<PAGE>
INSURER'S AUDITED FINANCIAL STATEMENTS
FINANCIAL GUARANTY INSURANCE COMPANY
===============================================================================
AUDITED FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. Report of Independent Auditors
2. Balance Sheets
3. Statements of Income
4. Statements of Stockholder's Equity
5. Statements of Cash Flows
6. Notes to Financial Statements
<PAGE>
KPMG LLP
345 Park Avenue
New York, NY 10154
INDEPENDENT AUDITOR'S REPORT
The Board of Directors and Stockholder
Financial Guaranty Insurance Company:
We have audited the accompanying balance sheets of Financial Guaranty Insurance
Company as of December 31, 1999 and 1998, and the related statements of income,
stockholder's equity, and cash flows for each of the years in the three year
period ended December 31, 1999. 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 in accordance with generally accepted auditing
standards. 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Financial Guaranty Insurance
Company as of December 31, 1999 and 1998 and the results of its operations and
its cash flows for each of the years in the three year period then ended in
conformity with generally accepted accounting principles.
/s/ KPMG LLP
January 21, 2000
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY BALANCE SHEETS
-------------------------------------------------------------------------------
($ in Thousands, except per share amounts)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
ASSETS 1999 1998
----------- -----------
<S> <C> <C>
Fixed maturity securities, at fair value
(amortized cost of $2,484,753 in 1999 and $2,519,490 in 1998) $ 2,412,504 $ 2,663,024
Short-term investments, at cost, which approximates fair value 114,776 30,395
Cash 924 318
Accrued investment income 38,677 40,038
Reinsurance recoverable 8,118 8,115
Prepaid reinsurance premiums 133,874 148,366
Deferred policy acquisition costs 71,730 80,924
Property and equipment, net of accumulated depreciation
($7,803 in 1999 and $6,981 in 1998) 967 1,802
Prepaid expenses and other assets 16,672 11,047
----------- -----------
Total assets $ 2,798,242 $ 2,984,029
=========== ===========
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Unearned premiums $ 578,930 $ 610,182
Loss and loss adjustment expenses 45,201 59,849
Ceded reinsurance balances payable 2,310 3,129
Accounts payable and accrued expenses 16,265 46,764
Current federal income taxes payable 62,181 69,542
Deferred federal income taxes 46,346 122,839
Payable for securities purchased 7,894 6
----------- -----------
Total liabilities 759,127 912,311
----------- -----------
Stockholder's Equity:
Common stock, par value $1,500 per share;
10,000 shares authorized, issued and outstanding 15,000 15,000
Additional paid-in capital 383,511 383,511
Accumulated other comprehensive income (46,687) 91,922
Retained earnings 1,687,291 1,581,285
----------- -----------
Total stockholder's equity 2,039,115 2,071,718
----------- -----------
Total liabilities and stockholder's equity $ 2,798,242 $ 2,984,029
=========== ===========
</TABLE>
See accompanying notes to financial statements.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY STATEMENTS OF INCOME
-------------------------------------------------------------------------------
($ in Thousands)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------
1999 1998 1997
--------- --------- ---------
REVENUES:
<S> <C> <C> <C>
Gross premiums written $ 112,029 $ 112,425 $ 95,995
Ceded premiums (14,988) (19,444) (19,780)
--------- --------- ---------
Net premiums written 97,041 92,981 76,215
Decrease in net unearned premiums 16,759 12,529 39,788
--------- --------- ---------
Net premiums earned 113,800 105,510 116,003
Net investment income 134,994 133,353 127,773
Net realized gains 32,878 29,360 16,700
--------- --------- ---------
Total revenues 281,672 268,223 260,476
--------- --------- ---------
EXPENSES:
Loss and loss adjustment expenses (11,185) 3,178 12,539
Policy acquisition costs 7,198 13,870 12,936
Decrease in deferred policy acquisition costs 9,194 5,362 5,659
Other underwriting expenses 18,467 18,539 14,691
--------- --------- ---------
Total expenses 23,674 40,949 45,825
--------- --------- ---------
Income before provision for Federal income taxes 257,998 227,274 214,651
--------- --------- ---------
Federal income tax expense:
Current 53,849 41,467 39,133
Deferred (1,857) 17 1,715
--------- --------- ---------
Total Federal income tax expense 51,992 41,484 40,848
--------- --------- ---------
Net income $ 206,006 $ 185,790 $ 173,803
========= ========= =========
</TABLE>
See accompanying notes to financial statements.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY STATEMENTS OF CASH FLOWS
-------------------------------------------------------------------------------
($ in Thousands)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------
1999 1998 1997
---- ---- ----
OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income $ 206,006 $ 185,790 $ 173,803
Adjustments to reconcile net income
to net cash provided by operating activities:
Change in unearned premiums (31,252) (18,371) (53,263)
Change in loss and loss adjustment expense reserves (14,648) (17,077) 4,310
Depreciation of property and equipment 835 1,399 2,013
Change in reinsurance recoverable (3) 105 (1,205)
Change in prepaid reinsurance premiums 14,492 5,842 13,475
Change in foreign currency translation adjustment 2,538 (958) (497)
Policy acquisition costs deferred (7,198) (13,870) (12,936)
Amortization of deferred policy acquisition costs 16,392 19,232 18,595
Change in accrued investment income, and prepaid
expenses and other assets (4,264) 12,847 (2,754)
Change in other liabilities (6,318) 15,606 (36,233)
Deferred income taxes 1,857 17 1,715
Amortization of fixed maturity securities 4,674 4,149 2,698
Change in current income taxes payable (7,361) 50,207 (32,681)
Net realized gains on investments (32,878) (29,360) (16,700)
--------- --------- ---------
Net cash provided by operating activities 142,872 215,558 60,340
--------- --------- ---------
Investing Activities:
Sales and maturities of fixed maturity securities 881,268 607,372 741,604
Purchases of fixed maturity securities (814,153) (818,999) (848,843)
Purchases, sales and maturities of short-term investments, net (84,381) 45,644 (2,200)
Purchases of property and equipment, net -- (59) (459)
--------- --------- ---------
Net cash used in investing activities (17,266) (166,042) (109,898)
--------- --------- ---------
Financing Activities:
Capital Contributions -- -- 49,500
Dividends paid (125,000) (50,000) --
--------- --------- ---------
Net cash used in financing activities (125,000) (50,000) 49,500
--------- --------- ---------
(Decrease) Increase in cash 606 (484) (58)
Cash at beginning of year 318 802 860
--------- --------- ---------
Cash at end of year $ 924 $ 318 $ 802
========= ========= =========
</TABLE>
See accompanying notes to financial statements.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY STATEMENTS OF STOCKHOLDER'S EQUITY
-------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN COMPREHENSIVE RETAINED
STOCK CAPITAL INCOME EARNINGS TOTAL
----- ------- -------------- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997 $15,000 $334,011 $ 38,731 $ 1,296,692 $1,684,434
Net income - - - 173,803 173,803
Other comprehensive income:
Change in fixed maturity securities
available for sale, net of tax of ($13,260) - - 45,527 - 45,527
Change in foreign currency translation adjustment - - (323) - (323)
-----------
Total comprehensive income - - - - 219,007
----------
Capital contribution - 49,500 - - 49,500
--------- -------- ----------- ------------- ----------
Balance, December 31, 1997 15,000 383,511 83,935 1,470,495 1,952,941
------ ------- ------- --------- ---------
Net Income - - - 185,790 185,790
Other comprehensive income:
Change in fixed maturity securities
available for sale, net of tax of ($24,516) - - 8,610 - 8,610
Change in foreign currency translation adjustment - - (623) - (623)
-----------
Total comprehensive income - - - - 193,777
----------
Dividend declared - - - (75,000) (75,000)
---------- -------- ---------- ----------- -----------
Balance at December 31, 1998 15,000 383,511 91,922 1,581,285 2,071,718
------ ------- ------ --------- ----------
Net Income - - - 206,006 206,006
Other comprehensive income:
Change in fixed maturity securities
available for sale, net of tax benefit of $75,524 - - (140,259) - (140,259)
Change in foreign currency translation adjustment - - 1,650 - 1,650
----------
Total comprehensive income - - - - 67,397
----------
Dividend declared - - - (100,000) (100,000)
---------- -------- ----------- ------------ -----------
Balance at December 31, 1999 $15,000 $383,511 $(46,687) $1,687,291 $2,039,115
======= ======== ========= ========== ==========
</TABLE>
See accompanying notes to financial statements.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------
(1) BUSINESS
Financial Guaranty Insurance Company (the "Company") is a wholly-owned
insurance subsidiary of FGIC Corporation (the "Parent"). The Parent is
owned approximately ninety-nine percent by General Electric Capital
Corporation ("GE Capital") and approximately one percent by Sumitomo
Marine and Fire Insurance Company, Ltd. The Company provides financial
guaranty insurance on newly issued municipal bonds and municipal bonds
trading in the secondary market, the latter including bonds held by
unit investment trusts and mutual funds. The Company also insures
structured debt issues outside the municipal market. Approximately 86%
of the business written since inception by the Company has been
municipal bond insurance.
The Company insures only those securities that, in its judgment, are of
investment grade quality. Municipal bond insurance written by the
Company insures the full and timely payment of principal and interest
when due on scheduled maturity, sinking fund or other mandatory
redemption and interest payment dates to the holders of municipal
securities. The Company's insurance policies do not provide for
accelerated payment of the principal of, or interest on, the bond
insured in the case of a payment default. If the issuer of a
Company-insured bond defaults on its obligation to pay debt service,
the Company will make scheduled interest and principal payments as due
and is subrogated to the rights of bondholders to the extent of
payments made by it.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that effect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
(2) SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements have been prepared on the basis
of generally accepted accounting principles ("GAAP") which differ in
certain respects from the accounting practices prescribed or permitted
by regulatory authorities (see Note 3). Significant accounting policies
are as follows:
INVESTMENTS
Securities held as available-for-sale are recorded at fair value and
unrealized holding gains/losses are recorded as a separate component of
stockholder's equity, net of applicable income taxes.
Short-term investments are carried at cost, which approximates fair
value. Bond discounts and premiums are amortized over the remaining
terms of the securities. Realized gains or losses on the sale of
investments are determined on the basis of specific identification.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
PREMIUM REVENUE RECOGNITION
Premiums for policies where premiums are collected in a single payment
at policy inception are earned over the period at risk, based on the
total exposure outstanding at any point in time. Financial guaranty
insurance policies exposure generally declines according to
predetermined schedules. For policies with premiums that are collected
periodically, premiums are reflected in income pro rata over the period
covered by the premium payment.
POLICY ACQUISITION COSTS
Policy acquisition costs include only those expenses that relate
directly to premium production. Such costs include compensation of
employees involved in underwriting, marketing and policy issuance
functions, rating agency fees, state premium taxes and certain other
underwriting expenses, offset by ceding commission income on premiums
ceded to reinsurers (see Note 6). Net acquisition costs are deferred
and amortized over the period in which the related premiums are earned.
Anticipated loss and loss adjustment expenses and maintenance costs are
considered in determining the recoverability of acquisition costs.
LOSS AND LOSS ADJUSTMENT EXPENSES
Provision for loss and loss adjustment expenses includes principal and
interest and other payments due under insured risks at the balance
sheet date for which, in management's judgment, the likelihood of
default is probable. Such reserves amounted to $45.2 million and $59.8
million at December 31, 1999 and 1998, respectively. As of December 31,
1999 and 1998, such reserves included $32.7 million and $39.6 million,
respectively, established based on an evaluation of the insured
portfolio in light of current economic conditions and other relevant
factors. As of December 31, 1999 and 1998, discounted case-basis loss
and loss adjustment expense reserves were $12.5 million and $20.2
million, respectively. Loss and loss adjustment expenses include
amounts discounted at an approximate interest rate of 6.6% in 1999 and
5.0% in 1998. The amount of the discount as of December 31, 1999 and
1998 was $8.7 million and $8.9 million, respectively. The discount rate
used is based upon the risk free rate for the average maturity of the
applicable bond sector. The reserve for loss and loss adjustment
expenses is necessarily based upon estimates, however, in management's
opinion the reserves for loss and loss adjustment expenses is adequate.
However, actual results will likely differ from those estimates.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. These temporary differences relate principally to
unrealized gains (losses) on fixed maturity securities
available-for-sale, premium revenue recognition, deferred acquisition
costs and deferred compensation. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
Financial guaranty insurance companies are permitted to deduct from
taxable income, subject to certain limitations, amounts added to
statutory contingency reserves (see Note 3). The amounts deducted must
be included in taxable income upon their release from the reserves or
upon earlier release of such amounts from such reserves to cover excess
losses as permitted by insurance regulators. The amounts deducted are
allowed as deductions from taxable income only to the extent that U.S.
government non-interest bearing tax and loss bonds are purchased and
held in an amount equal to the tax benefit attributable to such
deductions.
PROPERTY AND EQUIPMENT
Property and equipment consists of furniture, fixtures, equipment and
leasehold improvements which are recorded at cost and are charged to
income over their estimated service lives. Office furniture and
equipment are depreciated straight-line over five years. Leasehold
improvements are amortized over their estimated service life or over
the life of the lease, whichever is shorter. Computer equipment and
software are depreciated over three years. Maintenance and repairs are
charged to expense as incurred.
FOREIGN CURRENCY TRANSLATION
The Company has established foreign branches in France and the United
Kingdom and determined that the functional currencies of these branches
are local currencies. Accordingly, the assets and liabilities of these
foreign branches are translated into U.S. dollars at the rates of
exchange existing at December 31, 1999 and 1998 and revenues and
expenses are translated at average monthly exchange rates. The
cumulative translation gain/(loss) at December 31, 1999 and 1998 was
$0.3 million and $(1.4) million, respectively, net of tax, and is
reported in the statement of stockholder's equity.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities."
The requirements for SFAS No. 133 were delayed by SFAS No. 137,
"Deferral of the Effective Date of FASB Statement No. 133," and are now
effective for financial statements for periods beginning after June 15,
2000. SFAS No. 133 establishes standards for accounting and reporting
for derivative instruments and for hedging activities. It requires that
an entity recognizes all derivatives as either assets or liabilities in
the balance sheet and measure those instruments at fair value. The
Company is currently evaluating the impact of SFAS No. 133 but does not
expect it to have a material impact on the Company.
(3) STATUTORY ACCOUNTING PRACTICES
The financial statements are prepared on the basis of GAAP, which
differs in certain respects from accounting practices prescribed or
permitted by state insurance regulatory authorities. The NAIC has
approved the codification project effective January 1, 2001. The
Company is currently assessing the impact of the NAIC codification on
its statutory financial statements. The following are the significant
ways in which statutory-basis accounting practices differ from GAAP:
(a) premiums are earned directly in proportion to the
scheduled principal and interest payments rather than
in proportion to the total exposure outstanding at any
point in time.
(b) policy acquisition costs are charged to current
operations as incurred rather than as related premiums
are earned;
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
(c) a contingency reserve is computed on the basis of
statutory requirements for the security of all
policyholders, regardless of whether loss contingencies
actually exist, whereas under GAAP, a reserve is
established based on an ultimate estimate of exposure;
(d) certain assets designated as non-admitted assets are
charged directly against surplus but are reflected as
assets under GAAP, if recoverable;
(e) federal income taxes are only provided with respect to
taxable income for which income taxes are currently
payable, while under GAAP taxes are also provided for
differences between the financial reporting and the tax
bases of assets and liabilities;
(f) purchases of tax and loss bonds are reflected as
admitted assets, while under GAAP they are recorded as
federal income tax payments; and
(g) all fixed income investments are carried at amortized
cost rather than at fair value for securities
classified as available-for-sale under GAAP.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
4) INVESTMENTS
Investments in fixed maturity securities carried at fair value of $3.1
million and $3.2 million as of December 31, 1999 and 1998,
respectively, were on deposit with various regulatory authorities as
required by law.
The amortized cost and fair values of short-term investments and of
investments in fixed maturity securities classified as
available-for-sale are as follows (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
1999 COST GAINS LOSSES VALUE
----- --------- ---------- ---------- -----
<S> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 44,592 $ 2 $ 2,163 $ 42,431
Obligations of states and political
subdivisions 2,336,563 12,916 81,062 2,268,417
Debt securities issued by foreign
Other 62,555 112 2,285 60,382
------------ --------- --------- ------------
Investments available-for-sale 2,484,753 13,634 85,883 2,412,504
Short-term investments 114,776 - - 114,776
------------ ------------ ------------ ------------
Total $2,599,529 $13,634 $85,883 $2,527,280
========== ======= ======= ==========
</TABLE>
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
The amortized cost and fair values of short-term investments and of
investments in fixed maturity securities available-for-sale at December
31, 1999, by contractual maturity date, are shown below. Expected
maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
1999 COST VALUE
---- --------- -----
VALUE
<S> <C> <C>
Due in one year or less $ 138,289 $ 138,268
Due after one year through five years 122,715 123,151
Due after five years through ten years 652,777 646,212
Due after ten years through twenty years 1,459,655 1,411,749
Due after twenty years 226,093 207,900
------------ ------------
Total $2,599,529 $2,527,280
========== ==========
</TABLE>
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
1998 COST GAINS LOSSES VALUE
---- --------- ---------- ---------- -----
<S> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 75,595 $ 1,294 $ 2 $ 76,887
Obligations of states and political
subdivisions 2,367,682 142,777 4,112 2,506,347
Debt securities issued by foreign
Other 37,693 416 21 38,088
------------ ---------- -------- -----------
Investments available-for-sale 2,519,490 147,669 4,135 2,663,024
Short-term investments 30,395 - - 30,395
------------ -------------- ---------- ------------
Total $2,549,885 $147,669 $4,135 $2,693,419
========== ======== ====== ==========
</TABLE>
In 1999, 1998 and 1997, proceeds from sales and maturities of investments in
fixed maturity securities available-for-sale carried at fair value were $881.3
million, $607.3 million, and $741.6 million, respectively. For 1999, 1998 and
1997 gross gains of $35.1 million, $29.6 million, and $19.1 million
respectively, and gross losses of $2.2 million, $0.2 million, and $2.4 million
respectively, were realized on such sales.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
Net investment income of the Company is derived from the following
sources (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1999 1998 1997
------ ------ -----
<S> <C> <C> <C>
Income from fixed maturity securities $130,402 $129,942 $122,372
Income from short-term investments 5,564 4,421 6,366
----------- ----------- ---------
Total investment income 135,966 134,363 128,738
Investment expenses 972 1,010 965
----------- ----------- -----------
Net investment income $134,994 $133,353 $127,773
======== ======== ========
</TABLE>
As of December 31, 1999, the Company did not have more than 3% of its
investment portfolio concentrated in a single issuer or industry.
(5) INCOME TAXES
The Company files a federal tax return as part of the consolidated
return of General Electric Capital Corporation ("GE Capital"). Under a
tax sharing agreement with GE Capital, taxes are allocated to the
Company and the Parent based upon their respective contributions to
consolidated net income. The Company also has a separate tax sharing
agreement with its Parent. Under this agreement the Company can utilize
its Parent's net operating loss to offset taxable income on a
stand-alone basis. The Company's effective federal corporate tax rate
(20.1 percent in 1999, 18.3 percent in 1998, and 19.0 percent in 1997)
is less than the corporate tax rate on ordinary income of 35 percent in
1998, 1997 and 1996, primarily due to tax exempt interest on municipal
investments.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
The following is a reconciliation of federal income taxes computed at
the statutory rate and the provision for federal income taxes (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1999 1998 1997
--------- --------- --------
<S> <C> <C> <C>
Income taxes computed on income
before provision for federal
income taxes, at the statutory rate $90,299 $79,546 $75,128
Tax effect of:
Tax-exempt interest (34,914) (35,660) (34,508)
Original issue discount - (2,511) -
Other, net (3,393) 109 228
--------- --------- --------
Provision for income taxes $51,992 $41,484 $40,848
======= ======= =======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the net deferred tax liability or asset at December 31,
1999 and 1998 are presented below (in thousands):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Deferred tax assets:
Unrealized losses on fixed maturity
Loss reserves 9,914 12,364
Deferred compensation 2,274 2,230
Tax over book capital gains 4,754 3,464
Other 3,189 3,579
-------- --------
Total gross deferred tax assets 45,418 21,637
-------- --------
Deferred tax liabilities:
Unrealized gains on fixed maturity
Deferred acquisition costs 25,106 28,323
Premium revenue recognition 45,350 44,935
Rate differential on tax and loss bonds 9,454 9,454
Tax exempt bond discount 6,593 5,746
Other 5,261 5,781
-------- --------
Total gross deferred tax liabilities 91,764 144,476
-------- --------
Net deferred tax liability $ 46,346 $122,839
======== ========
</TABLE>
Based upon the level of historical taxable income, projections of
future taxable income over the periods in which the deferred tax assets
are deductible and the estimated reversal of future taxable temporary
differences, the Company believes it is more likely than not that it
will realize the benefits of these deductible differences and has not
established a valuation allowance at December 31, 1999 and 1998. The
Company anticipates that the related deferred tax asset will be
realized based on future profitable business.
Total federal income tax payments during 1999, 1998 and 1997 were $60.4
million, $(8.7) million, and $71.8 million, respectively.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
(6) REINSURANCE
The Company reinsures portions of its risk with other insurance
companies through quota share reinsurance treaties and, where
warranted, on a facultative basis. This process serves to limit the
Company's exposure on risks underwritten. In the event that any or all
of the reinsuring companies were unable to meet their obligations, the
Company would be liable for such defaulted amounts. The Company
evaluates the financial condition of its reinsurers and monitors
concentrations of credit risk arising from activities or economic
characteristics of the reinsurers to minimize its exposure to
significant losses from reinsurer insolvencies. The Company holds
collateral under reinsurance agreements in the form of letters of
credit and trust agreements in various amounts with various reinsurers
totaling $59.8 million that can be drawn on in the event of default.
Net premiums earned are presented net of ceded earned premiums of $29.5
million, $25.3 million and $33.3 million for the years ended December
31, 1999, 1998 and 1997, respectively. Loss and loss adjustment
expenses incurred are presented net of ceded losses of $0.2 million,
$0.9 million and $0.2 million for the years ended December 31, 1999,
1998 and 1997, respectively.
In accordance with an amendment to an existing reinsurance agreement,
the Company received additional ceding commission income of $6.2
million from the reinsurer. In addition, the Company bought back $14.4
million of ceded premium from the reinsurer and subsequently ceded the
risk to a different reinsurer.
(7) LOSS AND LOSS ADJUSTMENT EXPENSES
Activity in the reserve for loss and loss adjustment expenses is
summarized as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1999 1998 1997
-------------- -------------- --------------
<S> <C> <C> <C> <C>
Balance at January 1, $59,849 $76,926 $72,616
Less reinsurance recoverable (8,115) (8,220) (7,015)
------- -------- ---------
Net balance at January 1, 51,734 68,706 65,601
Incurred related to:
Current year 2,407 568 1,047
Prior years (6,592) (1,290) 6,492
Portfolio reserves (7,000) 3,900 5,000
------- ------- -----
Total Incurred (11,185) 3,178 12,539
--------- ------- ------
Paid related to:
Current year - - (1,047)
Prior years (3,466) (20,150) (8,387)
--------- -------- -------
Total Paid (3,466) (20,150) (9,434)
---------- -------- -------
Net balance at December 31, 37,083 51,734 68,706
Plus reinsurance recoverable 8,118 8,115 8,220
-------- -------- --------
Balance at December 31, $45,201 $59,849 $76,926
======= ======= =======
</TABLE>
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
The changes in incurred portfolio and case reserves principally relates
to business written in prior years. The changes are based upon an
evaluation of the insured portfolio in light of current economic
conditions and other relevant factors. Due to improvements on specific
credits, items were removed from the credit watchlist causing a
reduction in the portfolio loss reserves.
(8) RELATED PARTY TRANSACTIONS
The Company has various agreements with subsidiaries of General
Electric Company ("GE") and GE Capital. These business transactions
include appraisal fees and due diligence costs associated with
underwriting structured finance mortgage-backed security business;
payroll and office expenses incurred by the Company's international
branch offices but processed by a GE subsidiary; investment fees
pertaining to the management of the Company's investment portfolio; and
telecommunication service charges. Approximately $2.6 million, $3.2
million and $4.9 million in expenses were incurred in 1999, 1998 and
1997, respectively, related to such transactions.
The Company also insured certain non-municipal issues with GE Capital
involvement as sponsor of the insured securitization and/or servicer of
the underlying assets. For some of these issues, GE Capital also
provides first loss protection in the event of default. Gross premiums
written on these issues amounted to $0.4 million in 1999, $0.5 million
in 1998, and $0.5 million in 1997. As of December 31, 1999, par
outstanding on these deals before reinsurance was $83.7 million.
The Company insures bond issues and securities in trusts that were
sponsored by affiliates of GE (approximately 1 percent of gross
premiums written) in 1999, 1998 and 1997.
(9) COMPENSATION PLANS
Officers and other key employees of the Company participate in the
Parent's incentive compensation, deferred compensation and profit
sharing plans. Expenses incurred by the Company under compensation
plans and bonuses amounted to $2.6 million, $2.2 million and $5.0
million in 1999, 1998 and 1997, respectively, before deduction for
related tax benefits.
(10) DIVIDENDS
Under New York insurance law, the Company may pay a dividend only from
earned surplus subject to the following limitations: (a) statutory
surplus after such dividend may not be less than the minimum required
paid-in capital, which was $66.4 million in 1999 and 1998, and (b)
dividends may not exceed the lesser of 10 percent of its surplus or 100
percent of adjusted net investment income, as defined by New York
insurance law, for the 12 month period ending on the preceding December
31, without the prior approval of the Superintendent of the New York
State Insurance Department. At December 31, 1999 and 1998, the amount
of the Company's surplus available for dividends was approximately
$127.2 million and $124.6 million, respectively, without prior
approval.
During 1999, and 1998, the Company declared dividends of $100.0
million, and $75.0 million, respectively.
(11) CAPITAL CONTRIBUTION
During 1997, the Parent made a capital contribution of $49.5 million to
the Company.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
(12) FINANCIAL INSTRUMENTS
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating fair values of financial instruments:
Fixed Maturity Securities: Fair values for fixed maturity securities
are based on quoted market prices, if available. If a quoted market
price is not available, fair values is estimated using quoted market
prices for similar securities. Fair value disclosure for fixed maturity
securities is included in the balance sheets and IN Note 4.
Short-Term Investments: Short-term investments are carried at cost,
which approximates fair value.
Cash, Receivable for Securities Sold, and Payable for Securities
Purchased: The carrying amounts of these items approximate their fair
values.
The estimated fair values of the Company's financial instruments at
December 31, 1999 and 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
------------------------- ---------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Financial Assets
Cash
On hand and in demand accounts $924 $924 $318 $318
Short-term investments 114,776 114,776 $30,395 $30,395
Fixed maturity securities $2,412,504 $2,412,504 $2,663,024 $2,663,024
</TABLE>
Financial Guaranties: The carrying value of the Company's financial
guaranties is represented by the unearned premium reserve, net of
deferred acquisition costs, and loss and loss adjustment expense
reserves. Estimated fair values of these guaranties are based on
amounts currently charged to enter into similar agreements (net of
applicable ceding commissions), discounted cash flows considering
contractual revenues to be received adjusted for expected prepayments,
the present value of future obligations and estimated losses, and
current interest rates. The estimated fair values of such financial
guaranties range between $335.3 million and $364.1 million compared to
a carrying value of $410.4 million as of December 31, 1999 and between
$379.1 million and $419.0 million compared to a carrying value of
$432.6 million as of December 31, 1998.
As of December 31, 1999 and 1998, the net present value of future
premiums was $55.7 million and $49.5 million, respectively.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
CONCENTRATIONS OF CREDIT RISK
The Company considers its role in providing insurance to be credit
enhancement rather than credit substitution. The Company insures only
those securities that, in its judgment, are of investment grade
quality. The Company has established and maintains its own underwriting
standards that are based on those aspects of credit that the Company
deems important for the particular category of obligations considered
for insurance. Credit criteria include economic and social trends, debt
management, financial management and legal and administrative factors,
the adequacy of anticipated cash flows, including the historical and
expected performance of assets pledged for payment of securities under
varying economic scenarios and underlying levels of protection such as
insurance or overcollateralization.
In connection with underwriting new issues, the Company sometimes
requires, as a condition to insuring an issue, that collateral be
pledged or, in some instances, that a third-party guarantee be provided
for a term of the obligation insured by a party of acceptable credit
quality obligated to make payment prior to any payment by the Company.
The types and extent of collateral pledged varies, but may include
residential and commercial mortgages, corporate debt, government debt
and consumer receivables.
As of December 31, 1999, the Company's total insured principal exposure
to credit loss in the event of default by bond issuers was $137.4
billion, net of reinsurance of $36.3 billion. The Company's insured
portfolio as of December 31, 1999 was broadly diversified by geography
and bond market sector with no single debt issuer representing more
than 1% of the Company's principal exposure outstanding, net of
reinsurance.
As of December 31, 1999, the composition of principal exposure by type
of issue, net of reinsurance, was as follows (in millions):
NET
PRINCIPAL
OUTSTANDING
Municipal:
General obligation $77,780.2
Special revenue 45,531.2
Industrial revenue 471.5
Non-municipal 13,575.3
-----------
Total $137,358.2
==========
As of December 31, 1999, the composition of principal exposure ceded to
reinsurers was as follows (in millions):
CEDED
PRINCIPAL
OUTSTANDING
Reinsurer:
Capital Re $12,267.6
Enhance Re 8,921.9
Other 15,148.5
----------
Total $36,338.0
=========
The Company's gross and net exposure outstanding, which includes
principal and interest, was $305,682.7 million and $237,682.2 million,
respectively, as of December 31, 1999.
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
The Company is authorized to do business in 50 states, the District of
Columbia, and in the United Kingdom and France. Principal exposure
outstanding at December 31, 1999 by state, net of reinsurance, was as
follows (in millions):
NET
PRINCIPAL
OUTSTANDING
California $15,453.9
New York 13,081.7
Pennsylvania 12,829.8
Florida 12,548.5
Illinois 10,142.0
Texas 6,331.0
Michigan 5,912.3
New Jersey 5,120.4
Ohio 3,838.8
Arizona 3,665.6
Sub-total 88,924.0
Other states 48,015.1
International 419.1
----------
Total $137,358.2
==========
(13) COMMITMENTS
Total rent expense was $2.6 million, $2.6 million and $2.4 million in
1999, 1998 and 1997, respectively. For each of the next two years and
in the aggregate as of December 31, 1999, the minimum future rental
payments under noncancellable operating leases having remaining terms
in excess of one year approximate (in thousands):
YEAR AMOUNT
2000 $2,909
2001 2,911
-------
Total minimum future rental payments $5,820
======
FINANCIAL GUARANTY INSURANCE
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
(14) COMPREHENSIVE INCOME
Comprehensive income requires that an enterprise (a) classify items of
other comprehensive income by their nature in a financial statement and
(b) display the accumulated balance of other comprehensive income
separately from retained earnings and additional paid-in capital in the
equity section of a statement of financial position. Accumulated other
comprehensive income of the Company consists of net unrealized gains on
investment securities and foreign currency translation adjustments.
The following are the reclassification adjustments (in thousands) for
the years ended December 31, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
1999
-------------------------------------------------------
Before Tax Tax Net of Tax
Amount Benefit Amount
---------- ---------- -----------
<S> <C> <C> <C>
Unrealized holding losses arising
during the period $(182,905) $64,017 $(118,888)
Less: reclassification adjustment for
gains realized in net income (32,878) 11,507 (21,371)
Unrealized losses on investments $(215,783) $75,524 $(140,259)
1998
-------------------------------------------------------
Before Tax Tax Net of Tax
Amount Expense Amount
---------- ---------- -----------
Unrealized holding losses arising
during the period $42,606 $(14,912) $27,694
Less: reclassification adjustment for
gains realized in net income (29,360) 10,276 (19,084)
4 Unrealized gains on investments $13,246 $ (4,636) $ 8,610
1997
-------------------------------------------------------
Before Tax Tax Net of Tax
Amount Expense Amount
---------- ---------- -----------
Unrealized holding losses arising
during the period $86,742 $(30,360) $56,382
Less: reclassification adjustment for
gains realized in net income (16,700) 5,845 (10,855)
--------- -------- ----------
Unrealized gains on investments $70,042 $(24,515) $45,527
======= ========= =======
</TABLE>
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
-------------------------------------------------------------------------------
The following is a reconciliation of net income and stockholder's equity
presented on a GAAP basis to the corresponding amounts reported on a
statutory-basis for the periods indicated below (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------------------
1999 1998
---------------------------- ---------------------------
NET STOCKHOLDER'S NET STOCKHOLDER'S
INCOME EQUITY INCOME EQUITY
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
GAAP basis amount $ 206,006 $ 2,039,115 $ 185,790 $ 2,071,718
Premium revenue recognition 596 (194,559) (13,946) (195,155)
Deferral of acquisition costs 9,194 (71,730) 5,362 (80,924)
Contingency reserve -- (721,427) -- (627,257)
Contingency reserve tax deduction (see Note 2) -- 74,059 -- 74,059
Non-admitted assets -- (806) -- (1,502)
Case basis loss reserves (1,294) (1,221) 1,945 73
Portfolio loss reserves (7,000) 25,900 3,900 32,900
Deferral of income taxes (1,857) 71,551 17 72,521
Unrealized (gains) on fixed maturity
securities held at fair value, net of tax -- 46,962 -- (93,297)
Recognition of profit commission (1,092) (7,143) 1,338 (6,050)
Unauthorized reinsurance -- (87) -- (39)
Allocation of tax benefits due to
Parent's net operating loss to the
Company (see Note 5) (76) 11,093 253 11,169
----------- ----------- ----------- -----------
Statutory-basis amount $ 204,477 $ 1,271,707 $ 184,659 $ 1,258,216
=========== =========== =========== ===========
<PAGE>
<CAPTION>
---------------------------
1997
---------------------------
NET STOCKHOLDER'S
INCOME EQUITY
----------- -------------
<C> <C>
$ 173,803 $ 1,952,941
(4,924) (181,209)
5,659 (86,286)
-- (540,677)
-- 95,185
-- (2,593)
1,377 (1,872)
5,000 29,000
1,715 72,260
-- (84,687)
(1,203) (7,388)
-- --
313 10,916
----------- -----------
$ 181,740 $ 1,255,590
=========== ===========
</TABLE>
22
