partially offset by higher income from FSA International, which, while
subject to U.S. income taxes as a controlled foreign corporation, nonetheless
benefits from a lower overall effective tax rate than the Company's domestic
insurance company subsidiaries.

Market Risk

The primary objective in managing the Company's investment portfolio,
excluding the GIC bond portfolio, is generation of an optimal level of after-tax
investment income while preserving capital and maintaining adequate liquidity.
Investment strategies are based on many factors, including the Company's tax
position, fluctuation in interest rates, regulatory and rating agency criteria
and other market factors. One internal investment manager and two external
investment managers execute fixed-income investments. These investment decisions
are based on guidelines established by management and approved by the board of
directors. FSA Asset Management LLC manages the investments in the GIC bond
portfolio.

Market risk represents the potential for loss due to adverse changes in
the fair value of financial instruments. The market risks related to financial
instruments of the Company relate primarily to its investment portfolio, of
which over 99.6% (excluding the GIC bond portfolio) was invested in fixed-income
securities at December 31, 2001. Changes in interest rates affect the value of
the Company's fixed-income portfolio. As interest rates rise, the fair value of
fixed-income securities decreases. Sensitivity to interest rate movements can be
estimated by projecting a hypothetical increase in interest rates of 1.0%. Based
on market values and interest rates at year-end 2001, this

32

hypothetical increase in interest rates would result in an after-tax decrease of
$115.6 million in the net fair value of the Company's fixed-income portfolio,
excluding the GIC bond portfolio, and an after-tax decrease of $5.7 million for
the GIC bond portfolio. Since the Company does not expect to trade investments
prior to maturity, absent an unusually large demand for funds, it does not
expect to recognize any material adverse impact to income or cash flows under
the above scenario.

The Company's investment portfolio holdings, excluding the GIC bond
portfolio, are primarily U.S. dollar-denominated fixed-income securities,
including municipal bonds, U.S. government and agency bonds, and
mortgage-backed, asset-backed and corporate securities. In calculating the
sensitivity to interest rates for the taxable securities, U.S. Treasury rates
are changed instantaneously by 1.0%, and the option-adjusted spreads of the
securities are held constant. Tax-exempt securities are subjected to a change in
the municipal Triple-A obligation curve that would be equivalent to a 1.0%
taxable interest rate change based on the average taxable/tax-exempt ratios for
the prior 12 months. The simulation for tax-exempts calculates duration by
taking into account the applicable call date if the bond is at a premium or the
maturity date if the bond is at a discount.

FSA-insured GICs subject the Company to risk associated with early
withdrawal 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 AA- by S&P or Aa3 by Moody's,
unless the GIC provider posts collateral or otherwise enhances its credit.

Critical Accounting Policies

The Company's losses and loss adjustment expenses comprise case basis
reserves and a non-specific general reserve. A case basis reserve is recorded at
the net present value of an estimated loss 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. A case basis reserve is determined using
primarily cash flow or similar models and represents FSA's estimate of the net
present value of the anticipated shortfall, net of reinsurance, between (i)
scheduled payments on the insured obligation plus anticipated loss adjustment
expenses and (ii) anticipated cash flow from and proceeds to be received on
sales of any collateral supporting the obligation and other anticipated
recoveries. The non-specific general reserve is available to be applied against
future additions or accretions to existing case basis reserves or to new case
basis reserves. The general reserve is calculated by applying a loss factor to
the total net par amount outstanding of the Company's insured obligations over
the term of such insured obligation and discounting the result at the then
current risk-free rates. The loss factors used for this purpose are determined
on the basis of an independent rating agency study of default rates and the
Company's portfolio characteristics and history. The selection of loss factors
and a discount rate involves judgment as to which factors to use and whether
those factors are reflective of the Company's insured obligations. Management's
judgments may also consider macroeconomic factors, political developments and
changes in underwriting standards or mix of business.

Management conducts periodic credit reviews of its exposures to identify
events, as they happen, that might cause a default on a transaction. With timely
identification of these events, the Company may limit its potential for loss by
taking actions to improve transaction performance. Certain events have occurred
in the past, such as the decline in commercial real estate in the early 1990s,
that have had a significant impact on the Company's losses and loss adjustment
expenses. Although these events are difficult to predict, the Company's credit
review process is designed to identify such events early so the Company can act
to limit its exposure.

Management of the Company periodically evaluates the assumptions and
judgments underlying its estimate for losses and loss adjustment expenses and
establishes a liability that management believes is adequate to cover the
present value of the ultimate net cost of claims. Management has consistently
applied this approach from period to period. Since the reserves are based upon
estimates, there can be no assurance that the ultimate liability will not differ
from such estimates.

A large portion of the Company's investment portfolio and its derivative
instruments are carried at fair value. Fair value is defined as the amount at
which an asset or a liability could be bought or sold in a current transaction
between willing parties. The fair value of substantially all of the Company's
investment portfolio is determined based upon quoted market prices. For
derivative instruments where a quoted market price exists, the Company uses that
price.

If quoted market prices are not available, as is the case primarily with
credit default swaps on pools of assets, then the determination of fair value is
based upon 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.

33

YEAR ENDED DECEMBER 31, 2000 VERSUS YEAR ENDED DECEMBER 31, 1999

Adjusted book value per common share of the Company was $59.52 at December
31, 2000, up 18.3% including dividends since year-end 1999. Excluding realized
and unrealized capital gains and losses, adjusted book value per share rose
12.5% including dividends.

The Company's 2000 net income was $63.3 million ($138.8 million excluding
merger-related costs), compared with $125.4 million for 1999, a decrease of
49.5%. Core net income was $176.0 million for 2000, compared with $140.0 million
for 1999, an increase of 25.7%. Total core revenues increased in 2000 by $46.6
million, to $303.7 million for 2000 from $257.1 million for 1999, while total
core expenses increased only $3.0 million. Operating net income was $181.5
million for 2000 versus $146.7 million for 1999, an increase of $34.8 million,
or 23.7%.

The Company's principal operating subsidiary, FSA, produced strong
origination results despite a decline in U.S. municipal market volume and a
generally slow first quarter caused by Year 2000 (Y2K) concerns. Anticipated
computer problems associated with Y2K prompted many issuers to accelerate
closing dates for their financings, which increased premium production in the
fourth quarter of 1999 and reduced first quarter 2000 production. FSA wrote
insurance policies generating $448.3 million of gross PV premiums written in
2000, 13.3% lower than the record $517.2 million in 1999. In 2000, the annual
par value of obligations insured by FSA rose 4.8%, to $62.6 billion. Gross PV
premiums written declined because FSA generally insured higher quality, lower
premium transactions.

In the U.S. asset-backed securities market, strong CDO production and
repeat business from auto loan and residential mortgage issuers contributed to
FSA's 2000 results. FSA also increased its participation in other sectors,
including franchise loans, sub-prime credit cards and manufactured housing. For
the year, par value reached $28.0 billion and PV premiums totaled $198.9
million, compared with $24.8 billion and $200.4 million, respectively, for 1999.

In the U.S. municipal bond market, the Company confronted reduced market
volume. A strong economy created budget surpluses, reducing the need for bond
issues to fund capital expenditures, and interest rate conditions discouraged
refundings. The U.S. municipal business contributed $140.1 million in gross PV
premiums written, compared with $183.0 million written in 1999. FSA's U.S.
municipal par insured fell to $21.5 billion in 2000 from $26.3 billion in 1999.
The business was well diversified across sectors, average capital charges
declined, and FSA guaranteed approximately 25% of the insured bonds issued
during the year.

In international markets, business was particularly strong in Europe,
where FSA guaranteed public-private partnership (PPP) financings in the United
Kingdom, synthetic CDOs and other transactions. A large market has developed in
Europe for synthetics, which tend to be large-scale, high-quality transactions
that produce attractive returns. Financial institutions use synthetics both to
restructure their portfolios to achieve optimal allocations of regulatory
capital and to take advantage of arbitrage opportunities. In synthetic
transactions, FSA guarantees payment obligations of counterparties under credit
default swaps referencing asset portfolios. Synthetics do not rely on new issues
of public securities and therefore represent a growing business area that is not
dependent on bond market variables. During 2000, FSA insured $13.2 billion of
international par, compared with $8.7 billion in 1999, to generate gross PV
premiums written of $109.3 million, compared with $133.8 million in 1999. In its
international business, FSA focuses on Western Europe and on certain developed
countries in the Asia Pacific region.

FSA's gross premiums written increased 2.7% to $372.3 million for 2000
from $362.7 million for 1999. Net premiums written were $218.1 million during
2000, a decrease of 5.3% when compared with the 1999 result. Gross premiums
written grew at a faster pace than net premiums written because the Company
utilized more reinsurance. This was largely the result of employment of
reinsurance to address single-risk concerns on large transactions and
capacity-constrained issues and also reflected increased use of reinsurance
products providing first-loss coverage. Reinsurance cessions totaled 41.4% of
2000 gross premiums written, compared with 36.5% in 1999. Net premiums earned in
2000 were $192.1 million, compared with $175.0 million in 1999, an increase of
9.8%. Premiums earned from refundings and prepayments were $11.7 million for
2000 and $13.9 million for 1999, contributing $5.5 million and $6.6 million,
respectively, to after-tax earnings. Refundings declined in response to the
rising interest rate environment of 2000. Excluding the effects of refundings,
net premiums earned grew 12.0% over the comparable 1999 result. No assurance can
be given that refundings and prepayments will continue at the level experienced
in 2000 or 1999.

34

Net investment income was $121.1 million for 2000 and $94.7 million for
1999, an increase of 27.9%. This increase was due primarily to higher invested
balances arising from the proceeds of an equity offering in the fourth quarter
of 1999 and revenues from new business writings. The Company's effective tax
rate on investment income was 13.1% for 2000, compared with 15.3% for 1999. In
2000, the Company realized $36.8 million in net capital losses, compared with
$13.3 million of net capital losses in 1999. Capital losses in 2000 were
affected by losses purposely incurred in order to apply expiring tax loss
carry-back opportunities against previously realized capital gains. Capital
gains and losses are a by-product of the normal investment management process
and can vary substantially from period to period.

Interest expense in 1999 and 2000 was $16.6 million each year. For further
discussion, see "Liquidity and Capital Resources" below.

The provision for losses and loss adjustment expenses in 2000 was $9.4
million, compared with $8.8 million in 1999, representing additions to the
Company's general reserve. The additions to the general reserve represent
management's estimate of the amount required to cover the present value of the
net cost of claims adequately. The Company will, on an ongoing basis, 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. At December 31, 2000, the general reserve totaled
$65.2 million.

Total policy acquisition and other operating expenses (excluding the cost
of equity-based compensation programs, which was $27.1 million for 2000 and
$17.1 million for 1999) were $51.2 million in 2000, compared with $49.1 million
in 1999, an increase of $2.1 million. Further excluding the effect of
refundings, total policy acquisition and other operating expenses were $47.9
million in 2000, compared with $45.4 million in 1999, an increase of $2.5
million. The increase resulted from higher personnel costs. The Company's core
expense ratio fell to 26.5% from 28.2% in 1999 due to higher core premiums
earned. The Company recognized $105.5 million in merger-related expenses, of
which $85.8 million represented an increase in equity-based compensation and
$19.7 million was for various fees.

Income before income taxes for 2000 was $67.4 million, down 58.9% from
$164.0 million for 1999. The decrease resulted primarily from expenses incurred
in 2000 of $105.5 million relating to the merger with Dexia.

The Company's effective tax rate for 2000 was 6.1%, compared with 23.5%
for 1999. The effective tax rate declined because merger-related expenses
reduced net income, resulting in a higher than normal proportion of income
derived from the Company's tax-exempt investment securities.

LIQUIDITY AND CAPITAL RESOURCES

The Company's consolidated invested assets at December 31, 2001, net of
unsettled security transactions, were $3,132.6 million, compared with the
December 31, 2000 balance of $2,234.7 million. These balances include the change
in the market value of the investment portfolio, which had an unrealized gain
position of $92.4 million at December 31, 2001, compared with an unrealized gain
position of $104.9 million at December 31, 2000. At December 31, 2001, the
Company had, at the holding company level, an investment portfolio of $27.3
million available to fund the liquidity needs of its activities outside of its
insurance operations. Because the majority of the Company's operations are
conducted through FSA, the long-term ability of the Company to service its debt
will largely depend upon its receipt of dividends from, or payment on surplus
notes by, FSA.

FSA's ability to pay dividends is dependent upon FSA's financial
condition, results of operations, cash requirements, rating agency approval and
other related factors, and is also subject to restrictions contained in the
Insurance Laws and related regulations of New York and other states. Under 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 (i) 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 (ii) adjusted net
investment income during this period. FSA paid no dividends in 2001 and 2000.
Based upon FSA's statutory statements for the year ended December 31, 2001, 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 following 12 months is approximately $77.1 million.

35

However, as a customary condition for approving the application of Dexia for a
change in control of FSA, the prior approval of the New York Superintendent is
required for any payment of dividends by FSA to the Company for a period of two
years following the change in control, which occurred July 5, 2000. In 2001, FSA
International paid a preferred dividend of $1.6 million to its minority interest
owner.

At December 31, 2000, the Company held $120.0 million of surplus notes of
FSA. In October 2001, FSA repaid $26.0 million of such surplus notes. In
December 2001, the Company purchased an additional $50.0 million of surplus
notes from FSA. At December 31, 2001, the Company held $144.0 million of FSA
surplus notes. Payments of principal or interest on such notes may be made only
with the approval of the New York Superintendent.

Dividends paid by the Company to its shareholders were $31.1 million and
$7.9 million in 2001 and 2000, respectively.

In the second quarter of 2000, in connection with the merger of the
Company with a Dexia subsidiary, FSA repurchased $55.0 million of its stock from
the Company, and the Company sold 511,031 of its shares held in a rabbi trust to
Dexia for $38.6 million. The proceeds from these transactions were used to fund
the Company's obligations under certain of its long-term, equity-based
compensation programs.

During the fourth quarter of 1999, the Company sold 2,583,764 shares at
$54.20 per share for a total of $140.0 million. The Company issued 1,400,000 new
shares and also sold 1,183,764 shares from its treasury and rabbi trust
accounts. The proceeds were used to augment the Company's capital base for
future growth and for anticipated employee compensation payments at the
beginning of 2000.

On December 19, 2001, the Company issued $100.0 million of 6 7/8%
Quarterly Income Bond Securities due December 15, 2101 and callable without
premium or penalty on or after December 19, 2006. The Company used these
proceeds to supplement the capital in its insurance company subsidiaries and for
general corporate purposes. The Company has two other debt issues outstanding:
$100.0 million of 6.950% Senior Quarterly Income Debt Securities due November 1,
2098 and callable on or after November 1, 2003; and $130.0 million of 7.375%
Senior Quarterly Income Debt Securities due September 30, 2097 and callable on
or after September 18, 2002.

At the time of the merger with a subsidiary of Dexia, the Company was
party to forward agreements with certain counterparties and made the economic
benefit and risk of a number of forward shares available for subscription by
certain of the Company's employees and directors. All of the Company's forward
agreements and corresponding employee and director subscriptions were settled in
connection with the merger with a subsidiary of Dexia and, at June 30, 2000, the
Company recognized a $39.4 million increase in the Company's additional paid-in
capital, reflecting the amounts received from the counterparties.

In December 2000, FSA International contributed $24.0 million of
additional capital to XLFA to maintain the Company's 15% ownership. In December
1999, FSA International received $50.0 million of additional capital. FSA
contributed $40.0 million, and XL contributed the remaining $10.0 million to
maintain its minority ownership interest percentage in the subsidiary.

In December 2001, the Company contributed an additional $15.0 million to
Fairbanks Capital Holding Corp., increasing its equity ownership in that company
to 28.36%.

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, 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. The insurance policies issued by
FSA 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. These policy provisions prohibiting
acceleration of certain claims are mandatory under Article 69 of the New York
Insurance Law and serve to reduce FSA's liquidity requirements.

36

The Company believes that FSA's expected operating liquidity needs, both
on a short- and long-term basis, can be funded from its operating cash flow. In
addition, FSA has a number of sources of liquidity that are available to pay
claims on a short- and long-term basis: cash flow from written premiums, FSA's
investment portfolio and earnings thereon, reinsurance arrangements with
third-party reinsurers, liquidity lines of credit with banks, and capital market
transactions.

FSA has a standby line of credit in the amount of $240.0 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 $240.0 million or the average annual
debt service of the covered portfolio multiplied by 5.75%, which amounted to
$653.7 million at December 31, 2001. The obligation to repay loans made 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 term that will expire on April 30, 2008
and contains an annual renewal provision subject to approval by the banks. No
amounts have been utilized under this commitment as of December 31, 2001.

FSA has a credit arrangement, aggregating $125.0 million at December 31,
2001, that is provided by commercial banks and intended for general application
to transactions insured by FSA and its insurance company subsidiaries. At
December 31, 2001, there were no borrowings under this arrangement, which
expires on April 26, 2002, unless extended.

The Company has no plans for material capital expenditures during the next
twelve months.

SPECIAL PURPOSE ENTITIES

Asset-backed and, to a lesser extent, municipal transactions insured by
FSA may employ special purpose entities (SPEs) for a variety of purposes. A
typical asset-backed transaction, for example, employs an SPE as the purchaser
of the securitized assets and as the issuer of the obligations insured by FSA.
FSA's participation is typically requested by the sponsor of the SPE or the
underwriter, either via a bid process or on a sole source basis. SPEs are
typically owned by transaction sponsors or charitable trusts, although FSA may
have an ownership interest in some cases. FSA maintains certain contractual
rights and exercises varying degrees of influence over SPE issuers of
FSA-insured obligations. FSA also bears some of the "risks and rewards"
associated with the performance of the SPE's assets. Specifically, as issuer of
a financial guaranty insurance policy insuring the SPE's obligations, FSA bears
the risk of asset performance (typically, but not always, after a significant
depletion of overcollateralization, excess spread, a deductible or other credit
protection). FSA's underwriting policy is to insure only obligations that are
otherwise investment grade. In addition, the SPE typically pays a periodic
premium to FSA in consideration of the issuance by FSA of its insurance policy,
with the SPE's assets typically serving as the source of such premium, thus
providing some of the "rewards" of the SPE's assets to FSA. SPEs are also
employed by FSA in connection with "repackaging" of outstanding securities into
new securities insured by FSA and with refinancing underperforming non-
investment-grade transactions insured by FSA. The degree of influence exercised
by FSA over these SPEs varies from transaction to transaction, as does the
degree to which "risks and rewards" associated with asset performance are
assumed by FSA. While all transactions insured by FSA are included in the
Company's outstanding exposure, and losses under these obligations are reflected
in the Notes to Consolidated Financial Statements for December 31, 2001, the
assets and liabilities of these SPEs have not been consolidated with those of
the Company for financial reporting purposes and are considered "off-balance
sheet" obligations. Two such SPEs, Canadian Global Funding Corporation (Canadian
Global) and FSA Global Funding Limited (FSA Global), are discussed in more
detail below.

In August 1994, FSA entered into a facility agreement with Canadian Global
and Hambros Bank Limited. Canadian Global was established to provide a source of
liquidity to refinance FSA-insured transactions that experience difficulty in
meeting debt service obligations. Canadian Global was capitalized with $180.6
million of debt securities and $6.3 million in preferred equity sold to
third-party investors. Under the agreement, FSA pays an annual fee to Canadian
Global to compensate it for making its liquidity available and can arrange
financing for transactions subject to certain conditions. When Canadian Global
purchases an FSA-insured obligation, the new obligation is insured by FSA for a
premium and case basis reserves are established when required. As of December
31, 2001, FSA was carrying gross and net case basis reserves of $15.7 million
and $3.9 million, respectively, against transactions refinanced by Canadian
Global. Canadian Global invests its funds in high-quality, short-term
investments. Canadian Global has total assets of $197.3 million. The amount of
this facility was $186.9 million, of which $124.3 million was unutilized at
December 31, 2001.

37

The Company owns 29% of the equity of FSA Global, a Cayman Islands
domiciled issuer of FSA-insured notes and other obligations in international
markets (generally referred to as medium term notes or "MTNs"). FSA Global
generally issues securities at the request of interested purchasers in a process
known as "reverse inquiry," which generally results in lower interest rates and
borrowing costs than would apply to direct borrowings. Funds raised by FSA
Global are raised at or converted to U.S. dollars and LIBOR-based floating rates
and are generally invested in obligations that are insured by FSA and, in some
cases, another financial guaranty insurer and that mature prior to the maturity
of the related FSA Global notes and pay a higher interest rate than the interest
rate on the related FSA Global notes. FSA Global is managed as a "matched
funding vehicle", in which the proceeds from the sale of FSA Global notes are
generally invested in obligations chosen to provide cash flows substantially
matched to those of the FSA Global notes. The matched funding structure
minimizes the market risks borne by FSA Global and FSA. At December 31, 2001,
FSA Global had total assets and total liabilities of $3.5 billion and $3.5
billion, respectively, and for the year ended December 31, 2001, FSA Global had
net income of $0.6 million. As of December 31, 2001, there were no case basis
reserves required for any transactions related to FSA Global.

The Financial Accounting Standards Board (FASB) is currently addressing
financial reporting issues relating to SPEs. Until the FASB has completed this
project, the Company cannot determine the impact on its financial statements of
any new accounting standards that may be issued regarding SPEs.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Quantitative and qualitative disclosures about market risk are set forth
in Item 7 under the caption "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Results of Operations - Market Risk".

38

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES

39

REPORT OF INDEPENDENT ACCOUNTANTS

To the Shareholders and Board of Directors
of Financial Security Assurance Holdings Ltd.:

In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Financial Security Assurance Holdings Ltd. and Subsidiaries at
December 31, 2001 and 2000, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the accompanying index presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP
New York, New York
February 4, 2002

40

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.

41

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS)

The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.

42

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.

43

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLARS IN THOUSANDS)

Continued

(a) In 2000, $14,088 in treasury stock was distributed to employees to settle
the Company's deferred equity obligation. In 2001, restricted treasury
stock of $288 was distributed to a Director as a deferred compensation
plan payout.

The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.

44

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED

(DOLLARS IN THOUSANDS)

The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.

45

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

1. ORGANIZATION AND OWNERSHIP

Financial Security Assurance Holdings Ltd. (the Company) is a holding
company incorporated in the State of New York. The Company is principally
engaged, through its insurance company subsidiaries, in providing financial
guaranty insurance on asset-backed and municipal obligations. The Company's
underwriting policy is to insure asset-backed and municipal obligations that it
determines would be of investment-grade quality without the benefit of the
Company's insurance. The 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 or trade receivables, securities or
other assets having an ascertainable cash flow or market value. The municipal
obligations insured 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. Financial guaranty insurance written by the Company
guarantees scheduled payments on an issuer's obligation. In the case of a
payment default on an insured obligation, the Company is generally required to
pay the principal, interest or other amounts due in accordance with the
obligation's original payment schedule or, at its option, to pay such amounts on
an accelerated basis.

The Company expects to continue to emphasize a diversified insured
portfolio characterized by insurance of both asset-backed and municipal
obligations, with a broad geographic distribution and a variety of revenue
sources and transaction structures. The Company's insured portfolio consists
primarily of asset-backed and municipal obligations originated in the United
States of America, but the Company has also written and continues to pursue
business in Europe and the Asia Pacific region.

In the fourth quarter of 2001, the Company began offering guaranteed
investment contracts (GICs) through its wholly owned subsidiaries, FSA Capital
Markets Services LLC and FSA Capital Management Services LLC. The GICs are
provided primarily to municipalities and are insured by the Company's insurance
company subsidiary. The GICs provide for the return of principal and the payment
of interest at a guaranteed rate.

On July 5, 2000, the Company completed a merger in which the Company
became a direct subsidiary of Dexia Holdings, Inc., which, in turn, is a
subsidiary of Dexia Credit Local. Dexia Credit Local is a subsidiary of Dexia
S.A. (Dexia), a publicly held Belgian corporation. At the merger date, each
outstanding share of the Company's common stock was converted into the right to
receive $76.00 in cash. Dexia also indirectly acquired the Company's redeemable
preferred stock, which was then contributed to the Company's capital. As a
result of this transaction, the Company valued its liabilities under the
Company's equity-based compensation plans at the transaction price and changed
its assumption regarding those plans by assuming all future payments will be
settled in cash. It also reflected the settlement of its forward share
agreements at the merger price and the sale of 511,031 shares of the Company's
common stock to Dexia at the merger price. The net effect of the merger,
reflected in the December 31, 2000 financial statements, was to decrease net
income by $75.5 million and decrease shareholders' equity by $36.1 million. At
December 31, 2001, the only holders of the Company's common stock were Dexia
Holdings, Inc., White Mountains Insurance Group, Ltd. and certain directors of
the Company who owned shares of the Company's common stock or economic interests
in the Company's common stock under the Director Share Purchase Program (see
Note 11).

46

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
(GAAP), which, for the insurance company subsidiaries, differ in certain
material respects from the accounting practices prescribed or permitted by
insurance regulatory authorities (see Note 5). The preparation of financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities in the Company's consolidated
balance sheets at December 31, 2001 and 2000 and the reported amounts of
revenues and expenses in the consolidated statements of operations and
comprehensive income during the years ended December 31, 2001, 2000 and 1999.
Such estimates and assumptions include, but are not limited to, losses and loss
adjustment expenses, fair value of financial instruments and the deferral and
amortization of deferred policy acquisition costs. Actual results may differ
from those estimates. Significant accounting policies under GAAP are as follows:

BASIS OF PRESENTATION

The consolidated financial statements include the accounts of the Company
and its direct and indirect subsidiaries, FSA Portfolio Management Inc.,
Transaction Services Corporation, Financial Security Assurance Inc. (FSA), FSA
Insurance Company, Financial Security Assurance International Ltd.
(International), FSA Capital Markets Services LLC, FSA Capital Management
Services LLC, FSA Asset Management LLC (AMC), FSA Services (Australia) Pty
Limited and Financial Security Assurance (U.K.) Limited (collectively, the
Subsidiaries). All intercompany accounts and transactions have been eliminated.
Certain prior-year balances have been reclassified to conform to the 2001
presentation.

INVESTMENTS

Investments in debt securities designated as available for sale are
carried at market value. Equity investments are carried at market value. The
unrealized gain or loss on the investments that are not hedged is reflected as a
separate component of shareholders' equity, net of applicable deferred income
taxes. The unrealized gain or loss on the investments that qualify as fair value
hedges is recorded in income currently. All of the Company's debt and equity
securities are classified as available for sale.

Bond discounts and premiums are amortized on the effective yield method
over the remaining terms of the securities acquired. For mortgage-backed
securities, and any other holdings for which prepayment risk may be significant,
assumptions regarding prepayments are evaluated periodically and revised as
necessary. Any adjustments required due to the resulting change in effective
yields are recognized in current income. Short-term investments, which are those
investments with a maturity of less than one year at time of purchase, are
carried at market value, which approximates cost. Cash equivalents are amounts
deposited in money market funds and investments with a maturity at time of
purchase of three months or less and are included in short-term investments.
Realized gains or losses on sale of investments are determined on the basis of
specific identification. Investment income is recorded as earned.

Investments in unconsolidated affiliates are based on the equity method of
accounting (see Note 19).

DERIVATIVES

Derivative instruments, which are primarily designated as fair-value
hedges, are entered into to manage the interest rate exposure of the Company's
GICs and GIC bond portfolio and are recorded at fair value. These derivatives
generally include interest rate futures and interest rate swap agreements, which
are primarily utilized to convert the Company's fixed-rate obligations on its
GICs and GIC bond portfolio into floating-rate obligations. The gains and losses
relating to these fair value hedges are included in guaranteed investment
contract net revenues and expenses, as appropriate, along with the offsetting
change in fair value of the hedged item attributable to the risk being hedged,
on the consolidated statements of operations and comprehensive income. Any
ineffective portion of the hedge is recognized in earnings.

The Company has also insured a number of credit default swap agreements
that it intends, in each case, to hold for the full term of the agreement. 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. Changes in fair value are recorded in premiums earned and in
other assets. The Company uses quoted market prices, when available, to
determine fair value. If quoted prices are not available, management uses
internally developed estimates.

PREMIUM REVENUE RECOGNITION

Gross and ceded premiums are earned in proportion to the amount of risk
outstanding over the expected period of coverage. The amount of risk outstanding
is equal to the sum of the par amount of debt insured. Deferred premium revenue
and prepaid reinsurance premiums represent the portion of premium that is
applicable to coverage of risk to be provided in the future on policies in
force. When an insured issue is retired or defeased prior to the end

47

of the expected period of coverage, the remaining deferred premium revenue and
prepaid reinsurance premium, less any amount credited to a refunding issue
insured by the Company, are recognized.

LOSSES AND LOSS ADJUSTMENT EXPENSES

A case basis reserve for unpaid losses and loss adjustment expenses is
recorded at the net present value of the estimated loss 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 then current risk-free rates ranging from
5.79% to 6.1%.

The Company also maintains a non-specific general reserve, which is
available to be applied against future additions or accretions to existing case
basis reserves or to new case basis reserves to be established in the future.
The general reserve is calculated by applying a loss factor to the total net par
amount outstanding of the Company's insured obligations over the term of such
insured obligations and discounting the result at the then current risk-free
rates. The loss factor used for this purpose has been determined based upon an
independent rating agency study of bond defaults and the Company's portfolio
characteristics and history.

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.
The reserves are necessarily based on estimates, and there can be no assurance
that the ultimate liability will not differ from such estimates. The Company
will, on an ongoing basis, monitor these reserves and may periodically adjust
such reserves based on the Company's actual loss experience, its future mix of
business, and future economic conditions.

DEFERRED ACQUISITION COSTS

Deferred acquisition costs comprise those expenses that vary with, and are
primarily related to, the production of business (including GICs), including
commissions paid on reinsurance assumed, compensation and related costs of
underwriting and marketing personnel, certain rating agency fees, premium taxes
and certain other underwriting expenses, reduced by ceding commission income on
premiums ceded to reinsurers. Deferred acquisition costs and the cost of
acquired business are amortized over the period in which the related premiums
are earned. Recoverability of deferred acquisition costs is determined by
considering anticipated losses and loss adjustment expenses.

GUARANTEED INVESTMENT CONTRACTS

The Company enters into GICs whereby the Company receives deposits at a
contractual interest rate. These contracts are recorded at amortized cost.
Additionally, the Company may enter into associated transactions in order to
reduce the Company's exposure to fluctuations in interest rates related to the
GICs. For fair value hedges, changes in the fair value of the hedging instrument
are recognized in income currently. The change in the fair value of the hedged
item, attributable to the hedged risk, adjusts the carrying amount of the hedged
item and is recognized in income currently.

FEDERAL INCOME TAXES

The provision for income taxes consists of an amount for taxes currently
payable and a provision for the deferred tax consequences of temporary
differences between the tax basis of assets and liabilities and the financial
statement basis.

Non-interest bearing tax and loss bonds are purchased for the tax benefit
that results from deducting contingency reserves as provided under Internal
Revenue Code Section 832(e). The Company records the purchase of tax and loss
bonds as pre-payments of federal income taxes and includes them in other assets.

48

3. INVESTMENTS

Bonds at amortized cost of $14,579,000 and $11,690,000 at December 31,
2001 and 2000, respectively, were on deposit with state regulatory authorities
as required by insurance regulations.

Consolidated net investment income, excluding income attributable to the
GIC bond portfolio and the GIC short-term investment portfolio (collectively the
GIC Portfolio), consisted of the following (in thousands):

The credit quality of bonds, excluding the GIC bond portfolio, at December
31, 2001 were as follows:

The amortized cost and estimated market value of bonds, excluding the GIC
bond portfolio, were as follows (in thousands):

The change in net unrealized gains (losses) consisted of (in thousands):

The amortized cost and estimated market value of bonds, excluding the GIC
bond portfolio, at December 31, 2001, by contractual maturity, are shown below
(in thousands). Actual maturities could differ from contractual maturities
because borrowers have the right to call or prepay certain obligations with or
without call or prepayment penalties.

Proceeds from sales of bonds, excluding the GIC bond portfolio, during
2001, 2000 and 1999 were $537,062,000, $1,452,485,000 and $2,162,425,000,
respectively. Gross gains of $9,120,000, $10,262,000 and $17,896,000 and gross
losses of $1,763,000, $41,217,000 and $32,406,000 were realized on sales in
2001, 2000 and 1999, respectively.

50

Proceeds from sales of equity investments during 2001, 2000 and 1999 were
$0, $14,167,000 and $87,471,000, respectively. Gross gains of $0, $0 and
$11,707,000 and gross losses of $0, $5,927,000 and $5,008,000 were realized on
sales in 2001, 2000 and 1999, respectively. Equity investments had gross
unrealized gains of $75,000 and $0 and gross unrealized losses of $5,000 and
$259,000 as of December 31, 2001 and 2000, respectively.

The Company held open positions in U.S. Treasury bond futures contracts,
Eurodollar futures contracts, and municipal bond index futures during 2000 and
1999. Such positions were marked to market on a daily basis and, for the years
ended December 31, 2000 and 1999, resulted in net realized gains (losses) of
$480,000 and $(5,490,000), respectively.

GIC PORTFOLIO

Net investment income for the GIC Portfolio consisted of the following (in
thousands):

The credit quality of bonds held in the GIC bond portfolio, at December
31, 2001 were as follows:

The amortized cost and estimated market value of bonds held in the GIC
bond portfolio, were as follows (in thousands):

51

The amortized cost and estimated market value of the GIC bond portfolio,
at December 31, 2001, by contractual maturity, are shown below (in thousands).
Actual maturities could differ from contractual maturities because borrowers
have the right to call or prepay certain obligations with or without call or
prepayment penalties.

Proceeds from sales of bonds held in the GIC Portfolio during 2001 were
$174,195,000. Gross losses of $346,000 were realized on sales. The change in net
unrealized loss for bonds was $24,000 for 2001.

4. DEFERRED ACQUISITION COSTS

Acquisition costs deferred for amortization against future income and the
related amortization charged to expenses are as follows (in thousands):

5. STATUTORY ACCOUNTING PRACTICES

GAAP for the Subsidiaries differs in certain significant respects from
accounting practices prescribed or permitted by insurance regulatory
authorities. The principal differences result from the following statutory
accounting practices:

o Upfront premiums on municipal business are recognized as earned when
related principal and interest have expired rather than over the expected
coverage period;

o Acquisition costs are charged to operations as incurred rather than as
related premiums are earned;

o A contingency reserve (rather than a general reserve) is computed based on
the following statutory requirements:

52

1) For all policies written prior to July 1, 1989, an amount equal to
50% of cumulative earned premiums less permitted reductions plus

2) For all policies written on or after July 1, 1989, an amount equal
to the greater of 50% of premiums written for each category of
insured obligation or a designated percentage of principal
guaranteed for that category. These amounts are provided each
quarter as either 1/60th or 1/80th of the total required for each
category, less permitted reductions;

o Certain assets designated as "non-admitted assets" are charged directly to
statutory surplus but are reflected as assets under GAAP;

o For New York domiciled insurance companies, federal income taxes are
provided only on taxable income for which income taxes are currently
payable;

o Bonds are carried at amortized cost; and

o Surplus notes are recognized as surplus rather than a liability.

A reconciliation of net income for the calendar years 2001, 2000 and 1999
and shareholders' equity at December 31, 2001 and 2000, reported by the Company
on a GAAP basis, to the amounts reported by the Subsidiaries on a statutory
basis, is as follows (in thousands):

53

The U.S. domiciled insurance subsidiaries file statutory-basis financial
statements with state insurance departments in all states in which they are
licensed. On January 1, 2001, significant changes to the statutory basis of
accounting became effective. The cumulative effect of these changes, known as
Codification guidance, was recorded as a direct adjustment to statutory surplus.
The effect of adoption, at January 1, 2001, was a $50,293,000 decrease to
statutory surplus, which related primarily to the accrual of deferred
compensation obligations.

6. FEDERAL INCOME TAXES

Prior to the Dexia merger, the Company and its Subsidiaries, except
International, filed a consolidated federal income tax return. The calculation
of each company's tax benefit or liability was controlled by a tax-sharing
agreement that based the allocation of such benefit or liability upon a separate
return calculation. Dexia Holdings, Inc. and the Company and its Subsidiaries,
except International, filed a consolidated federal income tax return for periods
subsequent to the merger, under a new tax-sharing agreement.

Federal income taxes have not been provided on substantially all of the
undistributed earnings of International, since it is the Company's practice and
intent to reinvest such earnings in the operations of this subsidiary. The
cumulative amount of such untaxed earnings was $41,899,000 and $18,629,000 at
December 31, 2001 and 2000, respectively.

The cumulative balance sheet effects of deferred federal tax consequences
are as follows (in thousands):

No valuation allowance was necessary at December 31, 2001 or 2000.

A reconciliation of the effective tax rate with the federal statutory rate
follows:

54

7. SHAREHOLDERS' EQUITY AND REDEEMABLE PREFERRED STOCK

On September 2, 1994, the Company issued to White Mountains Insurance
Group, Ltd. 2,000,000 shares of Series A, non-dividend paying, voting,
redeemable preferred stock having an aggregate liquidation preference of
$700,000. The preferred stock was purchased by Dexia as part of the merger and
simultaneously contributed back to the Company and retired.

The Company was party to forward share agreements with certain
counterparties and made the economic benefit and risk of a number of these
shares available for subscription by certain of the Company's employees and
directors. As part of the merger, the Company settled all of its forward share
agreements and corresponding employee and director subscriptions at the merger
price. The Company recognized compensation expense of $30,324,000 as a result of
the settlement. In addition, in 2000, the Company recognized an increase to
additional paid-in capital of $39,408,000, reflecting the amounts received from
the counterparties.

On November 3, 1998, the Company and XL Capital Ltd (XL) closed a
transaction to create two new Bermuda-based financial guaranty insurance
companies. Each of the new companies was initially capitalized with
approximately $100,000,000. One company, International, is an indirect
subsidiary of FSA, and the other company, XL Financial Assurance Ltd, is a
subsidiary of XL. The Company has a minority interest in the XL subsidiary, and
XL has a minority interest in the FSA indirect subsidiary. In conjunction with
forming the new companies, the Company and XL exchanged $80,000,000 of their
respective common shares, with the Company delivering to XL 1,632,653 common
shares out of treasury. Prior to the closing of the transaction with XL, the
Company had entered into an agreement with an unrelated third party to sell for
cash, at no gain or loss, $60,000,000 of the XL shares. This $60,000,000 was
used to fund, in part, the Company's investment in International. In 2000, the
Company sold its remaining investment in XL.

8. DIVIDENDS AND CAPITAL REQUIREMENTS

Under New York Insurance Law, FSA may pay a dividend to the Company
without the prior approval of the Superintendent of Insurance of the State of
New York (the New York Superintendent) only from earned surplus subject to the
maintenance of a minimum capital requirement. In addition, the dividend,
together with all dividends declared or distributed by FSA during the preceding
twelve months, may not exceed the lesser of 10% of its policyholders' surplus
shown on FSA's last filed statement, or adjusted net investment income, as
defined, for such twelve-month period. As of December 31, 2001, FSA had
$77,052,000 available for the payment of dividends over the next twelve months.
However, as a customary condition for approving the application of Dexia for a
change in control of FSA, the prior approval of the New York Superintendent is
required for any payment of dividends by FSA to the Company for a period of two
years following the change in control, which occurred July 5, 2000. In 2001,
International paid a preferred dividend of $1,589,000 to its minority interest
owner. In addition, at December 31, 2001, the Company held $144,000,000 of
surplus notes of FSA. Payments of principal or interest on such notes may be
made with the approval of the New York Superintendent. In 2001, with the
approval of the New York Superintendent, FSA repaid $26,000,000 of principal on
such notes and subsequently issued an additional $50,000,000 of notes to the
Company. In July 2000, in connection with the merger, FSA repurchased
$55,000,000 of its stock from the Company.

9. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES

FSA has a credit arrangement aggregating $125,000,000 at December 31,
2001, which is provided by commercial banks and intended for general application
to transactions insured by the Subsidiaries. At December 31, 2001, there were no
borrowings under this arrangement, which expires on April 26, 2002, if not
extended. In addition, there are credit arrangements assigned to specific
insured transactions. In August 1994, FSA entered into a facility agreement with
Canadian Global Funding Corporation and Hambros Bank Limited. Under the
agreement, which expires in August 2004, FSA can arrange financing for
transactions subject to certain conditions. The amount of this facility was
$186,911,000, of which $124,261,000 was unutilized at December 31, 2001.

55

FSA has a standby line of credit commitment in the amount of $240,000,000
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 $240,000,000 or the average annual
debt service of the covered portfolio multiplied by 5.75%, which amounted to
$653,671,000 at December 31, 2001. The obligation to repay loans made 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 term expiring on April 30, 2008 and
contains an annual renewal provision subject to approval by the banks. No
amounts have been utilized under this commitment as of December 31, 2001.

10. LONG-TERM DEBT

On September 18, 1997, the Company issued $130,000,000 of 7.375% Senior
Quarterly Income Debt Securities (Senior QUIDS) due September 30, 2097 and
callable without premium or penalty on or after September 18, 2002. Interest on
these notes is paid quarterly beginning on December 31, 1997. Debt issuance
costs of $4,320,000 are being amortized over the life of the debt.

On November 13, 1998, the Company issued $100,000,000 of 6.950% Senior
QUIDS due November 1, 2098 and callable without premium or penalty on or after
November 1, 2003. Interest is paid quarterly beginning on February 1, 1999. Debt
issuance costs of $3,375,000 are being amortized over the life of the debt.

On December 19, 2001, the Company issued $100,000,000 of 6 7/8% Quarterly
Income Bond Securities due December 15, 2101 and callable without premium or
penalty on or after December 19, 2006. Interest is paid quarterly beginning on
March 15, 2002. Debt issuance costs of $3,250,000 are being amortized over the
life of the debt.

11. EMPLOYEE BENEFIT PLANS

The Company and its Subsidiaries maintain both qualified and
non-qualified, non-contributory defined contribution pension plans for the
benefit of all eligible employees. The Company and its Subsidiaries'
contributions are based upon a fixed percentage of employee compensation.
Pension expense, which is funded as accrued, amounted to $3,570,000, $3,521,000
and $1,788,000 (net of forfeitures of $1,316,000 in 1999) for the years ended
December 31, 2001, 2000 and 1999, respectively.

The Subsidiaries have an employee retirement savings plan for the benefit
of all eligible employees. The plan permits employees to contribute a percentage
of their salaries up to limits prescribed by IRS Code, Section 401(k). The
Subsidiaries' contributions are discretionary, and none have been made.

Performance shares are awarded under the Company's 1993 Equity
Participation Plan. The Plan authorizes the discretionary grant of performance
shares by the Human Resources Committee to key employees of the Company and its
Subsidiaries. The amount earned for each performance share depends upon the
attainment by the Company of certain growth rates of adjusted book value (or in
the case of performance shares issued after January 1, 2001, growth rates of
adjusted book value and book value) per outstanding share over a three-year
period. No payout occurs if the compound annual growth rate of the Company's
adjusted book value (or in the case of performance shares issued after January
1, 2001, growth rates of adjusted book value and book value) per outstanding
share is less than 7%, and a 200% payout occurs if the compound annual growth
rate is 19% or greater. Payout percentages are interpolated for compound annual
growth rates between 7% and 19%.

56

Performance shares granted under the 1993 Equity Participation Plan were
as follows:

The Company applies APB Opinion 25 and related Interpretations in
accounting for its performance shares. The Company estimates the final cost of
these performance shares and accrues for this expense over the performance
period. The accrued expense for the performance shares was $48,238,000,
$50,076,000, which includes $26,177,000 of merger-related costs, and $33,442,000
for the years ended December 31, 2001, 2000 and 1999, respectively. Prior to the
merger, in tandem with this accrued expense, the Company estimated those
performance shares that it expected to settle in stock and recorded this amount
in shareholders' equity as deferred compensation. The remainder of the accrual,
which represented the amount of performance shares that the Company estimated it
would settle in cash, was recorded in accrued expenses and other liabilities. As
a result of the merger, the Company revised its assumption by assuming that all
future payments would be settled in cash and recharacterized $39,599,000 from
shareholders' equity to a liability. Had the compensation cost for the Company's
performance shares been determined based upon the provisions of SFAS No. 123,
there would have been no effect on the Company's reported net income.

For obligations under the Company's Deferred Compensation Plan (DCP) and
Supplemental Executive Retirement Plan (SERP), the Company generally purchases
investments, which should perform similarly to the tracking investments chosen
by the participants under the plans. In the fourth quarter of 2000, the Company
purchased 304,757 shares of its common stock from Dexia Holdings, Inc. for
$24,004,000. This purchase was intended to fund obligations relating to the
Company's Director Share Purchase Program (DSPP), which enables its participants
to make deemed investments in the Company's common stock under the DCP and SERP.
Under the DSPP, the deemed investments in the Company's stock are irrevocable,
settlement of the deemed investments must be in stock and, after receipt, the
participants must generally hold the stock for at least six months. In 2001,
$288,000 of restricted treasury stock was distributed to a Director as a
deferred equity plan payout.

The Company does not currently provide post-retirement benefits, other
than under its defined contribution plans, to its employees, nor does it provide
post-employment benefits to former employees other than under its severance
plans or employment agreements with members of senior management.

12. COMMITMENTS AND CONTINGENCIES

The Company and its Subsidiaries lease office space and equipment under
non-cancelable operating leases, which expire at various dates through 2007.
Future minimum rental payments are as follows (in thousands):

Rent expense for the years ended December 31, 2001, 2000 and 1999 was
$6,207,000, $5,067,000 and $4,352,000, respectively.

57

During the ordinary course of business, the Company and its Subsidiaries
become parties to certain litigation. Management believes that these matters
will be resolved with no material impact on the Company's financial position,
results of operations or cash flows.

13. REINSURANCE

The Subsidiaries obtain reinsurance to increase their policy-writing
capacity on both an aggregate-risk and a single-risk basis; to meet rating
agency, internal and state insurance regulatory limits; to diversify risk; to
reduce the need for additional capital; and to strengthen financial ratios. The
Subsidiaries reinsure portions of their risks with affiliated (see Note 15) and
unaffiliated reinsurers under quota share, first-loss and excess-of-loss
treaties and on a facultative basis.

In the event that any or all of the reinsuring companies are unable to
meet their obligations to the Subsidiaries, or contest such obligations, the
Subsidiaries would be liable for such defaulted amounts. Certain of the
reinsuring companies have provided collateral to the Subsidiaries to secure
their reinsurance obligations. The Subsidiaries have also assumed reinsurance of
municipal obligations from unaffiliated insurers.

Amounts of reinsurance ceded and assumed were as follows (in thousands):

58

14. OUTSTANDING EXPOSURE AND COLLATERAL

The Company's policies insure the scheduled payments of principal and
interest on asset-backed and municipal obligations. The principal amount insured
(in millions) as of December 31, 2001 and 2000 (net of amounts ceded to other
insurers) and the terms to maturity are as follows:

The principal amount ceded as of December 31, 2001 and 2000 and the terms
to maturity are as follows (in millions):

The Company limits its exposure to losses from writing financial
guarantees by underwriting investment-grade obligations, diversifying its
portfolio and maintaining rigorous collateral requirements on asset-backed
obligations, as well as through reinsurance. The gross principal amounts of
insured obligations in the asset-backed insured portfolio are backed by the
following types of collateral (in millions):

59

The gross principal amount of insured obligations in the municipal insured
portfolio includes the following types of issues (in millions):

In its asset-backed business, the Company considers geographic
concentration as a factor in underwriting insurance covering securitizations of
pools of such assets as residential mortgages or consumer receivables. However,
after the initial issuance of an insurance policy relating to such
securitizations, the geographic concentration of the underlying assets may not
remain fixed over the life of the policy. In addition, in writing insurance for
other types of asset-backed obligations, such as securities primarily backed by
government or corporate debt, geographic concentration is not deemed by the
Company to be significant, given other more relevant measures of
diversification, such as issuer or industry diversification.

The Company seeks to maintain a diversified portfolio of insured municipal
obligations designed to spread its risk across a number of geographic areas. The
following table sets forth those states in which municipalities located therein
issued an aggregate of 2% or more of the Company's net par amount outstanding of
insured municipal securities as of December 31, 2001:

60

15. RELATED PARTY TRANSACTIONS

The Subsidiaries ceded premiums of $30,701,000 and $28,388,000 to Tokio
Marine and Fire Insurance Co., Ltd. (Tokio Marine), a partial owner of the
Company prior to the merger, for the years ended December 31, 2000 and 1999,
respectively. The amount included in prepaid reinsurance premiums at December
31, 2000 for reinsurance ceded to Tokio Marine was $89,574,000. Reinsurance
recoverable on unpaid losses ceded to Tokio Marine was $7,675,000 at December
31, 2000. The Subsidiaries ceded losses and loss adjustment expenses of
$2,935,000 and $3,376,000 to Tokio Marine for the years ended December 31, 2000
and 1999, respectively. The Subsidiaries ceded premiums of $12,795,000,
$22,581,000 and $19,840,000 to subsidiaries of XL, a partial owner of the
Company prior to the merger, for the years ended December 31, 2001, 2000 and
1999, respectively. The amounts included in prepaid reinsurance premiums at
December 31, 2001 and 2000 for reinsurance ceded to subsidiaries of XL were
$27,509,000 and $26,893,000, respectively.

The Subsidiaries ceded premiums of $(1,401,000) and $84,000 on a quota
share basis to Commercial Reinsurance Company (Comm Re), an affiliate of
MediaOne Capital Corporation (MediaOne), a partial owner of the Company prior to
the merger, for the years ended December 31, 2000 and 1999, respectively. The
Subsidiaries assumed premiums of $8,568,000 from Comm Re for the year ended
December 31, 2000, in connection with the acquisition of Comm Re by the Company
in June 2000. The sellers have either posted a letter of credit or assumed Comm
Re's exposure themselves to cover any losses on its exposure at the time of the
acquisition, all of which is being accounted for as reinsurance by the Company.
The Subsidiaries ceded losses and loss adjustment expense recoveries of $501,000
and $22,000 to this affiliate for the years ended December 31, 2000 and 1999,
respectively.

The Subsidiaries had premiums written of $54,295,000 and $4,412,000 in
2001 and 2000, respectively, relating to the guaranty of debt issued and of debt
obligations purchased by FSA Global Funding Limited (FSA Global), in which the
Company holds a 29% ownership interest (see Note 19). The amounts included in
deferred premium revenue relating to FSA Global transactions are $40,090,000 and
$431,000 at December 31, 2001 and 2000, respectively.

The Subsidiaries had premiums earned of $7,159,000 for the year ended
December 31, 2001 relating to business with affiliates of Dexia. Deferred
premium revenue and gross par outstanding relating to those transactions were
$4,336,000 and $10,906,755,000, respectively, at December 31, 2001.

16. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The following estimated fair values have been determined by the Company
using available market information and appropriate valuation methodologies.
However, considerable judgment is necessary to interpret the data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amount the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.

Bonds, equity investments and GIC bond portfolio - The carrying amount
represents fair value. The fair value is based upon quoted market price.

Short-term investments, including the GIC short-term investment portfolio
- - The carrying amount is fair value, which approximates cost due to the short
maturity of these instruments.

Cash, receivable for investments sold and payable for investments
purchased - The carrying amount approximates fair value because of the short
maturity of these instruments.

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Deferred premium revenue, net of prepaid reinsurance premiums - The
carrying amount of deferred premium revenue, net of prepaid reinsurance
premiums, represents the Company's future premium revenue, net of reinsurance,
on policies where the premium was received at the inception of the insurance
contract. The fair value of deferred premium revenue, net of prepaid reinsurance
premiums, is an estimate of the premiums that would be paid under a reinsurance
agreement with a third party to transfer the Company's financial guaranty risk,
net of that portion of the premiums retained by the Company to compensate it for
originating and servicing the insurance contract.

Notes payable - The carrying amount of notes payable represents the
principal amount. The fair value is based upon quoted market price.

Installment premiums - Consistent with industry practice, there is no
carrying amount for installment premiums since the Company will receive premiums
on an installment basis over the term of the insurance contract. Similar to
deferred premium revenue, the fair value of installment premiums is the
estimated present value of the future contractual premium revenues that would be
paid under a reinsurance agreement with a third party to transfer the Company's
financial guaranty risk, net of that portion of the premium retained by the
Company to compensate it for originating and servicing the insurance contract.

GICs - The fair value of a GIC is the present value of the expected cash
flows as of the reporting date.

Losses and loss adjustment expenses, net of reinsurance recoverable on
unpaid losses - The carrying amount is fair value, which is the net present
value of the expected cash flows for specifically identified claims and
potential losses in the Company's insured portfolio.

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17. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

Activity in the liability for losses and loss adjustment expenses, which
consists of the case basis and general reserves, is summarized as follows (in
thousands):

During 1999, the Company increased its general reserve by $8,829,000, of
which $8,575,000 was for originations of new business and $254,000 was for the
reestablishment of the general reserve. Also during 1999, the Company
transferred to the general reserve $3,549,000 representing recoveries received
on prior-year transactions and transferred $4,580,000 from the general reserve
to case basis reserves. Giving effect to these transfers, the general reserve
totaled $54,971,000 at December 31, 1999.

During 2000, the Company increased its general reserve by $9,403,000, of
which $6,672,000 was for originations of new business and $2,731,000 was for the
accretion of the discount on prior years' reserves. Also during 2000, the
Company transferred to the general reserve $2,053,000 representing recoveries
received on prior-year transactions and transferred $1,223,000 from the general
reserve to case basis reserves. Giving effect to these transfers, the general
reserve totaled $65,204,000 at December 31, 2000.

During 2001, the Company increased its general reserve by $12,497,000, of
which $8,203,000 was for originations of new business and $4,294,000 was for the
accretion of the discount on prior years' reserves. Also during 2001, the
Company transferred to the general reserve $89,000 representing recoveries
received on prior-year transactions and transferred $8,719,000 from the general
reserve to case basis reserves. Giving effect to these transfers, the general
reserve totaled $69,071,000 at December 31, 2001.

The amount of discount taken was approximately $29,578,000, $28,748,000
and $31,113,000 at December 31, 2001, 2000 and 1999, respectively.

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18. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

19. INVESTMENTS IN UNCONSOLIDATED AFFILIATES

In June 1998, the Company invested $10,000,000 to purchase 1,000,000
shares of common stock, representing a 25% interest, in Fairbanks Capital
Holding Corp. (Fairbanks), which buys, sells and services residential mortgage
loans. In October 1999, the Company invested $4,517,000 to purchase 361,333
shares of Fairbanks preferred stock, resulting in the Company owning a 22.2%
interest in Fairbanks as of December 31, 1999. In December 2001, the Company
invested an additional $14,980,000 in Fairbanks, resulting in the Company owning
a 28.36% interest in Fairbanks as of December 31, 2001. The Company's investment
in Fairbanks is accounted for using the equity method of accounting. Amounts
recorded by the Company in connection with Fairbanks as of December 31, 2001,
2000 and 1999 were as follows (in thousands):

At December 31, 2001 and 2000, the Company's retained earnings included
$3,237,000 and $(679,000) respectively, of accumulated undistributed earnings
(losses) of Fairbanks (net of goodwill amortization).

In November 1998, the Company invested $19,900,000 to purchase a 19.9%
interest in XL Financial Assurance Ltd (XLFA), a financial guaranty insurance
subsidiary of XL (see Note 7). In February 1999, the Company sold $4,900,000 of
its interest back to XLFA, giving the Company a 15.0% interest in XLFA as of
December 31, 1999. In December 2000, the Company invested an additional
$24,000,000 to maintain its 15.0% interest. The Company's investment in XLFA is
accounted for using the equity method of accounting because the Company has
significant influence over XLFA's operations. Amounts recorded by the Company in
connection with XLFA as of December 31, 2001, 2000 and 1999 are as follows (in
thousands):

64

At December 31, 2001 and 2000, the Company's retained earnings included
$10,726,000 and $3,862,000, respectively, of accumulated undistributed earnings
of XLFA.

In 1998, the Company purchased a 29% interest in FSA Global. The
investment is accounted for using the equity method of accounting. Total assets
and total liabilities for FSA Global at December 31, 2001 were $3,491,906,000
(unaudited) and $3,495,817,000 (unaudited), respectively. Total revenues and
total expenses for FSA Global were $151,135,000 (unaudited) and $150,530,000
(unaudited), respectively, for the year ended December 31, 2001. FSA Global's
net income for 2001, 2000 and 1999 was $605,000 (unaudited), $383,000 and
$164,000, respectively.

20. MINORITY INTEREST IN SUBSIDIARY

In November 1998, International sold to XL $20,000,000 of preferred shares
representing a minority interest in International, which is a Bermuda-based
financial guaranty subsidiary of FSA (see Note 7). In December 1999,
International sold to XL an additional $10,000,000 of preferred shares to
maintain its minority ownership percentage. The preferred shares are Cumulative
Participating Voting Preferred Shares, which in total have a minimum fixed
dividend of $1,500,000 per annum. For the years ended December 31, 2001, 2000
and 1999, the Company recognized minority interest of $8,929,000, $5,295,000 and
$2,715,000, respectively.

21. GICS

The obligations under GICs may be called at various times prior to
maturity based upon certain agreed-upon events. As of December 31, 2001, the
interest rates on these GICs were between 1.81% and 5.68% .

Principal payments due under these GICs in each of the next five years
ending December 31 and thereafter, based upon expected withdrawal dates, are as
follows (in thousands):

22. RECENTLY ISSUED ACCOUNTING STANDARDS

In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133 was
subsequently amended by SFAS No. 137 and No. 138. These statements established
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and hedging activities. It
requires that entities recognize all derivatives as either assets or liabilities
in the statement of financial position and measure the instruments at fair
value. At December 31, 2000, the Company had a limited number of insurance
policies considered to be derivatives for accounting purposes and had no open
positions in U.S. Treasury bond futures, call options or other derivative
instruments used for hedging purposes. For the year ended December 31, 2001, the
Company recorded, as an increase to premiums earned, a fair value adjustment of
$6,743,000 relating to these policies. The adoption on January 1, 2001 of this
standard did not have a material impact on the Company's financial position,
results of operations or cash flows. In connection with the establishment of the
Company's GIC business in the fourth quarter of 2001, the Company enters into
derivative instruments to hedge the interest rate risks in certain of its fixed-
rate assets and liabilities. In 2001, the Company recorded a net gain of
$161,000 relating to the ineffectiveness of these hedges.

65

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. Management believes that the
implementation of these standards, on January 1, 2002, will not have a material
effect on the Company's financial position, results of operations or cash flows.

66

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None

67

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

DIRECTORS

On May 17, 2001, the Company's shareholders appointed 13 directors to
serve until the Company's next annual meeting of shareholders or until their
earlier resignation or removal. Two of those directors, Paul Vanzeveren and
Martine Decamps, resigned in September and October 2001, respectively. At
regularly scheduled meeting of the Company's Board of Directors in September and
November 2001, the Board of Directors appointed Bruno Deletre and Dirk Bruneel,
respectively, as directors. Information about the directors is set forth below
in this Item, under the caption "Directors and Executive Officers" in Item 12
and in Item 13.

Dirk Bruneel
Age 51 ............ Director of the Company since November 2001. Mr.
Bruneel has been a member of the Executive
Committee of Dexia S.A. since July 2001, and is a
director of a number of Dexia affiliated
companies. He was a member of the Board of
Directors of Banque Artesia (a Belgian based bank
which was acquired by Dexia S.A. in July 2001)
from November 1997 until March 2002; BACOB Bank
s.c. (the retail banking subsidiary of Banque
Artesia) from November 1993 until March 2002; and
Dexia Bank from July 2001 through January 2002.
Mr. Bruneel served as Chairman of the Management
Committee of Banque Artesia from November 1998
until August 2001 and of BACOB Bank s.c. from
January 1995 until August 2001, and was a member
of the Management Committee of Dexia Bank from
July 2001 through January 2002. Mr. Bruneel was
previously Vice President of the Board of the
Belgian Banking Association. He currently serves
as a director of EHSAL and Erste Bank, and as
Treasurer of VLAAMS OMROEPORKEST EN KAMERKOOR.

John J. Byrne
Age 69 ............. Director since July 2000. Mr. Byrne was Chairman
of the Board of Directors from May 1994 until
November 1997, and Vice Chairman of the Board of
Directors from November 1997 until he retired as a
director in November 1999. Mr. Byrne is Chairman,
Chief Executive Officer and former President of
White Mountains Insurance Group, Ltd. ("White
Mountains"), which was a major shareholder of the
Company prior to the Merger. Mr. Byrne served as
Chairman of OneBeacon Insurance Group from June
2001 until December 2001. Mr. Byrne serves on the
boards of OneBeacon, Folksamerica and Fund
American and is Chairman of Montpelier Re
Insurance. Each of these companies is an operating
affiliate of White Mountains. He also serves on
the board of Overstock.com. Mr. Byrne was formerly
Chairman of Fireman's Fund Insurance Company and
GEICO Corporation and has served on the boards of
American Express, Lehman Brothers, Lockheed
Martin, The Travelers Property & Casualty, CCC
Information Services Group, Markel Corporation and
Terra Nova (Bermuda) Holdings, Ltd. Mr. Byrne was
selected by The St. John's University School of
Risk Management as Insurance Industry Leader of
the Year for 2001.

Robert P. Cochran
Age 52 ............ Chairman of the Board of Directors of the Company
since November 1997, and Chief Executive Officer
and a Director of the Company since August 1990.
Mr. Cochran served as President of the Company and
FSA from August 1990 until November 1997. He has
been Chief Executive Officer of FSA since August
1990, Chairman of FSA since July 1994, and a
director of FSA since July 1988. Prior to joining
the Company in 1985, Mr. Cochran was managing
partner of the Washington, D.C. office of the
Kutak Rock law firm. Mr. Cochran is a director of
XL Financial Assurance Ltd and White Mountains
Insurance Group, Ltd.

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Bruno Deletre
Age 40 ............ Director of the Company since September 2001. Mr.
Deletre has been a member of the Executive Board
of Dexia Credit Local since May 2001. Prior to
that time, he held various positions in the French
Ministry of Finance -- Treasury, and served as
Advisor to the French Minister of Economy and
Finance from 1995 to 1997. He is a director of
Dexia Global Structured Finance.

Alain Delouis
Age 41 ............ Director of the Company since November 2000. Mr.
Delouis has been General Auditor of Dexia since
February 2002. He was a member of the Executive
Committee and head of the financial markets
division of Dexia Credit Local from mid-2000 until
February 2002. Prior to that time, he served as
the head of the Risk Management Department of
Dexia Group since 1997, and headed the internal
audit department of Credit Local de France during
1995 and 1996.

Robert N. Downey
Age 66 ............ Director of the Company since August 1994. Mr.
Downey has been a senior director of Goldman Sachs
& Co. since 1999, a limited partner from 1991 to
1999, and a general partner from 1976 until 1991.
At Goldman, Sachs & Co., Mr. Downey served as head
of the Municipal Bond Department and Vice Chairman
of the Fixed Income Division. Mr. Downey was a
Director of the Securities Industry Association
from 1987 through 1991 and served as its Chairman
in 1990 and Vice Chairman in 1988 and 1989. He was
also formerly Chairman of the Municipal Securities
Division of the Public Securities Association
(known today as the Bond Market Association) and
Vice Chairman of the Municipal Securities
Rulemaking Board.

Roland C. Hecht
Age 56 ............. Director of the Company since July 2000. Mr. Hecht
has been Chairman of the Board of Dexia Banque
Privee since October 2001. He was Executive Vice
President - Development and International, of
Dexia S.A. from December 2000 until October 2001.
He was Chairman of the Executive Board of Dexia
Project & Public Finance International Bank from
January 1998 until July 2000. He was also a member
of the Executive Board of Dexia Credit Local de
France, a subsidiary of Dexia S.A. formerly known
as Credit Local de France, from January 2000 to
November 2000. He joined Credit Local de France as
head of its international department in 1990. In
1993, he was named Executive Vice President and
later became Senior Executive Vice President and
member of the Board of Directors in 1996. Prior to
joining Credit Local de France, Mr. Hecht was
General Manager of Banque Nationale de Paris (BNP)
London branch.

David O. Maxwell
Age 71 ............ Director of the Company since August 1994. Mr.
Maxwell was Chairman and Chief Executive Officer
of Fannie Mae from 1981 until his retirement in
1991. Mr. Maxwell is an advisory director of
Potomac Electric Power Company (PEPCO), and a
member of the advisory boards of Centre Partners
II, L.P. and Centre Partners III, L.P.

Sean W. McCarthy
Age 43 ............ Director of the Company since February 1999. Mr.
McCarthy has been President and Chief Operating
Officer of the Company since January 2002, and
prior to that time served as Executive Vice
President of the Company since November 1997. He
has been President of FSA since November 2000, and
served as Chief Operating Officer of FSA from
November 1997 until November 2000. Mr. McCarthy
was named a Managing Director of FSA in March
1989, head of its Financial Guaranty Department in
April 1993 and Executive Vice President of FSA in
October 1999. He has been a director of FSA since
September 1993. Prior to joining FSA in 1988, Mr.
McCarthy was a Vice President of PaineWebber
Incorporated.

69

James H. Ozanne
Age 58 ............. Director of the Company since January 1990. Mr.
Ozanne served as Vice Chairman of the Board of
Directors of the Company from February 1998 until
July 2000. Mr. Ozanne is Chairman of Greenrange
Partners. He was Chairman of Source One Mortgage
Services Corporation, which was a subsidiary of
White Mountains ("Source One"), from March 1997 to
May 1999, Vice Chairman of Source One from August
1996 until March 1997, and a director of Source
One from August 1996 to May 1999. He was President
of Fund American Enterprises, Inc. from March 1997
until December 1999. He was Chairman and Director
of Nations Financial Holdings Corporation from
January 1994 to January 1996. He was President and
Chief Executive Officer of U S WEST Capital
Corporation ("USWCC") from September 1989 until
December 1993. Prior to joining USWCC, Mr. Ozanne
was Executive Vice President of General Electric
Capital Corporation. He is a director of
Acquisitor, PLC, and Vice Chairman of Fairbanks
Capital Holding Corp.

Pierre Richard
Age 61 ............ Director and Vice Chairman of the Company since
July 2000. Mr. Richard was appointed Group Chief
Executive and Chairman of the Executive Committee
of Dexia S.A. in December 1999 after its
reorganization. He had been co-Chairman of Dexia
Group since its creation through the alliance
between Credit Local de France and Credit Communal
de Belgique in December 1996. In October 1987,
when Credit Local de France was incorporated, he
took over as Chief Executive Officer and then, in
December 1993, after the firm's privatization, he
was named Chairman and Chief Executive Officer. He
previously served as Deputy General Manager of
Caisse des Depots et Consignations and, before
that, as head of the Local Authorities Department
at the French Ministry of Interior, where he was
closely involved in drafting the new legislation
for decentralization. He serves on the boards of
the European Investment Bank, Compagnie Nationale
Air France, Le Monde SA, Credit du Nord and
Generali France Holding. He has been decorated as
an OFFICIER of the LEGION D'HONNEUR and the ORDRE
NATIONAL DU MERITE,and as a COMMANDEUR of the
ORDRE OF LEOPOLD II.

Roger K. Taylor
Age 50 ............ Director of the Company since February 1995.
Effective January 2002, Mr. Taylor became a
part-time employee of the Company. Mr. Taylor
served as Chief Operating Officer of the Company
from May 1993 through December 2001 and President
of the Company from November 1997 through December
2001. Mr. Taylor joined FSA in January 1990, and
served FSA as its President from November 1997
until November 2000, a director since January 1992
and a Managing Director since January 1991. Prior
to joining FSA, Mr. Taylor was Executive Vice
President of Financial Guaranty Insurance Company,
a financial guaranty insurer. Mr. Taylor is a
director of Fairbanks Capital Holding Corp., in
which the Company owns an equity position.

Rembert von Lowis
Age 48 ............. Director of the Company since July 2000. Mr. von
Lowis is a member of the Executive Committee and
Chief Financial Officer of Dexia S.A. He became
Senior Executive Vice President of Credit Local de
France in 1993. Mr. von Lowis joined Credit Local
de France as Chief Financial Officer and member of
its Executive Board in 1988. Earlier, he held
management positions in the Local Development
Division in Caisse des Depots et Consignations and
the Local Authorities Department of the French
Ministry of Interior. Mr. Von Lowis is a director
of Dexia CLF Finance Company.

Each director of the Company who is not an officer of the Company or Dexia
received a fee of $40,000 per annum for service as a director, and an additional
annual fee of $5,000 if chairperson of a Committee of the Board of Directors.
Such directors also received $2,000 for each Board meeting and regular Committee
meeting attended and

70

reimbursement for expenses for each such meeting attended. Each director is
entitled to defer fees under the Company's Deferred Compensation Plan and to
participate in the "Director Share Purchase Program" described under that
caption in Item 11.

EXECUTIVE OFFICERS OF THE COMPANY

In addition to Messrs. Cochran, McCarthy and Taylor (who are described
above under the caption "Directors"), the Company's other executive officers are
described below. The Company's executive officers include the permanent members
of the Management Committee and Mr. Joseph, the Company's principal accounting
officer.

The present principal occupation and five-year employment history of each
of the above-named executive officers of the Company, as well as other
directorships of corporations currently held by each such person, are set forth
below:

Mr. Brewer has been a Managing Director of FSA since March 1989 and the
Chief Underwriting Officer of FSA since September 1990. He has been a Managing
Director of the Company since May 1999 and a director of FSA since September
1993. From March 1989 to August 1990, Mr. Brewer was Managing Director, Asset
Finance Group, of FSA. Prior to joining FSA in 1986, Mr. Brewer was an Associate
Director of Moody's Investors Service, Inc.

Mr. Farrell has been Managing Director of FSA in charge of FSA's Corporate
Finance Department since December 2000 and a member of the Management Committee
of the Company since January 2002. Mr. Farrell joined FSA as an Associate in the
Residential Mortgage Group in December 1990, and became a Managing Director of
FSA in January 1995.

Mr. Harrison has been a Managing Director and the Chief Financial Officer
of FSA since August 1991 and the Chief Financial Officer of the Company since
February 1993. He has been a director of FSA since September 1993. From April
1987 through August 1991, Mr. Harrison was Chief Financial Officer of Citibank,
N.A. -- U.S. Consumer Banking Group, and prior thereto was Managing Director,
Real Estate Finance Group, of Merrill Lynch & Co. Inc. Mr. Harrison has been a
director of Fairbanks Capital Holding Corp. and affiliated entities since
December 1998. Mr. Harrison has advised the Company of his intention to retire
upon the Company's appointment of a successor Chief Financial Officer.

Mr. Joseph has been a Managing Director of the Company and FSA since
December 1993 and the Controller of FSA since February 1992 and of the Company
since April 1993. Prior to joining FSA in 1992, he was Vice President and
Controller of Capital Markets Assurance Corporation, a financial guaranty
insurer.

Mr. Stern has been a Managing Director, the Secretary and the General
Counsel of the Company since April 1993. Since April 1993, he has been the
Secretary of FSA, and since March 1989, he has been a Managing Director of FSA.
He has been a director of FSA since August 1990. Prior to joining FSA as General
Counsel in 1987, Mr. Stern was an attorney with Cravath, Swaine & Moore.

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SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16 of the Securities Exchange Act of 1934 (the "Exchange Act")
requires periodic reporting by beneficial owners of more than 10% of any equity
security registered under Section 12 of the Exchange Act and directors and
executive officers of issuers of such equity securities. Upon the Merger in July
2000, the Company's Common Stock ceased to be registered under Section 12 of the
Exchange Act or listed on the New York Stock Exchange (the "NYSE").
Consequently, the Company no longer has equity securities registered under
Section 12 of the Exchange Act, and the reporting obligations of Section 16 of
the Exchange Act no longer apply.

ITEM 11. EXECUTIVE COMPENSATION.

SUMMARY COMPENSATION TABLE

The table below sets forth a summary of all compensation paid to the chief
executive officer of the Company and the other four most highly compensated
executive officers of the Company and its subsidiaries, in each case for
services rendered in all capacities to the Company and its subsidiaries for the
years ended December 31, 2001, 2000 and 1999.

(1) No awards of restricted stock or options/SARs were made to any of the
executives named in the table during the period covered by the table.

(2) Figures for 1999 represent the value of phantom stock granted as "equity
bonus" awards under the Company's 1993 Equity Participation Plan, as
amended, and deferred for a minimum of five years. Effective upon the
Merger, all equity bonus awards reported for prior years ceased to be
deferred, were valued at $76.00 per share and were paid out. The Company
ceased granting equity bonus awards following the Merger.

(3) Payouts were made to or deferred by each named executive in February 2002
with respect to performance shares for the three-year performance cycle
ending December 31, 2001. Payouts were made in cash for 2001 and 2000, and
in shares of Common Stock or cash for 1999. For purposes of this table,
shares of Common Stock are valued for 1999 at $49.1875 per share, which
was the New York Stock Exchange closing price per share on the day
preceding approval of the payout by the Human Resources Committee of the
Board of Directors and the per share value employed for those receiving
cash payments.

72

(4) All Other Compensation includes contributions by the Company to a defined
contribution pension plan ("Pension Plan") and supplemental executive
retirement plan ("SERP") as follows:

All Other Compensation also includes amounts paid by the Company to gross
up employees for medicare tax paid in respect of equity bonus awards and
other fringe benefits.

(5) Effective January 1, 2002, Mr. McCarthy became President and Chief
Operating Officer of the Company, and Mr. Taylor commenced part-time
employment status.

EMPLOYMENT AGREEMENTS AND ARRANGEMENTS; CHANGE IN CONTROL PROVISIONS

In connection with the Merger, each of Messrs. Cochran, Taylor and
McCarthy entered into four-year employment agreements with the Company,
effective July 5, 2000, the date of the Merger. The employment agreements
generally guarantee continuation of compensation and benefits through July 5,
2004. Compensation consists of (i) base salary at the annual rate in effect
immediately prior to the Merger, subject to increase at the Board's discretion;
(ii) annual bonus equal to a minimum percentage of a defined "bonus pool"; and
(iii) annual grants of performance shares under the Company's 1993 Equity
Participation Plan, as amended (the "Equity Plan"), equal to no less than 50% of
the number of performance shares granted to such executive officer in 2000. The
bonus pool equals 7% of the after-tax growth in adjusted book value for the
year, excluding realized and unrealized gains/losses on investments and
including a return on equity modifier consistent with the Company's practice in
effect before the Merger. An additional reserve bonus pool made up of previously
earned but undistributed bonus pool allocations from prior years, equal to
approximately $10 million after giving effect to 2001 bonuses (paid in the first
quarter of 2002), may also be distributable. Mr. Cochran is entitled to receive
an annual cash bonus equal to at least 5.6%, and Messrs. Taylor and McCarthy are
each entitled to receive an annual cash bonus equal to at least 4.25%, of the
bonus pool and, if applicable, the reserve pool. An additional 2.9% (or 1.75% if
Mr. Cochran is no longer employed by the Company; or 2.02% if either Mr. Taylor
or Mr. McCarthy is no longer employed by the Company) of the bonus pool and, if
applicable, the reserve pool, will be allocated among those three executive
officers as determined by the Human Resources Committee. The employment
agreements also provide for continued participation in the Company's benefit
plans and severance benefits in lieu of the Company's existing severance policy.
Specifically, if the Company terminates Mr. Cochran, Taylor or McCarthy without
cause or any of such executive officers terminates his employment for "good
reason", he will be entitled to twice his annual base and average annual bonus;
his outstanding performance shares will vest pro rata in proportion to the
percentage of the applicable performance cycle during which he was employed by
the Company; and two-thirds of both his remaining unvested performance shares
and the minimum annual performance shares which he is entitled to receive
through July 5, 2004 will vest. Each employment agreement provides that, if the
employee is terminated for cause or terminates his employment without "good
reason" during the term, he will be entitled only to be paid his pro rata annual
base salary through the date of termination. If such termination occurs after
the term, he will also be entitled to his pro-rata annual bonus through the date
of termination, his performance shares will vest pro rata in proportion to the
percentage of the applicable performance cycle during which he was employed by
the Company, and subsequently awarded performance shares will be treated as
provided in the 1993 Equity Participation Plan, as amended (the "Equity Plan").
The employment agreements contain a non-compete provision extending through the
four-year term.

In September 2001, the Company's Board of Directors approved an amended
and restated employment agreement with Mr. Taylor in connection with Mr.
Taylor's transition to part-time employment status. The amended agreement
provides for part-time employment of Mr. Taylor from January 1, 2002 through
July 5, 2004. During the part-time employment period, Mr. Taylor's annual salary
will be $250,000 and he will not be entitled to receive any

73

bonus (except in respect of the year ended December 31, 2001, which will be
calculated as described in the immediately preceding paragraph) or additional
performance shares. The amended agreement provides that Mr. Taylor's outstanding
performance shares will remain in effect and not be terminated by reason of his
transition to part-time employment status. He also remains entitled to
participate in the Company's benefit plans and, for so long as he serves as a
director of the Company, will receive compensation for director services in the
amounts paid to outside directors of the Company. The amended agreement provides
that if, during the term, the Company terminates Mr. Taylor without cause or if
he terminates his employment for "good reason", he will be entitled to the cash
compensation due him as if no such termination had occurred, in lieu of any
amount otherwise payable under the Company's severance policy for senior
management, and his remaining unvested performance shares will vest immediately.

The Company's severance policy for senior management entitles Messrs.
Stern and Brewer to 12 months of compensation, in each case if terminated
without cause and based upon current compensation (or, in certain events, prior
compensation if higher). The severance policy was amended in connection with the
Merger to provide reimbursement (on a grossed-up basis) for any "golden
parachute" excise taxes payable by employees upon their termination of
employment following the Merger, and to restrict adverse amendments to the
policy through December 31, 2004.

The Equity Plan provides for accelerated vesting and payment of equity
bonus shares, performance shares and stock options awarded thereunder upon the
occurrence of certain change in control transactions involving the Company.
These provisions are generally applicable to all participants in the Equity
Plan. Each of the named executive officers holds performance shares awarded
under the Equity Plan.

The Equity Plan provides that the Company's Board of Directors may elect
to continue the plan if a change in control occurs. Following a "plan
continuation", performance shares are not accelerated, but vest and are payable
as if no change in control had occurred, except in the case of any employee who
is terminated without cause or leaves for "good reason" following the change in
control. The Board elected a plan continuation in connection with the Merger.

DIRECTOR SHARE PURCHASE PROGRAM

In the fourth quarter of 2000, the Company entered into an agreement with
Dexia Holdings, Inc. ("DHI") and Dexia Public Finance Bank (now Dexia Credit
Local) establishing a program (the "Director Share Purchase Program") pursuant
to which Company directors could invest in shares of the Company's common stock.
The Director Share Purchase Program entitles each director of the Company to
purchase from Dexia S.A. (or an affiliate thereof) up to $10 million of
restricted shares ("Restricted Shares") of the Company's Common Stock at an
initial price of $78.766 per share; provided that (i) Restricted Shares must be
held for the lesser of four years or the participant's tenure as a director of
the Company; (ii) Restricted Shares may be put to Dexia Credit Local at any time
or from time to time following the required holding period for cash. Directors
may purchase such shares either directly or through deemed investments under the
Company's Deferred Compensation Plan ("DCP") or Supplemental Executive
Retirement Plan ("SERP"); and (iii) purchases of shares after inception of the
program are at a price equal to the purchase price for shares put to Dexia
Credit Local described below. Each deemed investment election with respect to
these shares is irrevocable. The Director Share Purchase Program enables the
Company to purchase from DHI, at the same price, the same number of shares of
common stock purchased by directors through phantom investments under the DCP or
SERP. Upon expiration of any applicable deferral period, the Company is
obligated to pay out the phantom investments in shares of common stock, which
must be held by the participant as if acquired directly from DHI for generally a
minimum of six months. The purchase price for each Restricted Share put to Dexia
Credit Local is equal to the product of 1.4676 and adjusted book value per share
("ABV per share"), with ABV per share determined in accordance with the
methodology employed for valuing performance share award payouts under the
Equity Plan. ABV per share is measured at the close of the calendar quarter in
which a director submits a repurchase notice, provided that ABV per share
freezes on the first anniversary of the later of the termination of directorship
or, in the case of deferred shares, receipt of shares upon expiration of the
deferral period.

During 2001, one of the Company's directors, Mr. Ozanne, made additional
investments in phantom shares under this program. Mr. Ozanne purchased
approximately 197, 168, 177 and 177 phantom shares on February 14, 2001, May 17,
2001, September 6, 2001 and November 15, 2001, respectively, at purchase prices
per share

74

determined under the formula described above of $87.35, $90.99, $97.40 and
$97.40, respectively. Sales under the program are not registered under the
Securities Act of 1933 in reliance upon an exemption from registration under
Section 4(2) of that Act. Such investments, and outstanding investments made by
the Company's directors, are described under the caption "Directors and
Executive Officers" in Item 12.

PERFORMANCE SHARES

Performance shares are awarded under the Equity Plan. The Equity Plan
authorizes the discretionary grant of performance shares by the committee
administering the Equity Plan (the Human Resources Committee) to key employees
of the Company and its subsidiaries. Each performance share represents the
economic value of up to two shares of Common Stock, and not just appreciation,
as is the case with a stock option. The number of shares of Common Stock
actually earned for each performance share depends upon the attainment by the
Company and its subsidiaries (on a consolidated basis) of "performance
objectives" during the time period specified by the Committee at the time an
award of performance shares is made.

The following table sets forth (a) a summary of performance shares awarded
to each of the named executive officers for the year ended December 31, 2001
(which awards were made in January or February 2002), (b) the applicable
performance period until payout and (c) the related estimated future payouts at
the stated assumed annual rates of adjusted book value per share and book value
per share growth.

LONG-TERM INCENTIVE PLANS - AWARDS IN 2001(1)

- ----------
(1) These performance shares were awarded under the Equity Plan in January or
February 2002 for the year ended December 31, 2001. The table excludes
performance shares awarded in January 2001 for the year ended December 31,
2000, which are set forth in a table under the caption "Performance
Shares" in Item 12 of the Company's Annual Report on Form 10-K for the
year ended December 31, 2000.

(2) One-third of each award relates to the three-year performance cycle ending
December 31, 2004; and two-thirds of each award relates to the three-year
performance cycle ending December 31, 2005. Awards are payable shortly
following completion of the applicable performance cycle, subject to
earlier payment in certain circumstances or to deferral. Such performance
shares vest at the completion of the applicable performance cycle, subject
to rules pertaining to the recipient's death, disability, retirement or
termination of employment, or change-in-control transactions.

(3) The actual dollar value received by a holder of performance shares, in
general, varies in accordance with the average of the annual rate of
growth in "adjusted book value" and "book value" per share ("ROE") of
Common Stock during an applicable "performance cycle" and the value of
Common Stock at the time of payout of such performance shares. At the
election of the holder at the time of the award, ROE may be determined
including or excluding realized and unrealized gains and losses in the
Company's investment portfolio. With respect to the performance shares
described in the table above, if ROE is 7% or less per annum for any
performance cycle, no shares of Common Stock will be earned for the
performance cycle; if ROE is 13% per annum for any performance cycle, a
number of shares of Common Stock equal to 100% of the number of
performance shares will be earned for that performance cycle; and if ROE
is 19% per annum or higher for any performance cycle, a number of shares
of Common Stock equal to 200% of the number of performance shares will be
earned for that performance cycle. If ROE is between 7% and 19%, the
payout percentage will be interpolated. So long as the Company's Common
Stock is not registered under the Securities Exchange Act of 1934, the
Company expects to pay its performance shares in cash rather than stock
with shares valued at the greater of (i) 0.85 times "adjusted book value"
per share and (ii) the average of (a) 1.15 times "adjusted book value" per
share and (b) thirteen times "operating earnings" per share.

75

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Human Resources Committee consisted of Messrs. Maxwell (Chairperson),
Byrne, Cochran, Downey, Hecht and Richard during 2001. Except for Mr. Cochran,
none of such persons is currently or has ever been an officer or employee of the
Company or any subsidiary of the Company. Mr. Byrne is Chairman and Chief
Executive Officer of White Mountains Insurance Group Ltd. ("White Mountains"),
which was a major shareholder of the Company prior to the Merger. Mr. Cochran,
Chairman and Chief Executive Officer of the Company, is a director of White
Mountains, the Chairman of its human resources committee and a member of its
compensation committee. Mr. Downey, a director of the Company, is a Senior
Director of Goldman, Sachs & Co. Goldman Sachs served as co-manager of the
Company's issuance in December 2001 of $100 million principal amount of 67/8%
Quarterly Interest Bond Securities due December 15, 2101 (QUIBS). Mr. Richard is
the Group Chief Executive and Chairman of the Executive Committee of Dexia S.A.,
and Mr. Hecht is Chairman of the Board of Dexia Banque Privee. Mr. Ozanne is
Vice Chairman of Fairbanks Capital Holdings Corp. ("Fairbanks"), a servicer of
residential mortgage loans, including a number of residential mortgage loan
portfolios supporting transactions insured by FSA. In December 2001, the Company
contributed an additional $15.0 million to Fairbanks, increasing its equity
ownership in that company to 28.36%

As described above under the caption "Director Share Purchase Program",
members of the Human Resources Committee are entitled to participate in a share
purchase program available to all directors of the Company, either directly or
through deemed investments under the Company's Deferred Compensation Plan or
Supplemental Executive Retirement Plan.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

5% SHAREHOLDERS

The following table sets forth certain information regarding beneficial
ownership of the Company's equity at March 15, 2002 as to each person known by
the Company to beneficially own, within the meaning of the Securities Exchange
Act of 1934 (the "Exchange Act"), 5% or more of the outstanding shares of the
Common Stock, par value $.01 per share, of the Company.

- ----------
(1) Shares are held indirectly through a subsidiary of Dexia S.A.

(2) For purposes of this table, Dexia S.A. is not deemed to be the beneficial
owner of 301,095 shares acquired by the Company in connection with the
Director Share Purchase Program described under the caption "Director
Share Purchase Program" in Item 11. Ownership percentage is calculated
based on 33,216,900 shares of Common Stock outstanding at March 15, 2002,
which excludes such shares acquired by the Company.

76

DIRECTORS AND EXECUTIVE OFFICERS

The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock at March 15, 2002 for (a) each director
of the Company, (b) each executive officer named under "Executive Compensation
- -- Summary Compensation Table" and (c) all executive officers and directors of
the Company as a group. The table also provides information regarding economic
ownership. Beneficial ownership is less than 1% for each executive officer and
director listed, individually, and as a group.

- ----------
(1) Shares beneficially owned were acquired under the Company's Director Share
Purchase Program described under the caption "Director Share Purchase
Program" in Item 11. To the extent shares economically owned exceed shares
beneficially owned, such economic ownership is attributable to (a)
performance shares, with each performance share treated as one share of
Common Stock, in the amounts shown below (excluding fractional shares),
and (b) deemed investments in the Company's Common Stock under the
Director Share Purchase Program:

The Company acquired 301,095 shares of its common stock from Dexia
Holdings, Inc. to satisfy most of its obligations under the Director Share
Purchase Program in an amount equal to the number of shares deemed
invested by directors at the Program's inception date under the DCP and
SERP.

(2) Messrs. Bruneel, Deletre, Delouis, Hecht, Richard and von Lowis, who are
directors of the Company, are officers of Dexia S.A. or its subsidiaries.
Dexia S.A. indirectly owns 98.6% of the Company's Common Stock.

(3) Mr. Byrne is also the chairman, Chief Executive Officer and a principal
owner of White Mountains Insurance Group Ltd. ("White Mountains"), which
was a major shareholder of the Company prior to the Merger. An affiliate
of White Mountains purchased 317,395 shares of the Company's Common Stock
from Dexia Holdings, Inc. in February 2001.

The Company is not aware of any arrangements that may result in a change
in control of the Company.

77

The following table sets forth beneficial ownership of common shares of
the Company's parent, Dexia S.A., at March 15, 2002, for (a) each director of
the Company, (b) each executive officer named under "Executive Compensation --
Summary Compensation Table" and (c) all executive officers and directors of the
Company as a group. Beneficial ownership is less than 1% for each executive
officer and director listed, individually, and as a group.

- ----------
(1) Shares beneficially owned by Company employees were acquired under the
employee Share Plans of Dexia S.A. during 2000 and 2001, which were made
available to all employees of the Company. These Plans allowed employees
to purchase shares at a 15% to 20% discount from market value, but
restricted the ability to dispose of such shares for a five-year period
following purchase, subject to limited exceptions. Shares purchased under
the 2001 Employee Share Plan include shares acquired under a "leveraged
option", under which employees were entitled to finance the purchase of
nine additional shares for each share purchased with his or her own funds,
with the lender being entitled to all dividends paid and 38% of any share
appreciation during the five-year investment period, and with the employee
having the benefit of a "floor" guarantying a return of invested funds
follwing expiration of the five-year investment period. The number of
shares in the table above includes shares owned under the leveraged option
as follows:

(2) Data not presently available.

78

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

FINANCIAL GUARANTY TRANSACTIONS

Since the Merger in July 2000, various affiliates of Dexia S.A., including
certain wholly owned bank subsidiaries and/or their U.S. branches, have
participated in transactions in which subsidiaries of the Company have provided
financial guaranty insurance. For example, Dexia affiliates have provided
liquidity facilities and letters of credit in FSA-insured transactions, and been
the beneficiary of financial guaranty insurance policies issued by insurance
company subsidiaries of the Company. In the opinion of management of the
Company, the terms of these arrangements are no less favorable to the Company
than the terms that could be obtained from unaffiliated parties.

DIRECTOR SHARE PURCHASE PROGRAM

Directors are entitled to purchase up to $10 million of actual or phantom
shares of the Company's Common Stock, as described above under the caption
"Director Share Purchase Program" in Item 11.

OTHER RELATIONSHIPS

Additional information relating to certain relationships and related
transactions is set forth under the caption "Compensation Committee Interlocks
and Insider Participation" in Item 11.

79

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

(a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES AND EXHIBITS.

1. FINANCIAL STATEMENTS

Item 8 sets forth the following financial statements of
Financial Security Assurance Holdings Ltd. and Subsidiaries:

Report of Independent Accountants

Consolidated Balance Sheets at December 31, 2001 and 2000

Consolidated Statements of Operations and Comprehensive Income
for the Years Ended December 31, 2001, 2000 and 1999

Consolidated Statements of Changes in Shareholders' Equity for
the Years Ended December 31, 2001, 2000 and 1999

Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999 Notes to Consolidated
Financial Statements

2. FINANCIAL STATEMENT SCHEDULES

The following financial statement schedule is filed as part of this
Report.

80

3. EXHIBITS

The following are annexed as exhibits to this Report:

81

Form 10-Q (Commission File No. 1-12644) for the quarterly period
ended September 30, 1997, and incorporated herein by reference.)

4.1(D) Form of 6.950% Senior Quarterly Income Debt Securities due 2098.
(Previously filed as Exhibit 2 to the November 1998 Form 8-K, and
incorporated herein by reference.)

4.1(E) Officers' Certificate pursuant to Sections 2.01 and 2.03 of the
Senior QUIDS Indenture. (Previously filed as Exhibit 5 to the
November 1998 Form 8-K, and incorporated herein by reference.)

4.1(F) Amended and Restated Trust Indenture dated as of February 24, 1999
(the "Amended and Restated Senior Indenture") between the Company
and the Trustee. (Previously filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-3 (Reg. No. 33-74165), and
incorporated herein by reference.)

4.1(G) Form of 67/8% Quarterly Interest Bond Securities due December 15,
2101. (Previously filed as Exhibit 2 to the Company's Current Report
on Form 8-K (Commission File No. 1-12644) dated December 12, 2001
(the "December 2001 Form 8-K"), and incorporated herein by
reference.)

4.1(H) Officers' Certificate pursuant to Sections 2.01 and 2.03 of the
Amended and Restated Senior Indenture. (Previously filed as Exhibit
3 to the December 2001 Form 8-K, and incorporated herein by
reference.)

10.1 Credit Agreement dated as of August 31, 1998 among FSA, each of its
insurance company affiliates listed on Schedule I attached thereto,
the Banks from time to time party thereto and Deutsche Bank AG, New
York Branch, as agent. (Previously filed as Exhibit 10 to the
Company's Quarterly Report on Form 10-Q (Commission File No.
1-12644) for the quarterly period ended September 30, 1998, and
incorporated herein by reference.)

10.2 Facility Agreement dated as of August 30, 1994, among FSA, Canadian
Global Funding Corporation and Hambros Bank Limited. (Previously
filed as Exhibit 2 to the Company's Quarterly Report on Form 10-Q
(Commission File No. 1-12644) for the quarterly period ended
September 30, 1994, and incorporated herein by reference.)

10.3 Credit Agreement dated as of April 30, 1996, among FSA, Financial
Security Assurance of Maryland Inc., Financial Security Assurance of
Oklahoma, Inc., the Banks signatory thereto and Bayerische
Landesbank Girozentrale, New York Branch, as Agent. (Previously
filed as Exhibit 2 to the Company's Quarterly Report on Form 10-Q
(Commission File No. 1-12644) for the quarterly period ended June
30, 1996, and incorporated herein by reference.)

10.4+ Money Purchase Pension Plan and Trust Agreement dated as of January
1, 1989 between FSA and Transamerica, with Adoption Agreement No.
001 and Addendum. (Previously filed as Exhibit 10.7 to the Form S-1,
and incorporated herein by reference.)

10.5+ Amended and Restated Supplemental Executive Retirement Plan (amended
and restated as of July 10, 2000). (Previously filed as Exhibit 10.2
to the September 30, 2000 10-Q, and incorporated herein by
reference.)

82

10.6+ Amended and Restated 1993 Equity Participation Plan (amended and
restated as of May 17, 2001). (Previously filed as Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q (Commission File No.
1-12644) for the quarterly period ended June 30, 2001 (the "June 30,
2001 10-Q"), and incorporated herein by reference.)

10.7+ Deferred Compensation Plan (amended and restated as of July 10,
2000). (Previously filed as Exhibit No. 10.1 to the September 30,
2000 10-Q, and incorporated herein by reference.)

10.8+ Severance Policy for Senior Management (amended and restated as of
May 17, 2001). (Previously filed as Exhibit No. 10.2 to the June 30,
2001 10-Q, and incorporated herein by reference.)

10.9(A)+ Share Purchase Program Agreement dated as of September 4, 2000,
among Dexia Public Finance Bank, Dexia Holdings, Inc. and the
Company. (Previously filed as Exhibit 10.3 to the September 30, 2000
10-Q, and incorporated herein by reference.)

10.9(B)+ Share Purchase Program Agreement dated as of December 15, 2000,
among Dexia Public Finance Bank, Dexia Holdings, Inc. and the
Company.

10.10+ Employment Agreement dated as of March 14, 2000 by and between the
Company and Robert P. Cochran.

10.11(A)+ Employment Agreement dated as of March 14, 2000 by and between the
Company and Roger K. Taylor.

10.11(B)+ Amended and Restated Employment Agreement dated as of September 6,
2001 by and between the Company and Roger K. Taylor. (Previously
filed as Exhibit No. 10.2 to the Company's Quarterly Report on Form
10-Q (Commission File No. 1-12644) for the quarterly period ended
March 30, 2001, and incorporated herein by reference.)

10.12+ Employment Agreement dated as of March 14, 2000 by and between the
Company and Sean W. McCarthy.

21* List of Subsidiaries.

23* Consent of PricewaterhouseCoopers LLP.

24* Powers of Attorney. (Filed herewith with respect to Messrs. Bruneel
and Deletre. Previously filed as Exhibit 24 to (i) the 1998 Form
10-K with respect to Mr. McCarthy; (ii) the 2000 Form 10-K with
respect to Messrs. Richard, Delouis, Hecht and von Lowis, and (iii)
the Company's Annual Report on Form 10-K (Commission File No.
1-12644) for the fiscal period ended December 31, 1996, with respect
to all other directors; and in each case incorporated herein by
reference.)

99* Financial Security Assurance Inc. and Subsidiaries 2001 Consolidated
Financial Statements and Report of Independent Accountants.

- ----------
+ Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form 10-K pursuant to Item 14(c).

* Filed herewith.

83

(b) REPORTS ON FORM 8-K

The Company filed a Current Report on Form 8-K dated December 12, 2001,
with the Securities and Exchange Commission on December 18, 2001, which
incorporated by reference the documents included as Exhibits thereto into the
Registration Statement relating to the Company's 67/8% Quarterly Interest Bond
Securities due December 15, 2101.

84

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

FINANCIAL SECURITY ASSURANCE
HOLDINGS LTD. (Registrant)

By: /s/ ROBERT P. COCHRAN
------------------------------------
Name: Robert P. Cochran
Title: Chairman and Chief Executive
Officer
Dated: March 27, 2002

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

85

/s/ PIERRE RICHARD* Vice Chairman and Director March 27, 2002
- --------------------------
Pierre Richard

/s/ ROGER K. TAYLOR* Director March 27, 2002
- --------------------------
Roger K. Taylor

/s/ REMBERT VON LOWIS* Director March 27, 2002
- --------------------------
Rembert von Lowis

- ----------
* Robert P. Cochran, by signing his name hereto, does hereby sign this Annual
Report on Form 10-K on behalf of himself and on behalf of each of the Directors
and Officers of the Registrant named above after whose typed names asterisks
appear pursuant to powers of attorney duly executed by such Directors and
Officers and filed with the Securities and Exchange Commission as exhibits to
this Report.

By: /s/ ROBERT P. COCHRAN
------------------------------------
Robert P. Cochran,
Attorney-in-fact

86

Schedule II

Parent Company Condensed Financial Information

CONDENSED BALANCE SHEETS
(DOLLARS IN THOUSANDS)

CONDENSED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS)

The Parent Company Condensed Financial Information should be read in
conjunction with the Consolidated Financial Statements and Notes to Consolidated
Financial Statements included in Item 8 Financial Statements and Supplementary
Data.

87

Schedule II

Parent Company Condensed Financial Information (Continued)

CONDENSED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)

(a) In 2000, $14,088 in treasury stock was used to pay employees to settle the
Company's deferred equity obligation.
(b) In 2001 and 2000, the Company's subsidiaries received a tax benefit of
$4,875 and $3,881, respectively, by utilizing the Company's losses. These
balances were recorded as capital contributions.

The Parent Company Condensed Financial Information should be read in
conjunction with the Consolidated Financial Statements and Notes to Consolidated
Financial Statements included in Item 8 Financial Statements and Supplementary
Data.

88

Schedule II

Parent Company Condensed Financial Information (Continued)

CONDENSED STATEMENTS OF CASH FLOWS, CONTINUED
(DOLLARS IN THOUSANDS)

The Parent Company Condensed Financial Information should be read in conjunction
with the Consolidated Financial Statements and Notes to Consolidated Financial
Statements included in Item 8 Financial Statements and Supplementary Data.

89

SCHEDULE II

Financial Security Assurance Holdings Ltd. (Parent Company)

Notes to Condensed Financial Statements

1. Condensed Financial Statements

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 condensed financial statements should be read in
conjunction with the Company's consolidated financial statements and the
notes thereto. Certain reclassifications have been made to conform to the
2001 presentation.

2. Significant Accounting Policies

The Parent Company carries its investments in subsidiaries under the
equity method.

3. Long-Term Debt

On September 18, 1997, the Company issued $130,000,000 of 7.375%
Senior Quarterly Income Debt Securities (Senior QUIDS) due September 30,
2097 and callable without premium or penalty on or after September 18,
2002. Interest on these notes is paid quarterly beginning on December 31,
1997. Debt issuance costs of $4,320,000 are being amortized over the life
of the debt.

On November 13, 1998, the Company issued $100,000,000 of 6.950%
Senior QUIDS due November 1, 2098 and callable without premium or penalty
on or after November 1, 2003. Interest is paid quarterly beginning on
February 1, 1999. Debt issuance costs of $3,375,000 are being amortized
over the life of the debt.

On December 19, 2001, the Company issued $100,000,000 of 6 7/8%
Quarterly Income Bond Securities due December 15, 2101 and callable
without premium or penalty on or after December 19, 2006. Interest is paid
quarterly beginning on March 15, 2002. Debt issuance costs of $3,250,000
are being amortized over the life of the debt.

90

Exhibit Index

All other Exhibits to Form 10-K are incorporated by reference, as described in
Item 14 of Form 10-K.