FINANCIAL SECURITY ASSURANCE HOLDINGS LTD/NY/ - 10-Q Quarterly Report

Financial Security Assurance Holdings Ltd.
(Exact name of registrant as specified in its charter)

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 ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

At November 11, 2003, there were 33,220,337 outstanding shares of Common Stock of the registrant (excludes 297,658 shares of treasury stock).

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(Dollars in thousands)

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands)

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Note: On July 1, 2003, the Company consolidated $1.9 billion in assets and $1.9 billion in liabilities related to variable interest entities with no corresponding cash movement.

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Nine Months Ended September 30, 2003 and 2002

Financial Security Assurance Holdings Ltd. (the Company) is an insurance holding company incorporated in the State of New York. The Company is primarily engaged (through its insurance company subsidiaries, collectively known as FSA) in the business of providing financial guaranty insurance on asset-backed and municipal obligations. The Company also offers guaranteed investment contracts (GICs) through its wholly owned subsidiaries, FSA Capital Markets Services LLC and FSA Capital Management Services LLC (collectively, CMS). The Company is an indirect subsidiary of Dexia S.A. (Dexia), a publicly held Belgian corporation.

In the third quarter of 2003, the Company consolidated FSA Global Funding Limited (FSA Global) and Canadian Global Funding Corporation (Canadian Global) as a result of FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). The Company also consolidated Premier International Funding Co. (Premier) in the third quarter as a result of obtaining control provisions (see Note 10).

The accompanying condensed consolidated financial statements have been prepared in accordance with instructions to Form 10-Q and, accordingly, do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America. These condensed consolidated statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. The accompanying condensed consolidated financial statements have not been audited by independent accountants in accordance with auditing standards generally accepted in the United States of America but, in the opinion of management, all adjustments, which include only normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows at September 30, 2003 and for all periods presented, have been made. The December 31, 2002 condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The results of operations for the periods ended September 30, 2003 and 2002 are not necessarily indicative of the operating results for the full year. Certain prior-year balances have been reclassified to conform to the 2003 presentation.

The Company establishes a case basis reserve for unpaid losses and loss adjustment expenses for the 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, which ranged from 4.77% to 6.1%. For insured collateralized debt obligations (CDOs), a case basis reserve is recorded to the extent that the overcollateralization ratio (non-defaulted collateral at par value divided by the debt insured) has fallen below 100% and there is a projected loss when calculating the present value of cash flows.

The Company also maintains a non-specific general reserve, which is available to be applied against future additions or accretions to existing case basis reserves or to new case basis reserves to be

established in the future. The general reserve is derived from two calculations. The first is calculated by applying loss factors to the Company's total net par underwritten and discounting the result at the then current risk-free rates. The loss factors used for this purpose have been determined based upon an independent rating agency study of bond defaults and the Company's portfolio characteristics and history. The second pertains to the Company's insured CDOs where a present value "deterministic" approach is utilized to calculate the general reserve for the Company's insured CDOs. The deterministic model applies a run of the collateral portfolio for each transaction considering each CDO transaction's unique attributes (such as reinsurance, individual collateral ratings and status, derivatives purchased, premiums due to the guarantor, etc.) utilizing a Moody's default pattern for frequency of defaults, an estimate of collateral recovery values for severity, and a risk-free rate of interest.

Management 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.

At September 30, 2003, the general reserve totaled $91.4 million. Net case reserves were $82.4 million, net of $85.0 million in reinsurance recoverables.

FSA has insured a number of credit default swaps 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. The Company recorded $11.2 million and $34.9 million in net earned premium under these agreements for the three and nine months ended September 30, 2003, respectively, and $9.4 million and $24.7 million in net earned premium for the three and nine months ended September 30, 2002, respectively. The changes in fair value, which were gains of $4.5 million and $8.6 million for the three and nine months ended September 30, 2003, respectively, and losses of $28.5 million and $33.5 million for the three and nine months ended September 30, 2002, respectively, were recorded in net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income and in accrued expenses and other liabilities. The losses or gains recognized by recording these contracts at fair value will be determined each quarter based upon market pricing of Super Triple-A (defined as having first-loss protection of 1.3 times the level required for a Triple-A rating) swap guarantees. The Company does not believe the fair value adjustments are an indication of potential claims under FSA's guarantees. The inception-to-date net unrealized loss was recorded in accrued expenses and other liabilities and was $35.6 million and $44.2 million at September 30, 2003 and December 31, 2002, respectively.

Derivative instruments, which are primarily designated as fair-value hedges, are entered into to manage the interest rate exposure of the Company's GICs, GIC bond portfolio and interest rate and currency exchange rate exposure on FSA Global and Canadian Global's debt and investments. The derivatives are recorded at fair value. These derivatives generally include interest rate futures and

interest rate and foreign currency 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 and convert FSA Global and Canadian Global's debt and investments into U.S. dollar floating-rate obligations. The gains and losses relating to the fair value hedges on the GIC business and FSA Global are included in financial products net interest income and net interest expense, as appropriate, along with the offsetting change in fair value of the hedged item attributable to the risk being hedged, in the consolidated statements of operations and comprehensive income. The gains and losses relating to the fair-value hedges of Canadian Global are included in interest expense along with the offsetting change in fair value of the hedged item attributable to the risk being hedged, in the consolidated statements of operations and comprehensive income. For the three and nine months ended September 30, 2003, the Company recorded a net gain of $3.1 million and $2.2 million, respectively, and for the three and nine months ended September 30, 2002, the Company recorded a net gain of $1.1 million and $3.3 million, respectively, relating to the ineffectiveness of these hedges, all of which related to the Company's GIC business. In addition, there are derivatives that were purchased for the purpose of economically hedging the interest rate risk on the GIC business that have not been designated to specific GICs or bonds and, as a result, hedge accounting is not permitted. The change in fair value of these derivatives was a gain of $1.3 million and loss of $1.2 million for the three and nine months ended September 30, 2003, respectively. These amounts were recorded in net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income.

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 principal amount of insured obligations in the asset-backed insured portfolio is backed by the following types of collateral (in millions) at September 30, 2003 and December 31, 2002:

Net of amounts ceded and ceded amounts are not necessarily reflective of the risk retained by FSA since FSA employs first loss reinsurance on a material portion of its asset-backed business.

The principal amount of insured obligations in the municipal insured portfolio includes the following types of issues (in millions) at September 30, 2003 and December 31, 2002:

As of September 30, 2003, the interest rates on GICs were between 0.81% and 6.07% per annum.

Payments due under GICs, excluding mark-to-market adjustments and prepaid interest of $14.6 million, in the remainder of 2003 and each of the next five years ending December 31 and thereafter, based upon expected withdrawal dates, are as follows (in millions):

Expected Withdrawal Date	Principal Amount
2003	$	166.5
2004		1,014.2
2005		565.9
2006		180.1
2007		384.1
2008		37.3
Thereafter		829.1

Total	$	3,177.2

As of September 30, 2003, the interest rates on variable interest entities' debt (VIE Debt) were between 1.12% and 7.73% per annum.

Payments due under the VIE Debt (including $840.0 million of interest accretion on zero coupon obligations) in the remainder of 2003 and each of the next five years ending December 31 and thereafter, are as follows (in millions):

Year	Principal Amount
2003	$	0.3
2004		10.3
2005		204.1
2006		87.7
2007		170.7
2008		39.8
Thereafter		2,565.8

Total	$	3,078.7

The Company operates in two business segments, financial guaranty and financial products (FP). The financial guaranty segment is primarily in the business of providing financial guaranty insurance on asset-backed and municipal obligations. The financial guaranty segment also includes the results of Canadian Global. The FP segment consists of the Company's GIC operations and, beginning in the third quarter of 2003, the operations of FSA Global and Premier (the FP VIEs). The FP VIEs are included in the FP segment even though FSA consolidates these entities for financial reporting purposes. The FP business involves only matched funded activities. Securitized loans and a component of other assets are financial guaranty assets financed by FP and give rise to the balance sheet inter-segment elimination amount. The GICs provide for the return of principal and the payment of interest

at a guaranteed rate. The following table is a summary of the financial information (in thousands) by segment as of and for the nine months ended September 30, 2003 and 2002:

The Company owns a minority interest in Fairbanks Capital Holding Corp., the parent company of Fairbanks Capital Corp. (collectively with its parent, Fairbanks). Fairbanks is a servicer of single-family residential mortgage loans originated by unaffiliated third parties. Most of the mortgage loans serviced by Fairbanks are considered "sub-prime", reflecting the lower than "prime" credit quality of the borrower/homeowner. Fairbanks is owned 56.8% by The PMI Group Inc. and 29.8% by the Company, with the remainder owned by certain founders of Fairbanks. At September 30, 2003, the Company's interest in Fairbanks had a book value of $49.9 million, of which $7.6 million represented goodwill. The Company's equity in the earnings from Fairbanks for the nine months ended September 30, 2003 and 2002 was a loss of $10.0 million and income of $9.2 million, respectively. The decrease in the Company's equity in the earnings of Fairbanks was largely a result of estimated Federal Trade Commission (FTC) and related litigation settlement charges accrued in 2003. The Company's share of that settlement, included in the loss for the quarter, was $10.7 million.

Fairbanks' business is subject to regulation, supervision and licensing by various federal, state and local authorities, which have increased their focus on lending and servicing practices in the sub-prime lending industry. In October 2002, the FTC informed Fairbanks that it was investigating whether Fairbanks' loan servicing or other practices violated the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, Section 5 of the Federal Trade Commission Act or other laws enforced by the FTC. The Company understands that, in March 2003, the U.S. Department of Housing and Urban Development (HUD) initiated a criminal investigation into Fairbanks' servicing practices. Certain of Fairbanks' shareholders, including the Company, have received civil investigative demands from the FTC relating to their investments in Fairbanks and their knowledge of Fairbanks' servicing operations.

Fairbanks is also subject to private litigation, including a number of putative class action suits, alleging violations of federal and/or state laws. The publicity surrounding sub-prime lending and servicing practices may result in the filing of other putative class action suits against Fairbanks.

Fairbanks is highly leveraged and dependent upon credit facilities to make servicing and delinquency advances in the regular course of its business, to finance the acquisition of mortgage servicing rights and for other business purposes. In May 2003, Moody's Investors Service, Inc. and Standard & Poor's Ratings Services downgraded their loan servicer rankings for Fairbanks from strong to below average. These actions constituted potential events of default under Fairbanks' credit facilities, which led to a restructuring of and amendments to the credit facilities in June 2003.

In order to address alleged violations of various federal and state laws, Fairbanks is reimbursing certain fees allegedly collected improperly, and is changing certain of its loan servicing practices, including the types and amounts of fees collected, without admitting any violations. Due to these developments, future income from Fairbanks' operations is expected to be reduced. While the impairment analysis done by the Company did not result in a write-down of the investment, the final outcome of the FTC and related investigations must be known before the Company can reasonably assess the value of its investment in Fairbanks.

On November 12, 2003, the FTC announced a settlement with Fairbanks, resolving the FTC's and HUD's civil allegations against Fairbanks. The settlement will require Fairbanks to pay $40.0 million to the FTC to compensate consumers who suffered harm, enjoins Fairbanks from future law violations and imposes new restrictions on Fairbanks' business practices. The settlement is contingent on approval by a federal district court in Massachusetts and will be coordinated with a related settlement in a class action lawsuit. The settlement amount has been reflected in Fairbanks', and hence the Company's, results for the third quarter of 2003.

In June 2003, $200.0 million of money market committed preferred trust securities (the CPS Securities) were issued by trusts created for the primary purpose of issuing the CPS Securities, investing the proceeds in high quality commercial paper and providing FSA with put options for selling to the trusts non-cumulative redeemable perpetual preferred stock (the Preferred Stock) of FSA. If a put option were to be exercised by FSA, the applicable trust would use the portion of the proceeds attributable to principal received upon maturity of its assets, net of expenses, and transfer such proceeds to FSA in exchange for Preferred Stock of FSA. FSA pays a floating put premium to the

trusts. The cost of the structure was $3.3 million in the first nine months of 2003 and was recorded in equity. The trusts are vehicles for providing FSA access to new capital at its sole discretion through the exercise of the put options.

The Company does not consider itself to be the primary beneficiary of the trusts under FIN 46 because it does not retain the majority of the residual benefits or expected losses.

In January 2003, the FASB issued FIN 46, which is an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements". FIN 46 addresses consolidation of variable interest entities (VIEs) which have one or both of the following characteristics: (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity; and (ii) the equity investors lack the direct or indirect ability to make decisions about the entity's activities through voting rights or similar rights, the obligation to absorb the expected losses of the entity if they occur or the right to receive the expected residual returns of the entity if they occur. In October 2003, the FASB issued FASB Staff Position (FSP) 46-6, which provided a broad deferral of the latest date by which all public entities must apply FIN 46 to certain VIEs, to the first reporting period ending after December 15, 2003. Early application of FIN 46 was encouraged and the deferral did not have to be applied to all VIEs or potential VIEs. The deferral applies to VIEs in which an enterprise holds a variable interest created prior to February 1, 2003. The provisions of FIN 46 remain effective immediately for VIEs created after January 31, 2003 and for VIEs in which an enterprise obtains an interest after that date.

The Company applied FIN 46 and consolidated for financial reporting purposes, effective July 1, 2003, FSA Global and Canadian Global. In addition, as a result of the Company obtaining control provisions of another VIE, Premier, on July 1, 2003, the Company consolidated Premier beginning July 1, 2003. FIN 46 requires that, upon consolidation, the Company initially measure the VIE's assets, liabilities and minority interest at their carrying amounts under existing GAAP as if the entity had been consolidated from the time the Company was considered its primary beneficiary (or parent). The increase in total assets and total liabilities related to the consolidation of these entities was $1.9 billion. Any differences upon consolidation were reflected as a cumulative effect of a change in accounting principle. The cumulative effect of a change in accounting principle for Canadian Global resulted in additional income of $4.8 million, net of income tax. There were no cumulative income statement effects from consolidating FSA Global and Premier. FSA Global is managed as a "matched funding vehicle", in which the proceeds from the issuance of FSA guaranteed notes are invested in obligations having cash flows substantially matched to those of, and maturing prior to, such notes. In certain cases, investments of FSA Global consist of GICs issued by CMS. Similarly, Canadian Global and Premier have GICs issued by CMS in their investment portfolios. In these cases, the Company's GIC liability and asset are eliminated in consolidation. At September 30, 2003, $896.6 million was eliminated as a result of such consolidation. The VIEs' permitted activities are limited by charter and do not involve active management. The legal documents that establish the VIEs do not permit the sale or other disposal of the financial assets held by the VIEs except in automatic response to the terms of such financial assets. The VIEs are structured as bankruptcy remote entities. The Company's management

believes that the assets held by the VIEs, including those that are eliminated in consolidation, are beyond the reach of the Company and its creditors, even in bankruptcy or other receivership. All intercompany insured amounts between FSA and FSA Global and Canadian Global previously included in the Company's outstanding exposure are excluded from the Notes to the Condensed Consolidated Financial Statements for September 30, 2003.

The Company has identified certain asset-backed transactions that it has insured in the ordinary course of business that may require consolidation under FIN 46. The Company did not consolidate these entities in the third quarter as the Company is continuing to assess the impact of FIN 46, in light of the recently issued exposure draft proposing amendments to FIN 46. The Company will continue to analyze the effects of FIN 46, the proposed amendments to FIN 46 and FASB Staff Positions. The analysis may result in additional entities being consolidated into the Company.

Following is a summary of the impact of consolidating the FP VIEs and Canadian Global (in thousands) at September 30, 2003:

On July 31, 2003, the Company issued $100.0 million of 5.60% Notes due July 15, 2103 and callable on or after July 31, 2008. Debt issuance costs of approximately $3.3 million will be amortized over the life of the Notes. In September 2003, the Company called for redemption, on November 1, 2003, its 6.950% Senior Quarterly Income Debt Securities (6.950% Senior QUIDS) due November 1, 2098 and delivered to the trustee sufficient collateral to legally defease the 6.950% Senior QUIDS. The unamortized debt issuance costs of $3.2 million for the 6.950% Senior QUIDS were reflected as part of interest expense in net income for the third quarter of 2003. Subsequently, the trustee used the defeasance collateral to redeem all of the 6.950% Senior QUIDS.

The detailed balances that comprise other assets and accrued expenses and other liabilities at September 30, 2003 and December 31, 2002 are as follows (in thousands):

		2003		2002
Other Assets:
	Fair value of VIE swaps	$	310,569	$
	Deferred compensation trust		93,847		83,380
	AIG Global CBO Sr. Notes		82,628		92,605
	Tax and loss bonds		78,244		67,763
	Accrued interest on VIE swaps		68,553
	Accrued interest income		64,675		42,099
	Other assets		247,722		232,192

Total Other Assets		$	946,238	$	518,039

		2003		2002
Accrued Expenses and Other Liabilities:
	Payable for securities purchased	$	100,350	$	10,490
	Deferred compensation trust		93,596		83,031
	Share performance plan		87,038		98,087
	Securities sold under agreements to repurchase		82,936
	Other liabilities		321,209		290,333

Total Accrued Expenses and Other Liabilities		$	685,129	$	481,941

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Management and investors consider the following measures important in analyzing the financial results of the Company: operating earnings and gross present value of originations (PV originations). However, neither of these measures is promulgated in accordance with accounting principles generally accepted in the United States of America and should not be considered a substitute for net income and gross premiums written.

The Company's third quarter 2003 net income was $66.1 million, compared with net income of $34.4 million for the same period in 2002. Operating earnings were $63.0 million for the third quarter of 2003, compared with $53.9 million for the third quarter of 2002. In the third quarter of 2003, net income was positively affected by $3.1 million of fair value adjustments for pooled credit default swaps (CDS) under Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133). Net income was also positively affected by $4.8 million as a result of the Company's adoption of FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). In the third quarter of 2002, net income was negatively affected by $19.5 million of fair value adjustments for CDS under SFAS No. 133.

In December 2002, the Company revised its definition of operating earnings from that used in prior periods. Operating earnings is now defined as net income before the after-tax effects of SFAS No. 133 fair value adjustments for pooled CDS. For purposes of calculating operating earnings, pooled CDS are defined as FSA-insured CDS that reference pools of financial obligations and require payments by the Company if losses exceed a defined deductible providing an investment-grade level of protection to the Company. Management considers operating earnings a key measure of normal operating results, as the SFAS No. 133 adjustments for each guaranteed CDS are expected to sum to zero over the life of the transaction. Operating earnings for 2002 disclosed in this discussion differ from those previously disclosed due to the revised definition of operating earnings.

The table below shows a reconciliation of net income to operating earnings for the quarters ended September 30, 2003 and 2002:

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 present value of premiums written (PV premiums), 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 PV premiums. The Company considers PV premiums to be the better indicator of a given period's insurance 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 PV premiums, management estimates the life of each transaction that has installment premiums and discounts the future installment premium payments. The present value of the future net interest margin from the Company's financial products business

represents the present value of the difference between the estimated interest to be received on financial products investments and the estimated interest to be paid on financial products guaranteed investment contracts (GICs) and debt issued by the Company's financial products operations over the estimated life of each transaction, giving effect to swaps and other derivatives which convert fixed-rate assets and liabilities to U.S. floating rates. PV premiums and the present value of the future net interest margin from the Company's financial products segment are collectively referred to as PV originations. The Company calculates the discount rate for PV originations as the average pre-tax yield on its investment portfolio for the previous three years. Accordingly, year-to-year comparisons of PV originations are affected by the application of different discount factors. The rate for both 2003 and 2002 was 5.91%. Management intends to revise the discount rate in future years according to the same formula, in order to reflect interest rate changes.

Gross premiums written increased 21.8% to $262.1 million in the third quarter of 2003 from $215.2 million for the third quarter of 2002. PV originations increased 3.1% to $259.3 million in the third quarter of 2003 from the third quarter result of $251.4 million in 2002.

The table below shows the components of PV originations for the third quarter of 2003 and 2002:

	2003		2002
	(in millions)
U.S municipal obligations(1)	$	160.0	$	103.1
U.S. asset-backed obligations(1)(2)		51.1		50.2
International obligations(1)		35.1		67.0
Financial products(3)		13.1		31.1

Total	$	259.3	$	251.4

For the third quarter of 2003, the Company guaranteed a par amount of $17.5 billion of U.S. primary and secondary municipal obligations, an increase of 34.6% over the amount insured in the prior year's comparable period. FSA's U.S. municipal PV premium originations were $160.0 million for the quarter, 55.2% higher than in the third quarter of 2002. Average premium rates continued to be strong across municipal sectors and were boosted further by a higher proportion of transportation and health care transactions, which tend to have higher premiums relative to par.

For the third quarter of 2003, the Company's U.S. asset-backed par originated was $5.3 billion, compared with $10.2 billion in the third quarter of last year, but asset-backed PV premiums increased slightly to $51.1 million. The decline in par insured largely reflected reduced activity in Super Triple-A credit default swaps (CDS) and Triple-A mortgage-backed securities, both of which tend to have low premium rates, and increased activity in higher premium sectors, such as residential mortgage net interest margin securitizations and collateralized loan obligations.

For the third quarter of 2003, FSA insured $4.7 billion par of international obligations, generating $35.1 million of PV premiums, versus $1.7 billion of par and $67.0 million of PV premiums in the third quarter of 2002. FSA executed a variety of European infrastructure finance and asset-backed transactions during the third quarter of 2003. The decline in PV premiums despite the increase in par primarily reflects a single high-premium infrastructure transaction executed in the same period a year ago, as well as certain high-quality, high-par asset-backed transactions in the third quarter of this year.

The financial products segment comprises the Company's GIC business and the operations of FSA Global Funding Limited (FSA Global) and Premier International Funding Co. (Premier), two entities that the Company consolidated in the third quarter of 2003.

The present value of future net interest margin (PVNIM) in this segment was $13.1 million in the third quarter of 2003 compared with $31.1 million in the comparable period of last year. Substantially all of this PVNIM was generated by the GIC business. Third-quarter PVNIM declined primarily because of three high-value-added transactions in the third quarter of 2002 that represented special opportunities.

Net premiums written were $182.9 million for the third quarter of 2003, an increase of 22.5% over the comparable period in 2002. Net premiums earned for the third quarter of 2003 were $95.5 million, a 19.2% increase from $80.1 million in the third quarter of 2002. Net premiums earned from refundings and prepayments were $10.7 million for the third quarter of 2003 and $6.4 million for the same period of 2002, contributing $5.2 million and $3.3 million, respectively, to after-tax earnings. Net premiums earned for the quarter grew 15.0% over the result in the same period of 2002 if the effects of refundings and prepayments are eliminated.

Net investment income was $39.2 million for the third quarter of 2003 and $34.5 million for the comparable period in 2002, an increase of 13.8%. The Company's effective tax rate on investment income was 9.6% (excluding the effects of variable interest entities) and 9.9% for the third quarter of 2003 and 2002, respectively. In the third quarter of 2003, the Company realized $0.2 million in net capital gains, compared with $2.8 million for the same period in 2002. Capital gains and losses are generally a by-product of the normal investment management process and could vary substantially from period to period.

The provision for losses and loss adjustment expenses during the third quarter of 2003 was $14.6 million compared with $8.9 million for the same period in 2002. Since the reserves are based upon estimates, there can be no assurance that the ultimate liability will not differ from such estimates. The Company will continue, on an ongoing basis, to monitor these reserves and may periodically adjust such reserves, upward or downward, based on the Company's actual loss experience, its future mix of business and future economic conditions. At September 30, 2003, the general reserve totaled $91.4 million. Net case reserves were $82.4 million, net of $85.0 million in reinsurance recoverables.

Total policy acquisition and other operating expenses were $28.2 million for the third quarter of 2003 compared with $24.4 million for the same period in 2002. Excluding the effects of refundings and prepayments, total policy acquisition and other operating expenses were $25.4 million for the third quarter of 2003 compared with $23.0 million for the same period in 2002. Expenses increased primarily as a result of the lowering of the percentage of expenses deferred, based upon a study performed by the Company of its origination costs, and higher personnel costs.

The Company's financial products group produced a net interest margin of $1.7 million and $3.5 million for the third quarter of 2003 and 2002, respectively.

A portion of FSA's business has been in the form of insured CDS referencing diversified pools of corporate obligations. Many of these require periodic adjustments to reflect an estimate of fair value under SFAS No. 133. These transactions have generally been underwritten with Triple-A or higher levels of credit protection before our guaranty. For the third quarter of 2003 and 2002, these fair value adjustments resulted in a benefit to net income of $3.1 million and a charge to net income of $19.5 million, respectively. The gain or loss created by estimated fair value adjustments will rise or fall each quarter based on estimated market pricing of highly rated swap guarantees and is not expected to be an indication of potential claims under FSA's guaranty. 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 is determined based upon quoted market prices, if available. If quoted market prices are not

available, as is the case primarily with CDS on pools of assets, then the determination of fair value is based 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. Due to changes in these factors, the gain or loss from derivative instruments can vary substantially from period to period. Absent any claims under FSA's guaranty, any "losses" recorded in marking a guaranty to market will be reversed by an equivalent mark-to-market "gain" at or prior to the expiration of the guaranty. The gain recorded in the third quarter of 2003 was a reversal of losses recorded in prior periods. In addition, in the first half of 2002, FSA was party to a CDS (the single-name CDS) referencing a highly diversified portfolio of 100 corporate names, with $10.0 million of exposure per name, to which the Company had first-loss exposure. The Company terminated its exposure to this transaction in the third quarter of 2002 and recorded a $15.0 million charge to income in that quarter. These amounts are included in net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income.

Total equity in earnings of unconsolidated affiliates was a loss of $5.9 million and income of $6.8 million for the third quarter of 2003 and 2002, respectively. The decrease is primarily related to the equity earnings in Fairbanks Capital Holding Corp. The Company owns a minority interest in Fairbanks Capital Holding Corp., the parent company of Fairbanks Capital Corp. (collectively with its parent, "Fairbanks"). Fairbanks is a servicer of single-family residential mortgage loans originated by unaffiliated third parties. Most of the mortgage loans serviced by Fairbanks are considered "sub-prime", reflecting the lower than "prime" credit quality of the borrower/homeowner. Fairbanks is owned 56.8% by The PMI Group Inc. and 29.8% by the Company, with the remainder owned by certain founders of Fairbanks. At September 30, 2003, the Company's interest in Fairbanks had a book value of $49.9 million, of which $7.6 million represented goodwill. The Company's equity in the earnings from Fairbanks for the quarter ended September 30, 2003 and 2002 was a loss of $11.8 million and income of $3.7 million, respectively. The decrease in the Company's equity in the earnings of Fairbanks for the quarter was largely a result of estimated Federal Trade Commission (FTC) and related litigation settlement charges accrued in 2003. The Company's share of that settlement, included in the loss for the quarter, was $10.7 million.

In order to address alleged violations of various federal and state laws, Fairbanks is reimbursing certain fees allegedly collected improperly, and is changing certain of its loan servicing practices, including the types and amounts of fees collected, without admitting any violations. Due to these developments, future income from Fairbanks' operations is expected to be reduced. While the impairment test done by the Company did not result in a write-down of the investment, the final outcome of the FTC and related investigation must be known before the Company can accurately assess the value of its investment in Fairbanks.

The Company's effective tax rate for the third quarter of 2003 was 25.1% compared with a rate of less than 0% for the same period in 2002. In 2003 and 2002, the effective tax rate differed from the statutory rate of 35% due primarily to tax-exempt interest income and income from Financial Security Assurance International Ltd (FSA International). Although FSA International is subject to U.S. income taxes as a controlled foreign corporation, it nonetheless benefits from a lower overall effective tax rate than the Company's domestic insurance company subsidiaries. In addition, in the third quarter of 2003, the Company recorded a pre-tax charge of $11.8 million relating to Fairbanks, which has an effective tax rate of only 7% instead of 35%. In the third quarter of 2002, the Company changed its method of taxing its equity earnings on Fairbanks. Prior to the third quarter of 2002, the Company taxed 100% of its equity earnings for Fairbanks at the statutory rate of 35%. Due to changes in Fairbanks' investors, the Company determined that it would be appropriate to apply the 80% dividend received deduction allowed by the Internal Revenue Service when calculating the tax on its equity earnings from Fairbanks. In the third quarter of 2002, the Company recorded a cumulative to date benefit of $4.0 million.

The Company's net income for the first nine months of 2003 was $200.0 million, compared with net income of $133.9 million for the same period in 2002. Operating earnings were $194.1 million for the first nine months of 2003, compared with $156.6 million for the first nine months of 2002. In the first nine months of 2003, net income was positively affected by $5.9 million of mark-to-market adjustments for pooled CDS under SFAS No. 133. In the first nine months of 2002, net income was negatively affected by $22.7 million of mark-to-market adjustments for CDS under SFAS No. 133.

The table below shows a reconciliation of net income to operating earnings for the first nine months of 2003 and 2002:

	2003		2002
	(in millions)
Net Income	$	200.0	$	133.9
Less mark-to-market of pooled CDS(1)		5.9		(22.7	)

Operating Earnings(1)	$	194.1	$	156.6

Gross premiums written increased 29.4% to $686.5 million in the first nine months of 2003 from $530.6 million for the first nine months of 2002. PV originations increased 10.5% to $692.0 million in the first nine months of 2003 from $626.1 million in the first nine months of 2002.

The table below shows the components of PV originations for the first nine months of 2003 and 2002:

	2003		2002
	(in millions)
U.S municipal obligations(1)	$	368.6	$	253.6
U.S. asset-backed obligations(1)(2)		138.2		163.1
International obligations(1)		153.8		151.7
Financial products(3)		31.4		57.7

Total	$	692.0	$	626.1

For the first nine months of 2003, FSA insured $44.2 billion par amount of U.S. primary and secondary municipal obligations, an increase of 19.3% from the amount insured in the comparable period of the prior year. FSA's U.S. municipal PV premiums were $368.6 million in the first nine months of 2003, a 45.3% increase from U.S. municipal PV premiums in the first nine months of 2002.

For the first nine months of 2003, the Company's U.S. asset-backed par originated was $11.8 billion, compared with $33.6 billion in the first nine months of last year. U.S. asset-backed PV premiums declined 15.3% to $138.2 million for the first nine months of 2003 from $163.1 million in the first nine months of 2002.

For the first nine months of 2003, FSA insured $8.2 billion par of international obligations, generating $153.8 million of PV premiums, versus $13.3 billion of par and $151.7 million of PV premiums for the first nine months of 2002. International PV premiums have increased slightly over the first three quarters despite the decline in par insured primarily because of a shift in the asset-backed business mix from Super Triple-A pooled corporate CDS to a broader range of transactions.

The PVNIM for financial products was $31.4 million in the first nine months of 2003, compared with $57.7 million in the comparable period of last year. Substantially all of this PVNIM was generated by the GIC business. The low interest rate environment has led to reduced demand for long-term GICs throughout the year, and the year-to-date results were affected by previously disclosed regulatory constraints that limited the GIC business until April 2003, when an exemption from the Investment Company Act was received.

Net premiums written were $463.0 million for the first nine months of 2003, an increase of 25.2% when compared with the comparable period result in 2002. Net premiums earned for the first nine months of 2003 were $263.7 million, compared with $226.8 million for the first nine months of 2002. Net premiums earned from refundings and prepayments were $22.6 million for the first nine months of 2003 and $15.7 million for the same period of 2002, contributing $11.2 million and $8.1 million, respectively, to after-tax earnings. Net premiums earned for the first nine months grew 14.2% over the result in the same period of 2002, if the effects of refundings and prepayments are eliminated.

Net investment income was $113.5 million for the first nine months of 2003 and $103.0 million for the comparable period in 2002, an increase of 10.3%. The Company's effective tax rate on investment income was 9.5% (excluding the effects of variable interest entities) for the first nine months of 2003, compared with 10.7% for the same period in 2002. For the first nine months of 2003, the Company realized $4.0 million in net capital gains, compared with $26.8 million for the same period in 2002. Capital gains and losses are generally a by-product of the normal investment management process and could vary substantially from period to period.

The provision for losses and loss adjustment expenses during the first nine months of 2003 was $27.5 million compared with $51.0 million in the first nine months of 2002. The decrease in the provision is due largely to the $31.0 million strengthening of the general reserve in the second quarter of 2002 to reflect estimated losses in the Company's insured CDO portfolio.

Total policy acquisition and other operating expenses were $88.1 million for the first nine months of 2003 compared with $71.3 million for the same period in 2002. Excluding the effects of refundings and prepayments, total policy acquisition and other operating expenses were $82.7 million for the first nine months of 2003, compared with $67.9 million for the same period in 2002.

For the first nine months of 2003 and 2002, the Company's financial products group produced a net interest margin of $3.8 million and $6.1 million, respectively.

For the first nine months of 2003 and 2002, the mark-to-market adjustments for CDS resulted in a benefit to net income of $5.9 million and a net charge to income of $22.7 million, respectively. In addition, in the first nine months of 2002, the single-name CDS program resulted in a $28.3 million after-tax charge to income as a result of marking the transaction to market. The Company terminated its exposure to this transaction in the third quarter of 2002 at a $15.0 million loss. These amounts are included in net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income.

The Company's consolidated invested assets and cash at September 30, 2003, net of unsettled security transactions, was $6,949.5 million, compared with the December 31, 2002 balance of $5,027.2 million. These balances include the change in the market value of the investment portfolio, which had an unrealized gain position of $226.6 million at September 30, 2003 and $201.0 million at December 31, 2002, but exclude the variable interest entities' bond portfolio.

At September 30, 2003, the Company had, at the holding company level, an investment portfolio of $27.2 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 the receipt of dividends or surplus note payments from FSA and upon external financings.

FSA's ability to pay dividends is dependent upon FSA's financial condition, results of operations, cash requirements, maintenance of FSA's ratings 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 the 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 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 the first nine months of 2003 or 2002. Based upon FSA's statutory statements for September 30, 2003, the maximum amount available for payment of dividends by FSA without regulatory approval over the following 12 months would be approximately $110.6 million.

At June 30, 2003, the Company held $200.4 million of surplus notes of FSA. During the third quarter of 2003, FSA repaid $47.5 million of such surplus notes. At September 30, 2003, the Company held $152.9 million of FSA surplus notes. Payments of principal and interest on such notes may be made only with the approval of the New York Superintendent. FSA paid $7.3 million and $6.4 million in surplus note interest in the first nine months of 2003 and 2002, respectively.

The Company paid no dividends in the first nine months of 2003. In the first nine months of 2002, the Company paid dividends of $11.7 million.

On July 31, 2003, the Company issued $100.0 million of 5.60% Notes due July 15, 2103 and callable on or after July 31, 2008. Debt issuance costs of approximately $3.3 million will be amortized over the life of the Notes. In September 2003, the Company called for redemption, on November 1, 2003, its 6.950% Senior Quarterly Income Debt Securities (6.950% Senior QUIDS) due November 1, 2098, and delivered to the trustee sufficient collateral to legally defease the 6.950% Senior QUIDS. The unamortized debt issuance costs of $3.2 million for the 6.950% Senior QUIDS were reflected as part of interest expense in net income for the third quarter of 2003. Subsequently, the trustee used the defeasance collateral to redeem all of the 6.950% Senior QUIDS.

FSA's primary uses of funds are to pay operating expenses and to pay dividends to, or principal of or interest 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 within the transactions. 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 absent consent of the insurer are mandatory under Article 69 of the New York insurance law and serve to reduce FSA's liquidity requirements.

FSA had a credit arrangement, aggregating $150.0 million at September 30, 2003, provided by commercial banks and intended for general application to transactions insured by FSA and its insurance company subsidiaries. At September 30, 2003, there were no borrowings under this arrangement, which expires April 23, 2004, unless extended.

FSA has a standby line of credit in the amount of $325.0 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 $325.0 million or the average annual debt service of the covered portfolio multiplied by 5.00%, which amounted to $833.0 million at September 30, 2003. 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 seven-year term that will expire on April 30, 2010 and contains an annual renewal provision subject to approval by the banks. No amounts have been utilized under this commitment as of September 30, 2003.

In June 2003, $200.0 million of money market committed preferred trust securities (the CPS Securities) were issued by trusts created for the primary purpose of issuing the CPS Securities, investing the proceeds in high-quality commercial paper and providing FSA with put options for selling to the trusts non-cumulative redeemable perpetual preferred stock (the Preferred Stock) of FSA. If a put option were to be exercised by FSA, the applicable trust would use the portion of the proceeds attributable to principal received upon maturity of its assets, net of expenses, and transfer such proceeds to FSA in exchange for Preferred Stock of FSA. FSA pays a floating put premium to the trusts. The cost of the structure was $0.3 million and $3.3 million in the third quarter and first nine months of 2003, respectively, and was recorded in equity. The trusts are vehicles for providing FSA access to new capital at its sole discretion through the exercise of the put options.

The Company's financial products group has a $100.0 million line of credit with UBS AG, Stamford Branch, which expires December 12, 2003, unless extended. This line of credit provides an additional source of liquidity should there be unexpected draws on GICs issued by the Company. There were no borrowings under this arrangement as of September 30, 2003.

Standard & Poor's Ratings Services (S&P), Moody's Investors Service, Inc. (Moody's) and Fitch Ratings each periodically assess the capital adequacy of FSA and other financial guarantors rated by them, and publish such assessments along with associated ratings confirmations or ratings changes. Given the importance of its ratings to its ongoing business, management of FSA considers the impact on rating agency capital adequacy an important factor in evaluating the types of risks it may insure and other activities it may pursue. In assessing the capital adequacy of a financial guarantor, rating agencies consider a number of factors, including claims-paying resources, "worst case" loss potential of the insured portfolio, and the quality and liquidity of the investment portfolio. Claims-paying

resources include qualified statutory capital (policyholders' surplus and contingency reserves determined in accordance with statutory accounting principles), unearned premium reserves, loss reserves and the present value of future installment premiums, as well as credit allowed for recoveries of ceded losses from reinsurers and other capital support arrangements. The rating agencies base their estimates of "worst case" insured losses on evaluations of the default frequency and loss severity of individual insured risks in a period of severe economic stress. Credit allowed for reinsurance under these capital adequacy models is generally a function of the rating of the reinsurer providing the reinsurance, as well as any collateral provided by the reinsurer. Estimates of "worst case" losses and reinsurer ratings are subject to change by the rating agencies at any time. Any downgrade of reinsurers, increase in "worst case" loss estimates on insured transactions or other adverse changes in the factors that determine capital adequacy ratios may prompt the Company to augment FSA's paid-in capital and other capital support arrangements to maintain its rating agency capital adequacy and Triple-A ratings. In 2002 and 2003, a number of the reinsurers used by FSA were downgraded by one or more rating agencies and "worst case" loss estimates were generally increased in the CDO sector, including transactions in FSA's insured portfolio. Giving effect to these changes, FSA continues to satisfy the Triple-A standards of the rating agencies. FSA expects to augment its claims-paying resources from time to time to the extent management considers it appropriate to maintain sufficient rating agency capital adequacy.

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. The proceeds of FSA-insured GICs may be invested in FSA-insured obligations, including FSA-insured securities issued to refinance poorly performing transactions. 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. Some FSA-insured GICs also allow for withdrawal of GIC funds in the event of a downgrade of FSA below A- by S&P or A3 by Moody's, with no right of the GIC provider to avoid such withdrawal by posting collateral or otherwise enhancing its credit. The Company manages this risk through the maintenance of liquid collateral and bank liquidity facilities.

The Company has made no material commitments for capital expenditures as of September 30, 2003.

Asset-backed and, to a lesser extent, municipal transactions insured by FSA may employ variable interest entities (VIEs) for a variety of purposes. A typical asset-backed transaction, for example, employs a VIE 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 VIE or the underwriter, either via a bid process or on a sole source basis. VIEs 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 VIE issuers of FSA-insured obligations. FSA also bears some of the "risks and rewards" associated with the performance of the VIE's assets, but in most situations FSA's financial guaranty policy will not expose it to significant variability due to the significant level of other credit protection. Specifically, as issuer of a financial guaranty insurance policy insuring the VIE'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 VIE typically pays a periodic premium to FSA in consideration of the issuance by FSA of its insurance policy, with the VIE's assets typically serving as the source of such premium, thus providing some of the "rewards" of the VIE's assets to FSA. VIEs 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 VIEs 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 September 30, 2003, the assets and liabilities of these VIEs have generally not been consolidated with those of the Company for financial reporting purposes and are considered "off-balance sheet" obligations.

sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity; and (ii) the equity investors lack the direct or indirect ability to make decisions about the entity's activities through voting rights or similar rights, the obligation to absorb the expected losses of the entity if they occur or the right to receive the expected residual returns of the entity if they occur. In October 2003, the FASB issued FASB Staff Position (FSP) 46-6 that provided a broad deferral of the latest date by which all public entities must apply FIN 46 to certain VIEs, to the first reporting period ending after December 15, 2003. Early application of FIN 46 was encouraged and the deferral did not have to be applied to all VIEs or potential VIEs. The deferral applies to VIEs in which an enterprise holds a variable interest that it acquired prior to February 1, 2003. The provisions of FIN 46 remain effective immediately for VIEs created after January 31, 2003 and for VIEs in which an enterprise obtains an interest after that date.

on July 1, 2003, the Company consolidated Premier beginning July 1, 2003. FIN 46 requires that, upon consolidation, the Company initially measure the VIE's assets, liabilities and minority interest at their carrying amounts under existing GAAP as if the entity had been consolidated from the time the Company was considered its primary beneficiary (or parent). The aggregate increase in the balance sheet related to the consolidation of these entities was $1.9 billion. Any differences upon consolidation were reflected as a cumulative effect of a change in accounting principle. The cumulative effect of a change in accounting principle for Canadian Global resulted in additional income of $4.8 million, net of income tax. There were no cumulative income statement effects from consolidating FSA Global and Premier. FSA Global is managed as a "matched funding vehicle", in which the proceeds from the issuance of FSA guaranteed notes are invested in obligations having cash flows substantially matched to those of, and maturing prior to, such notes. In certain cases, investments of FSA Global consist of GICs issued by CMS. Similarly, Canadian Global and Premier have GICs issued by CMS in their investment portfolios. In these cases, the Company's GIC liability and asset are eliminated in consolidation. At September 30, 2003, $896.6 million was eliminated as a result of such consolidation. The VIEs' permitted activities are limited by charter and do not involve active management. The legal documents that establish the VIEs do not permit the sale or other disposal of the financial assets of the VIEs except in automatic response to the terms of such financial assets. The VIEs are structured as bankruptcy remote entities. The Company's management believes that the assets held by the VIEs, including those that are eliminated in consolidation, are beyond the reach of the Company and its creditors, even in bankruptcy or other receivership. All intercompany insured amounts between FSA and FSA Global and Canadian Global previously included in the Company's outstanding exposure are excluded from the Notes to the Condensed Consolidated Financial Statements for September 30, 2003.

The Company has identified certain asset-backed transactions that it has insured in the ordinary course of business that may require consolidation under FIN 46. The Company did not consolidate these entities in the third quarter of 2003 as the Company is continuing to assess the impact of FIN 46, in light of the recently issued exposure draft proposing amendments to FIN 46. The Company will continue to analyze the effects of FIN 46, the proposed amendments to FIN 46 and proposed FASB Staff Positions.

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 investors, 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), 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 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.

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; (viii) downgrade or default of one or more of FSA's reinsurers; (ix) the amount and nature of business opportunities that may be presented to the Company; (x) market conditions, including the credit quality and market pricing of securities issued; (xi) capacity limitations that may impair investor appetite for FSA-insured obligations; (xii) market spreads and pricing on insured credit default swap exposures, which may result in gain or loss due to mark-to-market accounting requirements; (xiii) prepayment speeds on FSA-insured asset-backed securities and other factors that may influence the amount of installment premiums paid to FSA; (xiv) changes in the value or performance of strategic investments made by the Company; and (xv) other factors, most of which are beyond the Company's control. 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.

The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures as of September 30, 2003. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon and as of the date of the evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported as and when required. Such evaluation did not identify any change in the Company's internal control over financial reporting that occurred during the quarter ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

On July 21, 2003, the Company filed with the Securities and Exchange Commission (the "SEC") a current report on Form 8-K dated July 17, 2003, pursuant to which it reported that it had issued a press release on July 17, 2003, announcing that the Company had priced a $100 million issue of 5.60% Notes due July 15, 2103 (the "5.60% Notes") and callable on or after July 31, 2008. The press release also stated that the Company planned to use the proceeds of the 5.60% Notes to redeem all of its outstanding 6.950% Senior Quarterly Income Debt Securities due November 1, 2098, which were callable, without premium or penalty, on or after November 1, 2003. The current report included as exhibits the press release and a copy of the Prospectus Supplement, dated July 17, 2003, with respect to the 5.60% Notes, which was filed with the SEC on July 21, 2003.

On July 30, 2003, the Company filed with the SEC a current report on Form 8-K dated July 17, 2003, which incorporated by reference into the registration statement relating to the Company's 5.60% Notes due July 15, 2103, the underwriting agreement, form of note and officers' certificate relating to the Company's 5.60% Notes due July 15, 2103.

On August 8, 2003, the Company filed with the SEC a current report on Form 8-K dated August 5, 2003, pursuant to which it furnished to the SEC (i) a press release announcing its second quarter 2003 results; (ii) the Company's current Quarterly Operating Supplement; and (iii) a quarterly letter from its Chairman and Chief Executive Officer; and stating that the Company was posting such materials on August 5, 2003, to its website, http://www.fsa.com.

On September 26, 2003, the Company filed with the SEC a current report on Form 8-K dated September 22, 2003, pursuant to which it furnished to the SEC (i) a press release announcing that it was posting that date to its website, http://www.fsa.com, an Investor Relations Presentation intended primarily for fixed-income investors, which includes supplementary information related to its previously disclosed June 30, 2003 results, and (ii) a copy of the presentation.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

New York (State or other jurisdiction of incorporation or organization)		13-3261323 (I.R.S. employer identification no.)
350 Park Avenue New York, New York 10022 (Address of principal executive offices)
(212) 826-0100 (Registrant's telephone number, including area code)

		PAGE
PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Unaudited Financial Statements Financial Security Assurance Holdings Ltd. and Subsidiaries Condensed Consolidated Balance Sheets—September 30, 2003 and December 31, 2002	1
	Condensed Consolidated Statements of Operations and Comprehensive Income—Three and nine months ended September 30, 2003 and 2002	2
	Condensed Consolidated Statement of Changes in Shareholders' Equity—Nine months ended September 30, 2003	3
	Condensed Consolidated Statements of Cash Flows—Nine months ended September 30, 2003 and 2002	4
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	15
Item 4.	Controls and Procedures	26
PART II	OTHER INFORMATION
Item 6.	Exhibits and Reports on Form 8-K	27
SIGNATURES		28

				September 30, 2003			December 31, 2002
ASSETS
Bonds at market value (amortized cost of $3,203,178 and $2,615,173)				$	3,436,759		$	2,829,763
Short-term investments					163,348			375,688

	Total financial guaranty investment portfolio				3,600,107			3,205,451
Variable interest entities' bonds at market value (amortized cost of $1,389,953)					1,386,777
Variable interest entities' short-term investment portfolio					6,723
Guaranteed investment contract bond portfolio at market value (amortized cost of $3,206,339 and $1,840,949)					3,203,909			1,827,312
Guaranteed investment contract bond portfolio pledged as collateral at market value (amortized cost of $91,789)					87,205
Guaranteed investment contract short-term investment portfolio					151,082			4,632

	Total investment portfolio				8,435,803			5,037,395
Cash					19,839			31,368
Securitized loans					457,649			437,462
Deferred acquisition costs					258,719			253,777
Prepaid reinsurance premiums					668,144			557,659
Investment in unconsolidated affiliates					113,247			115,833
Reinsurance recoverable on unpaid losses					84,963			75,950
Other assets					946,238			518,039

		TOTAL ASSETS		$	10,984,602		$	7,027,483

LIABILITIES AND MINORITY INTEREST AND SHAREHOLDERS' EQUITY
Deferred premium revenue				$	1,766,830		$	1,450,211
Losses and loss adjustment expenses					258,751			223,618
Guaranteed investment contracts					3,191,769			2,449,033
Variable interest entities' debt					2,238,734
Deferred federal income taxes					140,307			124,310
Notes payable					626,572			430,000
Accrued expenses and other liabilities					685,129			481,941

		TOTAL LIABILITIES AND MINORITY INTEREST			8,908,092			5,159,113

Common stock (200,000,000 shares authorized; 33,517,995 issued; par value of $.01 per share)					335			335
Additional paid-in capital — common					900,166			903,494
Accumulated other comprehensive income (net of deferred income taxes of $74,340 and $66,270)					146,156			134,683
Accumulated earnings					1,029,853			829,858
Deferred equity compensation					23,445			23,445
Less treasury stock at cost (297,658 shares held)					(23,445	)		(23,445	)

		TOTAL SHAREHOLDERS' EQUITY			2,076,510			1,868,370

			TOTAL LIABILITIES AND MINORITY INTEREST AND SHAREHOLDERS' EQUITY	$	10,984,602		$	7,027,483

				Three Months Ended September 30,						Nine Months Ended September 30,
				2003			2002			2003			2002
Revenues:
	Net premiums written			$	182,946		$	149,304		$	463,015		$	369,731

	Net premiums earned				95,460			80,087			263,708			226,838
	Net investment income				39,218			34,457			113,527			102,955
	Net realized gains				151			2,803			4,044			26,760
	Financial products net interest income				17,041			9,612			36,947			17,787
	Financial products net realized gains (losses)							54			(1,096	)		54
	Net realized and unrealized gains (losses) on derivative instruments				8,259			(54,296	)		10,399			(78,994	)
	Other income				290			646			1,917			1,828

			TOTAL REVENUES		160,419			73,363			429,446			297,228

Expenses:
	Losses and loss adjustment expenses				14,638			8,876			27,533			50,995
	Interest expense				11,750			5,880			25,921			17,622
	Policy acquisition costs				16,349			13,292			43,285			39,169
	Financial products net interest expense				15,060			6,117			29,289			11,640
	Other operating expenses				11,872			11,110			44,811			32,094

			TOTAL EXPENSES		69,669			45,275			170,839			151,520

Minority interest					(3,025	)		(1,435	)		(7,745	)		(5,650	)
Equity in earnings of unconsolidated affiliates					(5,874	)		6,784			3,512			19,664

INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE					81,851			33,437			254,374			159,722
Benefit (provision) for income taxes					(20,570	)		959			(59,179	)		(25,801	)

INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE					61,281			34,396			195,195			133,921
Cumulative effect of accounting change, net of income taxes of $2,598					4,800						4,800

NET INCOME					66,081			34,396			199,995			133,921
Other comprehensive income (loss), net of tax:
	Unrealized gains (losses) on securities:
		Holding gains (losses) arising during period			(27,218	)		75,240			14,180			110,160
		Less: reclassification adjustment for gains included in net income			229			2,022			2,707			19,577

	Other comprehensive income (loss)				(27,447	)		73,218			11,473			90,583

COMPREHENSIVE INCOME				$	38,634		$	107,614		$	211,468		$	224,504

	Common Stock		Additional Paid-In Capital			Accumulated Other Comp- rehensive Income		Accumulated Earnings		Deferred Equity Compen- sation		Treasury Stock			Total
BALANCE, December 31, 2002	$	335	$	903,494		$	134,683	$	829,858	$	23,445	$	(23,445	)	$	1,868,370
Net income									199,995							199,995
Capital issuance costs				(3,328	)											(3,328	)
Net unrealized gain on investments, net of tax							11,473									11,473

BALANCE, September 30, 2003	$	335	$	900,166		$	146,156	$	1,029,853	$	23,445	$	(23,445	)	$	2,076,510

			Nine Months Ended September 30,
			2003			2002
Cash flows from operating activities:
	Premiums received, net		$	441,514		$	362,080
	Policy acquisition and other operating expenses paid, net			(96,722	)		(97,689	)
	Termination fee on derivatives						(43,000	)
	Recoverable advances recovered			73			4,292
	Losses and loss adjustment expenses paid, net			(1,273	)		(3,820	)
	Net investment income received			143,554			126,475
	Interest paid			(22,021	)		(17,483	)
	Interest paid on guaranteed investment contracts			(23,897	)		(5,697	)
	Variable interest entities' net interest income received			8,063
	Variable interest entities' interest paid			(6,730	)
	Federal income taxes paid			(64,208	)		(65,423	)
	Other			11,832			6,567

		Net cash provided by operating activities		390,185			266,302

Cash flows from investing activities:
	Proceeds from sales of bonds			704,522			677,588
	Purchases of bonds			(1,255,165	)		(928,688	)
	Net decrease in short-term investments			218,093			2,416
	Proceeds from sales of guaranteed investment contract bonds			928,615			165,964
	Purchases of guaranteed investment contract bonds			(2,312,443	)		(1,655,577	)
	Securities purchased under agreements to resell			57,000
	Net decrease (increase) in guaranteed investment contract short-term investments			(146,450	)		224,195
	Purchases of variable interest entities' bonds			(16,200	)
	Net decrease in variable interest entities' short-term investments			12,403
	Purchases of property and equipment			(885	)		(5,757	)
	Net increase in other investments			(466	)		(9,219	)

		Net cash used for investing activities		(1,810,976	)		(1,529,078	)

Cash flows from financing activities:
	Dividends paid						(20,379	)
	Capital issuance costs			(3,328	)
	Proceeds from the issuance of variable interest entities' debt			101,189
	Proceeds from securities sold under agreements to repurchase			82,936
	Repayment of guaranteed investment contracts			(830,224	)		(167,897	)
	Proceeds from issuance of guaranteed investment contracts			2,058,689			1,466,049

		Net cash provided by financing activities		1,409,262			1,277,773

Net increase (decrease) in cash				(11,529	)		14,997
Cash at beginning of period				31,368			7,784

Cash at end of period			$	19,839		$	22,781

		Net of Amounts Ceded				Ceded
Types of Issues		Net of Amounts Ceded				Ceded
Types of Issues		2003		2002		2003		2002
General obligation bonds		$	64,690	$	54,563	$	19,819	$	18,388
Housing revenue bonds			7,188		5,833		1,928		1,687
Municipal utility revenue bonds			29,166		23,442		14,241		13,468
Health care revenue bonds			6,436		5,970		6,767		6,683
Tax-supported (non-general obligation) bonds			32,660		27,556		12,802		12,391
Transportation revenue bonds			10,694		7,640		7,433		5,748
Other municipal bonds			14,386		12,173		6,875		5,761

	Total municipal obligations	$	165,220	$	137,177	$	69,865	$	64,126

		For the Nine Months Ended September 30, 2003
		Financial Guaranty		Financial Products			Inter-segment Eliminations			Total
Revenues:
	External	$	412,805	$	16,641		$			$	429,446
	Inter-segment		317		17,893			(18,210	)
Expenses:
	External		129,344		41,495						170,839
	Inter-segment		17,893		317			(18,210	)
Income (loss) before income taxes and cumulative effect of accounting change			261,652		(7,278	)					254,374
Segment assets			5,796,703		5,817,202			(629,303	)		10,984,602

		For the Nine Months Ended September 30, 2002
		Financial Guaranty		Financial Products			Inter-segment Eliminations			Total
Revenues:
	External	$	279,388	$	17,840		$			$	297,228
	Inter-segment				390			(390	)
Expenses:
	External		130,546		20,974						151,520
	Inter-segment		390					(390	)
Income (loss) before income taxes			162,466		(2,744	)					159,722

		FP VIEs		Canadian Global		Eliminations			Total
Bonds		$	1,386,777	$	35,000	$			$	1,421,777
GIC assets			896,875		96,400		(993,275	)
Short-term investments			6,723		4,443					11,166
Other assets			392,924		76,897		(6,276	)		463,545
Other financial guaranty assets							(2,224	)		(2,224	)

	Total Assets	$	2,683,299	$	212,740	$	(1,001,775	)	$	1,894,264

Debt		$	2,634,763	$	196,572	$			$	2,831,335
GIC liability							(993,275	)		(993,275	)
Other liabilities			50,448		16,168		(2,224	)		64,392
Other financial guaranty liabilities							(6,276	)		(6,276	)

	Total Liabilities	$	2,685,211	$	212,740	$	(1,001,775	)	$	1,896,176

	2003		2002
	(in millions)
Net Income	$	66.1	$	34.4
Less mark-to-market of pooled CDS(1)		3.1		(19.5	)

Operating Earnings	$	63.0	$	53.9

		4.1	Form of 5.60% Notes due July 15, 2103. (Previously filed as Exhibit 2 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated July 17, 2003, and filed on July 30, 2003 (the "July 30, 2003 Form 8-K"), and incorporated herein by reference.)
		4.2	Officers' Certificate Pursuant to Sections 2.01 and 2.03 of the Indenture (as defined in the form of 5.60% Notes due July 15, 2103). (Previously filed as Exhibit 3 to the July 30, 2003 Form 8-K, and incorporated herein by reference.)
		10.1	Underwriting Agreement dated July 17, 2003 between the Underwriters listed on Schedule I thereto and the Company, relating to the Company's 5.60% Notes due July 15, 2103. (Previously filed as Exhibit 1 to the July 30, 2003 Form 8-K, and incorporated herein by reference.)
		31.1	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
		31.2	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
		32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
		32.2	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
		99.1	Condensed consolidated financial statements of Financial Security Assurance Inc. for the nine month period ended September 30, 2003.

	FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.

November 14, 2003	By:	/s/ JEFFREY S. JOSEPH Jeffrey S. Joseph Managing Director & Controller (Chief Accounting Officer)

		Net of Amounts Ceded				Ceded
		2003		2002		2003		2002
Residential mortgages		$	20,519	$	23,379	$	4,233	$	5,480
Consumer receivables			15,441		19,454		5,534		5,954
Pooled corporate obligations			79,295		78,113		12,080		13,007
Investor-owned utility obligations			543		619		320		348
Other asset-backed obligations(1)			5,061		4,528		3,766		3,225

	Total asset-backed obligations	$	120,859	$	126,093	$	25,933	$	28,014