FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES

Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm
December 31, 2007

FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

        The New York State Insurance Department recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under the New York Insurance Law, and for determining whether its financial condition warrants the payment of a dividend to its stockholders. No consideration is given by the New York State Insurance Department to financial statements prepared in accordance with accounting principles generally accepted in the United States of America in making such determinations.

Report of Independent Registered Public Accounting Firm

To Board of Directors and Shareholder
of Financial Security Assurance Inc.:

        In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive income, changes in shareholder's equity, and cash flows present fairly, in all material respects, the financial position of Financial Security Assurance Inc. and Subsidiaries (the "Company") at December 31, 2007 and December 31, 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards 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.

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

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

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(in thousands)

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

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY

(dollars in thousands)

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

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

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

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED

(in thousands)

        The Company received no tax benefit in 2007 and received tax benefits of $1.1 million and $4.1 million in 2006 and 2005, respectively, by utilizing its Parent's losses. These amounts were recorded as a capital contribution.

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

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005

1.    ORGANIZATION AND OWNERSHIP

        Financial Security Assurance Inc. ("FSA" or together with its consolidated entities, the "Company"), a wholly owned subsidiary of Financial Security Assurance Holdings Ltd. (the "Parent"), is an insurance company domiciled in the State of New York. The Company operates in two business segments: a financial guaranty segment and a variable interest entities ("VIE") segment. The Company is primarily engaged in providing financial guaranty insurance on public finance and asset-backed obligations in domestic and international markets including Europe, the Asia Pacific region and elsewhere in the Americas. The financial strength of FSA and its insurance company subsidiaries is rated "Triple-A" by the major securities rating agencies and obligations insured by them are generally awarded "Triple-A" ratings by reason of such insurance. FSA was the first insurance company organized to insure non-municipal obligations and has been a major insurer of asset-backed and other non-municipal obligations since its inception on 1985 and a major insuror of municipal bonds since 1990.

        Financial guaranty insurance written by the Company typically guarantees scheduled payments on financial obligations. Upon 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 may, at its option, pay such amounts on an accelerated basis. The Company's underwriting policy is to insure obligations that would otherwise be investment grade without the benefit of its insurance. In addition, the Company insures guaranteed investment contracts ("GICs") issued by FSA Capital Management Services LLC ("FSACM"), FSA Capital Markets Services (Caymans) Ltd. and, prior to April 2003, FSA Capital Markets Services LLC (collectively, the "GIC Affiliates"), affiliates of the Company.

        Commencing in the fourth quarter of 2007, major financial institutions, including financial guaranty insurers, became subject to increasing stress. This has led to ratings downgrades and negative outlooks for a number of the Company's competitors as well as increased scrutiny from regulatory authorities and rating agencies. The Company and its insurance company subsidiaries remain rated Triple-A/stable by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's Ratings Services ("S&P") and Fitch Ratings ("Fitch"). However, the impact of recent developments on the financial guaranty insurance industry and the Company remains uncertain, and could include decreased demand for financial guaranty insurance as well as increases in the requirements for conducting, or restrictions on the types of business conducted by, financial guaranty insurers.

        Public finance obligations insured by the Company consist primarily of general obligation bonds supported by the issuers' taxing powers, tax-supported bonds and revenue bonds and other obligations of states, their political subdivisions and other municipal issuers supported by the issuers' or obligors' covenant to impose and collect fees and charges for public services or specific projects. Public finance obligations include obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including government office buildings, toll roads, health care facilities and utilities.

        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 Company insures synthetic asset-backed obligations that generally take the form of credit default swap ("CDS") obligations or credit-linked notes that reference asset-backed securities or pools of securities or other

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obligations, with a defined deductible to cover credit risks associated with the referenced securities or loans.

        The Company refinanced certain defaulted transactions by employing refinancing vehicles to raise funds. These refinancing vehicles are also consolidated and considered part of its financial guaranty business.

        The Company consolidated the results of certain variable interest entities ("VIEs"), which include FSA Global Funding Limited ("FSA Global") and Premier International Funding Co. ("Premier") because it retains the majority of the risks and rewards related to the VIEs. The Company does not own and equity interest in the VIEs. The Company consolidates FSA Global in accordance with Financial Accounting Standard Board ("FASB") Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" (revised December 2003) ("FIN 46").

        FSA Global is a special purpose funding vehicle partially owned by a subsidiary of FSA Holdings. FSA Global issues FSA-insured medium term notes and generally invests the proceeds from the sales of its notes in FSA-insured GICs or other FSA-insured obligations with a view to realizing the yield difference between the notes issued and the obligations purchased with the notes proceeds. Premier is principally engaged in debt defeasance for finance lease transactions.

        The Company's management believes that the assets held by FSA Global, Premier and the refinancing vehicles, including those that are eliminated in consolidation, are beyond the reach of the Company and its creditors, even in bankruptcy or other receivership.

        On July 5, 2000, the Company completed a merger in which FSA Holdings became a direct subsidiary of Dexia Holdings, Inc. ("Dexia Holdings"), which, in turn, is owned 90% by Dexia Crédit Local S.A. ("Dexia Crédit Local") and 10% by Dexia S.A. ("Dexia"). Dexia is a Belgian corporation whose shares are traded on the Euronext Brussels and Euronext Paris markets, as well as on the Luxembourg Stock Exchange. Dexia Crédit Local is a wholly owned subsidiary of Dexia.

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

        The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), which differ in certain material respects from the accounting practices prescribed or permitted by insurance regulatory authorities (see Note 24). The preparation of financial statements in conformity with GAAP requires management to make extensive estimates and assumptions that affect the reported amounts of assets and liabilities in the Company's consolidated balance sheets at December 31, 2007 and 2006, the reported amounts of revenues and expenses in the consolidated statements of operations and comprehensive income during the years ended December 31, 2007, 2006 and 2005 and disclosure of contingent assets and liabilities. Such estimates and assumptions include, but are not limited to, losses and loss adjustment expenses, fair value of financial instruments, the deferral and amortization of policy acquisition costs and taxes. Actual results may differ from those estimates.

Basis of Presentation

        The consolidated financial statements include the accounts of the Company and its direct and indirect subsidiaries, (collectively, the "Subsidiaries"), principally including:

•

FSA Insurance Company



•

Financial Security Assurance International Ltd. ("FSA International")



•

Financial Security Assurance (U.K.) Limited

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•

FSA Mexico Holdings Inc.

        The consolidated financial statements also include the accounts of certain VIEs and refinancing vehicles as described in Note 1. Intercompany accounts and transactions have been eliminated. Certain prior-year balances have been reclassified to conform to the current year presentation.

        Significant accounting policies under GAAP are as follows:

Investments

        The Company segregates its investments into various portfolios:

•

the VIE Segment Investment Portfolio, consisting of the investments supporting the VIE liabilities, which are primarily designated as available-for-sale, but in some cases are classified as held-to-maturity;



•

the assets acquired in refinancing FSA-insured transactions, which are designated as available-for-sale; and



•

the General Investment Portfolio, consisting of the investments held by the Company and its subsidiaries, which are designated as available-for-sale.

        Investments in debt and equity securities designated as available for sale are carried at fair value. The unrealized gain or loss on investments that are not hedged with derivatives or are economically hedged but do not qualify for hedge accounting is reflected as a separate component of shareholders' equity, net of tax. The unrealized gain or loss attributable to the hedged risk on investments that qualify as fair-value hedges is recorded in the consolidated statements of operations and comprehensive income in net interest income from VIE segment.

        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. The cost of securities sold is based on specific identification of each security.

        Short-term investments, which are those investments with a maturity of less than one year at time of purchase, are carried at fair value. Changes in fair value of short-term investments are due to changes in foreign exchange rates. Amounts deposited in money market funds and investments with a maturity at time of purchase of three months or less are included in short-term investments.

        Variable rate demand notes ("VRDNs") are included in bonds in the General Investment Portfolio. VRDNs are long-term bonds that bear floating interest rates and provide investors with the option to tender or put the bonds at par, generally on a daily, weekly or monthly basis. The cash flows related to these securities are presented on a gross basis in the consolidated statements of cash flows.

        Mortgage loans are carried at the lower of cost or market on an aggregate basis.

        Other-than-temporary impairments ("OTTI") are reflected in earnings as a realized loss.

Derivatives

        The VIEs enter into derivative contracts to manage interest rate and foreign currency risks associated with the Company's VIE Segment Investment Portfolio and VIE segment debt. The derivatives are recorded at fair value and generally include interest rate and currency swap agreements, which are primarily utilized to convert the Company's fixed rate securities in the VIE Segment Investment Portfolio and VIE segment debt into U.S.-dollar floating rate assets and liabilities. The

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gains and losses relating to derivatives not designated as fair-value hedges are included in net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income.

        The gains and losses related to derivatives designated as fair-value hedges are included in either net interest income or net interest expense from the VIE segment, as appropriate, along with the offsetting change in the fair value of the risk being hedged. The Company also has a portfolio of insured derivatives (primarily CDS) that it intends, in each case, to hold for the full term of the agreement. It considers these agreements to be a normal part 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 effect of these derivatives is to record earned premiums over the installment period, 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 net realized and unrealized gains (losses) on derivative instruments and in either other assets or other liabilities, as appropriate.

        Fair value is defined as the price at which an asset or liability could be bought or sold in a current transaction between willing parties. Fair value is determined based on quoted market prices, if available. If quoted market prices are not available, as is the case with most of the Company's insured CDS contracts because these contracts are not traded, then the determination of fair value is based on internally developed estimates that employ credit-spread algorithms. These algorithms are unique to each insured CDS category and utilize various publicly available indices, depending on the types of assets referenced by the insured CDS contract and the length of the contract. 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 credit assessments or rating agency-based shadow ratings, and, for its insured obligations, the level at which the deductible has been set. Estimates generated from the Company's valuation process may differ materially from values that may be realized in market transactions. The following is a description of the market pricing information that the Company utilizes in determining the fair value for significant categories of its insured CDS portfolio.

Pooled Corporate CDS Valuation

        A pooled corporate CDS contract is a contract that insures the default risk of a pool of reference corporate entities. As there is no observable exchange trading of bespoke pooled corporate CDS the Company values these contracts using an internal pricing model that uses published third-party indexes as inputs to its pricing model, principally the Dow Jones CDX for domestic corporate CDS and iTraxx for European corporate CDS. Each such index provides price quotes for standard attachment and detachment points (or "tranches") for contracts with maturities of three, five, seven and ten years. Prices quoted for these tranches do not represent perfect pricing references but are the only relevant market-based information available for this type of non-traded contract. The recent market volatility in the index tranches has had a significant impact on the estimated fair value of the Company's portfolio of pooled corporate CDS.

        The Company's valuation process for the pooled corporate CDS portfolio involves stratifying the investment-grade and high-yield contracts by remaining term to maturity, consistent with the reference indexes. Within maturity bands, further distinction is made for contracts that have higher attachment points. As index prices are quoted for standard attachment and detachment points (or tranches), the Company calibrates the quoted index price to the typical attachment points for its individual CDS contracts in order to derive the appropriate value, which is then validated by comparing it with relevant recent market transactions, if available. In order to estimate the weighted-average market price of an investment-grade pooled corporate CDS contract, the Company utilizes the applicable market prices of the quoted tranches of the published CDX North America IG Index.

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        In order to estimate the weighted-average market price for high-yield pooled corporate CDS contracts, the Company obtains dealer prices for the most senior quoted three-year and five-year tranches of the CDX North America High Yield Index and then applies a factor to the quoted prices. The factor depends on (a) the term to maturity of the Company's contract and (b) the attachment point of the Company's pooled corporate CDS contract, and is intended to calibrate the published index price to the Company's pooled corporate CDS contract, which references entities with higher credit quality than those reflected in the published indexes.

CDS of Funded CDOs and CLO Valuation

        As with pooled corporate CDS, there is no observable exchange trading of CDS of funded CDOs and collateralized loan obligations ("CLOs"). The Company estimates the market price with reference to the all-in LIBOR spread in the current published JP Morgan High Yield CLO Triple-A index, which includes a credit and funding component. Depending on the absolute value of the LIBOR spread, the Company may also apply a factor to the spread as a means of estimating the credit enhancement component.

Other Structured Obligations Valuation

        The Company determines fair value of insured CDS of European residential mortgage loan portfolios with reference to the recent auction prices of KfW Bankengruppe, the German development bank, when available. For CDS for which observable market value information is not available, management applies its best judgment to estimate the appropriate current fair value.

Premium Revenue Recognition

        Gross and ceded premiums received at inception of an insurance contract (i.e., upfront premiums) are earned in proportion to the expiration of the related risk. For upfront payouts, premium earnings are greater in the earlier periods, when there is a higher amount of exposure outstanding. The amount of risk outstanding is equal to the sum of the par amount of debt insured over the expected period of coverage. Deferred premium revenue and prepaid reinsurance premiums represent the portions of gross and ceded premium, respectively, that are 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 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.

        For premiums received on an installment basis, the Company earns the premium over the installment period, typically less than one year, throughout the period of coverage. Typically, installment premiums are applicable to insured transactions that involve CDS or special purpose entities ("SPEs") structured to finance pools of assets such as auto loans or mortgage loans. Premiums on such transactions are typically paid in installments, as the nature of the assets financed can have uncertain debt service schedules due to prepayments. When the Company, through its ongoing credit review process, identifies transactions where premiums are paid on an installment basis and certain default triggers have been breached, the Company ceases to earn premiums on such transactions. Premium revenue recognition is subject to change as a result of the FASB project described in "—Financial Guaranty Insurance—Proposed Guidance."

Losses and Loss Adjustment Expenses

        Financial guaranty insurance generally provides an unconditional and irrevocable guaranty that protects the holder of a financial obligation against non-payment of principal and interest when due. Upon a payment default on an insured obligation, the Company is generally required to pay the

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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 financial guaranty industry has emerged over the past 35 years. Management believes that existing insurance accounting under Statement of Financial Accounting Standards ("SFAS") No. 60, "Accounting and Reporting by Insurance Enterprises" ("SFAS 60"), does not specifically address financial guaranty insurance. Accordingly, the accounting for loss and loss adjustment expenses within the financial guaranty insurance industry has developed based on analogy to the most directly comparable elements of existing literature, including sections of SFAS 60, SFAS No. 5, "Accounting for Contingencies" ("SFAS 5") and Emerging Issues Task Force Issue 85-20, "Recognition of fees for guaranteeing a loan" ("EITF 85-20").

        The Company establishes losses and loss adjustment expense ("LAE") liabilities based on its estimate of specific and non-specific losses. LAE consists of the estimated cost of settling claims, including legal and other fees and expenses associated with administering the claims process.

Case Reserves

        The Company calculates a case reserve for the portion of the losses and LAE liability based upon identified risks inherent in its insured portfolio. If an individual policy risk has a reasonably estimable and probable loss as of the balance sheet date, a case reserve is established. For the remaining policy risks in the portfolio, a non-specific reserve is established to account for the inherent credit losses that can be statistically estimated.

        Case reserves for financial guaranty insurance companies differ from those of traditional property and casualty insurance companies. The primary difference is that traditional property and casualty case reserves include only claims that have been incurred and reported to the insurance company. In a traditional property and casualty company, claims are incurred when defined events occur such as an auto accident, home fire or storm. Unlike traditional property and casualty claims, financial guaranty losses arise from the extension of credit protection and occur as the result of the credit deterioration of the issuer or underlying assets of the insured obligations over the lives of those insured obligations. Such deterioration and ultimate loss amounts can be projected based on historical experience in order to estimate probable loss, if any. Accordingly, specific loss events that require case reserves include (1) policies under which claim payments have been made and additional claim payments are expected and (2) policies under which claim payments are probable and reasonably estimable, but have not yet been made.

        The Company establishes a case reserve for the present value of the estimated loss, net of subrogation recoveries, when, in management's opinion, the likelihood of a future loss on a particular insured obligation is probable and reasonably estimable at the balance sheet date. When an insured obligation has met the criteria for establishing a case reserve and that transaction pays a premium in installments, those premiums, if expected to be received prospectively, are considered a form of recovery and are no longer earned as premium revenue. Typically, a case reserve is determined using cash flow or similar models that represent the Company's estimate of the net present value of the anticipated shortfall between (1) scheduled payments on the insured obligation plus anticipated loss adjustment expenses and (2) anticipated cash flow from and proceeds to be received on sales of any collateral supporting the obligation and other anticipated recoveries. The estimated loss, net of recovery, on a transaction is discounted using the risk-free rate appropriate for the term of the insured obligation at the time the reserve is established and is not subsequently adjusted. In certain situations where cash flow models are not practical, a case reserve represents management's best estimate of expected loss.

        The Company records a non-specific reserve to reflect the credit risks inherent in its portfolio. The non-specific and case reserves together represent the Company's estimate of total reserves. The

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establishment of a non-specific reserve for credits that have not yet defaulted is a common practice in the financial guaranty industry, although there are differences in the specific methodologies applied by other financial guarantors in establishing and measuring these reserves.

Non-specific Reserve

        The Company establishes a non-specific reserve on its portfolio of credits because management believes that a portfolio of insured obligations will deteriorate over its life and that the existence of inherent loss can be proven statistically by data such as that published by rating agencies. The establishment of the reserve is a systematic process that considers this quantitative, statistical information obtained primarily from Moody's and S&P, together with qualitative factors such as overall credit quality trends resulting from economic and political conditions, recent loss experience in particular segments of the portfolio and changes in underwriting policies and procedures. The factors used to establish reserves are evaluated periodically by comparing the statistically computed loss amount with the incurred losses as represented by case reserve activity to develop an experience factor that is updated and applied to current-year originations. The process results in management's best estimate of inherent losses associated with providing credit protection at each balance sheet date.

        The non-specific reserve established considers all levels of protection (e.g., reinsurance and overcollateralization). Net par outstanding for policies originated in the current period is multiplied by loss frequency and severity factors, with the resulting amounts discounted at the risk-free rates using the treasury yield curve (the "statistical calculation"). The discount rate does not change and is used to accrete the loss for the life of each policy. The loss factors used for the calculation are the product of default frequency rates obtained from Moody's and severity factors obtained from S&P. Moody's is chosen for default frequency rates due to its credibility, large population, statistical format and reliability of future update. The Moody's default information is applied to all credit sectors or asset classes as described below. In its publication of default rates for bonds issued from 1970-2006, Moody's tracks bonds over a 20-year horizon by credit rating at time of issuance. For the purpose of establishing appropriate severity factors, the Company's methodology segregates the portfolio into asset classes, including health care transactions, all other public finance transactions, pooled corporate transactions, commercial real estate, and all other asset-backed transactions. The severity factors are derived from capital charge assessments provided by S&P. S&P capital charges project loss levels by asset class and are incorporated into their capital adequacy stress scenario analysis.

        The product of the current-year statistical calculation multiplied by the current-year experience factor represents the present value of loss amounts calculated for current-year originations. The present value of loss amounts calculated for the current-year originations is established at inception of each policy, and there is no subsequent change unless significant adverse or favorable loss experience is observed. The experience factor is based on the Company's cumulative-to-date historical losses starting from 1993, when the Company established the non-specific reserve methodology. The experience factor is calculated by dividing cumulative-to-date actual losses incurred by the Company by the cumulative-to-date losses determined by the statistical calculation. The experience factor is reviewed and, where appropriate, updated periodically, but no less than annually.

        The present value of loss amounts calculated for the current-year originations plus an amount representing the accretion of discount pertaining to prior-year originations are charged to loss expense and increase the non-specific loss reserve after adjustments that may be made to reflect observed favorable or adverse experience. The entire non-specific reserve is available to absorb probable losses inherent in the portfolio. As there are no specific losses provided in the non-specific reserve, there is no identifiable reinsurance recoverable. At the time that a case reserve is identified, the gross loss liability is recognized along with the reinsurance recoverable, if any. The amount of reinsurance recoverable depends on the policy ceded and the reinsurance agreements covering such policy.

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Management cannot predict the specific policies that will emerge as case-basis losses from the portfolio and is not entitled to recovery from the reinsurer in advance of producing a case reserve.

        Since the non-specific reserve contains the inherent losses of the portfolio, when a case reserve adjustment is deemed appropriate, whether the result of adverse or positive credit developments, accretion or the addition of a new case reserve, a full transfer is made between the non-specific reserve and the case reserve balances with no effect to income. The adequacy of the non-specific reserve balance is reviewed periodically and at least annually. Such analyses are performed to quantify appropriate adjustments that may be either charges or benefits on the consolidated statements of operations and comprehensive income.

Reserving Methodology and Industry Practice

        Management is aware that there are differences regarding the method of defining and measuring both case reserves and non-specific reserves among participants in the financial guaranty industry. Other financial guarantors may establish case reserves only after a default and use different techniques to estimate probable loss. Other financial guarantors may establish the equivalent of non-specific reserves, but refer to these reserves by various terms such as, but not limited to, "unallocated losses," "active credit reserves" and "portfolio reserves," or may use different statistical techniques from those the Company uses to determine loss at a given point in time.

        Management believes that existing accounting literature does not address the unique attributes of financial guaranty insurance. As an insurance enterprise, the Company initially refers to the accounting and financial reporting guidance in SFAS 60. In establishing loss liabilities, the Company relies principally on SFAS 60, which prescribes differing treatment depending on whether a contract is a short-duration contract or a long-duration contract. Financial guaranty insurance does not fall clearly within the definition of either short-duration or long-duration contracts. Therefore, the Company does not believe that SFAS 60 alone provides sufficient guidance for financial guaranty claim liability recognition.

        As a result, the Company also analogizes to SFAS 5, which requires the establishment of liabilities when a loss is both probable and reasonably estimable. The Company also relies by analogy on EITF 85-20, which provides general guidance on the recognition of losses related to guaranteeing a loan. In the absence of a comprehensive accounting model provided by SFAS 60, industry participants, including the Company, have looked to such other guidance referred to above to develop their accounting policies for the establishment and measurement of loss liabilities. The Company believes that its financial guaranty loss reserve policy is appropriate under the applicable accounting literature, and that it best reflects the fact that a portfolio of credit-based insurance, comprising irrevocable contracts that cannot be unilaterally changed by the insurer and that match the maturity terms of the underlying insured obligations, contains probable and reasonably estimable losses.

Deferred Acquisition Costs

        Deferred acquisition costs are comprised of expenses primarily related to the production of business, 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 received on premiums ceded to reinsurers. Deferred acquisition costs are amortized over the period in which the related premiums are earned. When an insured issue is retired or defeased prior to the end of the expected period of coverage, the remaining deferred acquisition cost is recognized. A premium deficiency would be recognized if the present value of anticipated losses and loss adjustment expenses exceeded the sum of deferred premium revenue and estimated installment premiums.

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Variable Interest Entities Segment Debt

        VIE segment debt is recorded at amortized cost. The Company may enter into transactions in order to reduce the Company's exposure to fluctuations in interest rates and foreign exchange rates. VIE segment debt may include hybrid debt instruments that contain embedded derivatives. Under certain conditions, GAAP requires that embedded derivatives be separated from the debt instrument and accounted for at fair value, with all changes in fair value reflected through earnings. Changes in fair value of embedded derivatives in VIE segment debt are recorded in realized and unrealized gain (loss) on derivative instruments.

Foreign Currency Translation

        Monetary assets and liabilities denominated in foreign currencies are translated at the spot rate at the balance sheet date. Non-monetary assets and liabilities are translated at historical rates. Revenues and expenses denominated in foreign currencies are translated at average rates prevailing during the year. Unrealized gains and losses on available-for-sale securities, net of deferred taxes, resulting from translating investments denominated in foreign currencies are recorded in shareholders' equity. Gains and losses from transactions in foreign currencies are recorded in other income. The Company recorded $13.4 million in 2007, $2.8 million in 2006 and $8.4 million in 2005 related to transaction gains recorded in other income.

Federal Income Taxes

        The provision for income taxes consists of an amount for taxes currently payable and an amount for deferred taxes arising from temporary differences between the tax bases of assets and liabilities and the reported amounts in the financial statements that will result in deductible or taxable amounts in future years when the reported amounts of assets and liabilities are recovered or settled.

        Non-interest-bearing tax and loss bonds are purchased to prepay 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 in other assets.

        The Company adopted FAS Interpretation No. 48, "Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109" ("FIN 48") as of January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes in an entity's financial statements pursuant to FASB Statement No. 109, "Accounting for Income Taxes" and provides thresholds for recognizing and measuring benefits of a tax position taken or expected to be taken in a tax return. Consequently, the Company recognizes tax benefits only on tax positions where is it "more likely than not" to prevail. There was no effect on the Company's statements of operations and comprehensive income from adopting FIN 48.

Special Purpose Entities

        Asset-backed and, to a lesser extent, public finance transactions insured by the Company may employ special purpose entities for a variety of purposes. A typical asset-backed transaction, for example, employs a special purpose entity as the purchaser of the securitized assets and as the issuer of the insured obligations. The Company's participation is typically requested by the sponsor of the special purpose entity or the underwriter, either via a bid process or on a sole-source basis. Special purpose entities are typically owned by transaction sponsors or charitable trusts, although the Company may have an ownership interest in some cases. The Company maintains certain contractual rights and exercises varying degrees of influence over special purpose entity issuers insured by the Company obligations. The Company also bears some of the "risks and rewards" associated with the performance of those special purpose entities' assets. Specifically, as issuer of the financial guaranty insurance policy insuring a given special purpose entity's obligations, the Company bears the risk of asset performance

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(typically, but not always, after a significant depletion of overcollateralization, excess spread, a deductible or other credit protection). The Company's underwriting policy is to insure only obligations that are otherwise investment grade. In addition, the special purpose entity typically pays a periodic premium to the Company in consideration of the issuance by the Company of its insurance policy, with the special purpose entity's assets typically serving as the source of such premium, thereby providing some of the "rewards" of the special purpose entity's assets to the Company. Special purpose entities are also employed by the Company in connection with "repackaging" of outstanding securities into new securities insured by the Company and with refinancing underperforming, non-investment-grade transactions insured by the Company.

        The degree of influence exercised by the Company over these special purpose entities varies from transaction to transaction, as does the degree to which "risks and rewards" associated with asset performance are assumed by the Company.

        FIN 46-R addresses consolidation of VIEs that have one or both of the following characteristics: (a) 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 (b) the equity investors lack the direct or indirect ability to make decisions about the entity's activities through voting rights or similar rights and do not have 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 analyzing special purpose entities described above, the Company considers reinsurance to be an implicit variable interest. Where the Company determines it is required to consolidate the special purpose entity, the outstanding exposure is excluded from Note 9.

Employee Compensation Plans

        The Company records a liability in other liabilities related to the vested portion of employees' outstanding "performance shares" under the Company's 2004 Equity Participation Plan and 1993 Equity Participation Plan (the "Equity Plans"). The expense is recognized ratably over specified performance cycles. The Company also records prepaid assets for Dexia restricted share awards made under the Company's Equity Plans and amortize these amounts over the employees' vesting periods. For more information regarding the Equity Plans, see Note 12.

        The Company adopted SFAS No. 123, "Share-Based Payment" (revised 2004) ("SFAS 123 (R)") in 2006. SFAS 123 (R) did not have a material impact on the consolidated statements of operations and comprehensive income. Under SFAS 123 (R), $1.2 million and $1.0 million in additional after-tax expense related to the Dexia Employee Share Plans in 2007 and 2006, respectively.

Recently Issued Accounting Standards

        On September 15, 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), which addresses how companies should measure fair value when required to use fair value measures for recognition or disclosure purposes under GAAP. SFAS 157 adopted an "exit price" approach to determining fair value and established a three-level fair value hierarchy to prioritize the inputs used in valuation techniques. Level 1 is the highest priority and is defined as observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 is defined as inputs other than quoted prices included in Level 1 that are observable for the asset or liability through corroboration with observable market data. Level 3 is the lowest priority and is defined as a valuation based on unobservable inputs such as a company's own data. Prioritization of inputs, as well as other considerations, determines the level of disclosure required. SFAS 157 is applicable to financial statements issued for fiscal years beginning after November 15, 2007 and for interim periods within those fiscal years. The Company believes that the transition adjustment to opening retained

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earnings will not have a material effect on its financial statements. The Company is currently evaluating the prospective impact of SFAS 157 on its results and disclosures for the first quarter of 2008.

        In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 permits reporting entities to choose to measure at fair value many financial instruments and certain other items that are not currently required to be measured at fair value. The fair-value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments and not to portions of instruments. SFAS 159 is effective for fiscal years beginning after November 15, 2007. There was no material effect on retained earnings from adopting SFAS 159 as of January 1, 2008.

        In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, "Noncontrolling interests in consolidated financial statements," an amendment of ARB No. 51 ("SFAS 160"). SFAS 160 requires reporting entities to present noncontrolling (minority) interests as equity (as opposed to liability or mezzanine equity) and provides guidance on the accounting for transactions between an entity and noncontrolling interests. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. FSA is currently evaluating the provisions of SFAS 160 and their potential impact on the Company's financial statements.

Financial Guaranty Insurance—Proposed Guidance

        On April 18, 2007, the FASB issued an Exposure Draft entitled "Accounting for Financial Guarantee Insurance Contracts," an interpretation of SFAS 60 (the "Exposure Draft"). The Exposure Draft addresses premium revenue and claim liabilities recognition, as well as related disclosures. The proposed recognition approach for a claim liability would require the Company to recognize a claim liability when there is an expectation that a claim loss will exceed the unearned premium revenue (liability) on a policy basis based on the present value of expected cash flows. Under the Exposure Draft, the premium earnings methodology would also change. Additionally, the Exposure Draft would require the Company to provide expanded disclosures relating to factors affecting the recognition and measurement of financial guaranty contracts.

        Based on the comment letter responses to the Exposure Draft, the FASB re-deliberated on some of the proposed guidance of the Exposure Draft. The final statement is expected to be issued in the first quarter of 2008. Until final guidance is issued by the FASB, the Company will continue to apply its existing policies with respect to the establishment of both case and non-specific loss reserves and the recognition of premium revenue.

3.    GENERAL INVESTMENT PORTFOLIO

        Net investment income generated by the General Investment Portfolio consisted of the following:

Summary of Net Investment Income from General Investment Portfolio

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        The credit quality of fixed-income securities in the General Investment Portfolio based on amortized cost was as follows:

General Investment Portfolio Fixed-Income Securities by Rating
as of December 31, 2007

(1)

Ratings are based on the lower of Moody's or S&P ratings available at December 31, 2007.

(2)

Includes U.S. Treasury obligations, which comprised 2% of the portfolio as of December 31, 2007.

        The General Investment Portfolio includes bonds insured by FSA ("FSA-Insured Investments"). Of the bonds included in the General Investment Portfolio, 7.5% were Triple-A by virtue of insurance provided by FSA and 28.8% were insured by other monolines (see Note 25). 100% of the FSA-Insured Investments were investment grade without giving effect to the FSA insurance. The average shadow rating, which is the rating without giving effect to the FSA guaranty, of the FSA-Insured Investments was the Double-A range.

        The amortized cost and fair value of the securities in the General Investment Portfolio were as follows:

General Investment Portfolio by Security Type
as of December 31, 2007

(1)

The majority of foreign securities are government issues and are denominated primarily in British pounds.

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General Investment Portfolio by Security Type
as of December 31, 2006

(1)

The majority of foreign securities are government issues and corporate securities that are denominated primarily in British pound or euro.

        The following table shows the gross unrealized losses and fair value of bonds in the General Investment Portfolio, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:

Aging of Unrealized Losses of Bonds in General Investment Portfolio
as of December 31, 2007

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Aging of Unrealized Losses of Bonds in General Investment Portfolio
as of December 31, 2006

        At December 31, 2007 there were 350 investments in fixed-income bonds for which amortized cost exceeded fair value; the aggregate amount of the excess over fair value was $9.0 million, or 1.4%. Of the 180 investments in an unrealized loss position for 12 months or more, at December 31, 2007, the largest loss on an individual investment was $0.3 million, or 4.5% of its amortized cost. Of the 118 investments in an unrealized loss position for more than six months but less than 12 months, at December 31, 2007, the largest loss on an individual investment was $0.5 million, or 6.9% of its amortized cost. Of the 52 securities in an unrealized loss position less than six months, at December 31, 2007, the largest loss on an individual investment was $0.2 million, or 7.7% of its amortized cost. At December 31, 2006, there were 438 such investments, for which the aggregate amount of the excess over fair value was $9.6 million, or 1.5%.

        Management has determined that the unrealized losses on fixed-income securities at December 31, 2007 are primarily attributable to the current interest rate environment and has concluded that these unrealized losses are temporary in nature on the basis of (a) that there were no principal and interest payment defaults on these securities; (b) analysis of the creditworthiness of the issuer; and (c) FSA's ability and current intent to hold these securities until a recovery in fair value or maturity. As of December 31, 2007 and 2006, 100% of the securities that have been in a gross unrealized loss position were rated investment grade.

        The amortized cost and fair value of fixed-income securities in the General Investment Portfolio as of December 31, 2007 and 2006, by contractual maturity are shown below. 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.

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Distribution of Fixed-Income Securities in General Investment Portfolio
by Contractual Maturity

(1)

Stated maturities for mortgage-backed securities of four to 30 years as of December 31, 2007 and of two to 30 years as of December 31, 2006.

(2)

Stated maturities for asset-backed securities of one to 15 years as of December 31, 2007 and of one to 28 years as of December 31, 2006.

        Proceeds from sales of bonds from the General Investment Portfolio during 2007, 2006 and 2005 were $3,521.9 million, $1,581.7 million and $1,717.0 million, respectively. Proceeds from maturities of bonds for the investment portfolio during 2007, 2006 and 2005 were $184.5 million, $160.8 million and $129.7 million, respectively. Gross gains of $5.2 million, $0.8 million and $10.8 million and gross losses of $7.3 million, $5.7 million and $5.6 million were realized on sales in 2007, 2006 and 2005, respectively.

        Bonds and short-term investments at an amortized cost of $10.1 million and cash of $1.8 million, respectively, at December 31, 2007 and bonds and short-term investments at an amortized cost of $12.2 million at December 31, 2006, were on deposit with state regulatory authorities as required by insurance regulations.

Equity Investments

        The Company's investment in preferred shares of XL Financial Assurance Ltd ("XLFA"), a financial guaranty insurance company and subsidiary of Security Capital Assurance Ltd. ("SCA"), is redeemable starting November 3, 2008.

        The Company's carrying value for XLFA preferred shares represents redemption value. In March 2006, the XLFA Board of Directors approved a by-law amendment changing the coupon on XLFA's preferred shares from a participating dividend based on an internal rate of return up to 19% to a fixed rate dividend of 8.25% per annum, effective January 1, 2006. In March 2007, there was a return of capital of $15.0 million.

        Amounts recorded by the Company in connection with XLFA are as follows:

Summary of XLFA Investment

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        Based on information available as of December 31, 2007, management concluded that the $39 million carrying value of its investment in XLFA was recoverable. Subsequent to year-end, XLFA was downgraded by S&P from Triple-A to Single-A with a negative watch and by Moody's from Aaa to A3 with a review for downgrade. Management is closely monitoring developments and will continue to evaluate the carrying value and recoverability of its investment in XLFA preferred shares.

4.    VIE SEGMENT INVESTMENT PORTFOLIO

        All the investments supporting VIE liabilities are insured by the Company. The credit quality of the available-for-sale securities in the VIE Segment Investment Portfolio, without the benefit of the Company's insurance, was as follows:

Available-for-Sale Securities in the VIE Segment Investment Portfolio by Rating
as of December 31, 2007

(1)

Ratings are based on the lower of Moody's or S&P ratings available at December 31, 2007. Excludes VIE GICs. All VIE GICs are FSA-insured.

        The amortized cost and fair value of available-for-sale bonds and short-term investments in the VIE Segment Investment Portfolio were as follows:

Available-for-Sale Securities in the VIE Segment Investment Portfolio by Security Type
as of December 31, 2007