UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008
Commission File Number 1-12644
Financial Security Assurance Holdings Ltd.
(Exact name of registrant as specified in its charter)
New York
(State or other jurisdiction of incorporation or organization) |
13-3261323
(I.R.S. Employer Identification No.) |
|
31 West 52 nd Street, New York, New York 10019 (Address of principal executive offices, including zip code) |
(212) 826-0100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
---|---|---|
6
7
/
8
% Quarterly Interest Bond Securities Due 2101
6.25% Notes Due November 1, 2102 5.60% Notes Due July 15, 2103 |
New York Stock Exchange, Inc.
New York Stock Exchange, Inc. New York Stock Exchange, Inc. |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o |
Non-accelerated filer
ý
(Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý
There was no common equity held by non-affiliates of the registrant at June 30, 2008.
At March 1, 2009, there were outstanding 33,345,993 shares of common stock, par value $0.01 per share, of the registrant (excludes 172,002 shares of treasury stock).
Documents
Incorporated By Reference
None.
i
ii
Financial Security Assurance Holdings Ltd., through its insurance company subsidiaries, is primarily engaged in providing financial guaranty insurance on public finance obligations in domestic and international markets. Historically, the Company also provided financial guaranty insurance on asset-backed obligations. In addition, the Company historically issued FSA-insured guaranteed investment contracts and other investment agreements ("GICs") as well as medium term notes to municipalities and other market participants through its Financial Products ("FP") segment. In August 2008, the Company announced that it would cease insuring asset-backed obligations and instead participate exclusively in the global public finance financial guaranty business. In November 2008, the Company ceased issuing GICs. While the Company has ceased new originations of asset-backed financial guaranty business and GICs, a substantial portfolio of such obligations remains outstanding.
The Company's principal insurance company subsidiary is Financial Security Assurance Inc. ("FSA"), a wholly owned New York insurance company. References to the "Company" are to Financial Security Assurance Holdings Ltd. together with its subsidiaries. References to "FSA Holdings" are to Financial Security Assurance Holdings Ltd. without its subsidiaries.
In November 2008, the Company's principal shareholder entered into a Purchase Agreement (the "Purchase Agreement") providing for the sale of the Company to Assured Guaranty Ltd. ("Assured"), subject to the consummation of specified closing conditions, including regulatory approvals, absence of rating impairment and segregation or separation of the Company's FP operations from the Company's financial guaranty operations. In February 2009, the Company's ultimate parent, Dexia S.A. ("Dexia"), through its bank affiliates, entered into agreements assuming credit and liquidity risks associated with the Company's GIC operations, resulting in the "deconsolidation" of FSA Asset Management LLC ("FSAM") from the Company under accounting principles generally accepted in the United States of America ("GAAP").
Obligations insured by the Company are generally awarded ratings on the basis of the financial strength ratings given to the Company's insurance company subsidiaries by the major securities rating agencies. On December 31, 2008, the Company was rated Triple-A (negative credit watch) by Standard & Poor's Ratings Services ("S&P") and Fitch Ratings ("Fitch") and Aa3 (developing outlook) by Moody's Investors Service, Inc. ("Moody's"). Prior to the third quarter of 2008, the Company's insurance company subsidiaries, as well as the obligations they insured, had been awarded Triple-A ratings by the three major rating agencies.
During 2007 and 2008, the global financial crisis that began in the U.S. subprime residential mortgage market transformed the financial guaranty industry. By the end of November 2008, all of the monoline guarantors that had been rated Triple-A at the beginning of the year had been downgraded in varying degrees by Moody's, and all but one had been either downgraded or placed on negative outlook or negative credit watch by S&P and Fitch. FSA and the Company's other insurance company subsidiaries were among the last companies to be affected, and were rated "Triple-A/stable" by all three rating agencies until July 2008. Rating agencies raised concerns about the stability of FSA's rating during the second half of 2008, and Moody's lowered FSA's Aaa rating to Aa3 (developing outlook) in November. These developments, combined with illiquidity in the capital markets, led to a marked reduction in FSA's production in the second half of 2008. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsExecutive Overview."
For the year ended December 31, 2008, the Company had gross premiums written of $690.4 million, of which approximately 88% related to insurance of public finance obligations and approximately 12% related to insurance of asset-backed and other non-public finance obligations. The Company also had realized gains on credit derivatives of $126.9 million in 2008. At December 31, 2008,
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the Company had net par outstanding of $408.5 billion, of which approximately 75% represented insurance of public finance obligations and approximately 25% represented insurance of asset-backed and other non-public finance obligations. At December 31, 2008, the Company had $16.4 billion principal amount of outstanding FP segment debt.
FSA's exposure to mortgage-backed obligations with deteriorating credit performance has generated losses, as reflected in the Company's net loss reserves, which have increased from $198.1 million as of December 31, 2007 to $1,476.9 million at December 31, 2008, and a negative $7.2 billion change in fair value of the FP segment's investment portfolio over the same period, despite the fact that the Company has no material exposures to collateralized debt obligations ("CDOs") of asset-backed securities ("ABS") that include residential mortgage-backed securities ("RMBS"), which caused severe losses for a number of other financial guarantors. The full extent of credit losses in the mortgage sector, and the extent to which they may affect the Company, will not be known for several years. The Company is also closely monitoring the consumer and corporate sectors for signs of deepening economic stress. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsExecutive OverviewSummary Results of Operations and Financial Condition."
Transfer of Credit and Liquidity Risk of the GIC Business
The proceeds of GICs issued in connection with the Company's FP business were invested in securities owned by FSAM. Most of FSAM's assets consist of RMBS that have suffered significant market value declines and, in more limited cases, credit deterioration. The market value declines of FSAM's assets subject FSAM to significant liquidity risk insofar as the GICs are in most cases subject to redemption or collateralization upon the downgrade of FSA below certain thresholds, with a significant number of GICs subject to redemption or collateralization should FSA be downgraded below Aa3 by Moody's (FSA's current Moody's rating) or below AA- by S&P. Dexia had previously announced its intention to assume the credit and liquidity risk associated with the Company's FP business, and provided significant support to the FP business in the course of 2008.
In February 2009, Dexia entered into several agreements that transfer credit and liquidity risk of the GIC operations to Dexia, which resulted in "deconsolidation" of FSAM from the Company (the "FSAM Risk Transfer Transaction") as of that date. These agreements provide for the (i) elimination of FSA's guaranty of repayment of FSAM's borrowings under the credit facilities provided by Dexia's bank subsidiaries; (ii) elimination of FSA's guaranty of certain of FSAM's investments; and (iii) increase in the credit facilities provided to FSAM by Dexia's bank subsidiaries from $5 billion to $8 billion. For further information regarding these agreements, see "Expected Sale of the CompanyDexia's Retention of the FP Business" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationLiquidity and Capital ResourcesFP Segment LiquidityLiquidity Resources."
Purchase Agreement with Assured
In November 2008, Dexia and Assured entered into the Purchase Agreement providing for the purchase by Assured of all Company shares owned by Dexia (the "Acquisition"), subject to the satisfaction of specified closing conditions. Purchase Agreement closing conditions include (1) receipt of regulatory and Assured shareholder approvals; (2) confirmation from S&P, Moody's and Fitch that the acquisition of the Company would not result in a downgrade of the financial strength ratings of the insurance company subsidiaries of Assured or of the Company; and (3) segregation or separation of the Company's FP business such that the credit and liquidity risk of the FP business resides with Dexia, with FSA protected against any future Dexia credit impairment.
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Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act") and the rules promulgated thereunder by the Federal Trade Commission (the "FTC"), the Acquisition may not be consummated until notifications have been given and certain information has been furnished to the FTC and the Department of Justice (the "DOJ") and specified waiting period requirements have been satisfied. The HSR Act waiting period expired on January 21, 2009. In addition, under the insurance holding company laws and regulations applicable to the insurance subsidiaries of the Company and Assured, before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance commissioner of the state where the insurer is domiciled. Assured has informed the Company that Assured filed applications with the insurance departments of the States of New York and Oklahoma and the U.K. Financial Services Authority; that the applications to the New York Insurance Department and the U.K. Financial Services Authority have been approved; and that it has made pre-acquisition filings regarding the potential competitive impact of the acquisition, which are deemed to have been approved. Dexia has informed the Company that it has filed an application with the U.K. Financial Services Authority in connection with its acquisition of Assured common shares pursuant to the Purchase Agreement, which has been approved, and that it has filed disclaimers of control with the insurance departments of the states of Maryland, New York, and Oklahoma.
The Company cannot estimate whether or when the remaining closing conditions will be satisfied or relevant agreements negotiated, whether the Acquisition will be completed and, if completed, whether it will be structured as currently contemplated, or what the effects of the change in control or removal of the FP business will be on the Company and its results of operations. If the Acquisition is not completed, Dexia may explore other options with respect to the Company, including selling the Company or some of its operations to a third party or ceasing to write new business, which may have a material adverse effect on the Company.
Post-Closing Parameters
The Purchase Agreement imposes a number of limitations on FSA after the Purchase Agreement closing (each, a "Post-Closing Parameter"), intended to maintain the creditworthiness of FSA. The Post-Closing Parameters are subject to change, and currently include the following:
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reinsurance purchased by FSA or of other assets of FSA would be available on a preferred or priority basis to a particular class or subset of FSA policyholders relative to the position of Dexia as policyholder upon the default or insolvency of FSA, other than with Dexia's consent.
The first five Post-Closing Parameters will be in effect for three years following the closing of the Acquisition and Post-Closing Parameters six and seven will be in effect until the De-Linkage Date occurs, provided that all of the Post-Closing Parameters will terminate if at any time after the De-Linkage Date the aggregate principal amount or notional amount of exposure of Dexia and any of its affiliates (excluding the exposures relating to the FP business) to any transactions insured by FSA or any of its affiliates prior to the signing date is less than $1 billion (the "Exposure Limitation Date").
As a general matter, if FSA merges with, enters into a consolidation with or sells all or substantially all of its assets to another company, that company will be subject to the Post-Closing Parameters. However, if FSA and Assured merge, Post-Closing Parameters one and two will terminate one year after the Purchase Agreement closing and the other Post-Closing Parameters will expire three years after the closing date (subject in each case to any Exposure Limitation Date).
Dexia's Retention of the FP Business
Under the Purchase Agreement, Dexia is expected to retain the Company's FP business after the Acquisition. The Purchase Agreement provides that Dexia will provide guarantees with respect to the FP business' assets and liabilities, including derivative contracts, and anticipates that some of its guarantees will benefit from guarantees provided by the French and Belgian states. Dexia Holdings Inc. ("Dexia Holdings"), FSA Holdings' parent, agreed that if such sovereign guarantees are provided, it will cause FSA Holdings to transfer the ownership interests of certain of the subsidiaries that conduct the FP business, or all the assets and liabilities of such subsidiaries, to Dexia Holdings or one of its affiliates in form reasonably acceptable to Assured.
Under the Purchase Agreement, Dexia Holdings is expected to retain the risks associated with the medium term notes business and certain portions of its leveraged lease business, FSA is expected to retain the risks associated with the leveraged lease debt business, and no new business will be written by the variable interest entities ("VIEs") FSA Global Funding Limited ("FSA Global") and Premier International Funding Co. ("Premier"). See "OrganizationFinancial Products Segment."
The Company is a subsidiary of Dexia Holdings, which, in turn, is owned 90% by Dexia Crédit Local S.A. ("Dexia Crédit Local") and 10% by Dexia. Dexia is a Belgian corporation whose shares are
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traded on the Euronext Brussels and Euronext Paris markets as well as on the Luxembourg Stock Exchange. Dexia is primarily engaged in the business of public finance, banking and investment management in France, Belgium, Luxembourg and other European countries, as well as in the United States. Dexia Crédit Local is a wholly owned subsidiary of Dexia. In connection with the recent financial crisis, Dexia has received significant support from the governments of France and Belgium, who remain indirect major shareholders of Dexia.
The Company divides its operations into two business segments: financial guaranty and financial products. The financial guaranty segment is primarily in the business of providing financial guaranty insurance through FSA and its other insurance company subsidiaries, but also includes the Company's refinancing vehicles and several other direct subsidiaries not in the FP segment. The FP segment is a run-off operation that was formerly in the business of borrowing funds through the issuance of GICs and medium term notes and reinvesting the proceeds in investments insured or qualifying for insurance by FSA.
Financial Guaranty Segment
FSA wholly owns FSA Insurance Company ("FSAIC"), which in turn wholly owns Financial Security Assurance (U.K.) Limited ("FSA UK") and FSA Mexico Holdings Inc. ("FSA Mexico Holdings"). FSA and FSAIC together own Financial Security Assurance International Ltd. ("FSA International"). FSAIC is an Oklahoma insurance company that primarily provides reinsurance to FSA. FSA UK is a United Kingdom insurance company that primarily provides financial guaranty insurance for transactions in the United Kingdom and other European markets. FSA International is a Bermuda insurance company that provides reinsurance to FSA and financial guaranty insurance for transactions outside the United States and European markets. FSA Mexico Holdings is the New York holding company that, together with FSAIC, owns FSA's Mexican subsidiary, FSA Seguros México, S.A. de C.V. ("FSA Mexico"). FSA Mexico is licensed to transact financial guaranty insurance in Mexico.
The Company refinances certain underperforming transactions by employing special purpose vehicles to raise funds to refinance such transactions. These refinancing vehicles are consolidated with the Company.
FSA Portfolio Management Inc. ("FSA Portfolio Management"), a wholly owned subsidiary of the Company, is engaged in the business of managing a portion of the investment portfolios of the Company and certain of its subsidiaries. FSA Portfolio Management also owns strategic and other investments funded from time to time by the FSA group of companies. Transaction Services Corporation ("TSC"), a wholly owned subsidiary of the Company, is engaged in the business of managing troubled transactions within the insured portfolios of FSA and its subsidiaries.
Financial Products Segment
The Company conducted its GIC business through the GIC Subsidiaries FSACM, FSA Capital Markets Services (Caymans) Ltd. and, prior to April 2003, FSA Capital Markets Services LLC. FSACM conducted substantially all the Company's GIC business since April 2003, following its receipt of an exemption from the requirements of the Investment Company Act of 1940. When the GIC Subsidiaries sold GICs, they loaned the proceeds to FSAM, which invested the funds in fixed-income securities that satisfy the Company's investment criteria. The GIC Subsidiaries ceased issuing GICs in November 2008 in contemplation of the sale of the Company to Assured. FSAM wholly owns FSA Portfolio Asset Limited ("FSA-PAL"), a U.K. company that invests in non-U.S. securities.
The Company consolidates the results of FSA Global and Premier, which are VIEs. FSA Global issued FSA-insured medium term notes and generally invested the proceeds from the sale of its notes in FSA-insured GICs or other FSA-insured obligations with a view to realizing the yield difference
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between the notes issued and the obligations purchased with the note proceeds. Premier is principally engaged in leveraged lease transactions.
Under the Purchase Agreement, Dexia is expected to retain the Company's FP business after the Acquisition. In contemplation of this change, FSACM, FSA Capital Markets Services LLC and FSAM became direct subsidiaries of a newly formed subsidiary, FSA Financial Products Inc. ("FSA Financial Products"), in December 2008. Previously they had been direct subsidiaries of FSA Holdings.
Under the Purchase Agreement, Assured and Dexia Holdings agreed to cooperate in good faith to evaluate the feasibility of the actual or functional separation of FSA Global's leveraged lease and medium term notes businesses with a view to maximizing the tax, accounting and financial efficiency of the separation of the businesses for both parties. At March 17, 2009, an agreement had not been reached on the structure of the business separation. Regardless of the structure of such business separation, under the Purchase Agreement Dexia Holdings is expected to retain the risks associated with FSA Global's medium term notes business and certain portions of its leveraged lease business, FSA is expected to retain the risks associated with the leveraged lease debt business, and no new business will be written by FSA Global or Premier.
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's creditors, even in bankruptcy or other receivership.
When the Company commenced operations in 1985, it was the first insurance company organized to insure non-municipal obligations. At that time, it was owned by a number of large insurance companies and other institutional investors. In 1989, the Company was acquired by U S WEST Capital Corporation, which subsequently changed its name to MediaOne Capital Corporation ("MediaOne"). MediaOne was a subsidiary of MediaOne Group, Inc., with operations and investments in domestic cable and broadband communications and international broadband and wireless communication. In 1990, the Company established a strategic relationship with The Tokio Marine and Nichido Fire Insurance Co., Ltd. ("Tokio Marine"), which acquired a minority interest in the Company. Tokio Marine is a major Japanese property and casualty insurance company. Also in 1990 the Company expanded the focus of its business to include financial guaranty insurance of municipal obligations and has since become a major insurer of municipal and other public finance obligations.
In 1994, the Company completed an initial public offering of common shares, at which time White Mountains Insurance Group, Ltd. ("White Mountains") (formerly known as Fund American Enterprises Holdings, Inc.) made an investment in the Company, and the chairman of White Mountains became non-executive chairman of the Company. White Mountains is an insurance holding company.
In 1998, the Company and XL Capital Ltd ("XL"), a major Bermuda-based insurance holding company, entered into a joint venture, establishing two Bermuda-domiciled financial guaranty insurance companiesFSA International and XL Financial Assurance Ltd, now Syncora Guarantee Re Ltd. ("SGR"). In connection with the joint venture, XL acquired a minority interest in the Company and FSA International, and the Company acquired a minority interest in SGR. The Company sold its interest in SGR during the third quarter of 2008.
On July 5, 2000, the Company completed a merger in which the Company became a direct subsidiary of Dexia Holdings. At the merger date, each outstanding share of the Company's common stock was converted into the right to receive $76.00 in cash. At December 31, 2008, 99.9% of the Company's common stock was held by Dexia Holdings. The other holders are directors of the Company who own shares of the Company's common stock or economic interests therein as described
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under "Item 11. Executive CompensationCompensation of DirectorsDirector Share Purchase Program" and "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersDirectors and Executive Officers."
In October 2005, FSA purchased the interest in FSA International owned by XL for a cash purchase price of $39.1 million in anticipation of the repatriation of earnings and profits of FSA International. Giving effect to such purchase, FSA International became an indirect, wholly owned subsidiary of the Company.
In November 2008, Dexia entered in the Purchase Agreement providing for the sale of the Company to Assured.
Although the Company's common stock is no longer listed on the New York Stock Exchange ("NYSE") as a consequence of the merger, the Company continues to file periodic reports under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), because the Company has debt securities listed on the NYSE.
The Company's Executive Management Committee manages the Company's business. The Chief Executive Officer, President, General Counsel, Chief Risk Management Officer and Chief Financial Officer are members of the Executive Management Committee.
The principal executive offices of the Company and FSA are located at 31 West 52nd Street, New York, New York, 10019. The Company maintains offices domestically in San Francisco and Dallas and abroad in London, Madrid, Mexico City, Paris, Sydney, Tokyo and Bermuda. The Company is in the process of closing its Mexico and Paris offices.
The Financial Guaranty Business
Financial guaranty insurance written by FSA typically guarantees scheduled payments on financial obligations. Upon a payment default on an insured obligation, FSA is generally required to pay the principal, interest or other amounts due in accordance with the obligation's original payment schedule or may, at its option, pay such amounts on an accelerated basis. FSA's underwriting policy is to insure obligations that would otherwise be investment grade without the benefit of FSA's insurance.
Business Objectives
The Company's objective for its financial guaranty business is to remain a leading insurer of public finance obligations while generating premium volume at attractive returns and minimizing the occurrence and severity of credit losses in its insured portfolio. The Company believes that short-term trends for the Company are unfavorable due, among other things, to the following factors:
The Company believes that the demand for FSA's financial guaranty insurance will recover over the long term as a result of the following factors, subject to a restoration of stable ratings for FSA:
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Over the long term, the Company expects to continue to originate a diversified insured portfolio with a broad geographic distribution and a variety of revenue sources and transaction structures. In addition to its domestic business, the Company pursues international opportunities in Western European and Asia Pacific markets and, selectively, in Eastern European and Latin American markets.
Financial Guaranty Business
FSA's insurance is employed in both the new-issue and secondary markets. In the case of new issues, the insured obligations are sold with FSA insurance at the time the obligations are issued. For public finance obligations, FSA participates in negotiated offerings, where the investment banker and often the insurer have been selected by the sponsor or issuer. In addition, FSA participates in competitive offerings, where underwriting syndicates bid for securities and submit bids that may include insurance.
In certain insured transactions, the issuer of insured securities is party to an interest rate, basis or currency swap that matches the issuer's funding sources to the interest rate or currency of the insured securities or otherwise hedges the issuer's exposure. In certain of these transactions, FSA will insure the issuer's obligations under both the insured securities and the regularly scheduled payment under the derivative contract and, occasionally, the termination obligation. FSA may have provided its insurance directly to a security or other obligation or by insuring a credit default swap ("CDS") referencing such security or other obligation.
In November 2008, FSA ceased writing financial guaranties on GICs issued in connection with the Company's FP business.
FSA insures obligations already carrying insurance from other monoline guarantors, with FSA generally obligated to pay claims on a "second-to-pay" basis, following a default by both the underlying obligor and the first-to-pay financial guarantor. In recent years, FSA has also reinsured a modest amount of business from other financial guaranty insurers, but FSA did not assume reinsurance on any transactions during 2008.
FSA has several programs that provide insurance for public finance obligations trading in the secondary markets, including its Custody Receipt Program, which provides insurance primarily for domestic municipal obligations trading in the secondary market, and its Triple-A Guaranteed Secondary Securities ("TAGSS"®) Program, which provides insurance primarily for public infrastructure obligations trading in the secondary market. Investors and dealers generally obtain secondary-market insurance to upgrade or stabilize the credit ratings of securities they already hold or plan to acquire or to increase the market liquidity of such securities.
Prior to September 2008, FSA issued surety bonds under its Sure-Bid program, which provided an alternative to traditional types of good faith deposits for competitive municipal bond transactions. The Company may resume its Sure-Bid program, subject to improved credit protections from participating underwriters.
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The table below shows par outstanding and excludes intercompany insured transactions.
Par Outstanding by Type
|
December 31, 2008 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
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Par Outstanding | |||||||||||||||
|
Direct | Assumed | Total Gross | Ceded | Net | |||||||||||
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(in millions)
|
|||||||||||||||
Public finance |
$ | 404,413 | $ | 4,582 | $ | 408,995 | $ | 102,763 | $ | 306,232 | ||||||
Asset-backed |
119,046 | 1,570 | 120,616 | 18,318 | 102,298 | |||||||||||
Total |
$ | 523,459 | $ | 6,152 | $ | 529,611 | $ | 121,081 | $ | 408,530 | ||||||
At December 31, 2008, the weighted average life of the direct par insured was approximately 4.0 years for asset-backed and 13.7 years for public finance obligations.
The following table indicates the Company's percentages of par amount (net of reinsurance) outstanding with respect to each type of public finance and asset-backed program.
Net Par Outstanding by Program Type
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December 31, 2008 | ||||||||||||
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|
Public Finance Programs | Asset-Backed Programs | |||||||||||
|
Net Par
Outstanding |
Percent of
Total Net Par Outstanding |
Net Par
Outstanding |
Percent of
Total Net Par Outstanding |
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(dollars in millions)
|
||||||||||||
New Issue |
$ | 283,975 | 93 | % | $ | 94,513 | 92 | % | |||||
Secondary Market |
20,458 | 7 | 6,239 | 6 | |||||||||
Assumed |
1,799 | 0 | 1,546 | 2 | |||||||||
Total |
$ | 306,232 | 100 | % | $ | 102,298 | 100 | % | |||||
Premiums
In setting its premium rates for transactions, FSA takes into account the risk it assumes and its projected return. Critical factors in assessing risk include the credit quality of the risk, type of issue, sources of repayment, transaction structure and term to maturity. The premium rate is also a function of market factors, capital charges assessed by securities rating agencies and the competitive environment. Market factors include the value added by the use of insurance, such as the interest rate savings obtained by the issuer of an insured obligation. S&P assigns a "capital charge" for most obligations insured by FSA. The capital charge for a transaction is an important factor in determining the "return on equity" from a specified transaction premium rate under the Company's proprietary model. Competition arises from other insurers and alternative executions that do not involve insurance.
For insurance on GIC and medium term note transactions, transactions involving "repackaging" of outstanding securities and other transactions, FSA's premium may have been arbitrage-based, based upon the difference between the effective borrowing cost at a Triple-A rate and the interest rate on the underlying securities.
Public Finance Obligations
FSA insures a range of public finance obligations, including:
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Public finance obligations include municipal bonds, notes and other indebtedness issued by or on behalf of public and quasi-public entities, including states and their political subdivisions, utility districts, public housing and transportation authorities and universities and hospitals. Public finance obligations also include bonds, notes and other indebtedness issued by special purpose entities established to finance investments in infrastructure projects. Some public finance obligations, including most project finance obligations, include non-governmental credit risks (to swap counterparties, insurance companies, construction companies or other non-governmental credits) and operating risks (such as traffic volume or student enrollment).
In the case of general obligation bonds, an issuer's obligation to pay is supported by the issuer's taxing power. In the case of most revenue bonds and public-private infrastructure financings, an issuer's obligation to pay is supported by the issuer's or obligor's ability to impose and collect fees and charges for public services or specific projects or, in some cases, by federal subsidies or grants.
The Public Finance Market
According to industry sources, the total and insured volume since 2004 of long-term U.S. municipal new issues sold were as follows:
U.S. Municipal New Issues Sold(1)
Year
|
New Total
Volume |
New Insured
Volume |
New Insured
Volume as Percent of New Total Volume |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
|
(dollars in billions)
|
|||||||||
2004 |
$ | 359.7 | $ | 194.9 | 54.2 | % | ||||
2005 |
408.3 | 233.0 | 57.1 | |||||||
2006 |
388.6 | 191.3 | 49.2 | |||||||
2007 |
429.0 | 201.0 | 46.9 | |||||||
2008 |
391.5 | 68.3 | 17.4 |
In 2008, estimated U.S. municipal market volume of $391.5 billion was 9% lower than in 2007. After a slow start due to illiquidity in the auction rate securities ("ARS") market, municipal issuance rose significantly in the second quarter as a high volume of ARS were refinanced. However, volume fell off over the course of the second half as the cost of borrowing increased in response to the global
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credit contraction. In 2007, estimated U.S. municipal market volume of $429.0 billion was 10% higher than in 2006 and the highest market volume on record. Insurance penetration of the market for new U.S. municipal bonds sold in 2008 was approximately 17%, compared with 47% in 2007 and 49% in 2006. FSA's share of the insured par sold was approximately 54% in 2008, compared with 25% in 2007 and 24% in 2006. However, both insurance penetration and FSA's market share were significantly higher in the first half of 2008 than in the second. For a discussion of the Company's financial guaranty segment's results of operations in 2008, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsFinancial Guaranty SegmentResults of Operations."
Outside the United States, the global credit crisis produced severe illiquidity in the public infrastructure market during 2008, and demand for financial guarantees was low because of negative rating actions. International public finance transactions include public-private partnership financings, such as those authorized under the U.K. Private Finance Initiative, where host governments make payments to private developers or operators based either on the project's availability to meet its public purpose or on its cash revenues or observed usage, as well as other highly structured transactions. Because such transactions tend to have long development times and large par amounts, the timing of transactions may cause volatility in insured volume from year to year.
Since 2004, the annual totals of non-U.S. public finance par insured of financial guaranty insurance directly originated by monoline guarantors, according to industry sources, were as follows:
Par of Non-U.S. Public Finance Obligations Insured by Monoline
Insurance Companies(1)
Year
|
Amount | |||
---|---|---|---|---|
|
(in billions)
|
|||
2004 |
$ | 11.7 | ||
2005 |
14.9 | |||
2006 |
33.2 | |||
2007 |
35.2 | |||
2008 |
N/A(2 | ) |
FSA's Public Finance Obligations
FSA's insured portfolio of public finance obligations is divided into nine major categories. Where FSA insures obligations that already carry insurance from another monoline guarantor, FSA categorizes the obligation based on the type of bond or obligation underlying the insurance policy.
Domestic General Obligation Bonds. General obligation or full faith and credit bonds are issued by states, their political subdivisions and other municipal issuers, such as state bond banks, and are supported by the general obligation of the issuer or obligor to pay from available funds and by a pledge of the issuer or obligor to levy taxes in an amount sufficient to provide for the full payment of the bonds.
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Domestic Tax-Supported (Non-General Obligation) Bonds. Tax-supported (non-general obligation) bonds include a variety of bonds that, though not full faith and credit general obligations, are generally supported by leases, a specific or discrete source of taxation or moral obligation. Lease revenue bonds or certificates of participation ("COPs") are usually general fund obligations that finance real property or equipment that, in the case of leases subject to annual appropriation, FSA deems to serve an essential public purpose (e.g., schools, public safety facilities, courts and, less frequently, correctional facilities). Tax-backed revenue bonds are secured by a lien on pledged tax revenues, including income, retail sales, property, excise and gasoline taxes, or from tax increments (or tax allocations) generated by growth in property values within a district. FSA also insures bonds secured by special assessments levied against property owners, which benefit from covenants by the issuer to levy, collect and enforce collections and to foreclose on delinquent properties.
Domestic Municipal Utility Revenue Bonds. Municipal utility revenue bonds include obligations of municipal utilities, including electric, gas, water and sewer and solid waste. Insurable utilities may be organized as municipal enterprise systems, authorities or joint-action agencies.
Domestic Transportation Revenue Bonds. Transportation revenue bonds include a wide variety of revenue-supported bonds, such as bonds for airports, ports, municipal parking facilities, toll roads and toll bridges and tunnels.
Domestic Health Care Revenue Bonds. Health care revenue bonds include bonds of state and local municipal authorities issued on a conduit basis on behalf of not-for-profit health care providers and health care provider systems, payable from amounts derived under loan agreements and notes of such health care providers with such authorities. This category also includes exposure to HMOs, mental health providers and other health-related credits.
Domestic Housing Revenue Bonds. Housing revenue bonds include both multi-family and single family housing bonds, with multi-tiered security structures based on the underlying mortgages, reserve funds, and various other features such as Federal Housing Administration or private mortgage insurance, bank letters of credit, first-loss guarantees and, in some cases, the general obligation of the issuing housing agency or a state's moral obligation to make up deficiencies. This category also includes multi-family housing bonds supported by capital fund grants appropriated by Congress.
Domestic Education/University Bonds. Education/University bonds include obligations of colleges and universities, primarily public or state-supported, and independent primary and secondary schools.
Other Domestic Public Finance Obligations. Other domestic public finance obligations insured by FSA include bonds secured by revenues and guarantees from the Federal government, financings supported by specific state or local government entity revenues, and stadium financings. This category also includes guarantees of the debt of Citizens Property Insurance, a Florida state-sponsored entity, which provides residential and commercial property and casualty insurance coverage. This category also includes leveraged lease transactions ("Leveraged Lease Transactions"). A Leveraged Lease Transaction transfers the tax benefits from a tax-exempt entity, such as a transit agency (lessee) to a tax-paying entity (lessor) by transferring ownership of a depreciable asset, such as subway cars, to the lessor. The municipality (lessee) remains the primary user of the asset. In 2004, Congress amended the Internal Revenue Code to expressly prohibit tax benefits derived from such Leveraged Lease Transactions. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital ResourcesFSA's LiquidityLeveraged Lease Transactions."
International Public Finance Obligations. International public finance obligations have non-U.S. obligors and include obligations of sovereign and sub-sovereign issuers, project finance transactions involving projects leased to or supported by payments from governmental or quasi-governmental
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entities, toll road transactions supported by toll revenues, obligations arising under leases of equipment or facilities by municipal obligors, distribution and transmission utility and water utility financings, securitizations of government- supported receivables or sovereign or municipal debt, corporate debt guaranteed by government-owned financial institutions and other obligations having international aspects but otherwise within the public finance categories described above.
Asset-Backed Obligations
FSA ceased issuing financial guaranties on asset-backed obligations in August 2008. The asset-backed obligations in FSA's insured portfolio were generally issued in structured transactions backed by pools of assets such as residential mortgage loans, consumer or trade receivables, securities or other assets having an ascertainable cash flow or market value. Asset-backed obligations insured by FSA also included payment obligations of counterparties and issuers under synthetic obligations such as CDS and credit-linked notes referencing asset-backed securities or pools of securities or other obligations.
Asset-backed obligations are typically issued in connection with structured financings or securitizations where the securities being issued are secured by or payable with funds from a specific pool of assets. The assets are typically held by a special purpose entity that also acts as the issuer of the insured obligations. Most asset-backed obligations are secured by or represent interests in diverse pools of assets, such as residential mortgage loans, auto loans, credit card receivables, other consumer receivables, corporate loans or bonds, government debt and small business loans. Asset-backed obligations may also be secured by less diverse payment sources, such as small business loans. FSA sought to structure the asset-backed obligations it insured to mitigate the correlation risk.
Structure of Asset-backed and Other Non-Public Finance Obligations
The asset-backed obligations in the Company's insured portfolio include funded and synthetic transactions:
Funded Asset-backed Obligations. Funded asset-backed obligations are typically payable from cash flow generated by a pool of assets and take the form of either "pass-through" obligations, which represent interests in the related assets, or "pay-through" obligations, which generally are debt obligations collateralized by the related assets. Both types of funded asset-backed obligations generally have the benefit of one or more forms of credit enhancement, such as overcollateralization or excess cash flow, to cover credit risks associated with the related assets. Historically, asset securitization often represented an efficient way for commercial banks to comply with capital requirements and for corporations to access the capital markets at more attractive rates. Banks responded to increased capital requirements by selling certain of their assets, such as credit card receivables and automobile loans, in securitized structures to the financial markets. Some corporations found securitization of their assets to be a less costly funding alternative to traditional forms of borrowing or otherwise important in diversifying funding sources. Many finance companies have funded consumer finance and home equity lending through securitization.
Synthetic Asset-backed Obligations. Synthetic asset-backed obligations generally take the form of CDS obligations or credit-linked notes that reference either an asset-backed security or pool of securities or loans, with a defined deductible to cover credit risks associated with the referenced securities or loans. The Company has two basic types of insured CDS contracts. One type references a pool of underlying corporate obligations ("pooled corporate CDS") and the other type references existing structured finance securities, primarily CDOs and collateralized loan obligations ("CLOs"), or infrastructure finance transactions, including obligations insured by another financial guaranty insurer. In both cases, exposures insured by the Company generally had an attachment point (i.e., the minimum level of losses in a portfolio to which a tranche is exposed, usually expressed as a percentage of the
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total notional size of the portfolio) at the outset which was determined by the Company and the rating agencies to be at or above a Triple-A credit rating, or may have had such rating due to credit enhancement provided by another financial guaranty insurer.
Some CDS obligations expose FSA to elements of market value risk arising from obligations to pay the difference between par and market value upon the occurrence of a payment default or other defined "credit events" specified in the CDS. FSA generally addressed these risks by requiring large deductibles as a condition to payment under pooled corporate CDS insured by FSA.
The terms of the Company's guaranteed or "insured" CDS contracts generally are modified from standard CDS contract forms approved by the International Swaps and Derivatives Association, Inc. ("ISDA") in order to provide for payments on a scheduled basis and otherwise replicate the terms of a traditional financial guaranty insurance policy.
The Company considered its CDS to be a normal part of its financial guaranty insurance business but, for accounting purposes, FSA-insured CDS are accounted for as derivatives and therefore must be recorded at fair value, with periodic changes reflected through the statements of operation and other comprehensive income, causing volatility in the Company's reported net income. Despite the structural protections associated with the Company's pooled corporate CDS, the significant widening of credit spreads on pooled corporate CDS, as with other structured credit products, which started during the second half of 2007 and continued throughout 2008, resulted in significant mark-to-market losses. The ultimate amount of actual credit losses will depend on actual loss developments as opposed to market factors. For additional discussion of the impact of the mark-to-market accounting treatment, including valuation methods, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsFinancial Guaranty SegmentResults of OperationsFair Value of Credit Derivatives" and Note 3 to the consolidated financial statements in Item 8.
Most of the Company's industry peers have suffered material market concerns over their exposure to the CDO of ABS sector, relating to securitizations of high grade and mezzanine asset-backed securities, including subprime RMBS. Some of these companies assumed their exposure to CDOs of ABS in synthetic form, including through guaranties of CDS. Unlike other industry participants, the Company does not have material exposure in its insured portfolio to CDOs of ABS, either in the funded or synthetic form.
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Categorization of Asset-backed and Other Non-Public Finance Obligations
FSA's insured portfolio of asset-backed and other non-public finance obligations may be divided into five major categories, which are broadly based on the type of assets backing the insured obligations and include funded and synthetic obligations and may be in the form of insurance or insurance of CDS. Where FSA insures obligations that already carry insurance from another monoline guarantor, FSA categorizes the obligation based on the type of assets backing the obligations underlying the insurance policy. Until the fourth quarter of 2007, such obligations were categorized as "other domestic non-public finance obligations."
Domestic Residential Mortgage Loans. Obligations primarily backed by residential mortgage loans generally take the form of conventional pass-through certificates or pay-through debt securities, but also include other structured products. Residential mortgage loans backing these insured obligations include closed- and open-end first and second mortgage loans or home equity loans on one-to-four family residential properties, including condominiums and cooperative apartments and non-owner occupied residential housing. Approximately 17% of the asset-backed net par in FSA's insured portfolio is domestic residential mortgage products.
The Company has projected losses on some of the home equity line of credit ("HELOC"), Alt-A closed-end second-lien mortgage ("CES") securities, Option Adjustable Rate Mortgage ("Option ARM") transactions, Alt-A first-lien mortgages, subprime U.S. RMBS and net interest margin securitizations ("NIMs") in its insured portfolio and has established net case reserves of $1,234.3 million in relation to its domestic residential mortgage loans. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsFinancial Guaranty SegmentInsured Portfolio SummaryAsset-Backed Insured Portfolio." "Alt-A" refers to borrowers whose credit quality falls between prime and subprime.
Approximately 6.2% of the asset-backed net par outstanding in FSA's insured portfolio are HELOCs. The HELOCs are primarily backed by second liens and made to higher quality ("prime") borrowers. They have lower levels of structural protection than typical subprime transactions. The protection is typically provided by excess spread, which is used to pay current period losses and build reserves. Most of FSA's insured HELOCs were originated by mortgage finance companies.
Approximately 4.5% of the asset-backed net par outstanding in FSA's insured portfolio are in the "subprime" sector, characterized by lower quality borrowers and higher levels of structural credit protection through subordination and/or excess spread. Most subprime transactions are secured by fully-amortizing first-lien mortgage loans that pay a fixed rate of interest for two to five years, after which they pay a floating rate of interest. Typically all principal received on the underlying mortgages is paid through to the Triple-A noteholders for at least the first 36 months, causing credit protection to increase over time.
Approximately 2.6% of the asset-backed net par outstanding in FSA's insured portfolio are backed by Option ARMs. Option ARMs are generally backed by first lien mortgage loans made to prime borrowers (on average) with average original loan-to-value ratios of approximately 76%. The loans have three payment optionsfully amortizing payment, interest only, and a minimum payment that results in negative amortization of the borrower's loan. The loans generally reset to full amortization on their fifth anniversaries, or possibly earlier if the loan's negative amortization results in loan to value ratios that exceed limits usually between 110% and 120% of the original loan balance (which can happen if interest rates rise and the borrower makes only the minimum payment). Upon reset, monthly payment amounts can increase significantly.
Approximately 1.6% of asset-backed net par outstanding in FSA's insured portfolio consist of securities backed by Alt-A first lien residential mortgage loans. First lien Alt-A transactions insured by FSA are collateralized by fixed and floating rate loans secured by a first lien on residential property.
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All principal received on the underlying mortgages is paid through to the senior Triple-A note holders for at least the first 36 months, causing credit protection to increase over time.
Approximately 1.5% of the asset-backed net par outstanding in FSA's insured portfolio consist of closed-end second-lien mortgage transactions. Closed-end second-lien mortgage loan transactions are backed by fully amortizing loans secured by a second lien on residential property. All FSA closed-end second-lien transactions involve Alt-A borrowers. All principal received on the underlying mortgages is paid through to the senior note holders for at least the first 36 months, causing credit protection to increase over time.
Approximately 0.2% of asset-backed net par outstanding in FSA's insured portfolio consist of NIMs. NIMs are securities backed by the senior portion of residual cash flows from securitizations of domestic residential mortgage loans, generally the residual cash flows expected to be produced during the first 12-36 months of a subprime transaction.
FSA generally declined participation in securitizations of so-called "high-cost mortgage loans," characterized by very high interest rates or "points and fees" and subject to restrictive federal and state regulations.
Domestic Consumer Receivables. Obligations primarily backed by consumer receivables include conventional pass-through and pay-through securities as well as more highly structured transactions. Consumer receivables backing these insured obligations primarily include automobile loans, with some credit card receivables, manufactured housing loans and cash consumer loans. Consumer receivable transactions in FSA's insured portfolio tend to be concentrated in the subprime automobile loan sector.
Domestic Pooled Corporate Obligations. Obligations primarily backed by pooled corporate obligations include funded and synthetic obligations collateralized by corporate debt securities or corporate loans and obligations backed by cash flow or market value of non-consumer indebtedness, and include CDOs, such as collateralized bond obligations ("CBOs"), CLOs and comparable risks under CDS obligations. Corporate obligations include corporate bonds, bank loan participations, trade receivables, franchise loans and equity securities.
CDOs are securitizations of bonds, loans or other securities and may be insured on a funded or synthetic basis. CDOs have been used by financial institutions to manage their risk profiles, optimize capital utilization and improve returns on equity. CDOs have also been used by dealers or portfolio managers to provide leveraged investments in bond and loan portfolios tailored to conform to differing risk appetites of investors.
Other Domestic Non-Public Finance Obligations. Other domestic non-public finance obligations in FSA's insured portfolio include bonds or other securities backed by government securities, letters of credit or repurchase agreements collateralized by government securities, securities backed by a combination of assets that include elements of more than one of the categories set forth above and unsecured corporate obligations satisfying FSA's underwriting criteria. Other domestic non-public finance obligations insured by FSA also include first mortgage bond obligations of for-profit electric or water utilities providing retail, industrial and commercial service, sale-leaseback obligation bonds supported by such utilities and other obligations backed by investor-owned utilities. These bonds are generally either secured by a mortgage on property owned by or leased to an investor-owned utility or have the benefit of a "negative pledge" ensuring that no other material creditors have priority claims to the utility assets. Other domestic non-public finance obligations include securitization of life insurance risks (including so-called "triple-X transactions") and airplane leases, including transactions benefiting from third-party financial guaranty insurance.
International Asset-Backed Obligations. International asset-backed obligations in FSA's insured portfolio include (1) funded and synthetic CDOs, (2) securitizations of perpetual floating rate notes of
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non-domestic banks, diversified payment rights, future flows, health care receivables and residential housing construction loans, (3) obligations of non-domestic investor-owned utilities and (4) other obligations having international aspects but otherwise within the asset-backed categories described above. FSA allocates individual funded and synthetic CDOs between domestic and international based on the transactions' holdings or potential holdings. Most of the international obligations comprise the international component of funded or unfunded CDOs.
Insured Portfolio
A summary of the Company's insured portfolio at December 31, 2008 is shown below. Exposure amounts are expressed net of reinsurance but do not distinguish between quota share, first-loss or excess-of-loss reinsurance.
Summary of Insured Portfolio by Obligation Type
|
December 31, 2008 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Number
of Risks |
Net Par
Outstanding |
Net Par
and Interest Outstanding |
Percent of
Net Par and Interest |
||||||||||||
|
(dollars in millions)
|
|||||||||||||||
Public finance obligations |
||||||||||||||||
Domestic obligations |
||||||||||||||||
General obligation |
7,603 | $ | 125,063 | $ | 187,829 | 31 | % | |||||||||
Tax-supported |
1,259 | 55,321 | 87,120 | 14 | ||||||||||||
Municipal utility revenue |
1,246 | 50,279 | 82,593 | 14 | ||||||||||||
Health care revenue |
216 | 12,185 | 22,104 | 4 | ||||||||||||
Housing revenue |
161 | 7,434 | 12,909 | 2 | ||||||||||||
Transportation revenue |
165 | 21,304 | 37,072 | 6 | ||||||||||||
Education/University |
153 | 7,902 | 13,338 | 2 | ||||||||||||
Other domestic public finance |
26 | 2,181 | 3,370 | 1 | ||||||||||||
Subtotal |
10,829 | 281,669 | 446,335 | 74 | ||||||||||||
International obligations |
173 | 24,563 | 53,593 | 9 | ||||||||||||
Total public finance obligations |
11,002 | 306,232 | 499,928 | 83 | ||||||||||||
Asset-backed obligations |
||||||||||||||||
Domestic obligations |
||||||||||||||||
Residential mortgages |
200 | 17,052 | 21,131 | 3 | ||||||||||||
Consumer receivables |
39 | 5,915 | 6,346 | 1 | ||||||||||||
Pooled corporate |
279 | 54,903 | 57,855 | 9 | ||||||||||||
Other domestic asset-backed |
63 | 1,568 | 2,033 | 0 | ||||||||||||
Subtotal |
581 | 79,438 | 87,365 | 13 | ||||||||||||
International obligations |
54 | 22,860 | 24,155 | 4 | ||||||||||||
Total asset-backed obligations |
635 | 102,298 | 111,520 | 17 | ||||||||||||
Total |
11,637 | $ | 408,530 | $ | 611,448 | 100 | % | |||||||||
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Obligation Type
The table below sets forth the relative percentages of net par insured by obligation type during each of the last five years:
Annual New Business Insured by Obligation Type
|
Year Ended December 31, | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||
Public finance obligations |
|||||||||||||||||||
Domestic obligations |
|||||||||||||||||||
General obligation |
37 | % | 23 | % | 27 | % | 30 | % | 20 | % | |||||||||
Tax-supported |
18 | 8 | 9 | 12 | 7 | ||||||||||||||
Municipal utility revenue |
18 | 7 | 8 | 8 | 5 | ||||||||||||||
Health care revenue |
1 | 2 | 3 | 3 | 3 | ||||||||||||||
Housing revenue |
1 | 1 | 1 | 1 | 2 | ||||||||||||||
Transportation revenue |
12 | 3 | 2 | 4 | 2 | ||||||||||||||
Education/University |
6 | 1 | 1 | 1 | 1 | ||||||||||||||
Other domestic public finance |
1 | 1 | | | | ||||||||||||||
Subtotal |
94 | 46 | 51 | 59 | 40 | ||||||||||||||
International obligations |
3 | 7 | 7 | 5 | 2 | ||||||||||||||
Total public finance obligations |
97 | 53 | 58 | 64 | 42 | ||||||||||||||
Asset-backed obligations |
|||||||||||||||||||
Domestic obligations |
|||||||||||||||||||
Residential mortgages |
1 | 11 | 10 | 9 | 29 | ||||||||||||||
Consumer receivables |
1 | 5 | 10 | 5 | 3 | ||||||||||||||
Pooled corporate |
1 | 19 | 11 | 13 | 14 | ||||||||||||||
Other domestic asset-backed |
0 | 3 | 1 | 1 | 4 | ||||||||||||||
Subtotal |
3 | 38 | 32 | 28 | 50 | ||||||||||||||
International obligations |
0 | 9 | 10 | 8 | 8 | ||||||||||||||
Total asset-backed obligations |
3 | 47 | 42 | 36 | 58 | ||||||||||||||
Total |
100 | % | 100 | % | 100 | % | 100 | % | 100 | % | |||||||||
Terms to Maturity
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. The expected maturities for asset-backed obligations, in general, are considerably shorter than the contractual maturities for such obligations. For asset-backed obligations, the full par outstanding for each insured risk is shown in the maturity category that corresponds to the legal final maturity of such risk.
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The table below sets forth the contractual terms to maturity of the Company's policies:
Contractual Terms to Maturity of Net Par Outstanding of Insured Obligations
|
December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
Term to Maturity
|
Public
Finance |
Asset-
Backed |
Public
Finance |
Asset-
Backed |
||||||||||
|
(in millions)
|
|||||||||||||
0 to 5 years |
$ | 59,744 | $ | 36,797 | $ | 54,037 | $ | 42,714 | ||||||
5 to 10 years |
64,224 | 29,068 | 58,719 | 34,628 | ||||||||||
10 to 15 years |
59,381 | 17,818 | 53,676 | 19,332 | ||||||||||
15 to 20 years |
46,735 | 737 | 44,446 | 2,644 | ||||||||||
20 years and above |
76,148 | 17,878 | 71,642 | 24,619 | ||||||||||
Total |
$ | 306,232 | $ | 102,298 | $ | 282,520 | $ | 123,937 | ||||||
Issue Size
The table below sets forth the net par outstanding broken out by original net par amount:
Net Par Outstanding
|
December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
Original Net Par
|
Public
Finance |
Asset-
Backed |
Public
Finance |
Asset-
Backed |
||||||||||
|
(in millions)
|
|||||||||||||
Less than $10 million |
$ | 44,419 | $ | 72 | $ | 41,630 | $ | 114 | ||||||
$10 to $50 million |
96,141 | 4,194 | 90,554 | 4,752 | ||||||||||
$50 million to $100 million |
53,795 | 10,890 | 50,733 | 11,956 | ||||||||||
$100 million or greater |
111,877 | 87,142 | 99,603 | 107,115 | ||||||||||
Total |
$ | 306,232 | $ | 102,298 | $ | 282,520 | $ | 123,937 | ||||||
Geographic Concentration
The Company seeks to maintain a diversified portfolio of insured public finance obligations designed to spread its risk across a number of geographic areas. The table below sets forth those
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jurisdictions in which municipalities issued an aggregate of 2% or more of the total net par amount outstanding of FSA-insured public finance securities:
Public Finance Insured Portfolio by Location of Exposure
|
December 31, 2008 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Number
of Risks |
Net Par
Amount Outstanding |
Percent of
Total Net Par Amount Outstanding |
|||||||||
|
|
(dollars in millions)
|
||||||||||
Domestic obligations |
||||||||||||
California |
1,121 | $ | 40,868 | 13 | % | |||||||
New York |
774 | 23,033 | 8 | |||||||||
Pennsylvania |
892 | 20,475 | 7 | |||||||||
Texas |
826 | 19,525 | 6 | |||||||||
Illinois |
756 | 16,612 | 6 | |||||||||
Florida |
291 | 15,585 | 5 | |||||||||
Michigan |
639 | 13,093 | 4 | |||||||||
New Jersey |
659 | 12,509 | 4 | |||||||||
Washington |
344 | 10,225 | 3 | |||||||||
Massachusetts |
241 | 7,896 | 3 | |||||||||
Ohio |
452 | 7,242 | 2 | |||||||||
Georgia |
129 | 7,000 | 2 | |||||||||
Indiana |
300 | 6,674 | 2 | |||||||||
All other U.S. locations |
3,405 | 80,932 | 27 | |||||||||
Subtotal |
10,829 | 281,669 | 92 | |||||||||
International obligations |
173 | 24,563 | 8 | |||||||||
Total |
11,002 | $ | 306,232 | 100 | % | |||||||
In its asset-backed business, the Company considered geographic concentration as a factor in its underwriting decisions for insurance for securitizations of pools of assets, such as residential mortgage loans or consumer receivables. However, the geographic concentration of the underlying assets may change over the life of the policy. In addition, in writing insurance for other types of asset-backed obligations, such as securities primarily backed by government or corporate debt, geographic concentration may not have been a significant credit factor given other more relevant measures of diversification, such as issuer or industry diversification.
The Company earns premiums in its financial guaranty segment. The table below shows amounts attributed to foreign and domestic premiums during each of the last three fiscal years, based on the underlying risks:
Net Premiums Earned by Geographic Distribution
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in millions)
|
||||||||||
United States |
$ | 298.9 | $ | 263.7 | $ | 257.9 | |||||
International |
77.7 | 54.1 | 43.6 | ||||||||
Total net premiums earned |
$ | 376.6 | $ | 317.8 | $ | 301.5 | |||||
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For a discussion of risks related to the Company's foreign operations, see "Item 1A. "Risk FactorsThe Company's international operations expose it to less predictable credit and legal risks."
See Note 23 to the consolidated financial statements in Item 8 for revenues from external customers, pre-tax earnings and total assets by segment.
Issuer Concentration
The Company has adopted underwriting and exposure management policies designed to limit the net par insured or net retained credit gap for any one risk. Credit gap is a concept employed by S&P to estimate the at-risk amount (worst-case risk) on an insured exposure. FSA has also established procedures to ensure compliance with regulatory single-risk limits applicable to bonds it has insured. In many cases, the Company uses reinsurance to limit net exposure to any one risk.
At December 31, 2008, the ten largest net insured public finance risks represented $12.5 billion, or 3.1%, of the total net par amount outstanding and the ten largest net insured asset-backed transactions represented $18.3 billion, or 4.5%, of the total net par amount outstanding. For purposes of the foregoing, different issues of asset-backed securities by the same originator have not been aggregated. However, the Company's underwriting policies established single-risk guidelines applicable to asset-backed securities of the same originator. In addition, individual corporate names may appear in more than one FSA-insured CDO transaction, but such exposures are not aggregated for purposes of identifying the largest insured risks. Instead, FSA addresses these risks through structural elements of the transactions and by limiting its exposure to the CDO sector in the aggregate. In addition to the single-risk limits established by its underwriting guidelines, the Company is subject to regulatory limits and rating agency guidelines on exposures to single risks.
The Financial Products Business
Business Objectives
The Company's objective for its FP business had been to generate positive net interest margin through borrowing funds at attractive rates in the municipal GIC and other markets and investing the proceeds in investments satisfying the Company's investment criteria while minimizing the Company's exposure to interest rate and foreign exchange rate changes. In the course of 2008, the borrowing rates on GICs rose significantly, and the Company reduced its GIC issuance accordingly.
In November 2008, the Company ceased issuing GICs in contemplation of the sale of the Company to Assured. The Company's current objective in respect of the FP business is to accomplish a complete transfer of the credit and liquidity risk of that business to Dexia. This objective was largely accomplished in February 2009 in connection with the FSAM Risk Transfer Transaction. See "Transfer of Credit and Liquidity Risk of the GIC Business."
Under the terms of the Acquisition, Dexia will retain the FP segment of the Company. See "Expected Sale of the CompanyDexia's Retention of the FP business."
The FP Business
The Company's GIC business provided GICs to municipalities and other market participants through November 2008. FSA insured all GICs issued by the GIC Subsidiaries. Most municipal GICs issued by the GIC Subsidiaries relate to debt service reserve funds or construction funds that support municipal bond transactions. Most non-municipal GICs issued by the GIC Subsidiaries relate to funds held by issuers of credit-linked notes referencing CDOs of ABS or CLOs.
21
Each GIC entitles its holder to receive the return of the holder's initial principal plus interest at a specified rate, and to withdraw principal from the GIC as permitted. Generally, a municipal bond trustee or issuer will acquire a municipal GIC in order to invest funds on deposit in a debt service reserve fund or construction fund until it needs to use such funds to service debt or fund the payment of project expenses in accordance with the underlying bond documents.
The GIC Subsidiaries issued GICs and, on the same terms, loaned the funds raised to FSAM. The payment obligations relating to the GICs generally are (or were converted by FSAM into) U.S. dollar London Inter-Bank Offered Rate ("LIBOR") -based floating rate obligations. FSAM typically invests the funds in U.S. dollar LIBOR-based floating rate investments. To the extent that such investments do not meet such criteria, FSAM utilizes swaps, futures and other hedge transactions to convert them into U.S. dollar LIBOR-based floating rate investments. This investment and funding strategy was designed to minimize the Company's exposure to interest rate and foreign exchange rate changes.
FSA-PAL, which was formed in 2006, invests in non-U.S. securities. FSAM's and FSA-PAL's investments are investment-grade at the time of purchase. The FP business generates its gross profits or losses from the difference between the rates at which the GIC Subsidiaries borrowed the funds and the rates yielded by FSAM's and FSA-PAL's investments. All related risk management functions are performed by FSAM. FSAM invests most of its funds in asset-backed securities, predominantly mortgage-backed securities, which have experienced significant market value declines commencing with the third quarter of 2007.
The following table indicates the Company's par value of debt outstanding with respect to municipal and non-municipal GICs as well as VIEs:
Par Value of FP Segment Debt by Type(1)
|
December 31, | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||||
|
(in millions)
|
||||||||
GIC debt: |
|||||||||
Municipal |
$ | 6,165.9 | $ | 7,477.9 | |||||
Non-municipal GICs: |
|||||||||
CDOs of ABS GICs |
4,042.9 | 6,099.8 | |||||||
Pooled corporate and CLO structured GICs |
3,259.1 | 4,404.0 | |||||||
Other non-municipal GICs |
830.4 | 786.2 | |||||||
Total non-municipal GICs |
8,132.4 | 11,290.0 | |||||||
Total GIC debt |
14,298.3 | 18,767.9 | |||||||
VIE debt |
2,101.4 | 2,494.9 | |||||||
Total par value of FP segment debt |
$ | 16,399.7 | $ | 21,262.8 | |||||
Liquidity Risk in the FP Business
The Company is exposed to liquidity risk associated with unexpected withdrawals on its FSA-insured GICs. Liquidity risk is the current and prospective risk to earnings or capital arising from an inability to meet obligations when they come due without incurring unacceptable losses and includes the inability to manage unplanned decreases or changes in funding sources. In its FP segment, the Company relies on net interest income to fund its net interest expense and operating expenses.
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The FP segment business model contemplated that operating cash flow from interest and principal payments on the FP investments would provide sufficient liquidity to pay the FP obligations on a timely basis. The Company sought to manage the FP business' liquidity risk through the maintenance of liquid collateral and liquidity agreements. To minimize the refinancing risk in the portfolio of the investments supporting the GIC liabilities (the "FP Investment Portfolio"), bonds in the portfolio were targeted to have shorter weighted average lives than those of the related funding obligations. While this investment strategy posed a degree of reinvestment risk, the Company believed it could adequately minimize liquidity risk. These assumptions proved incorrect. During the course of 2008, the FP segment developed significant liquidity shortfalls as a result of a number of factors, including (i) greater than anticipated GIC withdrawals; (ii) slower than anticipated amortization of RMBS owned in the FP Investment Portfolio; (iii) redemption/collateralization requirements triggered by the downgrade of FSA's rating by Moody's; and (iv) a significant decline in market value of the FP Investment Portfolio due to market dislocation, with mark-to-market losses at December 31, 2008 of $8.6 billion. These liquidity shortfalls were addressed by liquidity support provided by Dexia over the course of 2008, culminating in the FSAM Risk Transfer Transaction in February 2009.
Unscheduled withdrawals of principal allowed by the terms of the GICs have increased due to a number of factors, and have largely been associated with non-municipal GICs. The majority of municipal GICs insured by FSA relate to debt service reserve funds and construction funds in support of municipal bond transactions. Debt service reserve fund GICs may be drawn earlier than expected upon a payment default by the municipal issuer. Construction fund GICs usually have withdrawal schedules based on expected construction funding requirements, but may be drawn earlier or later than expected when construction of the underlying municipal project does not proceed as expected. The majority of non-municipal GICs insured by FSA are purchased by issuers of credit-linked notes that provide credit protection with respect to CDOs of ABS and CLOs. These issuers of credit-linked notes typically sell credit protection by entering into a CDS referencing specified asset-backed or corporate obligations. Such GICs may be and in many cases have been drawn earlier than expected to fund credit protection payments due by the credit-linked note issuer under the related CDS or upon an acceleration of the related credit-linked notes following a transaction event of default.
Further, liquidity risk related to FSA's ratings has increased as FSA has been downgraded or placed on credit watch by the three major rating agencies. Some FSA-insured GICs allowed for withdrawal of GIC funds in the event of a downgrade of FSA below Aaa by Moody's, unless the relevant GIC Subsidiary posted collateral or otherwise enhanced its credit. The November 2008 downgrade to Aa3 by Moody's resulted in a trigger breach on $1.7 billion of unsecured GICs and $1.6 billion of secured GICs. The downgrade required the Company to either post collateral (or post additional collateral if already collateralized) or terminate, depending upon the requirements of the relevant GIC. In the case of termination, the Company either had to return par or negotiate a market value termination. In respect of unsecured GICs, the Company posted $1.0 billion of collateral, terminated $0.4 billion of GICs and modified the trigger to below Aa3 on $0.2 billion of GICs. The Company also posted $80 million of additional collateral to secured GICs.
Additional downgrades by Moody's or a downgrade by S&P would result in additional requirements. At December 31, 2008, a downgrade of FSA to below AA- by S&P or Aa3 by Moody's (A+ by S&P or A1 by Moody's) would result in withdrawal of $0.8 billion of GICs and the need to post collateral on GICs with a balance of $13.4 billion. Each GIC contract stipulates the types of securities eligible for posting and the collateralization percentage applicable to each security type. These collateralization percentages range from 100% of the GIC balance for cash collateral to, typically, 108% for asset-backed securities. Assuming an average margin of 105%, the market value of required collateral would be $14.1 billion. At December 31, 2008, a downgrade of FSA to below A- by S&P or A3 by Moody's (i.e., BBB+ by S&P or Baa1 by Moody's) would result in mandatory or
23
optional withdrawals of $5.1 billion of GICs and repayment or collateralization of the remainder of the $9.1 billion of GICs outstanding.
In anticipation of a need for increased liquidity resources, commencing with the fourth quarter of 2007 the Company began investing newly originated GIC proceeds into short-term investments. As a result, the net interest margin ("NIM") on new business originations in the FP segment has been eliminated and, in some cases, negative. In order to address its liquidity needs, FSAM has accessed lines of credit provided by Dexia, with $1.3 billion in draws on the First Dexia Line of Credit outstanding at December 31, 2008, and expects to rely upon liquidity provided by Dexia for its on-going liquidity requirements.
For further discussion of the liquidity risk and resources of the FP segment, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital ResourcesFP Segment Liquidity."
Consolidated Variable Interest Entities
FSA Global is a Cayman Islands-domiciled issuer of FSA-insured notes and other obligations sold in international markets that are generally referred to as "medium term notes." The Company owns 49% of the voting ordinary shares and 100% of the nonvoting preference shares of FSA Global. FSA Global issued securities at the request of interested purchasers in a process known as "reverse inquiry," which generally resulted in lower interest rates and borrowing costs than would apply to direct borrowings. FSA Global also issued securities in traditional private placements to institutional investors and to participants in Leveraged Lease Transactions in which Company affiliates may play a number of financing roles. At December 31, 2008, the VIEs, including FSA Global, had $2.1 billion principal amount of outstanding notes. In accordance with the Purchase Agreement, FSA Global has ceased offering securities.
FSA Global is managed as a "match funded vehicle," in which the proceeds from the sale of FSA Global notes are invested in obligations chosen to provide cash flows substantially matched to those of the notes (taking into account, in some cases, dedicated third-party liquidity). This match funded structure was designed to minimize the market and liquidity risks borne by FSA Global and FSA.
FSA Global generally raised funds denominated in U.S. dollars or converted into U.S. dollars at LIBOR-based floating borrowing rates. In recent years, the funds FSA Global raised have generally been invested in FSA-insured GICs, but it has invested in other FSA-insured obligations. FSA Global invests with a view to realizing the yield difference between the notes issued and the obligations purchased with the note proceeds. The majority of FSA Global's investments are either denominated in U.S. dollars or converted into U.S. dollars at LIBOR-based floating rates. FSA Global's investments mature prior to the maturity of the related FSA Global notes, and pay a higher interest rate than the interest rate on the related FSA Global notes.
Under the Purchase Agreement, Assured and Dexia Holdings agreed to cooperate in good faith to evaluate the feasibility of the actual or functional separation of FSA Global's leveraged lease and medium term notes businesses with a view to maximizing the tax, accounting and financial efficiency of the separation of the businesses for both parties. At March 17, 2009, an agreement had not been reached on the structure of the business separation. Regardless of the structure of such business separation, under the Purchase Agreement Dexia Holdings is expected to retain the risks associated with FSA Global's medium term notes business and certain portions of its leveraged lease business, FSA is expected to retain the risks associated with the leveraged lease debt business, and no new business will be written by FSA Global or Premier.
24
Credit Underwriting Guidelines, Standards and Procedures
Financial Guaranty Business
Financial guaranty insurance written by FSA generally relies on an assessment of the adequacy of various payment sources to meet debt service or other obligations in a specific transaction without regard to premiums paid or income from investment of premiums. FSA's underwriting policy is to insure public finance obligations, including infrastructure finance transactions, that it determines are investment grade without the benefit of FSA's insurance. To this end, each policy FSA writes or reinsures is designed to satisfy the general underwriting guidelines and specific standards for particular types of obligations approved by its Board of Directors. In addition, the Company's Board of Directors has established an Underwriting Committee that reviews completed transactions, generally on a quarterly basis, to ensure conformity with underwriting guidelines and standards.
Underwriting Guidelines for Public Finance Obligations
FSA's underwriting guidelines for public finance obligations require that a transaction be rated investment grade by Moody's or S&P or, in the alternative, that the credit quality of the obligor is considered by FSA to be the equivalent of investment grade. Where the obligor is a governmental entity with taxing power or providing an essential public service paid by taxes, assessments or other charges, supplemental protections may be required to ensure sufficient debt service coverage. Where appropriate, the obligor may be required to provide a rate covenant and a pledge of additional security (e.g., mortgages on real property, liens on equipment or revenue pledges) to secure the insured obligation.
Public finance obligations that are infrastructure finance transactions are also subject to underwriting guidelines requiring that they relate to facilities used to provide an essential public service. Such infrastructure financings may be domestic or international, and include public-private partnership transactions, such as those authorized under the U.K. Private Finance Initiative. Municipal utility revenue bonds and transportation revenue bonds may also be infrastructure transactions. FSA's underwriting guidelines require that FSA minimize or mitigate other sources of risk in its infrastructure finance transactions, such as construction or operations risk, through structural elements.
FSA has several programs that provide insurance for obligations trading in the secondary markets, including its Custody Receipt Program and its TAGSS® Program. FSA's underwriting guidelines require the same underwriting standards on secondary-market issues as on new issues, although FSA's control rights in the event of default are generally more limited.
Underwriting Guidelines for Asset-Backed Obligations
FSA ceased underwriting asset-backed obligations in August 2008. FSA's underwriting guidelines for asset-backed obligations varied by obligation type in order to reflect different structures and types of credit support. FSA sought to insure asset-backed obligations that generally provided for one or more forms of overcollateralization (such as excess collateral value, excess cash flow or "spread," reserves or, in the case of CDS, a deductible) or third-party protection. Asset-backed obligations in FSA's insured portfolio often benefit from self-adjusting mechanisms, such as cash traps or accelerated amortization that take effect upon a failure to satisfy performance-based triggers. Overcollateralization or third-party protection does not necessarily protect FSA against all risk of loss, but was generally intended to assume the primary risk of financial loss. Overcollateralization and third-party protection may not have been required in transactions in which FSA was insuring the obligations of certain highly rated issuers, which were typically regulated, had implied or explicit government support, or were short-term.
25
FSA's asset-backed obligations underwriting policy allowed for FSA to insure securities issued to refinance other securities insured by FSA as to which the issuer was or may have been in default. Overcollateralization and third-party protection may not have been required in such transactions. In addition, FSA insured on a selective basis so-called "future flow," "diversified payment right," "triple-X," "airplane enhanced equipment trust certificate" and "whole business" securitizations in which FSA may be exposed to a level of corporate risk greater than found in traditional asset-backed securities. FSA has also insured "extreme mortality" transactions, which, like "triple-X" securitizations insured by FSA, expose FSA to investment-grade levels of mortality risk. Historically, FSA was very selective in insuring securities with risks that it considered difficult to conservatively underwrite. For example, FSA has no material exposure in its insured portfolio to CDOs of ABS.
FSA's general policy was to insure 100% of the principal, interest and other amounts due in respect of funded asset-backed obligations rather than providing partial or first-loss coverage sufficient to confer a Triple-A rating on the senior obligations. In the CDS sector, FSA often insured risks, and in the funded sector FSA sometimes insured securities, on a "compressed" or "mezzanine" basis in which the obligations insured by FSA were subordinate, in whole or in part, to more senior uninsured obligations and where the risk insured by FSA was typically Triple-A without the benefit of FSA's insurance. FSA insures securities previously insured by another financial guaranty insurer. Until the fourth quarter of 2007, any such "previously wrapped" obligation was required to conform to FSA's underwriting requirements, where specific requirements were in place, without regard to the previous wrap or, in some cases, be a "near miss"i.e., a transaction that comes close to but does not entirely conform to FSA's underwriting guidelines. Commencing with the fourth quarter of 2007, previously wrapped transactions that were a "near miss" no longer qualified for FSA insurance.
The Underwriting Process
Final transaction approval is obtained from FSA's Municipal Underwriting Committee (the "MUNC") for domestic municipal transactions and FSA's Management Review Committee (the "MRC") for international infrastructure transactions and, in some cases, amendments to or developments in outstanding asset-backed transactions. Prior to August 2008, the MRC was also responsible for approving asset-backed transactions. In some cases, such as in the event of an international municipal transaction, the MUNC and MRC may both review a proposed transaction together. Approval is usually based upon both a written and an oral presentation by the underwriting group to the respective committee. Following approval, the Chair of the applicable underwriting committee may approve minor transaction modifications. Major changes require the concurrence of the applicable underwriting committee.
The Company's Risk Management Committee reviews the Company's insured portfolio on a periodic basis. The Risk Management Committee includes FSA's Chief Risk Management Officer and the three Chief Underwriting Officers (Municipal, International, and International Structured Finance Underwriting), as well as the Chief Executive Officer, President, General Counsel, Chief Financial Officer and the heads of the Transaction Oversight groups.
The underwriting process that implements the Company's underwriting guidelines and standards is supported by FSA's professional staff of analysts, underwriting officers, credit officers and attorneys. Moreover, the approval of senior management and/or designated senior underwriting officers is required for all transactions.
Each underwriting group in the Financial Guaranty Group is responsible for confirming that each transaction proposed by the Financial Guaranty Group conforms to the underwriting guidelines and standards. This evaluation is reviewed by the chief underwriting officer for the particular sector. This review may take place while the transaction is in its formative stages, thus facilitating the introduction of further enhancements at a stage when the transaction is more receptive to change.
26
The MUNC is composed of FSA's Chief Executive Officer, President, Chief Municipal Underwriting Officer, a Municipal Underwriting Officer, Managing Director of Public Finance and Associate General Counsel for Municipal Transactions. The MUNC approval process generally requires approval by at least:
The Chief Executive Officer and President are not required to participate in MUNC meetings for transactions meeting certain criteria. Subject to applicable limits, public finance transactions satisfying credit requirements may be approved by a committee (the "Demi-MUNC") composed of at least two voting members, one of whom must be the Chief Municipal Underwriting Officer or Municipal Underwriting Officer, and any one of certain managing directors and directors designated by the MUNC.
The MRC is composed of FSA's Chief Executive Officer, President, Chief Risk Management Officer, Chief International Underwriting Officer, Chief International Structured Finance Officer, General Counsel and Associate General Counsel for Asset-Backed Transactions.
The rating agencies participate to varying degrees in the underwriting process. In the case of domestic municipal obligations, prior rating agency review is a function of the type of insured obligation and the risk elements involved. Most asset-backed and international obligations insured by FSA were reviewed prior to issuance by both S&P and Moody's to evaluate the risk proposed to be insured. The independent review of FSA's underwriting practices performed by the rating agencies further strengthens the underwriting process.
Transaction Oversight and Transaction Services
FSA's Transaction Oversight Groups and its workout subsidiary TSC are independent of the analysts and credit officers involved in the underwriting process. The Municipal and Asset-Backed Transaction Oversight Groups are responsible for monitoring the performance of outstanding transactions. The Transaction Oversight Groups and TSC are responsible for taking remedial actions for underperforming transactions as appropriate. The managers of the transaction oversight and transaction services functions report to the Chief Risk Management Officer. The Underwriting Committee of the Board of Directors receives quarterly reports describing the changes in the overall insured portfolio during the quarter and developments with respect to poorly performing transactions. The Transaction Oversight Groups review insured transactions to confirm compliance with transaction covenants, monitor credit and other developments affecting transaction participants and collateral, and together with TSC and the Risk Management Committee determine the steps, if any, required to protect the interests of FSA and the holders of FSA-insured obligations. In the normal course of business, the Company monitors its exposures in all insured categories. Due to recent events, additional focus has been placed on the RMBS and other asset-backed categories.
Reviews of transactions typically include an examination of reports provided by, and (as circumstances warrant) discussions or site visits with, issuers, obligors, originators, servicers, collateral managers, trustees and other transaction participants. Review of reports may include financial audits, servicer audits, evaluations by third-party appraisers, engineers, consultants or reports by other experts retained by the obligor or FSA. The Transaction Oversight Groups review transactions to determine the level of ongoing attention required. These judgments relate to current credit quality and other factors, including compliance with reporting or other requirements, legal or regulatory actions involving transaction participants or other concerns that may not have a direct bearing on credit quality. Transactions with the highest risk profile are generally subject to more intensive review and, if
27
appropriate, remedial action. The Transaction Oversight Groups and TSC work together with the Legal Department and Corporate Research in monitoring these transactions, negotiating restructurings and pursuing appropriate legal remedies.
The Company's Transaction Oversight Groups maintain and update internal credit ratings. They also assign each credit to one of five designated surveillance categories to facilitate appropriate allocation of resources to loss mitigation efforts and to efficiently communicate the relative credit condition of each risk exposure, as well as the overall health of the insured portfolio. Such categorization is determined in part by the risk of loss and in part by the level of routine involvement required and monitoring cycle deemed appropriate. The surveillance categories are organized as follows:
The table below presents the gross and net par outstanding and the gross and net reserves for risks classified as described above:
Par Outstanding
|
December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Gross | Net | Gross | Net | ||||||||||
|
(in millions)
|
|||||||||||||
Categories I and II |
$ | 502,297 | $ | 386,964 | $ | 527,931 | $ | 395,470 | ||||||
Category III |
14,452 | 10,725 | 8,467 | 5,053 | ||||||||||
Category IV |
1,260 | 1,181 | 3,976 | 3,297 | ||||||||||
Category V no claim payments |
6,439 | 5,627 | 2,654 | 1,737 | ||||||||||
Category V with claim payments |
5,163 | 4,033 | 1,163 | 900 | ||||||||||
Total |
$ | 529,611 | $ | 408,530 | $ | 544,191 | $ | 406,457 | ||||||
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Case Reserves
|
December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Gross | Net | Gross | Net | ||||||||||
|
(in millions)
|
|||||||||||||
Category V no claim payments |
$ | 818.5 | $ | 708.0 | $ | 112.6 | $ | 64.4 | ||||||
Category V with claim payments |
787.9 | 614.4 | 62.0 | 33.7 | ||||||||||
Total |
$ | 1,606.4 | $ | 1,322.4 | $ | 174.6 | $ | 98.1 | ||||||
Activity in the liability for losses and loss adjustment expense reserve, which consists of case and non-specific reserves, is summarized as follows:
Reconciliation of Net Loss and Loss Adjustment Expense Reserves
|
Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||
|
(in millions)
|
|||||||||||
Case Reserve Activity: |
||||||||||||
Gross balance at January 1 |
$ | 174.6 | $ | 90.3 | $ | 90.0 | ||||||
Less reinsurance recoverable |
76.5 | 37.3 | 36.3 | |||||||||
Net balance at January 1 |
98.1 | 53.0 | 53.7 | |||||||||
Transfer from non-specific reserve |
1,823.2 | 69.4 | 1.2 | |||||||||
Paid (net of recoveries) related to: |
||||||||||||
Current year recovery (paid) |
16.7 | (8.3 | ) | | ||||||||
Prior year |
(615.6 | ) | (16.0 | ) | (1.9 | ) | ||||||
Total paid |
(598.9 | ) | (24.3 | ) | (1.9 | ) | ||||||
Net balance at December 31 |
1,322.4 | 98.1 | 53.0 | |||||||||
Plus reinsurance recoverable |
284.0 | 76.5 | 37.3 | |||||||||
Gross balance at December 31 |
1,606.4 | 174.6 | 90.3 | |||||||||
Non-specific Reserve Activity: |
||||||||||||
Balance at January 1 |
100.0 | 137.8 | 115.7 | |||||||||
Provision for losses |
||||||||||||
Current year |
1.3 | 25.8 | 17.8 | |||||||||
Prior year |
1,876.4 | 5.8 | 5.5 | |||||||||
Transfers to case reserves |
(1,823.2 | ) | (69.4 | ) | (1.2 | ) | ||||||
Net balance at December 31 |
154.5 | 100.0 | 137.8 | |||||||||
Plus reinsurance recoverable |
18.1 | | | |||||||||
Gross balance at December 31 |
172.6 | 100.0 | 137.8 | |||||||||
Total gross case and non-specific reserves |
$ | 1,779.0 | $ | 274.6 | $ | 228.1 | ||||||
Financial Products Business
The FP Business Underwriting and Investment Process
The Company's FP business is in the process of being transferred to Dexia. No new GICs have been issued since November 2008 and no further GIC issuance is currently contemplated.
29
FP's underwriting guidelines govern FSAM's investment of funds raised from the issuance of GICs. FSAM only invests in securities that are investment-grade at the time of purchase. The Company's objective is to manage its GIC investment portfolio to maintain sufficient liquidity to address expected and unexpected GIC withdrawals and to maintain sufficient eligible collateral to support collateralized GICs.
Final transaction approval for an investment by FSAM or its UK subsidiary FSA-PAL depends on the investment sector, credit rating, amount and other factors. Pending legal transfer of the FP business to Dexia, FSAM and FSA-PAL invest GIC proceeds in accordance with the FP underwriting guidelines, subject to oversight by a transition officer designated by Dexia and the Transaction Management Committee established by the Company's Board of Directors. The FP underwriting guidelines require that the head of the FP group and an FP group risk manager approve all investments and specify whether approvals from FSA's Chief Executive Officer, President, Chief Risk Management Officer and/or other officers are also required.
Prior to withdrawing from the FP business, final transaction approval for GICs depended on the type and size of the GICs, along with other criteria. FP's underwriting guidelines required that the head of the FP group and an FP group risk manager approve all GICs and specified whether approval from FSA's Chief Executive Officer, President, Chief Risk Management Officer and/or other officers was also required.
Financial Products Risk Management
FP Risk Management is divided into FP Market Risk Management and FP Credit Risk Management. Together they are responsible for monitoring the ongoing asset performance of the FP Investment Portfolio, including the underlying exposure to non-agency RMBS, as well as the performance of the portfolio of outstanding GICs. FP Market Risk Management and FP Credit Risk Management are independent of the FP business originations process and report to the Chief Risk Management Officer. The Underwriting Committee of the Board of Directors receives quarterly reports describing the market, credit and liquidity risks in the GIC portfolio and FP Investment Portfolio as well as material changes that may have occurred during the quarter.
In monitoring the FP Investment Portfolio, FP Risk Management utilizes both proprietary and third-party models and analytics, focusing on the underlying collateral of the ABS and the cash flows generated by the collateral to determine whether a security's performance is consistent with its credit rating. FP Risk Management evaluates the liquidity adequacy of the portfolio to ensure that even under various stress conditions, such as a decrease in current expected prepayment rates that would result in a lengthened weighted average life of the investments, the portfolio would still have adequate liquidity to pay the debt service on its funding obligations as they become due, and also evaluates interest rate and currency risks in the portfolio to assess market risk.
FP Risk Management monitors the portfolio of outstanding GICs and the interest rate, currency, and liquidity risks in the portfolio to assess market risk as well as liquidity risks arising from unexpected or early withdrawals. FP Credit Risk Management assesses the performance of individual GIC positions to determine the level of ongoing surveillance needed. These valuations relate to the credit quality of the transactions underlying each GIC as well as other factors and utilize both proprietary and third-party models and analytics.
With respect to transactions governed by ISDA master agreements, FP Risk Management monitors net counterparty credit exposure and, when the exposure exceeds an agreed to limit, demands collateral from the counterparty in accordance with the relevant master agreement.
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Corporate Research
FSA's Corporate Research Department is composed of a professional staff under the direction of the Chief Risk Management Officer. The Corporate Research Department is responsible for evaluating the credit quality of entities participating in or providing recourse on obligations insured by FSA. It also provides analysis of industry segments. Members of the Corporate Research Department generally report their findings directly to the appropriate underwriting committee in the context of transaction review and approval, and to the Risk Management Committee as part of its periodic portfolio reviews.
Legal
The Company's Legal Department is composed of a professional staff of attorneys and legal assistants under the direction of the General Counsel. The Company's Legal Department is divided into five sectors: municipal transactions, asset-backed transactions, financial products, regulatory/reinsurance/corporate and compliance. The Legal Department plays a major role in establishing and implementing legal requirements and procedures applicable to obligations insured by the Company. Members of the Legal Department serve on the MRC and MUNC, which provide final underwriting approval for transactions. An attorney in the Legal Department works together with his or her counterpart in the relevant financial guaranty group in determining the legal and credit elements of each obligation proposed for insurance and in overseeing the execution of approved transactions and, where applicable, loss mitigation efforts. Public finance obligations insured by the Company are ordinarily executed without employment of outside counsel. The financial products attorneys in the Legal Department work together with their counterparts in the FP group in developing and overseeing the execution of approved financial products transactions. The Legal Department works closely with the Transaction Oversight Groups and TSC in addressing legal issues, rights and remedies, as well as proposed amendments, waivers and consents, in connection with obligations insured by the Company. The Legal Department is also responsible for domestic and international regulatory compliance, reinsurance, secondary market transactions, litigation and other matters.
Finance
The Company's Finance Department is composed of a professional staff of accountants and financial analysts under the direction of the Chief Financial Officer. The Company's Finance Department is divided into two principal sections: Accounting and Treasury. Accounting plays the primary role in establishing and complying with accounting policies and procedures consistent with each of the various accounting standards under which the Company and its subsidiaries prepare its financial statements, including GAAP, international financial reporting standards ("IFRS") and various statutory methods prescribed for its domestic insurance operations and non-U.S. subsidiaries and branches. Treasury plays the primary role in developing and monitoring the operating and capital plans. This department is also responsible for optimizing the Company's capital structure, monitoring the capital and liquidity resources and periodically evaluating returns on deployed capital. The Finance Department works closely with all areas of the Company to ensure that all transactions are well understood, processed in an appropriate and controlled manner, and accounted for properly. This department is also responsible for ensuring that the Company maintains adequate internal control systems over financial reporting and periodically meets to review and discuss financial filings prior to their submission with the Securities and Exchange Commission ("SEC"). The Controller is the head of the Accounting Department and regularly attends meetings of the Audit Committee of the Board of Directors. The Treasurer is the leader of the Treasury Department and regularly attends meetings of the Investment Committee of the Board of Directors.
31
Management Information Systems
The Company's Management Information Systems ("MIS") Department is composed of a professional staff of technical architects, programmers, analysts and administrators under the direction of the Chief Technology Officer. The Company's MIS Department is divided into two principal sections: Operations and Development. Operations is responsible for the operations and monitoring of the Company's hardware, software and network systems. Development is responsible for developing and maintaining the firm's proprietary applications. The Chief Technology Officer reports directly to the Company's President. The MIS Department develops implementation procedures and standards, enforcement mechanisms, and user guidance for the Company's electronic information systems and networks. In its implementation and enforcement of electronic information policies, the MIS Department deploys technology to control the use of the Company's information and communication systems, and to log or monitor the use of the Company's computers, networks or other electronic systems by employees, contractors, or remote users.
Competition and Industry Concentration
Beginning in the second half of 2007, the credit markets commenced a period of significant dislocation that has not abated. At the same time, severe rating downgrades of most financial guaranty insurers have reduced the number of providers of financial guaranty insurance while calling into question the durability of financial guaranties in general. FSA and Assured Guaranty Corp. ("Assured Guaranty") are the principal active participants in the financial guaranty marketplace, with the Company operating at a competitive disadvantage due to its lower ratings and uncertain outlook.
FSA faces competition from both other providers of and alternatives to third-party credit enhancement. Most securities are sold without third-party credit enhancement. Accordingly, each transaction FSA proposes to insure must generally compete against an alternative execution that does not employ third-party credit enhancement. Many financings may be funded by banks through loans or in the capital markets through the sale of securities. Both types of fundings may be executed with or without insurance. Beginning in the second half of 2008, the appetite for insured securities declined dramatically with, in some cases, insured securities trading at a discount to uninsured securities of the same issuer. FSA seeks to restore investor confidence in its credit quality and stability with a view towards increasing investor appetite for FSA-insured securities.
Most of the Company's competitors in the financial guaranty industry announced sharp increases in projected losses on insured transactions commencing in late 2007, and subsequently were downgraded by the major securities rating agencies. At February 20, 2009, Assured Guaranty was rated Triple-A by S&P and Fitch and Aa2 by Moody's, while the Company's other historical competitors had suffered severe ratings downgrades, in most cases to non-investment grade levels, resulting in substantial or complete withdrawal from the marketplace. These downgraded insurers include Ambac Assurance Corp. ("Ambac"), CIFG Guaranty, Financial Guaranty Insurance Company ("FGIC"), MBIA Insurance Corp. ("MBIA"), Syncora Guarantee Inc. ("SGI") (formerly XL Capital Assurance) and Radian Asset Assurance Inc. Likewise, most derivative product companies and credit default swap providers that previously competed with financial guaranty insurers have generally suffered rating downgrades and/or ceased conducting new business.
In the fourth quarter of 2007, Berkshire Hathaway Assurance Company ("BHAC") commenced operations as a financial guaranty insurer. Given BHAC's affiliation with Triple-A rated Berkshire Hathaway Company, BHAC has the potential to be a significant competitor to the Company in the public finance sector but has to date insured transactions only on an opportunistic basis. Another new monoline competitor, Municipal and Infrastructure Assurance Corporation ("MIAC"), commenced operations in October 2008, intending to focus on municipal and infrastructure finance. National Public Finance Guaranty Corp. ("NPFG"), an affiliate of MBIA, commenced operations in February 2009,
32
intending to focus on municipal finance. In addition, Ambac has announced an intention to establish an affiliate, Everspan Financial Guaranty Corp., that will engage in municipal financial guaranty insurance. There are proposals for Congress to establish a federally chartered bond insurer, and for states and pension funds to establish bond insurers, in each case to address the public sector demand for bond insurance. Any such Federal, state or pension fund sponsored bond insurer would likely prove to be a significant competitor to the Company.
Concerns regarding the capital adequacy of financial guarantors have drawn attention not only from rating agencies but also state regulators, the federal government and financial institutions concerned about their own exposure to monolines. In 2008, the Superintendent of Insurance of the State of New York (the "New York Superintendent") stated his intention to propose new regulations or amendments to Article 69 ("Article 69"), a comprehensive financial guaranty insurance statute, of the insurance laws of the State of New York (the "New York Insurance Law") for financial guaranty insurers, potentially including limitations or prohibitions on insuring CDS and certain structured finance obligations, such as CDOs of ABS, or separating the municipal insurance business from the non-municipal insurance business. In September 2008, the New York Insurance Department issued a circular letter, effective January 1, 2009, that prescribes best practices for financial guaranty issuers that narrow the permitted scope of insurance of asset-backed securities, a business no longer pursued by the Company. There also have been proposals for a federal office to oversee bond insurers.
The long-term impact of recent developments on the Company's competitive position remains uncertain. At this stage, management cannot predict the impact of the financial crisis on the Company's future, or the competitive, regulatory and rating agency environments that will emerge.
Parties seeking to establish a new financial guaranty insurer that may compete with the Company face entry requirements that generally include:
Some entrants into the industry, such as BHAC, may be able to call on other options such as parent contingent guarantees to avoid or minimize some of these requirements, with regulators waiving requirements formerly applicable to monoline financial guaranty insurers and otherwise expediting the licensing process. In addition, government sponsored entities competing in this sector may operate under rules of conduct yet to be established.
Reinsurance is the commitment by one insurance company, the "reinsurer," to reimburse another insurance company, the "ceding company," for a specified portion of the insurance risks underwritten by the ceding company in consideration for a portion of the premiums received. The ceding company typically but not always receives a ceding commission to cover the cost of business generation. Because the insured party contracts for coverage solely with the ceding company, the failure of the reinsurer to perform does not relieve the ceding company of its obligation to the insured party under the terms of the insurance contract.
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At December 31, 2008, FSA reinsured approximately 23% of its principal amount outstanding. FSA's on-going use of reinsurance going forward remains uncertain due to a number of factors, including diminished reinsurance capacity from highly rated providers and concerns regarding the correlation of reinsurer credit-worthiness in an economic downturn.
FSA historically obtained reinsurance to increase its policy writing capacity, both on an aggregate-risk and a single-risk basis, to:
FSA's reinsurance may be on a quota share, first-loss, or excess-of-loss basis. Quota share reinsurance generally provides protection against a fixed specified percentage of all losses incurred by FSA. First-loss reinsurance generally provides protection against a fixed specified percentage of losses incurred up to a specified limit. Excess-of-loss reinsurance generally provides protection against a fixed percentage of losses incurred to the extent that losses incurred exceed a specified limit. Reinsurance arrangements typically require FSA to retain a minimum portion of the risks reinsured.
FSA arranges reinsurance on both a facultative (transaction-by-transaction) and treaty basis. By annual treaty, FSA employs "automatic facultative" reinsurance that permits FSA to apply reinsurance to transactions it selects subject to certain limitations. The remainder of FSA's treaty reinsurance provides coverage for a portion, subject in certain cases to adjustment at FSA's election, of the exposure from all qualifying policies issued during the term of the treaty. The reinsurer's participation in a treaty is either cancellable annually upon 90 days' prior notice by either FSA or the reinsurer or has a one-year term. Treaties generally provide coverage for the full term of the policies reinsured during the annual treaty period, except that, upon a financial deterioration of the reinsurer or the occurrence of certain other events, FSA generally has the right to reassume all or a portion of the business reinsured. Reinsurance agreements may be subject to other termination conditions as required by applicable state law. FSA monitors the financial condition of its reinsurers.
Primary insurers, such as FSA, are required to fulfill their obligations to policyholders even if reinsurers fail to meet their obligations. The financial condition of reinsurers is important to FSA, and FSA endeavors to place its reinsurance with financially strong reinsurers. FSA's treaty reinsurers at December 31, 2008 were Assured Guaranty Re Ltd.; Mitsui Sumitomo Insurance Company, Limited; RAM Reinsurance Co. Ltd.; and Tokio Marine. At March 1, 2009, FSA had not entered into any new reinsurance treaties or renewed existing treaties that would cover new business written in 2009.
FSA had reciprocal surplus share reinsurance treaties with Ambac and FGIC that provided quota share reinsurance on transactions exceeding specified par amounts insured. These reciprocal treaties expired on December 31, 2007 and June 30, 2007, respectively, and were not renewed. In September 2008, FSA commuted substantially all its ceded and assumed business with FGIC. In July 2008, FSA agreed to re-assume all reinsurance ceded to SGR. FSA agreed to cede a portion of this business to SGI, an affiliate of SGR, as of the re-assumption date. Ceded net unearned premiums and future ceded case reserves are secured by collateral held in a trust. In September, November and December 2008, FSA re-assumed portions of the business it ceded to SGI. Due to a liquidation order against Bluepoint RE, Limited ("Bluepoint"), FSA is treating all reinsurance ceded to Bluepoint as cancelled as of the date of the liquidation order.
Securities rating agencies allow FSA "credit" for reinsurance based on the reinsurer's ratings. Generally, 95-100% credit is allowed for Triple-A reinsurance, 65-90% credit is allowed for Double-A reinsurance, and 40-60% credit is allowed for Single-A reinsurance. In addition, a number of FSA's
34
reinsurers are required to pledge collateral to secure their reinsurance obligations to FSA. In some cases, the pledged collateral augments the rating agency credit for the reinsurance provided to FSA. Given the financial strength of its reinsurers, FSA requires collateral from reinsurers primarily to (a) receive statutory credit for the reinsurance, (b) provide liquidity to FSA in the event of claims on the reinsured exposures, and (c) enhance rating agency credit for the reinsurance.
In recent years, most of FSA's reinsurers have been downgraded by one or more rating agency. While ceding commissions or premium allocation adjustments may compensate in part for such downgrades, the effect of such downgrades, in general, is to decrease the financial benefits of using reinsurance under rating agency capital adequacy models.
Credit developments with respect to subprime residential mortgage-backed securities and CDOs of ABS adversely affected a number of the Company's reinsurers in 2008, but FSA's two principal reinsurers, Assured Guaranty Re Ltd. and Tokio Marine, have stable Double-A ratings. In the event of a downgrade by Moody's, S&P or, in some cases, Fitch of a reinsurer's rating, FSA generally has the option to re-assume all business ceded to the downgraded reinsurer on a treaty-by-treaty basis, and in some cases it has the option to re-assume all business that does not exceed internal, regulatory or rating agency single risk limits.
FSA, FSAIC and FSA International are party to a quota share reinsurance pooling agreement pursuant to which, after reinsurance cessions to other reinsurers, the FSA companies share in the net retained risk insured by each of these companies or reinsured by FSA from FSA UK. Under the pooling agreement, FSA, FSAIC and FSA International share the net retained risk in proportion to their policyholders' surplus and contingency reserves, or "statutory capital," at the end of the prior calendar quarter.
FSA UK and FSA are party to a quota share and stop loss reinsurance agreement pursuant to which:
Under this agreement, FSA UK ceded to FSA approximately 95% of its retention after third-party reinsurance of its policies issued in 2008.
In 2004, the New York Insurance Law was amended to allow financial guaranty insurers such as FSA to treat qualifying CDS from highly rated financial institutions as collateral for purposes of satisfying risk limits and certain reserve requirements. These amendments allow financial guaranty insurers to employ CDS as collateral for statutory accounting purposes, with the collateral having effects similar to reinsurance in reducing single and aggregate risks for statutory purposes.
Obligations insured by the Company are generally awarded ratings on the basis of the financial strength ratings given to the Company's insurance company subsidiaries by the major securities rating agencies. Accordingly, the Company's ability to originate new insurance business and compete with other financial guarantors and credit enhancers is based upon the perceived financial strength of FSA's insurance, which in turn is based in large part upon the financial strength ratings assigned to FSA and the Company's other insurance company subsidiaries by the major securities rating agencies. Prior to the third quarter of 2008, the insurance company subsidiaries, as well as the obligations they insured,
35
had historically been awarded Triple-A ratings by the three major securities rating agencies. During the third quarter of 2008, the rating agencies took various ratings actions regarding the Company:
Such ratings reflect only the views of the respective rating agencies, are not recommendations to buy, sell or hold securities and are subject to revision or withdrawal at any time by such rating agencies.
The ratings agencies stated that their actions regarding FSA were based in part upon rating agency concerns regarding the prospects for new business originations by financial guarantors, as well as uncertainty about future support for FSA under Dexia's new ownership and management and uncertainty regarding future RMBS loss.
The rating agencies periodically review FSA's business and financial condition, focusing on the insurer's underwriting policies and procedures and the quality of the obligations insured, and publish their ratings and supporting analyses. Each rating agency performs periodic assessments of the credits insured by FSA, as well as the reinsurers and other providers of capital support to FSA, to confirm that FSA continues to satisfy such rating agency's capital adequacy criteria necessary to maintain FSA's ratings. FSA's ability to compete with other financial guarantors, and its results of operations and financial condition, would be materially adversely affected by any reduction in its ratings.
Moody's, S&P and Fitch apply their own capital adequacy models in assessing the financial strength of FSA. Financial factors considered by the rating agencies in assessing capital adequacy include:
Given the importance of its ratings to its on-going business, FSA's underwriting process generally includes an analysis of the impact on rating agency capital adequacy determinations in addition to other measures of creditworthiness. Reference is made to the published reports of Moody's, S&P and Fitch regarding the Company, capital adequacy models, the bond insurance business in general and FSA's standing relative to other industry participants on the basis of capital adequacy and profitability.
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General
FSA is licensed to engage in insurance business in all 50 states, the District of Columbia, Guam, Puerto Rico and the U.S. Virgin Islands. FSA is subject to the New York Insurance Law and is also subject to the insurance laws of the other states in which it is licensed to transact insurance business. FSAIC is an Oklahoma-domiciled insurance company also licensed in New York and subject to the New York Insurance Law. FSA and its domestic insurance company subsidiary are required to file quarterly and annual statutory financial statements in each jurisdiction in which they are licensed, and are subject to statutory restrictions concerning the types and quality of investments and the filing and use of policy forms and premium rates. FSA's accounts and operations are subject to periodic examination by the New York Superintendent and other state insurance regulatory authorities. During 2008 the New York Superintendent began its review for the five-year period ended December 31, 2007, which period may be extended through December 31, 2008. The last completed examination was conducted in 2004 for the three-year period ended December 31, 2002.
FSA International is a Bermuda-domiciled insurance company subject to applicable requirements of Bermuda law. FSA International maintains its principal executive offices in Hamilton, Bermuda. FSA International does not intend to transact business or establish a permanent place of business in the United States or Europe.
FSA UK is a United Kingdom domiciled insurance company subject to applicable requirements of English law. FSA UK maintains its principal executive offices in London, England. Pursuant to European Union Directives, FSA UK is generally authorized to write business out of its London office in other member countries of the European Union, subject to the satisfaction of perfunctory registration requirements.
FSA has a Tokyo branch authorized to transact insurance business in Japan and subject to regulation by Japanese authorities. FSA Mexico has a license to transact financial guaranty insurance in Mexico and is subject to regulation by the Mexican authorities.
Domestic Insurance Holding Company Laws
The Company and its domestic insurance company subsidiaries (FSA and FSAIC) are subject to regulation under insurance holding company statutes of their jurisdiction of domicile (New York and Oklahoma, respectively), as well as other jurisdictions where these insurers are licensed to do insurance business. The requirements of holding company statutes vary from jurisdiction to jurisdiction but generally require insurance holding companies and their insurance company subsidiaries to register and file certain reports describing, among other information, their capital structure, ownership and financial condition. The holding company statutes also require prior approval of changes in control, certain dividends and other intercorporate transfers of assets and transactions between insurance companies and their affiliates. The holding company statutes generally require that all transactions with affiliates be fair and reasonable and that those exceeding specified limits require prior notice to or approval by insurance regulators.
Under the insurance holding company laws in effect in New York and Oklahoma, any acquisition of control of the Company, and thereby indirect control of FSA and FSAIC, requires the prior approval of the New York Superintendent and the Oklahoma Insurance Commissioner. "Control" is defined as the direct or indirect power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract or otherwise. Any purchaser of 10% or more of the outstanding voting securities of a corporation is presumed to have acquired control of that corporation and its subsidiaries, although the insurance regulator may find that
37
"control" in fact does or does not exist when a person owns or controls either a lesser or greater amount of voting securities.
New York Financial Guaranty Insurance Law
Article 69 of the New York Insurance Law, a comprehensive financial guaranty insurance statute, governs all financial guaranty insurers licensed to do business in New York, including FSA. This statute limits the business of financial guaranty insurers to financial guaranty insurance and related lines (such as surety).
Article 69 requires that financial guaranty insurers maintain a special statutory accounting reserve called the "contingency reserve" to protect policyholders against the impact of excessive losses occurring during adverse economic cycles. Article 69 requires a financial guaranty insurer to provide a contingency reserve:
This reserve must be maintained for the periods specified above, except that reductions by the insurer may be permitted under specified circumstances in the event that actual loss experience exceeds certain thresholds or if the reserve accumulated is deemed excessive in relation to the insurer's outstanding insured obligations. FSA has in the past sought and obtained releases of excessive contingency reserves from the New York Insurance Department. Financial guaranty insurers are also required to maintain reserves for losses and loss adjustment expenses on a case-by-case basis and reserves against unearned premiums.
For purposes of Article 69, "municipal bonds" includes qualifying project finance transactions, sovereign issuances and securitizations of government-supported receivables.
Article 69 establishes single risk limits for financial guaranty insurers applicable to all obligations issued by a single entity and backed by a single revenue source. For example, under the limit applicable to qualifying asset-backed securities, the lesser of:
Under the limit applicable to municipal obligations, the insured average annual debt service for a single risk, net of qualifying reinsurance and collateral, may not exceed 10% of the sum of the insurer's policyholders' surplus and contingency reserves. In addition, insured principal of municipal obligations attributable to any single risk, net of qualifying reinsurance and collateral, is limited to 75% of the insurer's policyholders' surplus and contingency reserves. Single-risk limits are also specified for other categories of insured obligations, and generally are more restrictive than those listed for asset-backed or municipal obligations. Obligations not qualifying for an enhanced single-risk limit are generally subject to the "corporate" limit (applicable to insurance of unsecured corporate obligations) equal to
38
10% of the sum of the insurer's policyholders' surplus and contingency reserves. For example, "triple-X" and "future flow" securitizations, as well as unsecured investor-owned utility obligations, are generally subject to these "corporate" single-risk limits.
Article 69 also establishes aggregate risk limits on the basis of aggregate net liability insured as compared with statutory capital. "Aggregate net liability" is defined as outstanding principal and interest of guaranteed obligations insured, net of qualifying reinsurance and collateral. Under these limits, policyholders' surplus and contingency reserves must not be less than a percentage of aggregate net liability equal to the sum of various percentages of aggregate net liability for various categories of specified obligations. The percentage varies from 0.33% for certain municipal obligations to 4% for certain non-investment-grade obligations. The New York Superintendent has broad discretion to order a financial guaranty insurer to cease new business originations if the insurer fails to comply with single or aggregate risk limits. In practice, the New York Superintendent has shown a willingness to work with insurers, including FSA, to address these concerns.
Adverse developments surrounding the Company's industry peers have led state insurance regulators and federal regulators to question the adequacy of the current regulatory scheme governing financial guaranty insurers. In 2008, the New York Superintendent stated his intention to propose new regulations or amendments to Article 69 for financial guaranty insurers, potentially including limitations or prohibitions on insuring CDS and certain structured finance obligations, such as CDOs of ABS, or separating the municipal insurance business from the non-municipal insurance business. In September 2008, the New York Insurance Department issued a circular letter, effective January 1, 2009, that prescribes best practices for financial guaranty issuers that narrow the permitted scope of insurance of asset-backed securities, a business no longer pursued by the Company. There also have been proposals for a federal office to oversee bond insurers.
Dividend Restrictions
FSA's ability to pay dividends is dependent on FSA's financial condition, results of operations, cash requirements, rating agency confirmation of non-impairment of FSA's ratings and other related factors, and is also subject to restrictions contained in the New York Insurance Law. Under New York Insurance Law, FSA may pay dividends out of statutory earned surplus, provided that, together with all dividends declared or distributed by FSA during the preceding 12 months, the dividends do not exceed the lesser of:
Based on FSA's statutory statements for 2008, the maximum amount available for payment of dividends by FSA without regulatory approval over the 12 months following December 31, 2008 is approximately $62.0 million, subject to certain limitations.
Financial Guaranty Insurance Regulation in Other Jurisdictions
FSA is subject to laws and regulations of jurisdictions other than the State of New York concerning the transaction of financial guaranty insurance. The laws and regulations of these other jurisdictions are generally not more stringent in any material respect than the New York Insurance Law.
The Bermuda Ministry of Finance regulates FSA International. The United Kingdom Financial Services Authority regulates FSA UK. Pursuant to European Union Directives, FSA UK has been authorized to provide financial guaranty insurance for transactions in numerous European countries from its home office in the United Kingdom. FSA has received a determination from the Australian Insurance and Superannuation Commissioner that the financial guarantees issued by FSA with respect
39
to Australian transactions do not constitute insurance for which a license is required. The Japan Financial Services Authority regulates the activities of FSA's Tokyo branch. The Ministry of Finance and the Mexican National Commission of Insurance and Finance regulate the activities of FSA Mexico.
Dexia indirectly owns 99.9% of the Company's common stock. Because Dexia has a non-U.S. bank subsidiary with a branch in the U.S., Dexia and all of its subsidiaries, including the Company and its subsidiaries, are subject to the U.S. Bank Holding Company Act (the "BHC Act"). In general, the BHC Act restricts the activities of banking organizations and their affiliates to the ownership and operation of banks and to other activities that are "closely related to banking" as determined by the Board of Governors of the Federal Reserve System. Insurance activities such as those conducted by certain of the Company's subsidiaries are generally not permissible under this restriction. Under the BHC Act, however, an organization that qualifies as a "financial holding company" is permitted to engage in a broader range of permissible "financial activities." "Financial activities" include insurance underwriting and agency activities as well as merchant banking. For Dexia to qualify as a "financial holding company," it and its non-U.S. bank subsidiary with a branch in the U.S. must be both:
Dexia holds its investment in, and operates, the Company and its subsidiaries under the "financial activities" authorization permitted to "financial holding companies." If Dexia does not continue to meet the requirements for qualifying as a "financial holding company," it may lose its ability to hold its investment in, or operate, the Company and its subsidiaries.
The Company segregates its investments into various portfolios:
The Company is exposed to various risks in its investment portfolios, including credit, liquidity, currency exchange rate and interest rate risks.
At December 31, 2008, the Company also had investments in strategic partners, including TheDebtCenter, L.L.C., which operates TheMuniCenter, L.L.C., an online exchange for municipal bonds. During the third quarter of 2008, the Company sold its investment in SGR.
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Investments Insured by the Company
Both the General Investment Portfolio and the FP Investment Portfolio include fixed-income investments insured by FSA ("FSA-Insured Investments") acquired in the ordinary course of business. At December 31, 2008, based on amortized cost, the General Investment Portfolio included $398.7 million of FSA-Insured Investments, representing approximately 6.6% of the portfolio, and the FP Investment Portfolio included $410.9 million of FSA-Insured Investments, representing approximately 4.5% of the available-for-sale portfolio. These assets are included in the Company's surveillance process and at December 31, 2008 no loss reserves were anticipated on any of these assets.
The Company records these investments as available-for-sale securities and carries them at fair value, which, so long as the investments are acquired in the ordinary course of business, includes the effect of the embedded FSA guaranty. The Company's accounting treatment of the FSA-Insured Investments is based on Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115") which requires that investment securities be carried at fair value, applying quoted prices where available. Quoted prices reflect the value of the embedded FSA insurance policy and related rating. For a discussion of the Company's fair value measurements, see Note 3 to the consolidated financial statements in Item 8.
General Investment Portfolio
Management's primary objective in managing the General Investment Portfolio is to generate an optimal level of after-tax investment income while preserving capital and maintaining adequate liquidity, subject to rating agency capital adequacy criteria that reduce credit for investments based on their ratings to the extent rated less than Triple-A. The General Investment Portfolio is managed by unaffiliated professional investment managers and the Company's affiliate FSA Portfolio Management, which manages the majority of the Company's municipal portfolio. The investment management function is overseen by the Investment Committee of the Company's Board of Directors. The Company's investment in SGR preferred stock was included in the General Investment Portfolio prior to its sale in the third quarter of 2008.
To accomplish its objectives, the Company has established guidelines for eligible fixed-income investments by FSA, requiring that at least 95% of such investments be rated at least Single-A at acquisition and the overall portfolio be rated Double-A on average. Fixed-income investments falling below the minimum quality level are disposed of at such time as management deems appropriate. For liquidity purposes, the Company's policy is to invest primarily in readily marketable investments with no legal or contractual restrictions on resale. Eligible fixed- income investments include U.S. Treasury and agency obligations, corporate bonds, tax-exempt bonds, asset-backed securities and mortgage-backed securities. In applying its investment guidelines, the Company uses the published rating for FSA-Insured Investments, rather than the rating that such securities would have without giving effect to the FSA guaranty, referred to as the "shadow rating." The Company's current investment strategy is to invest in high quality, readily marketable instruments of intermediate average duration so as to generate stable investment earnings with minimal market value or credit risk.
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The following table summarizes the Company's General Investment Portfolio by security type:
General Investment Portfolio by Security Type
|
December 31, | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||||||||
Investment
Category |
Amortized
Cost |
Weighted
Average Yield(1) |
Fair
Value |
Amortized
Cost |
Weighted
Average Yield(1) |
Fair
Value |
||||||||||||||
|
(dollars in millions)
|
|||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 103.7 | 3.33 | % | $ | 112.8 | $ | 97.3 | 4.53 | % | $ | 101.4 | ||||||||
Obligations of U.S. states and political subdivisions |
4,321.1 | 4.84 | 4,239.8 | 3,920.5 | 4.84 | 4,064.6 | ||||||||||||||
Mortgage-backed securities |
408.1 | 5.62 | 412.3 | 404.3 | 5.64 | 407.8 | ||||||||||||||
Corporate securities |
206.2 | 4.89 | 210.4 | 198.4 | 5.24 | 201.2 | ||||||||||||||
Foreign securities |
333.6 | 3.81 | 283.7 | 248.0 | 5.00 | 256.3 | ||||||||||||||
Asset-backed securities |
26.1 | 5.15 | 24.2 | 23.1 | 5.07 | 23.3 | ||||||||||||||
Total bonds |
5,398.8 | 4.81 | 5,283.2 | 4,891.6 | 4.93 | 5,054.6 | ||||||||||||||
Short-term investments |
651.1 | 0.38 | 651.9 | 96.3 | 4.18 | 97.4 | ||||||||||||||
Total fixed-income securities |
6,049.9 | 4.33 | 5,935.1 | 4,987.9 | 4.91 | 5,152.0 | ||||||||||||||
Equity securities |
1.4 | 0.4 | 40.0 | 39.9 | ||||||||||||||||
Total General Investment Portfolio |
$ | 6,051.3 | $ | 5,935.5 | $ | 5,027.9 | $ | 5,191.9 | ||||||||||||
The Company's investments in mortgage-backed securities primarily consisted of pass-through certificates and collateralized mortgage obligations ("CMOs"), which are backed by mortgage loans guaranteed or insured by agencies of, or sponsored by, the federal government. The Company also held, at December 31, 2008, $23.0 million of Triple-A-rated CMOs which are not guaranteed by government agencies.
Mortgage-backed securities differ from traditional fixed-income bonds because they are subject to prepayments at par value without penalty when the underlying mortgage loans are prepaid at the borrower's option. Prepayment rates on mortgage-backed securities are influenced primarily by the general level of prevailing mortgage interest rates, with prepayments increasing when prevailing loan interest rates are lower than the rates on the underlying mortgage loans, and by the terms of the loans. When prepayments occur, the proceeds must be reinvested at then-current market rates, which may be below the yield on the prepaid securities.
For further information regarding the General Investment Portfolio, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital ResourcesSummary of Invested AssetsGeneral Investment Portfolio."
FP Investment Portfolio
The FP Investment Portfolio is broadly comprised of short-term investments, agency and non-agency RMBS, securities issued or guaranteed by U.S. government sponsored agencies, taxable municipal bonds, securities issued by utilities, infrastructure-related securities, CDOs of ABS, and other asset-backed securities. Non-agency RMBS comprise the majority of the FP Investment Portfolio and include securities backed by pools of the following types of mortgage loans: first-lien mortgage loans to
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subprime borrowers, Alt-A loans, Option ARMs, closed-end second lien mortgage, HELOCs and prime loans. The FP Investment Portfolio also includes NIM securitizations.
The Company carries debt securities designated as "available-for-sale" on its balance sheet at fair value in accordance with SFAS 115. The Company records unrealized gains and losses, net of deferred tax, as a component of accumulated other comprehensive income, unless determined to be other than temporary impairments ("OTTI"). For further information regarding the portfolio, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital ResourcesSummary of Invested AssetsFP Investment Portfolio." For a discussion of the management of the investment strategies and management of the FP Investment Portfolio, see "The Financial Products Business" and "Credit Underwriting Guidelines, Standards and ProceduresFinancial Products BusinessFinancial Products Credit Risk Management."
The following table summarizes the Company's available-for-sale FP Investment Portfolio by security type:
Available-for-Sale Securities in the FP Investment Portfolio by Security Type
|
December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
Investment Category
|
Amortized
Cost(1) |
Fair
Value |
Amortized
Cost |
Fair
Value |
||||||||||
|
(in millions)
|
|||||||||||||
Mortgage-backed securities: |
||||||||||||||
Non-agency U.S. RMBS |
$ | 5,212.0 | $ | 5,212.8 | $ | 13,016.0 | $ | 11,714.6 | ||||||
Agency RMBS(2) |
1,230.1 | 1,230.1 | 1,064.3 | 1,058.2 | ||||||||||
U.S. Municipal bonds |
333.7 | 333.7 | 556.2 | 555.4 | ||||||||||
Corporate |
357.5 | 360.3 | 521.7 | 519.2 | ||||||||||
Asset-backed and other securities: |
||||||||||||||
Collateralized bond obligations, CDO and CLO |
206.1 | 206.1 | 471.0 | 431.6 | ||||||||||
Other(3) |
1,411.0 | 1,417.0 | 1,585.9 | 1,517.5 | ||||||||||
Total available-for-sale bonds |
8,750.4 | 8,760.0 | 17,215.1 | 15,796.5 | ||||||||||
Short-term investments |
463.3 | 463.3 | 1,918.7 | 1,918.7 | ||||||||||
Total available-for-sale bonds and short-term investments |
$ | 9,213.7 | $ | 9,223.3 | $ | 19,133.8 | $ | 17,715.2 | ||||||
VIE Investment Portfolio
The Company's management believes that the assets held by the VIEs, including those that are eliminated in consolidation, are beyond the reach of the Company's creditors, even in bankruptcy or other receivership. All bonds in the VIE Investment Portfolio are insured by FSA.
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The following table summarizes available-for-sale bonds and short-term investments in the VIE Investment Portfolio by security type:
Available-for-Sale Securities in the
VIE Investment Portfolio by Security Type
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December 31, | |||||||||||||
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2008 | 2007 | ||||||||||||
Investment
Category |
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
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(in millions)
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Obligations of U.S. states and political subdivisions |
$ | 12.9 | $ | 12.9 | $ | 15.5 | $ | 16.2 | ||||||
Foreign securities |
9.3 | 9.5 | 9.2 | 9.6 | ||||||||||
Asset-backed securities |
900.9 | 900.9 | 1,094.7 | 1,113.8 | ||||||||||
Short-term investments |
8.2 | 8.2 | 8.6 | 8.6 | ||||||||||
Total available-for-sale bonds and short-term investments |
$ | 931.3 | $ | 931.5 | $ | 1,128.0 | $ | 1,148.2 | ||||||
At December 31, 2008, the Company had 380 employees worldwide. None of its employees are covered by collective bargaining agreements. The Company considers its employee relations to be satisfactory.
The Company makes available, free of charge through its website, http://www.fsa.com, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) and 15(d) of the Exchange Act as soon as reasonably practicable after the Company electronically files such materials with, or furnishes them to, the SEC.
The Company relies on the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. This safe harbor requires that the Company specify important factors that could cause actual results to differ materially from those contained in forward-looking statements made by or on behalf of the Company. Accordingly, forward-looking statements by the Company and its affiliates are qualified by reference to the following cautionary statements.
In its SEC filings, reports to shareholders, press releases and other written and oral communications, the Company from time to time makes forward-looking statements. Such forward-looking statements include, but are not limited to:
Words such as "believes," "anticipates," "expects," "intends" and "plans" and future and conditional verbs such as "will," "should," "would," "could" and "may" and similar expressions are
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intended to identify forward looking statements but are not the exclusive means of identifying such statements.
The Company cautions that a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in forward-looking statements made by the Company. These factors include:
The Company cautions that the foregoing list of important factors is not exhaustive. In any event, such forward-looking statements made by the Company speak only as of the date on which they are made, and the Company does not undertake any obligation to update or revise such statements as a result of new information, future events or otherwise.
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In this Annual Report, the Company has included statements that may constitute "forward-looking statements" within the meaning of the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Words such as "believes," "anticipates," "expects," "intends" and "plans" and future and conditional verbs such as "will," "should," "would," "could" and "may" and similar expressions are intended to identify forward looking statements but are not the exclusive means of identifying such statements. The Company cautions that a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in forward-looking statements made by the Company. Important factors that could cause its results to differ, possible materially, from those indicated in the forward-looking statements include, but are not limited to, those discussed under "Item 1. BusinessForward-Looking Statements" and the risks and uncertainties expressed below.
The Acquisition of the Company by Assured may fail to close.
In September 2008, Dexia announced the provision of capital support to Dexia by the governments of Belgium, France and Luxembourg, which was followed by changes in Dexia senior management. Following such developments, Dexia announced its intention to refocus on its basic business lines, and its decision to explore options to reduce its risk related to the Company. On November 14, 2008, Dexia announced that Dexia and Assured entered into the Purchase Agreement, under which Assured will acquire all of Dexia's shares of the Company, subject to the satisfaction of specified closing conditions, including receipt of regulatory and Assured shareholder approvals, confirmation from S&P, Moody's and Fitch that the Acquisition of the Company would not have a negative impact on the financial strength ratings of Assured's insurance company subsidiaries or the Company's insurance company subsidiaries, and segregation or separation of the FP business, such that the credit and liquidity risk of the FP business resides with Dexia. The Company cannot estimate whether or when such closing conditions will be satisfied, whether the Acquisition will be completed and, if completed, whether it will be structured as currently contemplated, or what the effects of such a change in control will be on the Company and its results of operations. If the Acquisition is not carried out, Dexia may explore other options with respect to the Company, including selling the Company or some of its operations to a third party or ceasing to write new business, which may have a material adverse effect on the Company.
Following the Acquisition, the Company's management and processes may change materially and the Company may cease to file separately with the SEC.
The Purchase Agreement provides a number of Post-Closing Parameters intended to maintain the creditworthiness of FSA for a period of time following Purchase Agreement closing. Following Purchase Agreement closing, the Company and FSA are expected to come under new management and be overseen by the Board of Directors of Assured. Subject to the constraints of the Purchase Agreement Post-Closing Parameters, Assured is expected to take actions to combine the operations of Assured and the Company and, in some cases, may combine legal entities or accomplish risk transfers through intercompany reinsurance arrangements. As a result of such actions, the Company and FSA are likely to increase credit and operational exposure to Assured. In addition, following Purchase Agreement closing, Assured may take action that would eliminate the separate SEC disclosure requirements applicable to the Company.
Downgrade of FSA's financial strength ratings could impair its ability to originate new business.
The Triple-A ratings of the Company's insurance company subsidiaries were placed on "review for downgrade" on July 21, 2008 by Moody's and on "negative credit watch" on October 8, 2008 by S&P, and on October 9, 2008 by Fitch. On November 21, 2008, Moody's downgraded the Company's insurance company subsidiaries to Aa3 (developing outlook). These recent ratings actions have had a
46
negative impact on the Company's market opportunities. FSA's ability to originate new insurance business and compete with other credit enhancers is based upon the perceived financial strength of FSA's insurance, which in turn is based in large part upon the financial strength ratings assigned to FSA by the major securities rating agencies. Credit ratings are an important component of a financial institutions' ability to compete in the financial guaranty market.
The rating agencies base their ratings upon a number of objective and subjective factors. Credit deterioration in FSA's insured portfolio or changes to rating agency capital adequacy requirements could impair FSA's ratings. The recent ratings actions regarding FSA were based in part upon rating agency concerns regarding the prospects for new business originations by financial guarantors, as well as uncertainty about future support for FSA under Dexia's new ownership and management. For a discussion of other factors that might impair FSA's ratings, see "Item 1. BusinessRating Agencies." To maintain its current ratings, the Company may be required to take measures to preserve or raise capital, including through, among other things, increased use of reinsurance, capital contributions or the issuance of debt securities. The Company cannot ensure that it will be able to take the measures necessary to maintain its ratings. Further downgrades of FSA's financial strength ratings could have a material adverse effect on its long-term prospects for future business opportunities as well as its results of operations and financial condition.
The Company's FP business relies upon Dexia for material liquidity and credit support.
As a result of recent capital market developments, the Company's FP business has faced unanticipated GIC withdrawals at a time when issuance of new GICs has been curtailed. The Company expects to fund a material portion of GIC withdrawals by employing liquidity provided by Dexia in order to avoid realizing market value losses from the sale of RMBS and other securities in the Company's FP Investment Portfolio. In addition, the Company's FP business is dependent upon Dexia for the provision of liquidity support in the event that collateral is required to be posted to avoid GIC terminations in the event of a ratings downgrade of FSA. Insofar as the Company is dependent on the significant liquidity and credit support that Dexia has committed to provide the Company's FP business, any decrease in the creditworthiness of Dexia or any action by Dexia to limit its support for the Company's FP business may be adverse to the Company.
The Company's FP business may be required to repay GICs or post incremental collateral in the event of an FSA downgrade.
If FSA were downgraded, the Company may be required to repay GICs or post collateral to its GIC counterparties, introducing additional liquidity risk. Most FSA-insured GICs allow for withdrawal of GIC funds in the event of a downgrade of FSA, typically below AA- by S&P or Aa3 by Moody's, unless the relevant GIC Subsidiary posts collateral or otherwise enhances its credit. Some FSA-insured GICs also allow for withdrawal of GIC funds in the event of a downgrade of FSA, typically below A3 by Moody's or A- by S&P, with no right of the GIC provider to avoid such withdrawal by posting collateral or otherwise enhancing its credit. The November 2008 downgrade to Aa3 by Moody's resulted in a trigger breach on $1.7 billion of unsecured GICs and $1.6 billion of secured GICs. In respect of unsecured GICs, the Company posted $1.0 billion of collateral, terminated $0.4 billion of GICs and modified the trigger to below Aa3 on $0.2 billion of GICs. The Company also posted $80 million of additional collateral to secured GICs. At December 31, 2008, a downgrade of FSA to below AA- by S&P or Aa3 by Moody's (A+ by S&P or A1 by Moody's) would result in withdrawal of $0.8 billion of GICs and the need to post collateral on GICs with a balance of $13.4 billion. Each GIC contract stipulates the types of securities eligible for posting and the collateralization percentage applicable to each security type. These collateralization percentages range from 100% of the GIC balance for cash collateral to, typically, 108% for asset-backed securities. Assuming an average margin of 105%, the market value of required collateral would be $14.1 billion. At December 31, 2008, a
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downgrade of FSA to below A- by S&P or A3 by Moody's (i.e., BBB+ by S&P or Baa1 by Moody's) would result in mandatory or optional withdrawals of $5.1 billion of GICs and repayment or collateralization of the remainder of the $9.1 billion of GICs outstanding.
A downgrade could result in a significant increase in collateral required to be posted to avoid GIC terminations. In such event, the Company would be required to raise cash to fund such withdrawals by accessing lines of credit provided by Dexia, selling assets, in some cases realizing substantial market loss, or borrowing against the value of such assets. In addition, assets posted as collateral are subject to changes in market value and ratings. Such changes may reduce the value of the collateral or disqualify the assets as collateral. As a result, additional collateral, to which the Company may or may not have access, may be required to be posted to meet collateral requirements.
The Company's loss reserves may prove inadequate.
The Company's insurance policies guarantee financial performance of obligations over specified periods of time, in some cases over 30 years, and are generally non-cancellable. The Company projects expected deterioration and ultimate loss amounts based on historical experience in order to estimate probable loss. If an individual policy risk has a probable and reasonably estimable loss as of the balance sheet date, the Company establishes a case reserve. For the remaining policy risks in the portfolio, the Company establishes a non-specific reserve to account for inherent credit losses. The establishment of these reserves is a systematic process that considers quantitative and statistical information together with qualitative factors, resulting in management's best estimate of inherent losses associated with providing credit protection at a given date. However, the process is inherently uncertain, and the Company cannot assure that its reserves will prove adequate. In the course of 2008, the Company adjusted reserves upward from quarter to quarter as the economic downturn worsened. There can be no assurance that such trend will not continue. If losses in its insured portfolio materially exceed the Company's loss reserves, it could have a material adverse effect on the financial ratings, results of operations and financial condition of the Company. For additional discussion of the Company's reserve methodologies, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsFinancial Guaranty SegmentResults of OperationsLosses" and Note 2 and Note 9 to the consolidated financial statements in Item 8.
Loss of management or other key personnel may have an adverse effect on the Company's business.
The Company's senior management plays an active role in its underwriting and business decisions, as well as in performing its financial reporting and compliance obligations. The Company's Chief Executive Officer and Chief Operating Officer have disputes regarding the terms of their employment agreements with the Company. The Company has deferred payment of a portion of 2008 bonuses and, in the case of senior management, made such bonuses contingent upon closing of the Acquisition. The Company has not otherwise established a retention plan for key personnel pending closing of the Acquisition, nor has a retention plan been otherwise established to retain key personnel should the Acquisition fail to close. Failure by the Company to retain management or key personnel could have an adverse effect on the Company's business.
Resignation of independent directors may have an adverse effect on the Company's business.
The Company's independent directors play an important role in the corporate governance of the Company. In accordance with applicable SEC and NYSE requirements, the Audit Committee of the Company's Board of Directors is comprised exclusively of independent directors. Three of the four independent directors of the Company have disputes with Dexia regarding the valuation of Company shares acquired by them under the Company's Director Share Purchase Program. Resignation by one or more of the Company's independent directors may adversely impact the corporate governance of the Company, result in failure to comply with applicable SEC and NYSE Audit Committee requirements
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and be viewed unfavorably by the rating agencies in evaluating the corporate governance of FSA and the Company, which is a factor in determining their ratings.
Ceasing to provide financial guaranty insurance on asset-backed transactions could reduce the Company's new business originations.
On August 6, 2008, the Company announced that FSA would cease providing financial guaranty insurance on asset-backed obligations and participate exclusively in the global public finance and infrastructure markets. The long-term effect of the change has not yet been realized. The Company believes that withdrawal from the asset-backed business will enhance its ratings stability, reduce its exposure to structured credit risk in its insured portfolio, and reduce its operating costs. At the same time, however, withdrawal from the asset-backed business may result in decreased business originations, revenues and net income relative to historical levels. A decline in new business originations or profitability may, in turn, be considered adverse factors by the rating agencies in assessing FSA's financial strength.
Fair valuing the Company's insured CDS portfolio may subject the Company's reported earnings to extreme volatility.
The Company is required to mark to market certain derivatives, including FSA-insured CDS that are considered derivatives under GAAP. As a result of such treatment, and given the large principal balance of FSA's insured CDS portfolio, small changes in the market pricing for insurance of CDS will generally result in recognition by the Company of material gains or losses, with material market price increases generally resulting in large reported losses under GAAP. Sharp swings in the estimated fair value of the CDS portfolio may occur from quarter to quarter due to the volatility of credit spreads that drive the fair-value estimates. Such changes in fair value can be caused by general market conditions and perceptions of credit risk, including FSA's own credit risk, causing the Company's GAAP earnings to be more volatile than would be suggested by the actual performance of FSA's business operations and insured CDS portfolio.
While management believes that reported mark to market gains or losses on insured CDS are not necessarily indicative of realized losses, certain constituents, including capital market participants, may rely upon reported GAAP results. As a result, the Company's access to capital markets might be impaired if its reported earnings were considered unusually volatile.
The Company may face claims in connection with early termination of Leveraged Lease Transactions in the event of failure of municipal lessees to pay stipulated loss amounts when due.
At December 31, 2008, FSA had insured up to $2.8 billion of stipulated loss payments that may become due from investment grade municipal lessees upon early termination of Leveraged Lease Transactions. In the event of failure by the municipal lessees to make any stipulated loss payment when and if due, FSA would be obligated to pay such amounts, and would be entitled to reimbursement from the municipal lessees for any claims paid. AIG International Group, Inc. ("AIG") and Premier, among others, act as equity payment undertakers in a number of transactions in which FSA acts as strip coverage provider, with AIG acting as equity payment undertaker in the large majority of such transactions. AIG was downgraded in the third quarter of 2008 and FSA was downgraded by Moody's in the fourth quarter of 2008. As a result, 53 Leveraged Lease Transactions in which FSA acted as strip coverage provider have breached either a ratings trigger related to AIG or a ratings trigger related to FSA. Under Leveraged Lease Transactions, if an early termination of the lease occurs and the lessee does not make the required early termination payment, FSA would be exposed to a possible liquidity claim on the 53 transactions with a current gross exposure of approximately $1.5 billion. If FSA is further downgraded to A+ or A1 and an early termination of the lease occurs and the lessee does not make the required early termination payment, FSA would be exposed to a possible liquidity claim on a
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total of 77 transactions with a current gross exposure of approximately $2.6 billion. For a discussion of the Leveraged Lease Transactions, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital ResourcesFSA's LiquidityLeveraged Lease Transactions."
The Company is exposed to large risks.
The Company is exposed to the risk that issuers of debt that FSA has insured, issuers of debt that it holds in its investment portfolio, reinsurers and other contract counterparties may default in their financial obligations, whether as the result of insolvency, lack of liquidity, operational failure or other reasons. FSA seeks to manage exposure to large single risks, as well as concentrations of risks that may be correlated, through credit and legal underwriting, reinsurance and other risk mitigation measures. In addition, the securities rating agencies and insurance regulations establish limits applicable to FSA on the size of risks and concentrations of risks that it may insure.
Given FSA's capital base and the quality of risks that it insures, FSA may insure and has insured individual public finance and asset-backed risks well in excess of $1 billion. Should FSA's risk assessments prove inaccurate and should the limits applicable to FSA prove inadequate, FSA could be exposed to larger than anticipated losses, and could be required by the rating agencies to hold additional capital against insured exposures whether or not downgraded by the rating agencies. While FSA has to date experienced catastrophic events (such as the terrorist attacks of September 11, 2001 and the 2005 hurricane season) without material loss, unexpected catastrophic events may have a material adverse effect upon FSA's insured portfolio and/or its investment portfolios.
General economic conditions could adversely affect the Company's business results and prospects.
Recessions; increases in corporate, municipal and/or consumer bankruptcies; a continued downturn in the U.S. housing market; increases in mortgage delinquency rates; intervention by governments in financial markets, including the imposition of limits on the ability of mortgagees to foreclose on defaulted mortgage loans and/or to increase interest rates on mortgage loans in accordance with original contract terms; wars; and terrorist acts could adversely affect the performance of FSA's insured portfolio, by leading to increases in losses and loss reserves, and of the General, FP and VIE Investment Portfolios, by leading to decreases in the value of the portfolios and, therefore, the Company's financial strength. Any of the listed developments could lead to increased losses in the insured portfolio and corresponding increases in the Company's loss reserves.
Changes in rating scales applied to municipal bonds may reduce demand for financial guaranty insurance.
Fitch and Moody's have announced initiatives to establish "corporate equivalent ratings" for municipal issuers. Recently, they each announced that they are postponing their plans to shift to a global ratings scale, but may elect to do so in the future. Implementation of corporate equivalent ratings would be expected to result in ratings being raised for many municipal issuers which, in turn, might result in reduced demand for financial guaranty insurance.
Rating instability of the monoline financial guaranty insurers may call into question the value/durability of a monoline guaranty.
Monoline financial guaranty insurers have had their ratings downgraded by one or more securities rating agencies. The resulting market turmoil has called into question the durability of the monoline ratings and may lead to decreased demand for FSA's financial guarantees. In response to the market instability resulting from the recent rating actions surrounding the monoline financial guaranty insurers,
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rating agencies and regulators may enhance the requirements for conducting, or restrict the types of business conducted by, monoline financial guaranty insurers.
Further downgrades of one or more of the Company's reinsurers could reduce the Company's capital adequacy and return on equity.
At December 31, 2008, the Company had reinsured approximately 23% of its principal amount of insurance outstanding. In evaluating the credits insured by the Company, securities rating agencies allow "credit" for reinsurance based on the reinsurers' ratings. In recent years, a number of the Company's reinsurers were downgraded by one or more rating agencies, resulting in decreases in the credit allowed for reinsurance and in the financial benefits of using reinsurance under existing rating agency capital adequacy models. Many of the Company's reinsurers have already been downgraded to Single-A or below by one or more rating agencies. The Company could be required to raise additional capital to replace the lost reinsurance credit in order to satisfy rating agency and regulatory capital adequacy and single risk requirements. The rating agencies' reduction in credit for reinsurance could also ultimately reduce the Company's return on equity to the extent that ceding commissions paid to the Company by the reinsurers were not adequately increased to compensate for the effect of any additional capital required. In addition, downgraded reinsurers may default in amounts due to the Company and such reinsurer obligations may not be adequately collateralized.
Increased competition could reduce the Company's new business originations.
The Company's insurance company subsidiaries face competition from uninsured executions in the capital markets, other monoline financial guaranty insurers, banks and other credit providers, including government-sponsored entities in the mortgage-backed and multi-family sectors. Increased competition, either in terms of price, alternative structures, or the emergence of new providers of credit enhancement, could have an adverse effect on the Company's insurance business. In recent years, FSA also faces competition from new entrants to the market, including BHAC, MIAC and NPFG. In addition, there are proposals for Congress to establish a federally chartered bond insurer, and for states and pension funds to establish bond insurers. Any such bond insurer may have a competitive advantage over FSA.
Commencing with the fourth quarter of 2007, monoline financial guaranty insurers have had their ratings downgraded, placed on credit watch or placed on negative outlook by one or more rating agency. Ratings downgrades of major financial guaranty insurers and declining reliability of rating agency capital models impair investor confidence and reduce demand for financial guaranty insurance.
Changes in prevailing interest rates and other market risks could result in a decline in the market value of the Company's General Investment Portfolio.
At December 31, 2008, the Company's General Investment Portfolio had a fair value of approximately $5.9 billion dollars, almost entirely invested in bonds, primarily municipal bonds. The Company's investment strategy is to invest in highly rated marketable instruments of intermediate average duration so as to generate stable investment earnings with moderate market value or credit risk. Nonetheless, any increase in prevailing interest rates would reduce the market value of securities in the Company's General Investment Portfolio, which would in turn reduce the Company's capital as measured under GAAP. The market value of the General Investment Portfolio also may be adversely affected by general developments in the capital markets, including decreased market liquidity for investment assets, market perception of increased credit risk with respect to the types of securities held in the General Investment Portfolio, downgrades of credit ratings of issuers of investment assets and/or foreign exchange movements which impact investment assets. In addition, the Company invests in securities insured by other financial guarantors, the market value of which may be affected by the rating instability of the relevant financial guarantor.
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Changes in prevailing interest rate levels could adversely affect demand for financial guaranty insurance and the Company's financial condition.
Demand for financial guaranty insurance generally reflects prevailing credit spreads. When interest rates are lower or when the market is otherwise relatively less risk averse, the spread between insured and uninsured obligations typically narrows and, as a result, financial guaranty insurance typically provides lower cost savings to issuers than it would during periods of relatively wider spreads. These lower cost savings generally lead to a corresponding decrease in demand or premiums obtainable for financial guaranty insurance.
Conversely, in a deteriorating credit environment, credit spreads widen and pricing for financial guaranty insurance may improve. However, if the weakening environment is sudden, pronounced or prolonged, the stresses on the insured portfolio may result in claims payments in excess of normal or historical expectations. In addition, increases in prevailing interest rate levels can lead to a decreased volume of capital markets activity and, correspondingly, a decreased volume of insured transactions.
Change in industry and other accounting practices could impair the Company's reported financial results and impede its ability to do business.
The Financial Accounting Standards Board (the "FASB") issued a new GAAP accounting standard applicable to financial guaranty insurers that changes the accounting for claims liability recognition and premium revenue recognition. The Company and its industry peers will be required to implement changes to GAAP reporting requirements effective January 1, 2009. Such alterations, as well as any changes in the interpretation of current accounting guidance or the issuance of other new accounting standards, may have an adverse effect on the Company's reported financial results, including future revenues, and may influence the types and/or volume of business that management may choose to pursue.
Changes in or inability to comply with applicable law could impede the Company's ability to do business.
The Company's businesses are subject to direct and indirect regulation under, among other things, state insurance laws, federal securities law, the U.S. Bank Holding Company Act, tax law and legal precedents affecting public finance and asset-backed obligations, as well as applicable law in the other countries in which the Company operates. Recent adverse developments in the industry have led regulators to re-examine the regulatory framework for financial guaranty insurers. In September 2008, the New York Insurance Department issued a circular letter, effective January 1, 2009, that prescribed best practices for financial guaranty issuers that would significantly narrow the permitted scope of insurance of asset-backed securities, a business no longer pursued by the Company. Future legislative, regulatory or judicial changes in the U.S. or abroad could adversely affect the Company's business by, among other things, limiting the types of risks FSA may insure, placing limits on the Company's ability to carry out its non-insurance business, lowering applicable single or aggregate risk limits, increasing the level of supervision or regulation to which its operations may be subject or creating restrictions that make the Company's products less attractive to potential buyers or lead to a need for increased reserves.
In addition, if FSA fails to comply with applicable insurance laws and regulations it could be exposed to fines, the loss of insurance licenses, limitations on the right to originate new business and restrictions on its ability to dividend monies to the Company, all of which could have an adverse impact on the Company's business results and prospects. As a result of a number of factors, including incurred losses and risks reassumed from troubled reinsurers, FSA has from time to time exceeded regulatory risk limits. Failure to comply with these limits allows the New York Insurance Department to cause the Company to cease writing new business, although it has not done so in the past.
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The Company is exposed to volatility in GAAP net income from incorporating its own credit risk in the valuation of liabilities carried at fair value.
Effective January 1, 2008, the Company adopted SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 provides an option to elect fair value as an alternative measurement for selected financial assets and financial liabilities not previously carried at fair value. The fair-value option may be applied to single eligible instruments, is irrevocable and is applied only to entire instruments and not to portions of instruments. The Company's fair value elections were intended to mitigate the volatility in earnings that had been created by not recording financial instruments and the related risk management instruments at fair value, to eliminate the operational complexities of applying hedge accounting or to conform to the fair value elections made by the Company in 2006 under its IFRS reporting to Dexia. However, under SFAS No. 157, "Fair Value Measurements," the Company must incorporate its own credit risk in the valuation of liabilities which are carried at fair value, which adds volatility to GAAP earnings. During 2008, the Company's credit spread widened, leading to material unrealized gains.
The Company has received Department of Justice and SEC subpoenas and been named in class action lawsuits related to the municipal GIC industry.
In November 2006, the Company received subpoenas from (1) the Antitrust Division of the U.S. Department of Justice (the "DOJ"), issued in connection with an ongoing criminal investigation of bid rigging of awards of municipal GICs, and (2) the SEC, issued in connection with an ongoing industry-wide civil investigation of brokers of municipal GICs. In February 2008, the Company received a "Wells Notice" from the SEC in connection with the foregoing investigation, indicating that the SEC staff was considering recommending action against the Company. The Company issues municipal GICs through the FP segment, but does not serve as a GIC broker. The subpoenas request that the Company furnish to the DOJ and SEC records and other information with respect to the Company's municipal GIC business. The Company is at risk that information provided pursuant to the subpoenas or otherwise provided to the government in the course of its investigation will lead to indictments of the Company and/or its employees, with the potential for convictions or settlements providing for the payment of fines, restitution, disgorgement, restrictions on future business activities and, in the case of individual employees, imprisonment. Such an adverse outcome would damage the reputation of the Company and might impair the ability of the Company to conduct its financial products business and its financial guaranty business. The Company has had ongoing discussions with the DOJ and the SEC, but cannot predict the amount of loss that may arise from these investigations.
During 2008, nine putative class action lawsuits naming the Company and/or FSA were filed in federal court alleging antitrust violations in the municipal derivatives industry. The Company and FSA also are named in five non-class actions originally filed in the California Superior Courts alleging violations of California law related to the municipal derivatives industry. The suits name as plaintiffs various named and unnamed states and municipalities and name as defendants a large number of major financial institutions, including the Company and FSA. The lawsuits refer to the ongoing investigations by the DOJ Antitrust Division and the SEC regarding such activities, with respect to which the Company and FSA received subpoenas in November 2006. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. It is not possible to predict whether additional suits will be filed, and it is also not possible to predict the outcome of such litigation. There could be unfavorable outcomes in these or other proceedings. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits but, under some circumstances, adverse results in legal proceedings could be material to the Company's results of operations, financial condition or cash flows.
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The Company's ability to make debt service payments on its outstanding debt is subject to the financial strength of its insurance company operations.
Because it is a holding company, the registrant does not conduct operations or generate material income. Instead, FSA Holdings' financial condition and results of operations, and thus its long-term ability to service its debt, will largely depend on its receipt of dividends from, or share repurchases by, FSA. FSA's ability to declare and pay dividends to the Company depends, among other factors, upon FSA's financial condition, results of operations, cash requirements, and compliance with rating agency requirements for maintaining its ratings, and is also subject to restrictions contained in the applicable insurance laws and regulations. Based on FSA's statutory statements for 2008, the maximum amount available for payment of dividends by FSA without regulatory approval over the 12 months following December 31, 2008 is approximately $62.0 million. The Company has $46.1 million in debt service payments due over the 12 months following December 31, 2008, unless it elects to defer payments on its junior subordinated debentures, which would reduce its annual debt service payments due by $19.2 million per year for up to 10 years.
The Company's international operations expose it to less predictable credit and legal risks.
The Company pursues opportunities in international markets and currently operates in various countries in Europe, the Asia Pacific region and Latin America. The underwriting of obligations of an issuer in a foreign country involves the same process as that for a domestic issuer, but additional risks must be addressed, such as the evaluation of foreign currency exchange rates, foreign business and legal issues, and the economic and political environment of the foreign country or countries in which an issuer does business. Changes in such factors could impede the Company's ability to insure, or increase the risk of loss from insuring, obligations in the countries in which it currently does business and limit its ability to pursue business opportunities in other countries.
Item 1B. Unresolved Staff Comments.
Item 1B is not applicable to the Company, because the Company is not an accelerated filer or large accelerated filer, as defined in Rule 12b-2 of the Exchange Act, or a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933, as amended (the "Securities Act").
The principal executive offices of the Company and FSA are located at 31 West 52nd Street, New York, New York, 10019, and consist of approximately 110,000 square feet of office space.
FSA or its subsidiaries also maintain leased office space in San Francisco, Dallas, Hamilton (Bermuda), London (England), Madrid (Spain), Mexico City (Mexico), Paris (France), Sydney (Australia) and Tokyo (Japan). The Company and its subsidiaries do not own any material real property.
The Company's telephone number at its principal executive offices is (212) 826-0100.
In the ordinary course of business, the Company and certain subsidiaries are parties to litigation. Material legal proceedings are discussed below. It is not possible to predict whether additional inquiries or requests for information will be received from regulatory or other governmental authorities, and it is also not possible to predict the outcome of any proceedings, inquiries or requests for information. There could be unfavorable outcomes from these and other proceedings that could be material to the Company's business, operations, financial condition, results of operations or cash flows.
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The entitlements of the Chief Executive Officer and the President of the Company under their employment agreements with the Company are in dispute. See "Item 11. Executive CompensationSummary Compensation TableDiscussion of 2008 Compensation for the Named Executive Officers." In addition, holders of shares under the Director Share Purchase Program are in discussions with Dexia regarding the proper valuation of such shares, which may lead to mediation or arbitration of the dispute. See "Item 11. Executive CompensationCompensation of DirectorsDirector Share Purchase Program."
Proceedings Related to the Financial Products Business
In November 2006, (i) the Company received a subpoena from the Antitrust Division of the U.S. Department of Justice issued in connection with an ongoing criminal investigation of bid rigging of awards of municipal GICs and other municipal derivatives and (ii) FSA received a subpoena from the SEC related to an ongoing industry-wide investigation concerning the bidding of municipal GICs and other municipal derivatives. Pursuant to the subpoenas the Company has furnished to the DOJ and SEC records and other information with respect to the Company's municipal GIC business. On February 4, 2008, the Company received a "Wells Notice" from the staff of the Philadelphia Regional Office of the SEC relating to the foregoing matter. The Wells Notice indicates that the SEC staff is considering recommending that the SEC authorize the staff to bring a civil injunctive action and/or institute administrative proceedings against the Company, alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 17(a) of the Securities Act. The Company has had ongoing discussions with the DOJ and the SEC. The ultimate loss that may arise from these investigations remains uncertain.
During 2008 nine putative class action lawsuits were filed in federal court alleging federal antitrust violations in the municipal derivatives industry, seeking damages and alleging, among other things, a conspiracy to fix the pricing of, and manipulate bids for, municipal derivatives, including GICs. These cases have been coordinated and consolidated for pretrial proceedings in the U.S. District Court for the Southern District of New York as MDL 1950, In re Municipal Derivatives Antitrust Litigation, Case No. 1:08-cv-2516 ("MDL 1950").
Five of these cases name both the Company and FSA: (a) Hinds County, Mississippi v. Wachovia Bank, N.A. (filed on or about March 13, 2008); (b) Fairfax County, Virginia v. Wachovia Bank, N.A. (filed on or about March 12, 2008); (c) Central Bucks School District, Pennsylvania v. Wachovia Bank N.A. (filed on or about June 4, 2008); (d) Mayor & City Counsel of Baltimore, Maryland v. Wachovia Bank N.A. (filed on or about July 3, 2008); and (e) Washington County, Tennessee v. Wachovia Bank N.A. (filed on or about July 14, 2008). Four of the cases name only the Company and also allege that the defendants violated state antitrust law and common law by engaging in illegal bid-rigging and market allocation, thereby depriving the cities of competition in the awarding of GICs and ultimately resulting in the cities paying higher fees for these products: (a) City of Oakland, California, v. AIG Financial Products Corp. (filed on or about April 23, 2008); (b) County of Alameda, California v. AIG Financial Products Corp. (filed on or about July 8, 2008); (c) City of Fresno, California v. AIG Financial Products Corp. (filed on or about July 17, 2008); and (d) Fresno County Financing Authority v. AIG Financial Products Corp . (filed on or about December 24, 2008).
Interim lead counsel for the MDL 1950 plaintiffs filed a Consolidated Class Action Complaint ("Consolidated Complaint") in August 2008 alleging violations of the federal antitrust laws. Defendants filed motions to dismiss the Consolidated Complaint. The MDL 1950 court has determined that it will handle federal claims alleged in the Consolidated Complaint before addressing state claims. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
55
The Company and FSA also are named in five non-class actions originally filed in the California Superior Courts alleging violations of California law related to the municipal derivatives industry:
These cases have been transferred to the S.D.N.Y. and consolidated with MDL 1950 for pretrial proceedings. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
Proceedings Relating to Financial Guaranty Business
The Company has received various regulatory inquiries and requests for information regarding a variety of subjects. These include subpoenas duces tecum and interrogatories from the State of Connecticut Attorney General and the Attorney General of the State of California related to antitrust concerns associated with the methodologies used by rating agencies for determining the credit rating of municipal debt, including a proposal by Moody's to assign corporate equivalent ratings to municipal obligations, and the Company's communications with rating agencies. The Company is in the process of satisfying such requests. The Company may receive additional inquiries from these or other regulators and expects to provide additional information to such regulators regarding their inquiries in the future.
In December 2008 and January 2009, FSA and various other financial guarantors were named in three complaints filed in the Superior Court, San Francisco County: (a) City of Los Angeles Department of Water and Power v. Ambac Financial Group et. al (filed on or about December 31, 2008), Case No. CG-08-483689; Sacramento Municipal Utility District v. Ambac Financial Group et. al (filed on or about December 31, 2008), Case No. CGC-08-483691; and (c) City of Sacramento v. Ambac Financial Group Inc. et. al (filed on or about January 6, 2009), Case No. CGC-09-483862. These complaints alleged participation in a conspiracy in violation of California's antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and created market demand for municipal bond insurance and participation in risky financial transactions in other lines of business that damaged each bond insurer's financial condition (thereby undermining the value of each of their guaranties), and a failure to adequately disclose the impact of those transactions on their financial
56
condition. These latter allegations form the predicate for five separate causes of action against each of the Insurers: breach of contract, breach of the covenant of good faith and fair dealing, fraud, negligence, and negligent misrepresentation. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
In August 2008 a number of financial institutions and other parties, including FSA, were named as defendants in a civil action brought in the circuit court of Jefferson County, Alabama relating to the County's problems meeting its debt obligations on its $3.2 billion sewer debt: Charles E. Wilson vs. JPMorgan Chase & Co et al (filed on or about August 8, 2008 in the Circuit Court of Jefferson County, Alabama), Case No. 01-CV-2008-901907.00, a putative class action. The action was brought on behalf of rate payers, tax payers and citizens residing in Jefferson County, and alleges conspiracy and fraud in connection with the issuance of the County's debt. The complaint in this lawsuit seeks unspecified monetary damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss or range of loss that may arise from this lawsuit. FSA was also named as a defendant in a second civil action regarding Jefferson County, Alabama, but was dismissed from such action in January 2009.
There are no other material legal proceedings pending to which the Company is subject.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
57
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
On July 5, 2000, the Company completed a merger in which the Company became an indirect subsidiary of Dexia, a Belgian corporation whose shares are traded in the Euronext Brussels and Euronext Paris markets as well as on the Luxembourg Stock Exchange. See "Item 1. BusinessOrganization." As a consequence of the merger, there is no longer an established public trading market for the Company's common stock, and bid quotations are not reported or otherwise available.
As of March 1, 2009, the only holders of the Company's common stock were Dexia Holdings and directors of the Company who own shares of the Company's common stock or economic interests therein as described in "Item 11. Executive CompensationCompensation of DirectorsDirector Share Purchase Program."
After a period of suspension of dividends, the Company began payment of regular quarterly dividends in May 2004, paying $22.9 million in aggregate for 2004 and $71.1 million in aggregate for 2005. In 2006, the Company paid regular quarterly dividends of $130.0 million in aggregate, an extraordinary dividend of $300.0 million in November 2006 and an extraordinary dividend of $100.0 million in December 2006. In 2007, the Company paid regular quarterly dividends of $122.0 million in aggregate, and no extraordinary dividends. During the first quarter of 2008, the Company paid regular dividends of $33.6 million in aggregate, and no extraordinary dividends. In May 2008, the Board of Directors amended the Company's dividend policy to provide for a regular annual dividend rather than a regular quarterly dividend, with the first regular annual dividend expected to be considered by the Board of Directors at its May 2009 meeting. Information concerning restrictions on the payment of dividends is set forth in "Item 1. BusinessInsurance Regulatory MattersDividend Restrictions."
Information about securities authorized for issuance under the Company's equity compensation plans is set forth in "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersSecurities Available Under Equity Compensation Plans."
The Company does not have equity securities registered pursuant to Section 12 of the Exchange Act.
58
Item 6. Selected Financial Data.
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and accompanying notes included elsewhere herein.
|
As of and for the Year Ended December 31, | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||
|
(in millions)
|
||||||||||||||||||
SUMMARY OF OPERATIONS(a) |
|||||||||||||||||||
Revenues |
|||||||||||||||||||
Net premiums written |
$ | 658.4 | $ | 447.1 | $ | 441.8 | $ | 483.7 | $ | 507.0 | |||||||||
Net premiums earned |
376.6 | 317.8 | 301.5 | 314.9 | 325.9 | ||||||||||||||
Net investment income from general investment portfolio |
264.2 | 236.7 | 218.9 | 200.8 | 172.1 | ||||||||||||||
Net change in fair value of credit derivatives: |
|||||||||||||||||||
Realized gains (losses) and other settlements |
126.9 | 102.8 | 87.2 | 89.2 | 69.1 | ||||||||||||||
Net unrealized gains (losses) |
(745.0 | ) | (642.6 | ) | 31.8 | 11.1 | 56.4 | ||||||||||||
Net change in fair value of credit derivatives |
(618.1 | ) | (539.8 | ) | 119.0 | 100.3 | 125.5 | ||||||||||||
Net interest income from financial products segment |
647.4 | 1,079.6 | 858.2 | 487.9 | 194.7 | ||||||||||||||
Net realized gains (losses) from financial products segment |
(8,644.2 | ) | 1.9 | 0.1 | (7.5 | ) | 2.2 | ||||||||||||
Net realized and unrealized gains (losses) on derivative instruments |
1,424.5 | 62.8 | 131.4 | (183.6 | ) | 272.9 | |||||||||||||
Net unrealized gains (losses) on financial instruments at fair value |
130.4 | 14.0 | 3.6 | | | ||||||||||||||
Expenses |
|||||||||||||||||||
Losses and loss adjustment expenses |
1,877.7 | 31.6 | 23.3 | 25.4 | 20.6 | ||||||||||||||
Foreign exchange (gains) losses from financial products segment |
1.7 | 138.5 | 159.4 | (189.8 | ) | 91.3 | |||||||||||||
Net interest expense from financial products segment |
794.3 | 989.2 | 768.7 | 491.6 | 267.6 | ||||||||||||||
Net income (loss) |
(8,443.2 | ) | (65.7 | ) | 424.2 | 326.1 | 378.6 | ||||||||||||
BALANCE SHEET DATA(a) |
|||||||||||||||||||
Assets |
|||||||||||||||||||
General investment portfolio, available for sale |
$ | 5,935.5 | $ | 5,191.9 | $ | 4,872.4 | $ | 4,595.5 | $ | 4,281.8 | |||||||||
Financial products segment investment portfolio |
10,302.0 | 19,213.2 | 17,537.1 | 14,002.0 | 9,546.7 | ||||||||||||||
Assets acquired in refinancing transactions |
166.6 | 229.3 | 337.9 | 467.9 | 749.2 | ||||||||||||||
Prepaid reinsurance premiums |
1,011.9 | 1,119.6 | 999.5 | 859.4 | 754.3 | ||||||||||||||
Total assets |
20,258.0 | 28,318.7 | 25,764.7 | 22,000.1 | 17,079.0 | ||||||||||||||
Liabilities, minority interest and shareholders' equity |
|||||||||||||||||||
Deferred premium revenue |
3,044.7 | 2,870.6 | 2,621.5 | 2,339.0 | 2,063.8 | ||||||||||||||
Losses and loss adjustment expenses |
1,779.0 | 274.6 | 228.1 | 205.7 | 179.9 | ||||||||||||||
Financial products segment debt |
16,432.3 | 21,400.2 | 18,349.7 | 14,947.1 | 10,444.1 | ||||||||||||||
Notes payable |
730.0 | 730.0 | 730.0 | 430.0 | 430.0 | ||||||||||||||
Total liabilities and minority interest |
25,442.5 | 26,740.9 | 23,042.4 | 19,177.2 | 14,467.7 | ||||||||||||||
Shareholders' equity (deficit) |
(5,184.5 | ) | 1,577.8 | 2,722.3 | 2,822.9 | 2,611.3 | |||||||||||||
ADDITIONAL DATA |
|||||||||||||||||||
Qualified statutory capital(b) |
$ | 1,992.4 | $ | 2,703.1 | $ | 2,554.1 | $ | 2,417.5 | $ | 2,280.9 | |||||||||
Total claims-paying resources(c) |
7,713.1 | 6,738.8 | 6,055.8 | 5,675.8 | 5,230.6 | ||||||||||||||
Total dividends |
33.6 | 122.0 | 530.0 | 71.1 | 22.9 | ||||||||||||||
EXPOSURE |
|||||||||||||||||||
Net par outstanding |
$ | 408,530 | $ | 406,457 | $ | 359,560 | $ | 337,483 | $ | 317,743 | |||||||||
Net insurance in force (principal and interest) |
611,448 | 598,306 | 531,421 | 480,185 | 444,512 |
59
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement Regarding Forward-Looking Statements
This Annual Report includes statements that may constitute "forward-looking statements" within the meaning of the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Words such as "believes," "anticipates," "expects," "intends" and "plans" and future and conditional verbs such as "will," "should," "would," "could" and "may" and similar expressions are intended to identify forward looking statements but are not the exclusive means of identifying such statements. The Company cautions that a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in forward-looking statements made by the Company. Important factors that could cause its results to differ, possibly materially, from those indicated in the forward-looking statements include, but are not limited to, those discussed under "Item 1. BusinessForward-Looking Statements" and "Item 1A. Risk Factors."
Financial Security Assurance Holdings Ltd. ("FSA Holdings" or, together with its subsidiaries, the "Company") is a holding company incorporated in the State of New York. The Company, through its insurance company subsidiaries, engages in providing financial guaranty insurance on public finance obligations in domestic and international markets. Historically, the Company also provided financial guaranty insurance on asset-backed obligations. In addition, the Company historically issued FSA-insured guaranteed investment contracts and other investment agreements ("GICs"), as well as medium term notes to municipalities and other market participants through its Financial Products ("FP") segment.
After a careful strategic analysis, the Company decided, in August 2008, to cease issuing financial guaranty insurance contracts of asset-backed obligations in order to devote its resources to expanding its position in the global public finance and infrastructure markets. This decision was based on weighing the risks and volatility embedded in the asset-backed security business, in particular residential mortgage-backed securities ("RMBS"), versus the opportunities available in lower-risk sectors of the public finance markets. The change in strategic focus resulted in a staff reduction of 29 positions in 2008. The continuation of the lack of market opportunities led to a further reduction of 32 positions in the first quarter of 2009. The amortizing asset-backed portfolio is expected to generate in excess of $583.7 million of earned revenue over the remaining life of the policies. In November 2008, the Company ceased issuing GICs. While the Company has ceased new originations in its asset-backed financial guaranty business and of GICs, a substantial portfolio of such obligations remains outstanding.
Although the economy is faced with an unprecedented crisis, the Company believes that the current U.S. municipal operating environment remains favorable for highly rated bond insurers. While the insured penetration of bond insurance in the U.S. municipal market decreased to approximately 17% in 2008 compared with 47% in 2007, the Company believes that it will normalize to a higher level as financial markets stabilize, provided that there are highly rated financially stable bond insurers available to service market demand.
The Company's principal insurance company subsidiary is Financial Security Assurance Inc. ("FSA"), a wholly owned New York insurance company. The Company is a 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 primarily engaged in the business of public finance, banking and investment management in France, Belgium, Luxembourg and other European countries, as well as in the United States. Dexia Crédit Local is a wholly owned subsidiary of Dexia.
60
The Company conducted its GIC business through its non-insurance subsidiaries 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 Subsidiaries"). FSACM conducted substantially all the Company's GIC business since April 2003, following its receipt of an exemption from the requirements of the Investment Company Act of 1940. When the GIC Subsidiaries sold GICs, they loaned the proceeds to FSA Asset Management LLC ("FSAM"), which invests the funds in fixed-income obligations that satisfy the Company's investment criteria. The Company's affiliates ceased issuing GICs in November 2008 in contemplation of the sale of the Company to Assured Guaranty Ltd. ("Assured"). FSAM wholly owns FSA Portfolio Asset Limited ("FSA-PAL"), a U.K. company that invests in non-U.S. securities.
For the year ended December 31, 2008, the Company had gross premiums written of $690.4 million, of which approximately 88% related to insurance of public finance obligations and approximately 12% related to insurance of asset-backed and other non-public finance obligations. The Company also had realized gains on credit derivatives of $126.9 million in 2008. At December 31, 2008, the Company had net par outstanding of $408.5 billion, of which approximately 75% represented insurance of public finance obligations and approximately 25% represented insurance of asset-backed and other non-public finance obligations. At December 31, 2008, the Company had $16.4 billion principal amount of FP segment debt.
In 2008, the Company reported a net loss of $8,443.2 million, compared with a net loss of $65.7 million in 2007 and net income of $424.2 million in 2006, primarily due to $8,397.9 million of other than temporary impairment ("OTTI") charges in the FP investment portfolio supporting FSA-insured GICs (the "FP Investment Portfolio"). Of the FP investment portfolio OTTI, $797.5 million was considered economic credit impairment at December 31, 2008. In prior years, unrealized gains and losses in the FP Investment Portfolio and the portfolio of investments supporting the variable interest entity ("VIE") liabilities (the "VIE Investment Portfolio") were generally recorded in other comprehensive income, based in part on the Company's ability and intent to hold the FP Segment Investment Portfolio to maturity and the Company's conclusion that the unrealized losses were temporary. The FP Investment Portfolio and VIE Investment Portfolio together make up the "FP Segment Investment Portfolio." See "Expected Sale of the CompanyDexia's Retention of the FP Business."
Under the Purchase Agreement described below, Dexia agreed to segregate or separate the Company's FP operations from the financial guaranty operations and retain the FP segment. Consequently, the Company no longer has the intent to hold these assets to maturity and was required to record an OTTI for all securities in a loss position at December 31, 2008. The magnitude of the amount of the OTTI was a result of declines in fair value of RMBS securities in the portfolio. During 2008, the Company has relied on liquidity resources available under agreements with Dexia to meet the GIC withdrawal and collateralization requirements. Further deterioration in the market value of the FP Investment Portfolio or ratings downgrades could result in the FP business having inadequate market value of securities eligible to be pledged as collateral in the event of an FSA downgrade. For more information regarding the liquidity risks inherent to the FP business and the liquidity resources available to it, see "Liquidity and Capital ResourcesFP Segment Liquidity."
FSA's exposure to mortgage-backed obligations with deteriorating credit performance was the primary driver of loss expense in the Company's financial guaranty segment which have increased from $31.6 million as of December 31, 2007 to $1,877.7 million as of December 31, 2008, despite the fact that the Company has no material exposures to collateralized debt obligations ("CDOs") of asset-backed securities ("ABS") that include RMBS, which caused severe losses for a number of other financial guarantors. The full extent of credit losses in the mortgage sector, and the extent to which they may affect the Company, will not be known for several years. The Company is also closely
61
monitoring the consumer and corporate sectors for signs of deepening economic stress. See Note 3 to the consolidated financial statements in Item 8.
The Company is affected by conditions in the financial markets and general economic conditions, primarily domestic, but also international.
Expected Sale of the Company
Purchase Agreement with Assured Guaranty Ltd.
In November 2008, Dexia and Assured entered into a purchase agreement (the "Purchase Agreement") providing for the purchase by Assured of all Company shares owned by Dexia (the "Acquisition"), subject to the satisfaction of specified closing conditions. Purchase Agreement closing conditions include (1) receipt of regulatory and Assured shareholder approvals; (2) confirmation from Standard & Poor's Ratings Services ("S&P"), Moody's Investors Service, Inc. ("Moody's") and Fitch Ratings ("Fitch") that the acquisition of the Company would not result in a downgrade of the financial strength ratings of the insurance company subsidiaries of Assured or of the Company; and (3) segregation or separation of the Company's FP business such that the credit and liquidity risk of the FP business resides with Dexia, with FSA protected against any future Dexia credit impairment. In February 2009, the Company's ultimate parent, Dexia, entered into several agreements that transfer credit and liquidity risk of the GIC operations to Dexia, which resulted in the "deconsolidation" of FSAM from the Company (the "FSAM Risk Transfer Transaction").
Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act") and the rules promulgated thereunder by the Federal Trade Commission (the "FTC"), the Acquisition may not be consummated until notifications have been given and certain information has been furnished to the FTC and the Department of Justice (the "DOJ") and specified waiting period requirements have been satisfied. The HSR Act waiting period expired on January 21, 2009. In addition, under the insurance holding company laws and regulations applicable to the insurance subsidiaries of the Company and Assured, before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance commissioner of the state where the insurer is domiciled. Assured has informed the Company that Assured filed applications with the insurance departments of the States of New York and Oklahoma and the U.K. Financial Services Authority; that the applications to the New York Insurance Department and the U.K. Financial Services Authority have been approved; and that it has made pre-acquisition filings regarding the potential competitive impact of the acquisition, which are deemed to have been approved. Dexia has informed the Company that it has filed an application with the U.K. Financial Services Authority in connection with its acquisition of Assured common shares pursuant to the Purchase Agreement, which has been approved, and that it has filed disclaimers of control with the insurance departments of the states of Maryland, New York, and Oklahoma.
Satisfying all three rating agencies that the necessary steps have or will be taken to transfer the FP segment credit and liquidity risk to Dexia is one of the last conditions to the Purchase Agreement closing. Rating agency confirmation that the Acquisition will not have a negative impact on the financial strength ratings of Assured's insurance company subsidiaries or the Company's insurance company subsidiaries is a condition for closing, and is beyond the Company's control.
The Company cannot estimate whether or when the remaining closing conditions will be satisfied or relevant agreements negotiated, whether the Acquisition will be completed and, if completed, whether it will be structured as currently contemplated, or what the effects of the change in control or removal of the FP business will be on the Company and its results of operations. If the Acquisition is not carried out, Dexia may explore other options with respect to the Company, including selling the Company or some of its operations to a third party or ceasing to write new business, which may have a material adverse effect on the Company.
62
Dexia's Retention of the FP Business
Under the Purchase Agreement, Dexia is expected to retain the Company's FP business after the Acquisition. The Purchase Agreement provides that Dexia will provide guarantees with respect to the FP business' assets and liabilities, including derivative contracts, and anticipates that some of its guarantees will benefit from guarantees provided by the French and Belgian states. Dexia Holdings, the Company's parent, agreed that if such sovereign guarantees are provided, it will cause FSA Holdings to transfer the ownership interests of certain of the subsidiaries that conduct the FP business, or all the assets and liabilities of such subsidiaries, to Dexia Holdings or one of its affiliates in form reasonably acceptable to Assured.
Transfer of Credit and Liquidity Risk of the GIC Business
When the GIC Subsidiaries sold a GIC, they loaned the proceeds to FSAM. The terms governing FSAM's repayment of those proceeds to the GIC Subsidiaries match the payment terms under the related GIC. FSAM invests the proceeds in securities and enters into derivative transactions to convert any fixed-rate assets and liabilities into London Interbank Offered Rate ("LIBOR")-based floating rate assets and liabilities. Most of FSAM's assets consist of residential mortgage-backed securities ("RMBS") that have suffered significant market value declines and, in more limited cases, credit deterioration resulting in a shareholders' deficit for FSAM at December 31, 2008. The market value declines of FSAM's assets subject FSAM to significant liquidity risk insofar as the GICs are in most cases subject to redemption or collateralization upon the downgrade of FSA below certain thresholds, with a significant number of GICs subject to redemption or collateralization should FSA be downgraded below Aa3 by Moody's (FSA's current Moody's rating) or below AA- by S&P. Dexia had previously announced its intention to assume the credit and liquidity risk associated with the Company's FP business, and provided significant support to the FP business in the course of 2008.
In February 2009, Dexia entered into several agreements that transfer credit and liquidity risk of the GIC operations to Dexia, (the "FSAM Risk Transfer Transaction"). Each of the agreements executed under the FSAM Risk Transfer Transaction directly affect (1) FSAM and (2) the entities that absorb the risks created by FSAM. These agreements provide for the (i) elimination of FSA's guaranty of repayment of FSAM's borrowings under the credit facilities provided by Dexia's bank subsidiaries; (ii) elimination of FSA's guaranty of certain of FSAM's investments; and (iii) increase in the credit facilities provided to FSAM by Dexia's bank subsidiaries from $5 billion to $8 billion.
As a result of the significant decline in asset value and the November 2008 cessation of issuing GICs, the GIC business changed from a business model managed by the Company focused on attaining positive net interest margin, to a run-off business managed by Dexia seeking to minimize liquidity risk and optimize asset recovery values. As a result, the FSAM Risk Transfer Transaction was deemed a reconsideration event for FSAM under FASB Interpretation 46 (R), "Consolidation of Variable Interest Entities" ("FIN 46"). There was no reconsideration event for any of the GIC Subsidiaries.
Upon the reconsideration event, management determined that Dexia is now absorbing the majority of the variability of expected losses of FSAM, which resulted in deconsolidation of FSAM as of February 24, 2009, the effective date of the FSAM Risk Transfer Transaction.
The GIC subsidiaries, unlike FSAM, remain part of the Company's consolidated financial statements notwithstanding the FSAM Risk Transfer Transaction, which means that the GICs issued to third parties and the note receivable from FSAM will represent the primary liabilities and assets of the FP business in the Company's consolidated financial statements. Since some of the GICs were designated as fair value option, they will continue to be marked to market; however, derivatives are maintained within FSAM, so contracts meant to hedge the interest rate risk of those GICs will no longer be included in the Company's consolidated financial statements, increasing the volatility of the Company's net income (loss).
63
The following table shows the effect of deconsolidation of FSAM had the FSAM Risk Transfer Transaction been executed at December 31, 2008.
|
At December 31, 2008 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
As
reported |
Remove
FSAM (1) |
Add
Intercompany and other adjustments(2) |
Adjusted | ||||||||||
|
(in millions)
|
|||||||||||||
Assets: |
||||||||||||||
General investment portfolio |
$ | 5,935 | $ | | $ | | $ | 5,935 | ||||||
Financial products segment investment portfolio |
10,302 | 9,573 | 202 | 931 | ||||||||||
Assets acquired in refinancing transactions |
167 | | | 167 | ||||||||||
Total investment portfolio |
16,404 | 9,573 | 202 | 7,033 | ||||||||||
Notes receivable from FSAM |
| | 15,236 | 15,236 | ||||||||||
Other assets |
3,854 | 159 | 79 | 3,744 | ||||||||||
Total assets |
$ | 20,258 | $ | 9,732 | $ | 15,517 | $ | 26,043 | ||||||
Liabilities: |
||||||||||||||
Deferred premium revenue |
$ | 3,045 | $ | | $ | | $ | 3,045 | ||||||
Financial products segment debt |
16,432 | | | 16,432 | ||||||||||
Notes payable to GIC subsidiaries |
| 15,236 | 15,236 | | ||||||||||
Other liabilities |
5,965 | 1,596 | 260 | 4,629 | ||||||||||
Total liabilities |
25,442 | 16,832 | 15,496 | 24,106 | ||||||||||
Shareholder's equity (deficit) |
$ | (5,184 | ) | $ | (7,100 | ) | $ | 21 | $ | 1,937 | ||||
In the table above, the carrying value of the note receivable from FSAM represents net realizable value, in accordance with accounting principles generally accepted in the United States of America ("GAAP") in effect at December 31, 2008. Statement of Financial Accounting Standards ("SFAS") No. 160, "Noncontrolling Interests in Consolidated Financial Statements" ("SFAS 160"), became effective January 1, 2009 and may be applicable to the deconsolidation of FSAM. The Company is currently evaluating the impact of SFAS 160 on the Company's financial statements in 2009 as SFAS 160 may materially affect the method of valuing the carrying amount of the GIC entities' notes receivable from FSAM at the February 2009 deconsolidation date.
Business Environment and Market Trends
Continuing Stress on the Financial Guaranty Industry
Obligations insured by the Company are generally awarded ratings on the basis of the financial strength ratings given to the Company's insurance company subsidiaries by the major securities rating agencies. During 2007 and 2008, the global financial crisis that began in the U.S. subprime residential mortgage market transformed the financial guaranty industry. By the end of November 2008, all of the monoline guarantors that had been rated Triple-A at the beginning of the year had been downgraded in varying degrees by Moody's, and all but two had been either downgraded or placed on negative outlook or negative credit watch by S&P and Fitch, reducing the number of active providers of financial guaranty insurance while calling into question the durability of financial guaranties in general. On December 31, 2008, the Company was rated Triple-A (negative credit watch) by S&P and Fitch and
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Aa3 (developing outlook) by Moody's. Prior to November 2008, the Company's insurance company subsidiaries, as well as the obligations they insured, had been awarded Triple-A ratings by the three major rating agencies. Rating agencies raised concerns about the stability of FSA's rating during the second half of 2008. The rating agencies stated that their actions regarding FSA were based in part upon concerns regarding the prospects for new business originations by financial guarantors, as well as uncertainty about future support for FSA. As a result of the recent ratings actions, FSA's market opportunities were severely limited beginning in the second half of 2008 and its long-term opportunities remain unclear. These developments, combined with illiquidity in the capital markets, led to a marked reduction in FSA's production in the second half of 2008.
Given the rapidly deteriorating state of the U.S. economy, it is difficult to project the future for the Company. Unemployment rates are likely to continue to rise, fueling more residential mortgage delinquencies and putting further pressure on home prices. Loss reserves would grow if these trends continue beyond current assumptions. Consumer and corporate credits are also under pressure, although the Company's consumer and corporate portfolios are holding up relatively well. Commercial mortgage securitizations may be a future source of pain in the economy, however the Company is not exposed to this category of risk. The current environment represents a stress-case worse than any of the models had projected. In the public finance sector, the combination of falling property values and reduced commercial activity, which drive local tax revenues, are putting increasing pressure on municipal budgets at a time when the population is putting increasing pressure on municipal services. The closing of the proposed business combination with Assured is an important component of the Company's survival and, ultimately, return to success.
The following table shows the current ratings of the Company and its four main competitors at March 13, 2009, by each of the rating agencies:
Current Competitors' Ratings
|
Ratings at March 13, 2009 | |||||
---|---|---|---|---|---|---|
Guarantor
|
Moody's Investors
Service, Inc. |
Standard & Poor's
Ratings Services |
Fitch Ratings | |||
Financial Security Assurance Inc. |
Aa3/Developing | AAA/WatchNeg | AAA/WatchNeg | |||
Assured Guaranty Corp. |
Aa2/Stable | AAA/Stable | AAA/Stable | |||
Ambac Assurance Corporation |
Baa1/Developing | A/Neg Outlook | Rating Withdrawn | |||
Berkshire Hathaway Assurance Corp |
Aaa/Stable | AAA/Stable | Not Rated | |||
MBIA Insurance Corporation |
B3/Developing | BBB+/Neg Outlook | Rating Withdrawn |
In addition to FSA, a number of the Company's competitors in the financial guaranty industry have incurred unprecedented increases in projected losses on insured RMBS transactions in 2008 and subsequently were downgraded or placed on credit watch, negative outlook or review for further downgrade by the major securities rating agencies. Several guarantors had significant exposure to CDOs of ABS, which include CDOs of CDOs (also referred to as "CDO squared").
FSA was the U.S. municipal market leader in 2008, achieving a 54% share of market. However, most of its business was originated in the first half of 2008, after which the rating agency actions decreased demand for FSA guarantees. In international public finance markets, where liquidity was constrained all year, FSA's 2008 production decreased significantly in comparison to full year 2007.
Concerns regarding the capital adequacy of Triple-A guarantors have drawn attention not only from rating agencies but also state regulators, the federal government and financial institutions concerned about their own exposure to monolines. In September 2008, the New York Insurance Department issued a circular letter, effective January 1, 2009, that prescribes best practices for financial guaranty issuers that would significantly narrow the permitted scope of insurance of asset-backed securities, a business no longer pursued by the Company. There also have been proposals for a federal
65
office to oversee bond insurers. The cost of buying protection in the credit default swap ("CDS") market on monoline names rose significantly during 2008.
In the fourth quarter of 2007, Berkshire Hathaway Assurance Company ("BHAC") commenced operations as a financial guaranty insurer. Given BHAC's affiliation with Triple-A rated Berkshire Hathaway Company, BHAC has the potential to be a significant competitor to the Company in the public finance sector but has to date insured transactions only on an opportunistic basis. Another new monoline competitor, Municipal and Infrastructure Assurance Corporation ("MIAC"), commenced operations in October 2008, intending to focus on municipal and infrastructure finance. National Public Finance Guaranty Corp. ("NPFG"), an affiliate of MBIA Insurance Corporation, commenced operations in February 2009, intending to focus on municipal finance. In addition, Ambac Assurance Corporation has announced an intention to establish an affiliate, Everspan Financial Guaranty Corp, that will engage in municipal financial guaranty insurance. There are proposals for Congress to establish a federally chartered bond insurer, and for states and pension funds to establish bond insurers, in each case to address the public sector demand for bond insurance. Any such Federal, state or pension fund sponsored bond insurer would likely prove to be a significant competitor to the Company.
The Company has direct exposure to other financial guaranty insurers through secondary guaranties of previously insured securities, reinsurance and investments. Downgrades of other monolines could cause incurred loss in the insured and investment portfolios. Additionally, such downgrades could reduce the credit for reinsurance and for previously wrapped insured transactions that rating agencies assign in their capital adequacy models, increasing the capital charges in those models. At this stage, management cannot predict how the situation will be resolved for the Company or its competitors, or what competitive, regulatory and rating agency environments may emerge.
In 2008, the market turmoil resulted in disruptions in the domestic public finance market, evidenced by auction failures for auction rate municipal bonds, higher rates on variable rate demand notes and historic high yields for tax-exempt municipal bonds compared with U.S. government treasury securities. If these conditions persist for an extended period of time, the Company's own insured obligations could experience increased losses because, in extreme cases, higher borrowing costs could put financial stress on municipal issuers, leading to defaults of FSA-insured securities.
Credit Deterioration in Certain RMBS Sectors Accelerated
The credit crisis that began in 2007 followed several years of seemingly benign credit conditions, during which delinquency and default rates were comparatively low across the residential mortgage, consumer finance and corporate finance credit markets. Beginning in 2005, credit spreads were tight, indicating that investors were relatively undiscriminating about risk, and structures of some asset-backed securities were based on loss assumptions that have proven to be too optimistic. This was particularly true in the RMBS sector and with CDOs of ABS that contain a high percentage of RMBS. During these years, FSA maintained its underwriting and pricing standards, even though this meant declining to insure certain transactions.
The Company generally avoided insurance of CDOs of ABS. In all, FSA insured two CDOs of ABS with a total net par outstanding of $339 million: (1) a Double-A rated obligation insured in 2000 with $47 million net par outstanding and less than 3% invested in U.S. subprime and "Alt-A" RMBS collateral, and (2) a Triple-B rated CDS excess-of-loss reinsurance transaction insured in 2005 at four times the original Triple-A attachment point with $292 million net par outstanding at December 31, 2008. "Alt-A" refers to borrowers whose credit quality falls between prime and subprime. In contrast, most of the Company's peers have suffered from projected losses and market concerns related to their exposure to CDOs of ABS that contain a high percentage of mezzanine tranches of subprime RMBS, with most credit concerns focused on 2006 and 2007 originations.
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In 2007 and 2008, mortgage performance deteriorated rapidly, exceeding the most conservative historical loss expectations. For the first time since the Great Depression, year-over-year home prices declined across the entire United States, not just regionally. As projected losses on subprime and other RMBS increased, some mortgage lenders failed, and rating agencies downgraded many mortgage-related securities. This included a large amount of CDOs of ABS. In the home equity line of credit ("HELOC") market, which generally involves prime borrowers, projected losses rose to unprecedented levels. In the first quarter of 2008, these borrowers began to default at much higher rates, a trend which continued through the year.
In 2008, the Company established 38 new case reserves, primarily for first and second lien RMBS insured transactions. Loss provisions, primarily those related to the insured RMBS portfolio, reflect the assumption that economic stress in the U.S. economy will continue for the foreseeable future. Loss expense for the year ended December 31, 2008 was $1,877.7 million, related primarily to increases in loss estimates on RMBS transactions.
Additionally, in 2008 the Company recorded pre-tax OTTI charges in the FP Investment Portfolio of $8,397.9 million, of which $797.5 million was considered economic credit impairment. In the fourth quarter of 2008, $236.2 million was recorded in OTTI in the VIE Investment Portfolio, none of which was deemed to be economic. The fourth quarter OTTI charge reflects the Company's lack of intent to hold the securities as a result of the Purchase Agreement, which requires immediate recognition in income of all unrealized losses that had been previously recorded in other comprehensive income because the Company no longer intends to hold these assets to maturity or recovery of the losses. At December 31, 2008, approximately 56.6% of the available-for-sale FP Investment Portfolio based on amortized cost was invested in non-agency RMBS, of which 38.8% were rated Triple-A, with 17.2% rated Double-A, 7.0% rated Single-A, 10.0% rated Triple-B and 27.0% below investment grade.
The Company has evaluated all its U.S. RMBS of 2005 vintage or later, in both the insured portfolio and the FP Investment Portfolio, using the same modeling assumptions and the same approach to setting transaction default assumptions, driven by the actual performance of each transaction. The Company is also closely monitoring the consumer and corporate sectors for signs of deepening economic stress.
Adverse loss developments surrounding subprime RMBS may lead to earlier than anticipated withdrawals on GICs issued in connection with CDOs of ABS. At December 31, 2008, $983.6 million of CDO of ABS GICs had been terminated due to an event of default in the underlying collateral of the CDOs of ABS and a subsequent liquidation of the CDO portfolio. Between January 1, 2009 and March 2, 2009, no additional CDO of ABS GICs were terminated. Also in 2008, $852.0 million of pooled corporate CDO GICs were terminated due to an event of default caused by the bankruptcy of Lehman Brothers Holdings Inc. ("Lehman Brothers"), which was the guarantor of the CDS protection buyer in those transactions. The Company expects further GIC withdrawals and is regularly evaluating general market conditions, as well as specific transactions.
The full extent of credit losses in the mortgage sector, and the extent to which they may affect the Company, will not be known for several years.
Illiquidity Continued to Limit Public Finance Issuance Volume
Credit problems expanded beyond the mortgage market to constrain liquidity across the capital markets in 2008. This had a negative impact on new-issue volume in the public finance and structured finance markets. Credit spreads trended wider throughout 2008. Wider spreads generally necessitate unrealized negative fair-value (mark-to-market) adjustments for credit derivatives in the insured portfolio and for certain FP investments. On the other hand, wider spreads generally mean that a financial guarantor has more opportunities to sell insurance at higher premium rates. This was true for the first half of 2008 in the primary U.S. municipal business, where FSA's business production was
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strong. The Company's originations since mid-2008 have been limited, primarily due to market conditions and concerns regarding rating agency actions.
Summary Results of Operations and Financial Condition
Net Income (Loss)
In 2008, the Company reported a net loss of $8,443.2 million, compared with a net loss of $65.7 million in 2007 and net income of $424.2 million in 2006. Net income is volatile primarily because it includes (a) where applicable, OTTI charges that are not indicative of estimated economic loss, (b) fair-value adjustments for credit derivatives in the insured portfolio in excess of estimated economic loss, (c) beginning January 1, 2008, fair-value adjustments related to the Company's own credit risk, and (d) fair-value adjustments for instruments with economically hedged risks that are not in designated hedging relationships under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), and adjustments related to non-economic changes in fair value related to the trading portfolio.
Net income decreased in both the financial guaranty and FP segments. In the financial guaranty segment, higher losses related to insured RMBS transactions and negative fair-value adjustments for credit derivatives were primarily responsible for producing negative segment results. In the FP segment, the loss was largely due to OTTI charges. The Company no longer has the intent to hold such securities to maturity, due to Dexia's Purchase Agreement covenant to retain the FP operations and segregate or separate the FP operations from the Company's financial guaranty operations. As a result, the Company was required to record an OTTI charge for all assets in the Portfolio in an unrealized loss position at December 31, 2008.
In order to understand the results of operations reported in accordance with GAAP, the discussion that follows explains certain fair-value adjustments that cause volatility in reported earnings. While there is also volatility in reported earnings due to reserves and other economic gains and losses, management typically views fair-value adjustments that are not indicative of expected loss separate from its core operating results in making its decisions. For discussion of the Company's fair value methodology, see Note 3 to the consolidated financial statements in Item 8.
The fair-value adjustments that have an impact on net income (loss) are shown in the table below:
Noteworthy Fair-Value Adjustments
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in millions)
|
||||||||||
Pre-tax: |
|||||||||||
Fair-value adjustments attributable to impairment charges in FP segment investment portfolio |
$ | (8,634.1 | ) | $ | (11.1 | ) | $ | | |||
Fair-value adjustments for credit derivatives in insured portfolio |
(745.0 | ) | (642.6 | ) | 31.8 | ||||||
Fair-value adjustments attributable to the Company's own credit risk on the Company's CPS |
100.0 | | | ||||||||
Fair-value adjustments attributable to the Company's own credit risk in FP segment debt portfolio |
1,377.2 | | | ||||||||
Fair-value adjustments for instruments with economically hedged risks(1) |
(149.0 | ) | (39.9 | ) | 62.3 |
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Fair-value adjustments attributable to impairment charges: OTTI securities must be written down to fair value through the income statement, regardless of management's estimate of economic loss. Economic loss is determined by the Company using cash flow models that project the present value of future expected shortfalls in principal and interest. Management views the economic component of impairment charges separate from the full negative fair-value adjustments. For 2008, on a pre-tax basis, the Company recorded $8,397.9 million in OTTI charges in the FP Investment Portfolio, of which $797.5 million represented estimated economic loss. In addition, the Company recorded $236.2 million in non-economic OTTI charges in the VIE Investments Portfolio. The 2008 FP and VIE Investment Portfolio OTTI charges were recognized to reflect Dexia's Purchase Agreement covenant to segregate or separate the Company's FP operations from the Company's financial guaranty operations and retain the FP segment, resulting in the Company's inability to hold the securities to maturity. At December 31, 2008, 72.2% of the FP Segment Investment Portfolio was categorized as Level 3 in the SFAS 157 fair value hierarchy, indicating the significance of unobservable inputs in determining fair value.
Fair-value adjustments for credit derivatives in the insured portfolio: Fair-value adjustments for credit derivatives in the insured portfolio include credit impairments representing estimated economic losses as well as non-economic fair-value adjustments expected to reverse to zero over time. In 2008, the Company estimated credit impairments of $152.4 million pre-tax. At December 31, 2008, the non-economic portion of fair-value adjustments for credit derivatives in the insured portfolio of $592.6 million had no effect on insurance company statutory equity or claims-paying resources, and rating agencies generally do not take these unrealized gains or losses into account for evaluating FSA's capital adequacy. At December 31, 2008, all of the credit derivatives in the insured portfolio were categorized as Level 3 in the SFAS 157 fair value hierarchy.
Fair-value adjustments attributable to the Company's own credit risk: Fair value measurement rules under SFAS No. 157, "Fair Value Measurements" ("SFAS 157") require the consideration of the Company's own credit risk. The effect of fair-value adjustments attributable to the Company's own credit risk is included in net income. In 2008, the Company's credit spread widened, leading to material unrealized gains on the FP segment debt and on the Company's committed preferred trust securities ("CPS"). At December 31, 2008, all FP segment debt at fair value and the CPS were categorized as Level 3 in the SFAS 157 fair value hierarchy.
Fair-value adjustments for instruments with economically hedged risks: The majority of the Company's economic hedges relate to FP segment interest rate derivatives used to convert the fixed interest rates of certain assets to dollar-denominated floating rates based on the London Interbank Offered Rate ("LIBOR"). Without hedge accounting or a fair-value option, SFAS 133 requires the marking to fair value of each such derivative in income without the offsetting mark to fair value on the risk it is intended to hedge. The one-sided valuations for economically hedged risks that do not qualify for hedge accounting and unhedged credit risk valuations for securities in the trading portfolio cause volatility in the consolidated statements of operations and comprehensive income. Management views fair-value adjustments on economically hedged risks together with the fair-value adjustments on the hedging items in order to analyze and manage hedge inefficiency, regardless of the prescribed accounting treatment. For assets within the trading portfolio, net income reflects both the economic effect of hedged economic risks related to interest and foreign exchange rates, and non-economic changes in fair value related to credit spreads. At December 31, 2008, the majority of derivative instruments were categorized as Level 3 in the SFAS 157 fair value hierarchy.
Prior to January 1, 2008, the Company elected to comply with the SFAS 133 documentation and testing requirements for certain liability hedging relationships and for none of the asset hedging relationships. Effective January 1, 2008, the Company elected the fair value option under SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"), for
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certain of its FP segment liabilities, which allowed for fair value accounting through current income without the onerous SFAS 133 requirements. On January 1, 2008, the Company elected to designate fair-value hedging for certain assets and derivatives qualifying for hedge accounting under SFAS 133.
The Company established a tax valuation allowance of $2.5 billion in 2008 against deferred tax assets attributable to FP segment net unrealized losses.
Book Value
Shareholders' equity under GAAP ("book value") was negative $5.2 billion at December 31, 2008, compared with positive $1.6 billion at December 31, 2007. The decline in 2008 was primarily the result of mark-to-market losses in the FP segment, losses incurred in the financial guaranty segment and negative fair-value adjustments for credit derivatives.
New Business Production
The Company employs the non-GAAP measure present value originations ("PV originations") to describe the economic value of the Company's new business originations in a given period. PV originations are the sum of the non-GAAP measures PV financial guaranty originations and PV net interest margin ("NIM") originated in the FP segment and represents the Company's measure of business production in a given period. PV financial guaranty originations, PV NIM originated and PV originations are based on estimates of, among other things, prepayment speeds of asset-backed securities. PV financial guaranty originations is a measure of gross origination activity and does not reflect premiums ceded to reinsurers or the cost of CDS or other credit protection, which may be considerable, employed by the Company to manage its credit exposures.
Present Value Financial Guaranty Originations
The GAAP measure "gross premiums written" captures financial guaranty premiums collected or accrued in a given period, whether collected for business originated in the period or in installments for business originated in prior periods. It is not a precise measure of current-period originations because a portion of the Company's premiums are collected in installments. Therefore, management calculates the non-GAAP measure PV financial guaranty originations as a measure of current-period premium production. To do so, management combines the following for business closed in the reporting period: (1) gross present value of premium and credit derivative fee installments and (2) premiums received upfront.
The Company's insurance policies, including credit derivatives, are generally non-cancelable and remain outstanding for years from date of inception, in some cases 30 years or longer. Accordingly, PV financial guaranty originations, as distinct from earned premium or realized gains (losses) on credit derivatives, represents amounts to be realized in the future.
Viewed at a policy level, installment premiums and credit derivative fees are generally calculated as a fixed premium rate multiplied by the estimated or expected insured debt outstanding as of dates established by the terms of the policy. Because the actual installment premiums and credit derivative fees received could vary from the amount estimated at the time of origination based on variances in the actual versus estimated outstanding debt balances and foreign exchange rate fluctuations, the realization of PV financial guaranty originations could be greater or less than the amount reported.
Installment premiums and credit derivative fees are not recorded in the financial statements until due, which is a function of the terms of each insurance policy. Future installment premiums and credit derivative fees are not captured in current-period premiums earned or premiums written, the most comparable GAAP measures. Management therefore uses PV premiums and credit derivative fees originated to measure current business production.
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PV financial guaranty originations reflects estimated future installment premiums and credit derivative fees discounted to their present value, as well as upfront premiums, with respect to business originated during the period. To calculate PV financial guaranty originations, management discounts an estimate of all future installment premium receipts. The Company calculates the discount rate for PV financial guaranty originations as the average pre-tax yield on its insurance investment portfolio for the previous three years. The estimated installment premium receipts are determined based on each installment policy's projected par balance outstanding multiplied by its premium rate. The Company's Transaction Oversight Groups estimate the relevant schedule of future par balances outstanding for each insurance policy with installment premiums. At the time of origination, projected debt schedules are generally based on good faith estimates developed and used by the parties negotiating the transaction.
Year-to-year comparisons of PV financial guaranty originations are affected by the application of a different discount rate each year. The discount rates employed by the Company for this purpose were 4.92%, 4.86%, and 5.07% for 2008, 2007 and 2006 originations, respectively.
For a reconciliation of gross premiums written to the non-GAAP measure PV Financial Guaranty Originations, see "Financial Guaranty SegmentPV Financial Guaranty Originations."
Present Value of Financial Products Net Interest Margin Originated
The FP segment produces NIM, which is a non-GAAP measure, rather than insurance premiums. Like installment premiums, PV NIM originated in a given period is expected to be earned and collected in future periods.
FP segment debt is issued at or converted into LIBOR-based floating rate obligations, with proceeds invested in or converted into LIBOR-based floating rate investments intended to result in profits from a higher investment rate than borrowing rate. FP NIM represents the difference between the current period investment revenue and borrowing cost, net of the economic effect of derivatives used to hedge interest rate and currency risk.
PV NIM originated represents the difference between the present value of estimated interest to be received on investments and the present value of estimated interest to be paid on liabilities issued by the FP segment, net of transaction expenses and the expected results of derivatives used to hedge interest rate risk. The Company's future positive interest rate spread estimate generally relates to contracts or security instruments that extend for multiple years.
Net interest income and net interest expense are reflected in the consolidated statements of operations and comprehensive income but are limited to current period earnings. As the GICs and the assets they fund extend beyond the current period, management considers the PV NIM originated to be a useful indicator of future FP NIM to be earned.
Originations
Total Originations
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||
|
(in millions)
|
|||||||||
Gross par insured |
$ | 50,973.2 | $ | 119,134.2 | $ | 93,780.7 | ||||
Gross PV originations |
663.1 | 1,271.0 | 910.2 |
In 2008, the disruption of credit markets and the bond insurance industry reduced FSA's opportunities in the global asset-backed and public infrastructure sectors and, in the second half, the U.S. public finance market, resulting in declines from 2007 to 2008 of 57.2% in gross par originated
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and 47.8% in PV originations. FSA withdrew from the asset-backed business after the first half of 2008. Additionally, FSA's domestic public finance production fell significantly in the second half due to the negative impact of rating agency actions. PV NIM was negative in 2008 primarily due to the Company curtailing FP asset acquisitions throughout the year to build liquidity. The Company also curtailed the issuance of new GICs in the asset-backed market in August 2008, and ceased issuing GICs in November 2008, in contemplation of the sale of the Company to Assured.
In 2007, PV originations rose to a record level of $1,271.0 million, an increase of 39.6% over that of the previous year, primarily due to increased FSA production in the international public infrastructure sector, a preference for FSA insurance over guarantees from other monolines in the fourth quarter of 2007 and wider credit spreads across FSA's financial guaranty markets, partially offset by a decline in FP originations due to the Company's decision to build liquidity in the fourth quarter.
For discussion of the changes in the components of PV originations, see "Financial Guaranty SegmentPV Financial Guaranty Originations" and "Financial Products SegmentPV NIM Originated."
Results of Operations
Financial Guaranty Segment
|
Year Ended December 31, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||||
|
(in millions)
|
||||||||||||
Net premiums earned in financial guaranty segment |
$ | 379.5 | $ | 322.3 | $ | 305.8 | |||||||
Net investment income from general investment portfolio |
264.2 | 236.7 | 218.9 | ||||||||||
Net realized gains (losses) from general investment portfolio |
(6.7 | ) | (1.9 | ) | (8.3 | ) | |||||||
Net change in fair value of credit derivatives: |
|||||||||||||
Realized gains (losses) and other settlements |
126.9 | 102.8 | 87.2 | ||||||||||
Net unrealized gains (losses) |
(745.0 | ) | (642.6 | ) | 31.8 | ||||||||
Net change in fair value of credit derivatives |
(618.1 | ) | (539.8 | ) | 119.0 | ||||||||
Net realized and unrealized gains (losses) on derivative instruments |
0.3 | 0.7 | 1.2 | ||||||||||
Net unrealized gains (losses) on financial instruments at fair value |
82.8 | | | ||||||||||
Income from assets acquired in refinancing transactions |
11.2 | 20.9 | 24.7 | ||||||||||
Net realized gains (losses) from assets acquired in refinancing transactions |
(4.3 | ) | 4.7 | 12.7 | |||||||||
Other income (loss) |
(28.1 | ) | 33.0 | 27.8 | |||||||||
Total Revenues |
80.8 | 76.6 | 701.8 | ||||||||||
Losses and loss adjustment expenses |
(1,877.7 | ) | (31.6 | ) | (23.3 | ) | |||||||
Interest expense |
(58.4 | ) | (62.7 | ) | (49.2 | ) | |||||||
Amortization of deferred acquisition costs |
(65.7 | ) | (63.4 | ) | (63.0 | ) | |||||||
Other operating expenses |
(53.5 | ) | (117.1 | ) | (101.6 | ) | |||||||
Total Expenses |
(2,055.3 | ) | (274.8 | ) | (237.1 | ) | |||||||
Income (loss) before income taxes and minority interest |
(1,974.5 | ) | (198.2 | ) | 464.7 | ||||||||
GAAP income to segment operating earnings adjustments(1) |
431.9 | 628.9 | (1.8 | ) | |||||||||
Pre-tax segment operating earnings (losses) |
$ | (1,542.6 | ) | $ | 430.7 | $ | 462.9 | ||||||
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The financial guaranty segment includes the results of operations of the insurance company subsidiaries as well as the results of operations related to holding company activities. The primary components of financial guaranty segment earnings are premiums, credit derivative fees, net investment income from the Company's portfolio of investments held by FSA, FSA Holdings and certain other subsidiaries (the "General Investment Portfolio") and income on assets acquired in refinancing transactions, offset by loss and loss adjustment expenses ("LAE"), interest expense on corporate debt and other operating expenses. In prior years, all credit derivative fees were recorded in premiums earned but have been reclassified to realized gains (losses) and other settlements to conform to the 2008 presentation. Management analyzes segment results on a pre-tax operating earnings basis.
2008 vs. 2007: In the financial guaranty segment, negative operating earnings for the year ended December 31, 2008 were due to increased loss expense driven by increased net RMBS loss estimates, as well as higher public finance losses, credit impairments on the Company's insured CDS and insured net interest margin securitizations ("NIMs") portfolio and realized losses related to its investment in Syncora Guarantee Re Ltd. ("SGR") (formerly XL Financial Assurance Ltd.) and investments in Lehman Brothers. Higher upfront premiums in the first half of 2008 and $804.3 million of 2008 capital contributions to the financial guaranty segment increased the General Investment Portfolio's invested asset balance, which increased net investment income. Premiums earned and realized gains (losses) of credit derivative fees, collectively, also increased.
2007 vs. 2006: In the financial guaranty segment, higher invested assets in the General Investment Portfolio, resulting partially from record premiums received in 2007, produced higher net investment income. New business originations also contributed to earned premiums. Refundings (net of amortization) were up 14%. Non-recurring realized foreign exchange gains accounted for a $10.6 million pre-tax increase year over year. These increases were offset, in part, by increased interest expense, loss expense and other operating expenses. Interest expense increased due to the issuance of $300 million in hybrid debt in the fourth quarter of 2006. Loss expense rose primarily due to an increase in the experience factor used in calculating the non-specific reserve and higher originations in the international public finance sector, which attract higher charges in the non-specific reserving methodology. Higher operating expenses were caused by higher compensation expenses, which vary with production and growth in the non-GAAP adjusted book value ("ABV"), and lower deferral rates.
Premiums Earned
Premiums Earned
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in millions)
|
||||||||||
Premiums earned, excluding refundings |
$ | 275.9 | $ | 264.6 | $ | 252.7 | |||||
Refundings and accelerations |
100.7 | 53.2 | 48.8 | ||||||||
Consolidated net premiums earned |
376.6 | 317.8 | 301.5 | ||||||||
Intersegment premiums |
2.9 | 4.5 | 4.3 | ||||||||
Net premiums earned in financial guaranty segment |
$ | 379.5 | $ | 322.3 | $ | 305.8 | |||||
Net premiums earned are broken down into two major categories: premiums earned on refundings and accelerations and premiums earned on new and recurring insured obligations. Refundings may vary significantly from year to year as they are affected by the interest rate environment. In periods of declining interest rates, issuers generally seek to refinance their obligations. In cases where an issuer defeases or calls an outstanding obligation insured by the Company, all unearned premiums are accelerated and recognized in current earnings. Accelerations also include premiums earned on ceded contracts that have been commuted or terminated.
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The Company ceased issuing financial guaranties on asset-backed securities in August 2008. For several years prior to then, the Company had limited its originations of asset-backed securities, primarily because tightening credit spreads and the competitive market environment had resulted in unattractive premium rates or credit quality that did not comply with the Company's underwriting guidelines. As transactions originated in earlier years matured, they were not replaced with the same volume of new originations, resulting in a decline in asset-backed earnings. At December 31, 2008, the asset-backed transactions in FSA's insured portfolio had an average life of approximately 4.0 years. As the Company has ceased insuring such transactions, premium earnings from insured asset-backed transactions will continue for several years, but will decline as the insured par runs off.
At the same time, public finance originations and premiums earned had steadily increased over the past several years. In the second half of 2008, however, the Company's new originations in the public finance sector were restricted due to the ratings changes in the second half of 2008, including Moody's downgrade of FSA's rating to Aa3, as well as a decline in market acceptance of financial guaranties.
The Company employs reinsurance to manage single-risk limits and maintain capacity to write new business. Due to the 2008 downgrades of certain reinsurers, the Company has and may continue to re-assume ceded exposure. In 2008, net premiums earned included $28.5 million resulting from commutations or cancellations of reinsurance contracts. This primarily resulted in a ratio of ceded premiums written to gross premiums written of 5% in 2008, compared to 38% in 2007 and 2006.
Geographic diversification has always been a risk management strategy for the financial guaranty segment, particularly in the public finance sector. Through 2007, the Company's growth area had been in international business, particularly public-private partnership transactions in the infrastructure sector and financings of water and other utility companies. These types of transactions serve to support the Company's future earnings for extended periods of time due to their long-dated maturities. The table below shows the amount of U.S. and international premiums earned based on geography of underlying risks.
Net Premiums Earned by Geographic Distribution
|
Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||
|
(in millions)
|
|||||||||||
Public Finance: |
||||||||||||
United States |
$ | 245.8 | $ | 186.9 | $ | 183.2 | ||||||
International |
58.1 | 36.7 | 27.1 | |||||||||
Total Public Finance |
303.9 | 223.6 | 210.3 | |||||||||
Asset-Backed Finance: |
||||||||||||
United States |
53.1 | 76.8 | 74.7 | |||||||||
International |
19.6 | 17.4 | 16.5 | |||||||||
Total Asset-Backed Finance |
72.7 | 94.2 | 91.2 | |||||||||
Total United States |
298.9 | 263.7 | 257.9 | |||||||||
Total International |
77.7 | 54.1 | 43.6 | |||||||||
Consolidated net premiums earned |
376.6 | 317.8 | 301.5 | |||||||||
Intersegment premiums |
2.9 | 4.5 | 4.3 | |||||||||
Net premiums earned in financial guaranty segment |
$ | 379.5 | $ | 322.3 | $ | 305.8 | ||||||
74
Net Investment Income and Realized Gains (Losses) from General Investment Portfolio
Premium collections are invested in the General Investment Portfolio, which consists primarily of municipal tax-exempt bonds. The Company's invested balances have increased since prior year-end as a result of higher upfront premium originations (which occurred primarily in the first half of 2008), and capital contributions from Dexia Holdings in 2008, which increased net investment income. These increases were partially offset by claim payments during the year and a decrease in book yield as the Company accumulated short-term liquidity throughout the year. The Company's year-to-date effective tax rate on investment income (excluding the effects of realized gains and losses) was 12.7%, 12.4%, and 12.2% for 2008, 2007 and 2006, respectively.
In 2008, the Company had net realized losses of $6.7 million, which included a $36.1 million loss on the sale of its investment in SGR preferred stock and an OTTI charge of $6.0 million for several municipal bonds, offset in part by realized gains on sales of assets. Realized losses from the General Investment Portfolio were $1.9 million in 2007 and $8.3 million in 2006.
The following table sets forth certain information concerning the securities in the Company's General Investment Portfolio based on amortized cost and fair value.
General Investment Portfolio
|
At December 31, | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||||||||
|
Amortized
Cost |
Weighted
Average Yield(1) |
Fair
Value |
Amortized
Cost |
Weighted
Average Yield(1) |
Fair
Value |
||||||||||||||
|
(dollars in millions)
|
|||||||||||||||||||
Taxable bonds |
$ | 1,259.4 | 4.75 | % | $ | 1,226.3 | $ | 971.1 | 5.27 | % | $ | 990.0 | ||||||||
Tax-exempt bonds |
4,139.4 | 4.83 | 4,056.9 | 3,920.5 | 4.84 | 4,064.6 | ||||||||||||||
Short-term investments |
651.1 | 0.38 | 651.9 | 96.3 | 4.18 | 97.4 | ||||||||||||||
Equity securities |
1.4 | 0.4 | 40.0 | 39.9 | ||||||||||||||||
Total General Investment Portfolio |
$ | 6,051.3 | $ | 5,935.5 | $ | 5,027.9 | $ | 5,191.9 | ||||||||||||
Fair Value of Credit Derivatives
Prior to ceasing to insure asset-backed securities in August 2008, the Company sold credit protection by insuring CDS contracts under which special purpose entities or other parties provided credit protection to various financial institutions. In certain cases the Company acquired back-to-back credit protection on all or a portion of the risk written, primarily by reinsuring its CDS guaranties. Management viewed these CDS contracts as part of its financial guarantee business, under which the Company generally intends to hold its written and purchased positions for the entire term of the related contracts. These CDS contracts are accounted for at fair value since they do not qualify for the financial guarantee scope exception under SFAS 133.
In consultation with the Securities and Exchange Commission (the "SEC"), members of the financial guaranty industry have collaborated to develop a presentation of credit derivatives issued by financial guaranty insurers that is more consistent with that of non-insurers. The tables below illustrate the current required presentation with prior period balances reclassified to conform to the current presentation. The reclassifications do not affect net income or equity, although they do affect various revenue, asset and liability line items. Changes in fair value are recorded in "net change in fair value of credit derivatives" in the consolidated statements of operations and comprehensive income. The "realized gains (losses) and other settlements" component of this income statement line includes premiums received and receivable on written CDS contracts and premiums paid and payable on
75
purchased contracts. If a credit event occurred that required a payment under the contract terms, this line item would also include losses paid and payable to CDS contract counterparties due to the credit event and losses recovered and recoverable on purchased contracts.
The Company's insured portfolio includes other contracts accounted for as derivatives, including (a) insured interest rate swaps entered into by the issuer in connection with the issuance of certain public finance obligations ("IR swaps") and (b) insured NIM securitizations and other financial guaranty contracts that guarantee risks other than credit risk, such as interest rate basis risk, issued after January 1, 2007 ("FG contracts with embedded derivatives").
The components of the net change in the fair value of credit derivatives are shown in the table below:
Summary of the Net Change in the Fair Value of Credit Derivatives
|
Year Ended December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||||||
|
(in millions)
|
|||||||||||||||
Net change in fair value of credit derivatives: |
||||||||||||||||
Realized gains (losses) and other settlements(1) |
$ | 126.9 | $ | 102.8 | $ | 87.2 | ||||||||||
Net unrealized gains (losses): |
||||||||||||||||
CDS: |
||||||||||||||||
Pooled corporate CDS: |
||||||||||||||||
Investment grade |
(165.3 | ) | (159.7 | ) | 21.0 | |||||||||||
High yield |
(242.3 | ) | (151.8 | ) | 8.1 | |||||||||||
Total pooled corporate CDS |
(407.6 | ) | (311.5 | ) | 29.1 | |||||||||||
Funded CLOs and CDOs |
(226.5 | ) | (288.8 | ) | (0.0 | ) | ||||||||||
Other structured obligations |
(78.0 | ) | (35.5 | ) | 1.9 | |||||||||||
Total CDS |
(712.1 | ) | (635.8 | ) | 31.0 | |||||||||||
IR swaps and FG contracts with embedded derivatives |
(32.9 | ) | (6.8 | ) | 0.8 | |||||||||||
Subtotal |
(745.0 | ) | (642.6 | ) | 31.8 | |||||||||||
Net change in fair value of credit derivatives |
$ | (618.1 | ) | $ | (539.8 | ) | $ | 119.0 | ||||||||
Considerable judgment is necessary to interpret the data to develop the estimates of fair value. Under the SFAS 157 fair value hierarchy, all credit derivative valuations are categorized as Level 3. (For a description of the SFAS 157 fair value hierarchy, see Note 3 to the consolidated financial statements in Item 8.) Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair-value amounts.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 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 CDS contracts because these contracts are not traded, then the determination of fair value is based on internally developed estimates. The Company's methodology for estimating the fair value of a CDS contract incorporates all the remaining future premiums to be received over the life of the CDS contract, discounted to present value using the current LIBOR swap rate, which conforms to market practice, and multiplied by the ratio of the current exit value premium to the contractual premium. The estimation of the current exit value premium is derived using a unique
76
credit-spread algorithm for each defined CDS category that utilizes various publicly available credit indices, depending on the types of assets referenced by the 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, if available, performance of underlying assets, changes in internal credit assessments or rating agency-based shadow ratings, and 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. For more information regarding the Company's valuation process, see "Credit Derivatives in the Insured Portfolio" in Note 3 to the consolidated financial statements in Item 8.
As the fair value of a CDS contract incorporates all the remaining future payments to be received over the life of the CDS contract, the fair value of that contract will change, in part, solely from the passage of time as fees are received. Absent any claims under the contract, any "losses" recorded in marking the contract to fair value will be reversed by an equivalent "gain" at or prior to the expiration of the contract, and any "gain" recorded will be reversed by an equivalent "loss" over the remaining life of the transaction, with the cumulative changes in the fair value of the CDS summing to zero by the time of each contract's maturity. Unrealized fair-value adjustments for credit derivatives, except for estimates of economic losses, have no effect on operations, liquidity or capital resources.
Unrealized Gains (Losses) of Credit Derivatives Portfolio(1)
|
At December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||
|
(in millions)
|
|||||||||
Pooled corporate CDS: |
||||||||||
Investment grade |
$ | (256.0 | ) | $ | (116.2 | ) | ||||
High yield(2) |
(374.2 | ) | (144.4 | ) | ||||||
Total pooled corporate CDS |
(630.2 | ) | (260.6 | ) | ||||||
Funded CLOs and CDOs |
(478.9 | ) | (263.4 | ) | ||||||
Other structured obligations(2) |
(108.9 | ) | (33.0 | ) | ||||||
Total CDS |
(1,218.0 | ) | (557.0 | ) | ||||||
IR swaps and FG contracts with embedded derivatives(2) |
(38.4 | ) | (6.0 | ) | ||||||
Total net credit derivatives |
$ | (1,256.4 | ) | $ | (563.0 | ) | ||||
The negative fair-value adjustments over the past two years were a result of widening credit spreads in the underlying CDS portfolio and, in 2008, were offset in part by the positive income effects of the Company's own credit spread widening as reflected in the non-collateral posting factor. Despite the structural protections associated with the Company's CDS, the widening of credit spreads on pooled corporate CDS and funded CDOs and collateralized loan obligations ("CLOs"), as with other structured credit products, resulted in a decline in the fair value of these contracts compared with December 31, 2007.
The Company's typical CDS contract is different from CDS contracts entered into by parties that are not financial guarantors because:
77
written with the intent to provide protection for the stated duration of the contract, similar to the Company's intent with regard to a financial guaranty contract.
Credit derivatives in the asset-backed portfolio represent 71.2% of total asset-backed par outstanding. The Company has grouped CDS contracts by major category of underlying instrument for purposes of internal risk management and external reporting. The tables below summarize the credit rating, net par outstanding and remaining weighted-average life ("WAL") for the primary components of the Company's CDS portfolio.
Selected Information for CDS Portfolio
|
At December 31, 2008 | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Credit Ratings |
|
|
|||||||||||||||||||||
|
|
Remaining
Weighted Average Life |
||||||||||||||||||||||
|
Triple-A*(1) | Triple-A | Double-A |
Other
Investment Grades(2) |
Below
Investment Grade(3) |
Net Par
Outstanding(4) |
||||||||||||||||||
|
|
|
|
|
|
(in millions)
|
(in years)
|
|||||||||||||||||
Pooled Corporate CDS: |
||||||||||||||||||||||||
Investment grade |
100 | % | | % | | % | | % | | % | $ | 17,464 | 4.1 | |||||||||||
High yield |
41 | 54 | | | 5 | 15,467 | 2.4 | |||||||||||||||||
Funded CDOs and CLOs |
27 | 65 | (5) | 7 | 1 | | 31,681 | 2.6 | ||||||||||||||||
Other structured obligations(6) |
53 | 11 | (5) | 8 | 27 | 1 | 8,272 | 2.6 | ||||||||||||||||
Total |
50 | 41 | 4 | 4 | 1 | $ | 72,884 | 2.9 | ||||||||||||||||
|
At December 31, 2007 | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Credit Ratings |
|
|
|||||||||||||||||||||
|
|
Remaining
Weighted Average Life |
||||||||||||||||||||||
|
Triple-A*(1) | Triple-A | Double-A |
Other
Investment Grades(2) |
Below
Investment Grade |
Net Par
Outstanding(4) |
||||||||||||||||||
|
|
|
|
|
|
(in millions)
|
(in years)
|
|||||||||||||||||
Pooled Corporate CDS: |
||||||||||||||||||||||||
Investment grade |
91 | % | 1 | % | 8 | % | | % | | % | $ | 22,883 | 4.1 | |||||||||||
High yield |
95 | | | 5 | | 14,765 | 3.3 | |||||||||||||||||
Funded CDOs and CLOs |
28 | 72 | (5) | | | | 33,000 | 3.4 | ||||||||||||||||
Other structured obligations(6) |
62 | 36 | (5) | 1 | 1 | | 13,529 | 2.1 | ||||||||||||||||
Total |
62 | 34 | 3 | 1 | | $ | 84,177 | 3.4 | ||||||||||||||||
78
For the sensitivity of CDS contracts that would result from an increase of one basis point in market credit spreads, see "Item 7A. Quantitative and Qualitative Disclosures About Market RiskInsured PortfolioCredit Default Swaps."
Net Unrealized Gains (Losses) on Financial Instruments at Fair Value
Beginning January 1, 2008, the Company, in accordance with SFAS 159, elected to apply the fair-value option to certain assets acquired in refinancing transactions. The adjustment to retained earnings at January 1, 2008 was negative $1.6 million after-tax. The change in the fair value was negative $17.2 million for 2008. The fair-value option was elected in order to offset the fair-value adjustment on derivatives hedging interest rate risk of these refinancing assets with the corresponding fair-value adjustment on the hedged assets in income. The change in fair-value of the Company's CPS was $100.0 million for 2008 and was primarily due to widening FSA credit spreads during the year.
Considerable judgment is necessary to interpret the data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair-value amounts.
Income from Assets Acquired in Refinancing Transactions
Where the Company refinanced underperforming insured obligations, the underlying assets or obligations are carried on the consolidated financial statements and contribute income. The Company manages or sells such assets in order to maximize recoveries. The Company has not refinanced a transaction since 2004, and the related assets have either been sold or continue to run off. Therefore the income contribution of these assets has been declining since 2005.
Other Income
Other income includes income and fair-value adjustments on assets held in respect of the Company's deferred compensation plans ("DCP") and supplemental executive retirement plans ("SERP"), foreign exchange gains or losses and other miscellaneous income items.
Other Income
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in millions)
|
||||||||||
DCP and SERP interest income |
$ | 1.4 | $ | 12.5 | $ | 9.1 | |||||
DCP and SERP asset fair-value gain (loss) |
(38.9 | ) | (6.4 | ) | 5.3 | ||||||
Realized foreign exchange gain (loss) |
(3.6 | ) | 13.4 | 2.9 | |||||||
Commutation gain |
20.1 | | | ||||||||
Other |
9.1 | 13.3 | 12.0 | ||||||||
Subtotal |
(11.9 | ) | 32.8 | 29.3 | |||||||
Intersegment income (loss) |
(16.2 | ) | 0.2 | (1.5 | ) | ||||||
Total |
$ | (28.1 | ) | $ | 33.0 | $ | 27.8 | ||||
79
DCP and SERP assets are held to defease the Company's plan obligations and the changes in fair value may vary significantly from period to period. Increases or decreases in the fair value of the assets are primarily offset by like changes in the fair value of the related liability, which are recorded in other operating expenses.
Losses
The following table shows activity in the liability for losses and loss adjustment expense reserves, which consist of case and non-specific reserves. For a description of the Company's policies regarding case and non-specific reserves, see Note 2 and Note 9 to the consolidated financial statements in Item 8.
Reconciliation of Net Losses and Loss Adjustment Expenses
|
Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||
|
(in millions)
|
|||||||||||
Case Reserve Activity: |
||||||||||||
Gross balance at January 1 |
$ | 174.6 | $ | 90.3 | $ | 90.0 | ||||||
Less reinsurance recoverable |
76.5 | 37.3 | 36.3 | |||||||||
Net balance at January 1 |
98.1 | 53.0 | 53.7 | |||||||||
Transfer from non-specific reserve |
1,823.2 | 69.4 | 1.2 | |||||||||
Paid (net of recoveries) related to: |
||||||||||||
Current year recovery (paid) |
16.7 | (8.3 | ) | | ||||||||
Prior year |
(615.6 | ) | (16.0 | ) | (1.9 | ) | ||||||
Total paid |
(598.9 | ) | (24.3 | ) | (1.9 | ) | ||||||
Net balance at December 31 |
1,322.4 | 98.1 | 53.0 | |||||||||
Plus reinsurance recoverable |
284.0 | 76.5 | 37.3 | |||||||||
Gross balance at December 31 |
1,606.4 | 174.6 | 90.3 | |||||||||
Non-Specific Reserve Activity: |
||||||||||||
Gross balance at January 1 |
100.0 | 137.8 | 115.7 | |||||||||
Provision for losses |
||||||||||||
Current year |
1.3 | 25.8 | 17.8 | |||||||||
Prior year |
1,876.4 | 5.8 | 5.5 | |||||||||
Transfers to case reserves |
(1,823.2 | ) | (69.4 | ) | (1.2 | ) | ||||||
Net balance at December 31 |
154.5 | 100.0 | 137.8 | |||||||||
Plus reinsurance recoverable |
18.1 | | | |||||||||
Gross balance at December 31 |
172.6 | 100.0 | 137.8 | |||||||||
Total gross case and non-specific reserves |
$ | 1,779.0 | $ | 274.6 | $ | 228.1 | ||||||
Losses and loss adjustment expenses increased considerably in 2008 compared to 2007, primarily as a result of an increase in estimated ultimate losses on insured RMBS transactions and on a public finance transaction. Loss expense for 2007 and 2006 was relatively flat.
The increase in losses paid is driven primarily by payments on HELOC transactions. Generally, once the overcollateralization is exhausted on an insured HELOC transaction, the Company pays a claim if losses in a period exceed spread for the period, and, to the extent spread exceeds losses, the Company is reimbursed for any losses paid to date. In 2008, the Company paid net claims on HELOCs of $577.7 million. This brought the inception to date net claim payments on HELOC transactions to
80
$625.3 million. There were no claims paid on most other classes of insured transactions through December 31, 2008. Most claim payments on Alt-A closed end second lien mortgage securities ("CES") are not payable until 2037 or later. Option adjustable rate mortgage loan ("Option ARM") claim payments are expected to occur between 2010 and 2012.
The following table shows the gross and net par outstanding on transactions with case reserves, the gross and net case reserves recorded and the number of transactions comprising case reserves. In addition to case reserves in the following tables, the Company recorded net non-specific reserves of $154.5 million at December 31, 2008 and $100.0 million at December 31, 2007.
Case Reserve Summary
|
At December 31, 2008 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Par
Outstanding |
Net Par
Outstanding |
Gross Case
Reserve |
Net Case
Reserve |
Number of
Risks |
||||||||||||
|
(dollars in millions)
|
||||||||||||||||
Asset-backedHELOCs |
$ | 4,833.0 | $ | 3,853.8 | $ | 745.8 | $ | 593.8 | 10 | ||||||||
Asset-backedAlt-A CES |
999.5 | 954.3 | 245.7 | 234.1 | 5 | ||||||||||||
Asset-backedOption ARM |
1,674.7 | 1,587.2 | 282.1 | 260.6 | 9 | ||||||||||||
Asset-backedAlt-A first lien |
1,226.5 | 1,122.3 | 106.5 | 96.3 | 10 | ||||||||||||
Asset-backedNIMs |
90.1 | 85.3 | 16.0 | 15.8 | 3 | ||||||||||||
Asset-backedSubprime |
298.5 | 280.1 | 24.5 | 20.8 | 5 | ||||||||||||
Asset-backedother |
54.5 | 51.0 | 13.7 | 12.9 | 3 | ||||||||||||
Public finance |
1,238.8 | 698.7 | 172.1 | 88.1 | 6 | ||||||||||||
Total |
$ | 10,415.6 | $ | 8,632.7 | $ | 1,606.4 | $ | 1,322.4 | 51 | ||||||||
|
At December 31, 2007 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Par
Outstanding |
Net Par
Outstanding |
Gross Case
Reserve(1) |
Net Case
Reserve(1) |
Number of
Risks |
||||||||||||
|
(dollars in millions)
|
||||||||||||||||
Asset-backedHELOCs |
$ | 1,803.3 | $ | 1,442.7 | $ | 69.6 | $ | 56.9 | 5 | ||||||||
Asset-backedSubprime |
22.3 | 18.3 | 3.4 | 1.6 | 2 | ||||||||||||
Asset-backedother |
24.9 | 22.2 | 4.9 | 4.7 | 2 | ||||||||||||
Public finance |
1,164.3 | 560.6 | 96.7 | 34.9 | 4 | ||||||||||||
Total |
$ | 3,014.8 | $ | 2,043.8 | $ | 174.6 | $ | 98.1 | 13 | ||||||||
The table below presents certain assumptions inherent in the calculations of the case and non-specific reserves:
Case and Non-Specific Reserves Assumptions
|
At December 31, | |||
---|---|---|---|---|
|
2008 | 2007 | ||
Case reserve discount rate |
1.90%-5.90% | 3.13%-5.90% | ||
Non-specific reserve discount rate |
6.00% | 1.20%-7.95% | ||
Current experience factor |
18.5 | 2.0 |
Since case and non-specific reserves are based on estimates, there can be no assurance that the ultimate liability will not differ from such estimates. The Company will continue, on an ongoing basis,
81
to monitor these reserves and may periodically adjust such reserves, upward or downward, based on the Company's revised estimate of loss, its actual loss experience, mix of business and economic conditions.
In 2008, loss and loss adjustment expense was $1,877.7 million. The increase for the twelve month period was driven primarily by deteriorating credit performance in HELOCs, Alt-A CES, Option ARMs, Alt-A first lien and public finance transactions. In addition, the non-specific reserves increased by $54.5 million in 2008.
Risks Most Sensitive to Loss in the Insured Portfolio
In a volatile mortgage market, future HELOC reserves or actual future losses could vary from the current estimate of loss. In particular, the deterministic models used to establish case reserves for HELOCs are affected by multiple variables, including default rates, the rates at which new borrowings ("draws") under the HELOCs are funded, prepayment rates, recovery rates and the spread between LIBOR and Prime interest rates. Given that draw rates have reduced, management believes the key determinants of future loss are (a) default rates and (b) recoveries based on originator representations and warranties.
In setting its HELOC reserves, management applied recent "roll rates" from the transactions for which they were available to current delinquency amounts in order to project losses for the next five months, then assumed the resulting calculated conditional default rate would remain constant for a period (or plateau) of another four months (through September 2009). After September 2009, management assumes the conditional default rate decreases linearly over 12 months to the "normal" conditional default rate, defined as the constant conditional default rate the transaction would have achieved had it experienced the prepayment rate, draw rate and lifetime losses expected at closing. Should future default rates be different than those projected by management, actual losses could be more or less than projected. For example, retaining the same shape of the projected default curve, and all other assumptions remaining the same, but extending the plateau initially results in increased net PV losses of approximately $70 million for each month the plateau is extended. The estimated net PV losses per month decline over time as exposure runs off.
The Company has had vendors reviewing loan files for several months, and believes many of the defaulted HELOC loans are subject to repurchase under the governing documents. Actual recoveries on representations and warranties, if any, may vary from the Company's estimates and are dependent on, among other things, the ability of the provider of the representations and warranties to pay, the strength of the actual representations and warranties and the facts supporting the representation and warranty breaches as well as the expenses the Company incurs pursuing recovery.
In a volatile mortgage market, future Alt-A (or near-prime) CES reserves or actual future losses could vary from the current estimate of loss. In particular, the deterministic models used to establish case reserves for Alt-A CES are affected by multiple variables, including default rates, prepayment rates and recovery rates. Management believes the key determinant of loss is the default rate. In setting its Alt-A reserves, management applied recent "roll rates" from the transactions for which they were available to current delinquency amounts in order to project losses for the next five months, then assumed the resulting conditional default rate would remain constant for a period of another four months (through September), then decreased the conditional default rate linearly over 12 months to the "normal" conditional default rate. Should future default rates be different than those projected by management, actual losses could be more or less than projected. For example, retaining the same shape of the projected default curve but extending the plateau, and keeping all other assumptions the same, results in increased net PV losses of approximately $8 million for each month the plateau is extended.
Management's estimation of losses in the HELOC and Alt-A CES portfolios assumes that peak loss rates in these products will continue through September 2009 and that the market conditions and borrower behavior will return to normal by September 2010 and/or that homeowners who have
82
successfully made their loan payments for two years or more will default at more normalized or expected rates. If the market gets materially worse or does not recover as anticipated, or if the performance of the loans in the loss transactions does not improve with the U.S. residential market, management may need to allocate additional amounts from its non-specific loss reserve to its case reserves, or add to its non-specific reserve, to cover the projected performance of HELOCs and/or Alt-A CES.
In a volatile mortgage market, future Option ARM and Alt-A first lien actual losses could vary from the current estimate of loss. In particular, the deterministic models used to establish case reserves for Option ARM and Alt-A first lien reserves are affected by multiple variables, including default rates, prepayment rates and recovery rates. Management believes the key determinants of loss are default rates and recovery rates. Management applied liquidation rates to current delinquency amounts to calculate a conditional default rate for the next 18 months, then assumed that peak would extend another three months through September 2010, and decline thereafter. Should future default or severity rates be different than those projected by management, actual losses could be more or less than projected. For example, retaining the same shape of the projected default curve, and all other assumptions remaining the same, but extending the plateau initially results in increased net PV losses of approximately $38 million for each month the plateau is extended.
Management's estimation of losses in the Option ARM and Alt-A first lien portfolio assumes that peak loss rates (which take longer to generate losses than a second lien product) will continue through September 2010 and return to normal in September 2011 and/or that homeowners who have successfully made their loan payments for three to four years will default at more normalized rates or rates expected at time of origination.
Management notes that some analysts believe conditional default rates in Option ARM pools will increase at about the time the monthly loan payments are recalculated to cover principal not paid or added to the loan during periods when the borrower was making the minimum payment. However, management was unaware of any basis for projecting this effect, and notes that many of these borrowers are or will be eligible for mortgage relief programs being implemented by the government and servicers, so management chose not to model an additional stress for this factor.
The estimation of losses for MBS transactions are sensitive to the rate at which performing loans are assumed to prepay (i.e., voluntary prepayment rate), because in most MBS structures at least some of the protection is provided by excess spread, which depends on the size and average life of the collateral pool. In these structures, lower prepayment rates increase the amount of projected excess spread and so reduce projected losses. (For a few of the insured MBS structures that do not depend on excess spread, lower prepayments increase the amount of projected reserves.) Until the third quarter of 2008, management assumed recently experienced prepayment rates would continue for the life of the transactions. During the third quarter, prepayment rates fell to very low levels, which management does not believe will be sustained for the life of the transactions. Management believes that the low prepayment rates are another manifestation of the same mortgage market dislocation that is causing high default rates, so in 2008, it adopted a new prepayment assumption on all of its MBS projections. Recent low prepayment rates are assumed to continue during the same period as peak default rates are assumed to extend, then to gradually increase to 15%. Over the same 12 months the conditional default rates are assumed to decrease. Should future prepayment rates be more or less than those projected by management, actual losses could be more or less than projected.
Various governmental bodies have undertaken various initiatives to address dislocations in the residential real estate financing market. Should such initiatives have material effects on the performance of the mortgage loans underlying the various residential mortgage securitizations insured by the Company, the Company may revise or amend its projections and actual losses could be more or less than currently projected.
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FSA has $151.8 million net par exposure of the $3.2 billion sewer debt of Jefferson County, Alabama. FSA also provides a surety in the net par amount of $12.8 million. FSA had a $48.3 million case reserve for Jefferson County at December 31, 2008 due to the repeated failure of the County to restructure its sewer debt to alleviate high interest rates and avoid bank bond acceleration. Jefferson County is a unique municipal situation and not, in the Company's view, part of a larger trend for the following reasons: (1) 94% of Jefferson County's debt is in the form of Variable Rate Demand Obligations ("VRDOs") and Auction Rate Securities ("ARS"); (2) the market for ARS collapsed in the first quarter of 2008 due to general market illiquidity and an unexpectedly large increase in interest rates on the County's debt caused by the downgrade of its two primary bond insurers; (3) it is highly leveraged with $3.2 billion of debt and high user charges; and (4) the sewer debt structure includes over $5 billion of interest rate swaps. FSA is working with Jefferson County and its bankers and advisors on a solution to the county sewer system's debt situation, but the resolution remains uncertain.
FSA management believes that the liability it carries for losses and loss expenses is adequate to cover the net cost of claims. However, the loss liability is based on assumptions regarding the insured portfolio's probability of default and its severity of loss, and there can be no assurance that the liability for losses will not exceed such estimates.
Interest Expense
Interest expense in the financial guaranty segment represents interest on corporate debt and intersegment interest on notes payable to GIC Subsidiaries related to the funding of the refinancing transactions. The table below shows the composition of the interest expense. The decrease in interest expense in 2008 was primarily due to the declining balance of notes payable, which were used to fund the purchases of assets acquired in refinancing transactions and therefore are paid down in proportion to asset paydowns. The increase in interest expense in 2007 was primarily due to the issuance of $300 million in hybrid debt in the fourth quarter of 2006.
Financial Guaranty Segment Interest Expense
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in millions)
|
||||||||||
Hybrid debt |
$ | 19.3 | $ | 19.3 | $ | 2.1 | |||||
Other corporate debt |
27.0 | 27.0 | 27.0 | ||||||||
Total consolidated interest expense |
46.3 | 46.3 | 29.1 | ||||||||
Intersegment debt |
12.1 | 16.4 | 20.1 | ||||||||
Total financial guaranty segment interest expense |
$ | 58.4 | $ | 62.7 | $ | 49.2 | |||||
PV Financial Guaranty Originations
The GAAP measure "gross premiums written" captures financial guaranty premiums collected or accrued in a given period, whether collected for business originated in the period or in installments for business originated in prior periods. It is not a precise measure of current-period originations because a portion of the Company's premiums are collected in installments. Therefore, management calculates the non-GAAP measure "PV financial guaranty originations" as a measure of current-period premium and credit derivative fee production.
84
The following table reconciles gross premiums written to PV financial guaranty originations.
Reconciliation of Gross Premiums Written to Non-GAAP PV
Financial Guaranty Originations
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||
|
(in millions)
|
|||||||||
Gross premiums written |
$ | 690.4 | $ | 720.3 | $ | 717.0 | ||||
Gross installment premiums received |
(132.1 | ) | (163.4 | ) | (143.3 | ) | ||||
Gross upfront premiums originated |
558.3 | 556.9 | 573.7 | |||||||
Gross PV estimated installment premiums originated |
43.3 | 526.0 | 158.2 | |||||||
Gross PV premiums originated |
601.6 | 1,082.9 | 731.9 | |||||||
Gross PV credit derivative fees originated |
62.8 | 100.2 | 57.8 | |||||||
Gross PV financial guaranty originations |
$ | 664.4 | $ | 1,183.1 | $ | 789.7 | ||||
The following table shows gross par and PV premiums originated.
Financial Guaranty Originations(1)
|
Gross Par Originated |
Gross PV Financial Guaranty
Originations |
|||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||
|
2008 | 2007 | 2006 | 2008 | 2007 | 2006 | |||||||||||||||
|
(in millions)
|
||||||||||||||||||||
United States: |
|||||||||||||||||||||
Public Finance |
$ | 46,732.1 | $ | 56,949.3 | $ | 46,448.2 | $ | 531.3 | $ | 388.2 | $ | 309.6 | |||||||||
Asset-backed |
2,374.0 | 39,759.1 | 28,205.3 | 58.5 | 307.3 | 109.6 | |||||||||||||||
Total United States |
49,106.1 | 96,708.4 | 74,653.5 | 589.8 | 695.5 | 419.2 | |||||||||||||||
International: |
|||||||||||||||||||||
Public Finance |
1,342.2 | 13,871.1 | 10,338.3 | 50.4 | 423.9 | 328.8 | |||||||||||||||
Asset-backed |
524.9 | 8,554.7 | 8,788.9 | 24.2 | 63.7 | 41.7 | |||||||||||||||
Total International |
1,867.1 | 22,425.8 | 19,127.2 | 74.6 | 487.6 | 370.5 | |||||||||||||||
Total financial guaranty originations |
$ | 50,973.2 | $ | 119,134.2 | $ | 93,780.7 | $ | 664.4 | $ | 1,183.1 | $ | 789.7 | |||||||||
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The following table represents the ratings distribution at origination.
Financial Guaranty Originations by Rating(1)
|
Year Ended December 31, 2008 | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Public Finance
Obligations |
Asset-Backed
Obligations |
|||||||||||||
|
Gross Par
Originated |
% of Total |
Gross Par
Originated |
% of Total | |||||||||||
|
(dollars in millions)
|
||||||||||||||
United States: |
|||||||||||||||
Triple-A |
$ | 6,384.8 | 13 | % | $ | 1,330.1 | 46 | % | |||||||
Double-A |
12,718.4 | 26 | | | |||||||||||
Single-A |
25,911.4 | 54 | 1,043.9 | 36 | |||||||||||
Triple-B |
1,717.5 | 4 | | | |||||||||||
Total United States |
46,732.1 | 97 | 2,374.0 | 82 | |||||||||||
International: |
|||||||||||||||
Triple-A |
64.9 | 0 | 524.9 | 18 | |||||||||||
Double-A |
38.0 | 0 | | | |||||||||||
Single-A |
720.9 | 2 | | | |||||||||||
Triple-B |
518.4 | 1 | | | |||||||||||
Total International |
1,342.2 | 3 | 524.9 | 18 | |||||||||||
Total financial guaranty originations |
$ | 48,074.3 | 100 | % | $ | 2,898.9 | 100 | % | |||||||
In 2008, estimated U.S. municipal market volume of $391.5 billion was 9% lower than in 2007. After a slow start due to illiquidity in the ARS market, municipal issuance rose significantly in the second quarter as a high volume of ARS were refinanced. However, volume fell off over the course of the second half as the cost of borrowing increased in response to the global credit contraction. In 2007, estimated U.S. municipal market volume of $429.0 billion was 10% higher than in 2006 and the highest market volume on record.
Insurance penetration of the market for new U.S. municipal bonds sold in 2008 was approximately 17%, compared with 47% in 2007 and 49% in 2006. FSA's share of the insured par sold was approximately 54% in 2008, compared with 25% in 2007 and 24% in 2006. However, both insurance penetration and FSA's market share were significantly higher in the first half of 2008 than in the second.
On a closing-date basis for 2008 over 2007, including both primary- and secondary-market U.S. public finance transactions, FSA's par amount originated decreased 18%, but PV premiums originated increased 37% due to a more favorable credit spread environment and a market preference for FSA insurance during the first half of the year. Of the total amounts for 2008, 85% of par insured and 88% of PV originations were originated during the first half of 2008. The ratings actions in the second half of 2008, including Moody's downgrade of FSA's rating from Aaa to Aa3, contributed to a marked reduction in FSA's second-half production.
For 2007 compared with 2006, U.S. municipal par insured increased 23%, and PV premiums originated increased 25%. During the first nine months of 2007, the pricing environment was more competitive, and FSA generally focused on higher quality core sectors, such as general obligations, where more attractive relative returns were available. During the fourth quarter of 2007, FSA significantly increased its market share and premium rates based on wider credit spreads and a preference for FSA bond insurance.
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In international public finance markets, where liquidity was constrained all year, FSA's 2008 production decreased 90% in par insured and 88% in PV originations from 2007 levels. For 2007 compared with 2006, international public finance par originated increased 34%, and PV premiums originated increased 29% to a record $423 million, driven by a significant number of large transactions in diverse sectors, such as transportation, health care and utilities. Results in the international public finance sector tend to be irregular because of the timing of large transactions with long development periods.
Global asset-backed originations declined significantly in 2008 compared with 2007 and 2006, primarily because of the Company's decision to cease issuing financial guarantees for asset-backed obligations.
Insured Portfolio Summary
A summary of FSA's insured portfolio and distribution of ratings at December 31, 2008 is shown below. Exposure amounts are expressed net of quota share, first-loss and excess-of-loss reinsurance.
Summary of Insured Portfolio by Obligation Type
|
At December 31, 2008 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Number
of Risks |
Net Par
Outstanding |
Net Par
and Interest Outstanding |
||||||||||
|
(dollars in millions)
|
||||||||||||
Public finance obligations |
|||||||||||||
Domestic obligations |
|||||||||||||
General obligation |
7,603 | $ | 125,063 | $ | 187,829 | ||||||||
Tax-supported |
1,259 | 55,321 | 87,120 | ||||||||||
Municipal utility revenue |
1,246 | 50,279 | 82,593 | ||||||||||
Health care revenue |
216 | 12,185 | 22,104 | ||||||||||
Housing revenue |
161 | 7,434 | 12,909 | ||||||||||
Transportation revenue |
165 | 21,304 | 37,072 | ||||||||||
Education/University |
153 | 7,902 | 13,338 | ||||||||||
Other domestic public finance |
26 | 2,181 | 3,370 | ||||||||||
Subtotal |
10,829 | 281,669 | 446,335 | ||||||||||
International obligations |
173 | 24,563 | 53,593 | ||||||||||
Total public finance obligations |
11,002 | 306,232 | 499,928 | ||||||||||
Asset-backed obligations |
|||||||||||||
Domestic obligations |
|||||||||||||
Residential mortgages |
200 | 17,052 | 21,131 | ||||||||||
Consumer receivables |
39 | 5,915 | 6,346 | ||||||||||
Pooled corporate |
279 | 54,903 | 57,855 | ||||||||||
Other domestic asset-backed |
63 | 1,568 | 2,033 | ||||||||||
Subtotal |
581 | 79,438 | 87,365 | ||||||||||
International obligations |
54 | 22,860 | 24,155 | ||||||||||
Total asset-backed obligations |
635 | 102,298 | 111,520 | ||||||||||
Total |
11,637 | $ | 408,530 | $ | 611,448 | ||||||||
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Distribution of Insured Portfolio by Ratings based on Net Par Outstanding
|
At December 31, 2008 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Public
Finance |
Asset-
Backed |
Total
Portfolio |
||||||||
Rating |
|||||||||||
Triple-A |
2 | % | 70 | % | 19 | % | |||||
Double-A |
41 | 5 | 32 | ||||||||
Single-A |
46 | 3 | 35 | ||||||||
Triple-B |
11 | 9 | 10 | ||||||||
Other |
0 | 13 | 4 | ||||||||
Total |
100 | % | 100 | % | 100 | % | |||||
|
At December 31, 2007 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Public
Finance |
Asset-
Backed |
Total
Portfolio |
||||||||
Rating |
|||||||||||
Triple-A |
4 | % | 80 | % | 27 | % | |||||
Double-A |
40 | 3 | 29 | ||||||||
Single-A |
43 | 4 | 32 | ||||||||
Triple-B |
12 | 11 | 11 | ||||||||
Other |
1 | 2 | 1 | ||||||||
Total |
100 | % | 100 | % | 100 | % | |||||
In addition to amounts shown in the tables above, the Company had outstanding commitments to provide guarantees of $4,639.4 million at December 31, 2008. These commitments are typically short term and principally relate to primary and secondary public finance debt issuances. Commitments are contingent on the satisfaction of all conditions set forth in the commitments. These commitments may expire unused or be cancelled at the counterparty's request. Therefore, the total commitment amount does not necessarily reflect actual future guaranteed amounts.
Public Finance Insured Portfolio
The Company seeks to maintain a diversified portfolio of insured public finance obligations designed to spread its risk across a number of geographic areas. The table below sets forth those
88
jurisdictions in which municipalities issued an aggregate of 2% or more of the total net par amount outstanding of FSA-insured public finance securities:
Public Finance Insured Portfolio by Location of Exposure
|
At December 31, 2008 | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
Number of
Risks |
Net Par
Amount Outstanding |
|||||||
|
(dollars in millions)
|
||||||||
Domestic obligations |
|||||||||
California |
1,121 | $ | 40,868 | ||||||
New York |
774 | 23,033 | |||||||
Pennsylvania |
892 | 20,475 | |||||||
Texas |
826 | 19,525 | |||||||
Illinois |
756 | 16,612 | |||||||
Florida |
291 | 15,585 | |||||||
Michigan |
639 | 13,093 | |||||||
New Jersey |
659 | 12,509 | |||||||
Washington |
344 | 10,225 | |||||||
Massachusetts |
241 | 7,896 | |||||||
Ohio |
452 | 7,242 | |||||||
Georgia |
129 | 7,000 | |||||||
Indiana |
300 | 6,674 | |||||||
All other U.S. locations |
3,405 | 80,932 | |||||||
Subtotal |
10,829 | 281,669 | |||||||
International obligations |
173 | 24,563 | |||||||
Total |
11,002 | $ | 306,232 | ||||||
At December 31, 2008, the public finance insured portfolio contained risks for which the Company estimates an ultimate net loss: an international infrastructure obligation, a healthcare transaction, a waste treatment facility transaction, a sewer revenue refunding warrant and an emerging market CDO. At December 31, 2008, the Company had $88.1 million in case reserves for these transactions, net of reinsurance. Management continually monitors these obligations and adjusts reserves accordingly.
Asset-Backed Insured Portfolio
The Company insured a wide variety of structured finance securities, including derivatives, which were investment grade at origination, typically with low expected loss severity in the event of default. See "Results of OperationsFair Value of Credit Derivatives" for a discussion of the Company's credit derivatives in the insured portfolio. In the normal course of business, the Company monitors its exposures in all insured categories. Due to recent events, additional focus has been placed on the RMBS categories. The Company internally rates each insured credit periodically based on criteria similar to those used by the rating agencies. At December 31, 2008, the Company had $1,234.3 million in net case reserves for these transactions, on a present value basis, net of anticipated recoveries and reinsurance. See "Results of OperationsLosses." The Company paid $563.1 million in claims in the asset-backed sector in 2008, net of reinsurance and recoveries.
The following discussion summarizes the Company's exposure to various types of mortgage-backed obligations.
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HELOCs: HELOCs represented 6.2% of total asset-backed par outstanding at December 31, 2008. Most of the Company's insured HELOCs were originated by mortgage finance companies, which, prior to 2007, had experienced historical lifetime losses between 1% and 3% of original par. At underwriting, applying original expected net prepayment speeds, a typical finance company-originated HELOC pool would have had sufficient protection to withstand losses of approximately 15% of original par. During the early stages of a number of transactions, prepayment speeds exceeded expectations, reducing excess spread available to cover losses. Subsequently, default rates on a number of FSA-insured HELOC pools rose to historically unprecedented levels, resulting in net FSA claim payments of $625.3 million through December 31, 2008. At December 31, 2008, the Company projected present value cumulative lifetime net losses of $1.2 billion across ten HELOCs, including the $625.3 million already paid, up from projections of $65.0 million across five HELOCs at December 31, 2007. Most of the increase in projected loss was due to deterioration in the portfolio performance.
Alt-A Closed-End Second Lien Mortgages: Alt-A CES mortgages represented 1.5% of total asset-backed par outstanding at December 31, 2008. CES mortgage transactions insured by FSA were typically structured with 25-27% of subordination plus excess spread of approximately 8% on a present value basis. At initial underwriting, defaults were expected to equal approximately 11%, providing over three times coverage. All FSA-insured CES mortgage transactions were rated Triple-A at closing. At December 31, 2008, the Company had reserved $234.1 million for five Alt-A CES transactions due to deterioration in the portfolio performance. The Company assumed that the amount of the projected loss for an Alt-A CES insured by Syncora Guarantee Inc. ("SGI") (formerly XL Capital Assurance) was 70% of expected losses on the underlying transaction, due to its below investment grade rating and apparent financial deterioration. No claim payments have been made to date, and FSA does not expect to pay most of this amount until 2036 and thereafter. The Company does not currently expect losses on six insured 2007 transactions with an aggregate net par of $473 million that are wrapped by investment-grade rated monolines.
Subprime U.S. RMBS: Subprime U.S. RMBS represented 4.5% of total asset-backed par outstanding at December 31, 2008. Despite recent internal downgrades, 46% of the net par of subprime U.S. RMBS transactions insured by FSA were rated Single-A or better at December 31, 2008. At origination, typical FSA-insured subprime RMBS transactions contained approximately 20% overcollateralization and subordination plus excess spread typically estimated at 7% versus an original FSA loss expectation of 10% (22% defaults at 45% loss severity). One 2007 transaction with net par outstanding of $231.8 million, originally insured at Triple-A, is performing materially worse than the rest of the subprime portfolio. Management established a case reserve for this transaction of $18.1 million at December 31, 2008.
NIM Securitizations: NIM securitizations represented less than 0.2% of total asset-backed par outstanding at December 31, 2008. At December 31, 2008, FSA insured 17 NIMs with an aggregate net par of $214 million. During 2008, management established its net case reserve against the non-derivative NIMs of $15.8 million as a result of deteriorating performance of the underlying subprime RMBS transactions. Because the projections no longer assume the receipt of any cash flow from the underlying transactions, estimated losses should not rise by more than that unless Radian Asset Assurance Inc. and another investment grade third-party indemnitor fail to fulfill their obligations. FSA's projections assume payments from Radian Asset Assurance Inc. of approximately $124 million over the next three years. At December 31, 2008, the Company also estimated a $31.8 million credit impairment on FSA-insured NIM securitizations that are considered derivatives and are marked to market on the Company's financial statements. The estimated economic loss on these transactions is recorded in "net change in the estimated fair value of credit derivatives."
Option Adjustable Rate Mortgages: Option ARM securitizations represented 2.6% of total asset-backed par outstanding at December 31, 2008. All FSA-insured Option ARM transactions were originally rated Triple-A and are senior in the capital structure. These transactions are prepaying at
90
moderate speeds and building overcollateralization. Although delinquencies are rising, there are few mortgage loan losses to date. Cash flow projections done in 2008 resulted in additional internal downgrades and increased projected losses for nine new transactions with a net par of $1.59 billion. At December 31, 2008, the Company had a $260.6 million net case reserve for these transactions. The Company internally rates five additional Option ARM transactions (net par $957 million) below investment grade.
Alt-A First-Lien Mortgages: Alt-A first-lien mortgage securitizations represented 1.6% of total asset-backed par outstanding at December 31, 2008. In a typical Alt-A transaction, FSA was protected by approximately 8% subordination plus 3% of future spread, for total protection of 11%. At the time of origination, FSA typically expected pool losses to equal 3%, which assumed a 35% severity rate and 9% foreclosure frequency. All FSA-insured Alt-A first lien exposures were originally rated Triple-A. Deterioration in the performance of these transactions led FSA to establish a net case reserve of $96.3 million at December 31, 2008. At that date, FSA had reserves against ten transactions with a net par of $1.1 billion. FSA internally rates six additional Alt-A First Lien transactions (net par $378 million) below investment grade.
Reinsurance of Insured Portfolio
The Company obtains reinsurance to increase its policy-writing capacity on both an aggregate-risk and a single-risk basis; meet rating agency, internal and state insurance regulatory limits; diversify risk; reduce the need for additional capital; and strengthen financial ratios. The Company reinsures portions of its risks with affiliated and unaffiliated reinsurers under quota share, first-loss and excess-of-loss treaties and on a facultative basis. For balances recorded in the consolidated financial statements for related party reinsurance transactions, see Note 24 to the consolidated financial statements in Item 8. FSA's ongoing use of reinsurance going forward remains uncertain due to a number of factors, including diminished reinsurance capacity from highly rated providers and concerns regarding the correlation of reinsurer creditworthiness in an economic downturn.
Reinsurance does not relieve the Company of its obligations to policyholders. In the event that any or all of the reinsuring companies are unable to meet their obligations, or contest such obligations, the Company may be unable to recover amounts due. A number of FSA's reinsurers are required to pledge collateral to secure their reinsurance obligations to FSA in an amount equal to their statutory unearned premium loss and contingency reserves associated with the ceded business. FSA requires collateral from reinsurers primarily to (a) receive statutory credit for the reinsurance, (b) provide liquidity to FSA in the event of claims on the reinsured exposures, and (c) enhance rating agency credit for the reinsurance.
The Company cedes approximately 23% of its gross par insured to a diversified group of reinsurers, including other monolines. Based on ceded par outstanding at December 31, 2008, 56.1% of FSA's reinsurers were rated Double-A- or higher at March 13, 2009. Some are still under review by rating agencies. The Company's reinsurance contracts generally allow the Company to recapture ceded
91
business after certain triggering events, such as reinsurer downgrades. Included in the table below is $12,099 million in ceded par outstanding related to insured CDS.
Reinsurance Recoverable and Ceded Par Outstanding by Reinsurer and Ratings
|
Ratings as of
March 13, 2009 |
At December 31, 2008 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Moody's
Reinsurer Rating |
S&P
Reinsurer Rating |
Reinsurance
Recoverable |
Ceded Par
Outstanding |
Ceded Par
Outstanding as a % of Total |
||||||||||||
|
|
|
(dollars in millions)
|
||||||||||||||
Assured Guaranty Re Ltd. |
Aa3 | AA | $ | 82.5 | $ | 32,842 | 27 | % | |||||||||
Tokio Marine and Nichido Fire Insurance Co., Ltd |
Aa2 | (1) | AA | (1) | 133.6 | 31,478 | 26 | ||||||||||
Radian Asset Assurance Inc. |
Ba1 | BBB+ | 37.2 | 24,447 | 20 | ||||||||||||
RAM Reinsurance Co. Ltd. |
Baa3 | A+ | 22.3 | 11,929 | 10 | ||||||||||||
Syncora Guarantee Inc. |
Ca | CC | | 4,135 | 4 | ||||||||||||
Swiss Reinsurance Company. |
A1 | A+ | 11.0 | 4,097 | 3 | ||||||||||||
R.V.I. Guaranty Co., Ltd. |
Baa3 | A- | | 4,109 | 3 | ||||||||||||
Mitsui Sumitomo Insurance Co. Ltd. |
Aa3 | AA | (1) | 8.9 | 2,658 | 2 | |||||||||||
CIFG Assurance North America Inc. |
Ba3 | BB | 17.9 | 1,901 | 2 | ||||||||||||
Ambac Assurance Corporation |
Baa1 | A | 0.2 | 1,075 | 1 | ||||||||||||
Other(2) |
Various | Various | 1.0 | 2,410 | 2 | ||||||||||||
Valuation allowance |
N/A | N/A | (12.5 | ) | | | |||||||||||
Total |
$ | 302.1 | $ | 121,081 | 100 | % | |||||||||||
In 2008, $28.5 million of net premiums earned resulted from commutations or cancellations of reinsurance contracts. The largest such transactions were with SGR and Bluepoint Re, Limited ("Bluepoint").
In July 2008, FSA agreed to re-assume all reinsurance ceded to SGR, which consisted of $8.4 billion in outstanding par, in exchange for the June 30, 2008 statutory basis ceded unearned premium, net of its applicable ceding commission, any case basis reserves established at that date and a $35.0 million commutation premium. FSA agreed to cede a portion of this business, approximately $6.4 billion of outstanding par with no outstanding case basis reserves, to SGI, an affiliate of SGR, as of the re-assumption date. Ceded net unearned premiums and future ceded case reserves are secured by collateral then held in a trust. Since SGI was an affiliate of SGR, FSA did not consider the portion of the business bought back from SGR and subsequently ceded to SGI as commuted and as a result did not record any commutation gain on that portion of the business. FSA recorded a commutation gain of $10.0 million on the business it retained, which was recorded in other income in the statement of operations and comprehensive income. In 2008, $14.8 million of earned premium related to this commutation.
In September 2008, FSA agreed to re-assume a portion of the business it ceded to SGI in July for the statutory basis ceded unearned premium, net of its applicable ceding commissions. This resulted in a commutation gain of $10.0 million, which was recorded in other income in the statement of operations and comprehensive income. In 2008, $1.5 million of earned premium related to this commutation.
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Due to a liquidation order against Bluepoint, FSA is treating all reinsurance ceded to Bluepoint as cancelled as of the August 29, 2008 date of the liquidation order. Subsequent to September 30, 2008, in accordance with guidance obtained from the New York Insurance Department, FSA drew down from collateral maintained in trust by Bluepoint an amount equal to the net statutory basis unearned premium and case basis reserves and, as a result, FSA was able to take credit for such balances. In 2008, $9.4 million of earned premium related to this commutation.
Results of Operations
The FP segment includes the results of operations of FSAM, the GIC Subsidiaries and the consolidated VIEs. In November 2008, the Company ceased issuing GICs in contemplation of the sale of the Company to Assured.
Financial Products Segment
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in millions)
|
||||||||||
Net interest income from financial products segment |
$ | 647.4 | $ | 1,078.1 | $ | 857.5 | |||||
Net realized gains (losses) from financial products segment |
(8,644.2 | ) | 1.9 | 0.1 | |||||||
Net realized and unrealized gains (losses) on derivative instruments |
1,424.2 | 62.1 | 130.2 | ||||||||
Net unrealized gains (losses) on financial instruments at fair value |
47.6 | 14.0 | 3.6 | ||||||||
Income from assets acquired in refinancing transactions |
12.1 | 16.4 | 20.1 | ||||||||
Other income (loss) |
16.2 | (0.4 | ) | 1.3 | |||||||
Total Revenues |
(6,496.7 | ) | 1,172.1 | 1,012.8 | |||||||
Net interest expense from financial products segment |
(794.6 | ) | (989.2 | ) | (768.7 | ) | |||||
Foreign exchange gains (losses) from financial products segment |
(1.7 | ) | (138.5 | ) | (159.4 | ) | |||||
Other operating expenses |
(48.0 | ) | (28.0 | ) | (26.6 | ) | |||||
Total Expenses |
(844.3 | ) | (1,155.7 | ) | (954.7 | ) | |||||
Income (loss) before income taxes |
(7,341.0 | ) | 16.4 | 58.1 | |||||||
GAAP income to segment operating earnings adjustments |
6,594.6 | 60.5 | (11.0 | ) | |||||||
Pre-tax segment operating earnings (losses) |
$ | (746.4 | ) | $ | 76.9 | $ | 47.1 | ||||
2008 vs. 2007: The decrease in the FP segment operating earnings was driven primarily by OTTI charges on the FP and VIE Investment Portfolios. Pre-tax GAAP loss reflects $8.6 billion in OTTI charges. Historically, the Company had the ability and intent to hold the FP Segment Investment Portfolio to maturity. However, the Company no longer has the intent to hold such securities to maturity, due to Dexia's agreement under the Purchase Agreement to segregate or separate the Company's FP operations from the Company's financial guaranty operations and retain the FP segment. As a result, the Company was required to record an OTTI charge for all assets in the Portfolio in an unrealized loss position at December 31, 2008.
2007 vs. 2006: Despite an OTTI charge of $11.1 million pre-tax, FP segment operating earnings increased as the average aggregate balance of the GIC book of business grew from $14.5 billion in 2006 to $17.6 billion in 2007, and as a result of realized gains.
The Company is subject to an investigation by the DOJ and SEC of bid-rigging of awards of municipal GICs. In 2008, purported class action lawsuits and other civil actions were commenced
93
related to the subject of these investigations, naming as defendants a large number of financial institutions, including the Company. See "Item 3. Legal Proceedings."
The following table summarizes the components of the fair-value adjustments included in the results of operations of the FP segment:
|
Year Ended December 31, | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||||||
|
(in millions)
|
||||||||||||||
REVENUES Gains/(Losses): |
|||||||||||||||
Net interest income from financial products segment(1): |
|||||||||||||||
Fair-value adjustments on FP segment investment portfolio |
$ | 448.3 | $ | | $ | | |||||||||
Fair-value adjustments on FP segment derivatives |
(460.2 | ) | | | |||||||||||
Net interest income from financial products segment |
$ | (11.9 | ) | $ | | $ | | ||||||||
Net realized gains (losses) from financial products segment: |
|||||||||||||||
Fair-value adjustments attributable to impairment charges in FP segment investment portfolio |
$ | (8,634.1 | ) | $ | (11.1 | ) | $ | | |||||||
Net realized and unrealized gains (losses) on derivative instruments: |
|||||||||||||||
FP segment derivatives(2) |
$ | 1,424.2 | $ | 62.1 | $ | 130.2 | |||||||||
Net unrealized gains (losses) on financial instruments at fair value: |
|||||||||||||||
FP segment: |
|||||||||||||||
Assets designated as trading portfolio |
$ | (202.6 | ) | $ | 14.0 | $ | 3.6 | ||||||||
Fixed rate FP segment debt: |
|||||||||||||||
Fair-value adjustments other than the Company's own credit risk |
(1,127.0 | ) | | | |||||||||||
Fair-value adjustments attributable to the Company's own credit risk |
1,377.2 | | | ||||||||||||
Net unrealized gains (losses) on financial instruments at fair value in the FP segment |
$ | 47.6 | $ | 14.0 | $ | 3.6 | |||||||||
EXPENSES (Gains)/Losses: |
|||||||||||||||
Net interest expense from financial products segment(3): |
|||||||||||||||
Fair-value adjustments on FP segment debt |
$ | | $ | 146.9 | $ | (56.7 | ) | ||||||||
Fair-value adjustments on FP segment derivatives |
| (174.1 | ) | 39.9 | |||||||||||
Net interest expense from financial products segment |
$ | | $ | (27.2 | ) | $ | (16.8 | ) | |||||||
PV NIM Originated
In August 2008, the Company ceased issuing new GICs related to asset-backed transactions and, in November 2008, ceased issuing GICs in contemplation of the sale of the Company to Assured. In addition, throughout 2008 the Company curtailed acquisitions of FP assets to increase liquidity, resulting in negative PV NIM originated in 2008 of $1.3 million. PV NIM originated was $87.9 million and $120.5 million in 2007 and 2006, respectively. For a discussion of liquidity issues faced by the FP segment, see "Liquidity and Capital ResourcesFP Segment Liquidity."
94
FP Segment Investment Portfolio
The FP Segment Investment Portfolio is made up of:
Carrying Value of Assets
in the FP Segment
|
At December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in millions)
|
|||||||
FP Investment Portfolio |
$ | 9,370.5 | $ | 18,065.0 | ||||
VIE Investment Portfolio(1) |
931.5 | 1,148.2 | ||||||
Total |
$ | 10,302.0 | $ | 19,213.2 | ||||
The Company's management believes that the assets held in the VIE Investment Portfolio are beyond the reach of the Company's creditors, even in bankruptcy or other receivership.
Management uses judgment in reviewing the specific facts and circumstances of individual securities and uses estimates and assumptions of expected default rates, loss severity and prepayment speeds to determine expected economic loss. It uses both proprietary and third-party models to analyze the underlying collateral of asset-backed securities and the cash flows generated by the collateral to determine whether a security's performance is consistent with the view that all payments of principal and interest will be made as contractually required. Each mortgage-backed security in the FP Investment Portfolio was evaluated for economic loss at December 31, 2008 by applying projected default assumptions to various delinquency categories, starting with 30 days past due, in order to create a measure of loss coverage. Once default rate assumptions were applied by delinquency category, management applied severity rates to projected gross losses. The result of this calculation was then compared with the hard credit enhancement embedded in each asset. At December 31, 2008, 126 assets were determined to have economic losses amounting to $797 million.
For information regarding the liquidity risks inherent to the FP business and the liquidity resources available to it, see "Liquidity and Capital ResourcesFP Segment Liquidity."
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FP Segment Debt
The following table indicates the Company's par value of debt outstanding with respect to municipal and non-municipal GICs and VIE debt:
Par Value of FP Segment Debt by Type(1)
|
At December 31, | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||||
|
(in millions)
|
||||||||
GIC debt: |
|||||||||
Municipal |
$ | 6,165.9 | $ | 7,477.9 | |||||
Non-municipal GICs: |
|||||||||
CDOs of ABS GICs |
4,042.9 | 6,099.8 | |||||||
Pooled corporate and CLO structured GICs |
3,259.1 | 4,404.0 | |||||||
Other non-municipal GICs |
830.4 | 786.2 | |||||||
Total non-municipal GICs |
8,132.4 | 11,290.0 | |||||||
Total GIC debt |
14,298.3 | 18,767.9 | |||||||
VIE debt |
2,101.4 | 2,494.9 | |||||||
Total par value of FP segment debt |
$ | 16,399.7 | $ | 21,262.8 | |||||
GICs issued by the Company may be withdrawn based upon certain contractually established conditions. While management follows the performance of each contract carefully, in some cases withdrawals may occur substantially earlier than originally projected. In response, the Company enhanced the liquidity available in its FP Investment Portfolio by obtaining a $5.0 billion committed standby line of credit from Dexia Crédit Local (the "First Dexia Line of Credit") and investing available funds in short-term investments. At December 31, 2008, there were $1.3 billion in draws outstanding under the First Dexia Line of Credit. For information regarding the liquidity risks inherent to the FP business and the liquidity resources available to it, see "Liquidity and Capital ResourcesFP Segment Liquidity."
Effective January 1, 2008, the Company elected to account for certain fixed rate FP segment debt at fair value under the fair value option in accordance with SFAS 159. The fair value option was elected to reduce volatility in income on fixed rate debt that is converted to floating U.S. dollar denominated debt through the use of derivatives. The fair value option allows the fair value adjustment on debt to be offset with the fair value charge on derivatives used to hedge interest and foreign exchange rate risk. All the FP segment debt carried at fair value was categorized as Level 3 in the SFAS 157 fair value hierarchy.
Other Operating Expenses and Amortization of Deferred Acquisition Costs
The primary component of expenses is employee compensation, which represented 41%, 65% and 59% of total expenses in each of the last three years, net of deferrals. The table below shows other operating expenses with and without compensation expense related to DCP and SERP. These DCP and SERP expenses are substantially offset by the fair-value adjustments of the assets held to defease the plan obligations, which amounts are reflected in other income.
96
Other Operating Expenses
|
Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||
|
(in millions)
|
|||||||||||
Amortization of previously deferred underwriting expenses and reinsurance commissions |
$ | 65.7 | $ | 63.4 | $ | 63.0 | ||||||
Other operating expenses |
121.5 | 272.9 | 244.3 | |||||||||
Underwriting expenses deferred |
(27.7 | ) | (153.9 | ) | (148.3 | ) | ||||||
Financial products other operating expenses |
42.4 | 17.0 | 14.2 | |||||||||
Reinsurance commissions written, net |
(10.5 | ) | (83.3 | ) | (79.7 | ) | ||||||
Reinsurance commissions deferred, net |
10.5 | 83.3 | 79.7 | |||||||||
Other operating expenses, excluding DCP and SERP |
136.2 | 136.0 | 110.2 | |||||||||
DCP and SERP expenses |
(37.3 | ) | 6.1 | 14.4 | ||||||||
Total other operating expenses |
98.9 | 142.1 | 124.6 | |||||||||
Total expenses |
$ | 164.6 | $ | 205.5 | $ | 187.6 | ||||||
In 2008, financial products other operating expenses increased due primarily to increased liquidity facility fees payable to Dexia and an estimated accrual for a litigation settlement. Other operating expenses decreased due primarily to the reversal of substantially all of the Company's long term incentive compensation accrual. Deferral rates in the financial guaranty segment declined as the workforce shifted from deferrable underwriting personnel to non-deferrable surveillance and back office. In 2008, the Company eliminated the asset-backed underwriting department and increased its asset-backed surveillance unit. Reinsurance commissions decreased primarily as a result of reassumptions as discussed in"Financial Guaranty SegmentReinsurance of Insured Portfolio."
In 2007, expenses were higher than 2006 due primarily to lower deferral rates. The overall deferral rate for 2007 was 53%, compared to 57% in 2006.
The Company's effective tax rate benefit was 9% and 64% in 2008 and 2007, respectively, while in 2006 the effective tax rate provision was 29%. The 2008 effective tax rate reflects a lower than expected benefit of 35% due to the establishment of a valuation allowance of $2.5 billion in respect of FP segment OTTI charges. This adverse tax effect was partially offset by benefits accrued in respect of tax-exempt interest income and the non-taxable fair value adjustments related to the Company's committed preferred securities. The 2007 and 2006 rates differ from the statutory rate of 35% due primarily to tax-exempt interest and, in 2006, non-taxable minority interest. The 2007 rate reflects an unusually high benefit due to the disproportionate low amount of pre-tax income to tax-exempt interest.
In connection with Dexia's acquisition of the Company in July 2000, the Company became the successor, for tax purposes, to White Mountains Holdings, Inc. ("WMH"). WMH had previously sold an insurance subsidiary to a third party that was indemnified by White Mountains Insurance Group, Ltd. ("White Mountains") for certain future adverse loss development up to $50.0 million. In 2004, the Company made an indemnity payment of $47.0 million to the third party with funds provided for such purpose by White Mountains. While the Company had no legal liability in connection with the indemnity payment, the payment was treated for tax purposes as a $47.0 million loss deduction to the Company, as successor to WMH. The Company therefore recorded a tax benefit of $16.5 million. In addition, the Company shared 50% of the deferred tax benefit with White Mountains when the required circumstances were satisfied in the third quarter of 2008.
97
A valuation allowance is required when it is more likely than not that a portion or all of a deferred tax asset will not be realized. All evidence, both positive and negative, needs to be identified and considered in making the determination. Future realization of the existing deferred tax asset will depend on the Company's ability to generate sufficient taxable income of appropriate character (i.e., ordinary income versus capital gains) within the carryback and carryforward periods available under the tax law.
The economic conditions adversely affecting the Company did not fully materialize and the Purchase Agreement was not entered into until 2008 and, thus, the Company did not provide any valuation allowance on its net deferred tax assets at December 31, 2007.
The net deferred tax asset of $3.3 billion at December 31, 2008 consists primarily of unrealized capital losses and foreign exchange losses of about $3.0 billion, $368 million related to loss reserves, and $453 million related to mark-to-market on CDS, offset by other net deferred tax liabilities. The unrealized losses were primarily generated from OTTI losses recognized in the FP Investment Portfolio. The Company's management has concluded that a valuation allowance of $2.5 billion is required based on the following factors:
The Company treats its CDS contracts as insurance contracts for U.S. tax purposes. The current federal tax treatment of CDS contracts is an unsettled area of tax law. Market participants are generally treating CDS contracts for tax purposes as either: (1) notional principal contract ("NPC")
98
derivative instruments, (2) guarantees, (3) insurance contracts, or (4) capital assets. The Company believes that it is more likely than not that its CDS contracts are either NPC or insurance contracts. Both receipts and payments arising from NPC and insurance contracts are characterized as ordinary income (although a termination of a CDS contract as an NPC may be treated as a capital transaction). Although the Company believes it is properly treating potential losses on its CDS contracts as ordinary, there are no assurances that the Internal Revenue Service ("IRS") will agree with the Company. Should the IRS disagree with the Company and characterize such losses, if any, as capital losses, the Company's ability to realize a related tax asset would be more limited, possibly leading to a reduction or elimination of the related deferred tax asset.
The tables below summarize the exposure to each financial guaranty monoline insurer by exposure category and the underlying ratings of the Company's insured risks.
Summary of Exposure to Monolines
|
At December 31, 2008 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Insured Portfolios | Investment Portfolios | ||||||||||||
|
FSA
Insured Par Outstanding(1) |
Ceded Par
Outstanding |
General
Investment Portfolio(2) |
FP Segment
Investment Portfolio(2) |
||||||||||
|
(in millions)
|
|||||||||||||
Assured Guaranty Re Ltd. |
$ | 972 | $ | 32,842 | $ | 81.3 | $ | 84.9 | ||||||
Radian Asset Assurance Inc. |
96 | 24,447 | 1.9 | 99.2 | ||||||||||
RAM Reinsurance Co. Ltd. |
| 11,929 | | | ||||||||||
Syncora Guarantee Inc. |
1,364 | 4,135 | 26.4 | 192.3 | ||||||||||
CIFG Assurance North America Inc. |
195 | 1,901 | 24.0 | 29.8 | ||||||||||
Ambac Assurance Corporation |
4,976 | 1,075 | 626.3 | 431.2 | ||||||||||
ACA Financial Guaranty Corporation |
19 | 943 | | | ||||||||||
Financial Guaranty Insurance Company |
5,385 | 279 | 29.1 | 227.4 | ||||||||||
MBIA Insurance Corporation |
4,022 | | 938.7 | 419.7 | ||||||||||
Total |
$ | 17,029 | $ | 77,551 | $ | 1,727.7 | $ | 1,484.5 | ||||||
99
Exposures to Monolines
and Ratings of Underlying Risks
|
At December 31, 2008 | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Insured Portfolios (1) | Investment Portfolios | |||||||||||||
|
FSA
Insured Par Outstanding(2) |
Ceded Par
Outstanding |
General
Investment Portfolio(3) |
FP Segment
Investment Portfolio(1) |
|||||||||||
|
(dollars in millions)
|
||||||||||||||
Assured Guaranty Re Ltd. |
|||||||||||||||
Exposure(4) |
$ | 972 | $ | 32,842 | $ | 81.3 | $ | 84.9 | |||||||
Triple-A |
| % | 5 | % | 2 | % | | % | |||||||
Double-A |
10 | 40 | | 45 | |||||||||||
Single-A |
24 | 38 | 81 | 49 | |||||||||||
Triple-B |
8 | 15 | 17 | | |||||||||||
Below Investment Grade |
58 | 2 | | 6 | |||||||||||
Radian Asset Assurance Inc. |
|||||||||||||||
Exposure(4) |
$ | 96 | $ | 24,447 | $ | 1.9 | $ | 99.2 | |||||||
Triple-A |
4 | % | 8 | % | | % | | % | |||||||
Double-A |
| 43 | 100 | | |||||||||||
Single-A |
14 | 38 | | | |||||||||||
Triple-B |
57 | 10 | | | |||||||||||
Below Investment Grade |
25 | 1 | | 100 | |||||||||||
RAM Reinsurance Co. Ltd. |
|||||||||||||||
Exposure(4) |
$ | | $ | 11,929 | $ | | $ | | |||||||
Triple-A |
| % | 13 | % | | % | | % | |||||||
Double-A |
| 41 | | | |||||||||||
Single-A |
| 32 | | | |||||||||||
Triple-B |
| 12 | | | |||||||||||
Below Investment Grade |
| 2 | | | |||||||||||
Syncora Guarantee Inc. |
|||||||||||||||
Exposure(4) |
$ | 1,364 | $ | 4,135 | $ | 26.4 | $ | 192.3 | |||||||
Triple-A |
30 | % | | % | | % | 1 | % | |||||||
Double-A |
| 8 | 22 | | |||||||||||
Single-A |
21 | 36 | 75 | 16 | |||||||||||
Triple-B |
25 | 56 | | 52 | |||||||||||
Below Investment Grade |
24 | | | 31 | |||||||||||
Not Rated |
| | 3 | | |||||||||||
CIFG Assurance North America Inc. |
|||||||||||||||
Exposure(4) |
$ | 195 | $ | 1,901 | $ | 24.0 | $ | 29.8 | |||||||
Triple-A |
| % | 2 | % | | % | | % | |||||||
Double-A |
2 | 27 | | 41 | |||||||||||
Single-A |
9 | 37 | 100 | 6 | |||||||||||
Triple-B |
89 | 30 | | | |||||||||||
Below Investment Grade |
| 4 | | 53 | |||||||||||
Ambac Assurance Corporation |
|||||||||||||||
Exposure(4) |
$ | 4,976 | $ | 1,075 | $ | 626.3 | $ | 431.2 | |||||||
Triple-A |
6 | % | | % | | % | 5 | % | |||||||
Double-A |
42 | 9 | 42 | 9 | |||||||||||
Single-A |
32 | 39 | 53 | 36 | |||||||||||
Triple-B |
11 | 52 | 4 | 41 | |||||||||||
Below Investment Grade |
9 | 0 | 1 | 9 |
100
|
At December 31, 2008 | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Insured Portfolios (1) | Investment Portfolios | |||||||||||||
|
FSA
Insured Par Outstanding(2) |
Ceded Par
Outstanding |
General
Investment Portfolio(3) |
FP Segment
Investment Portfolio(1) |
|||||||||||
|
(dollars in millions)
|
||||||||||||||
ACA Financial Guaranty Corporation |
|||||||||||||||
Exposure(4) |
$ | 19 | $ | 943 | $ | | $ | | |||||||
Triple-A |
| % | | % | | % | | % | |||||||
Double-A |
69 | 72 | | | |||||||||||
Single-A |
| 26 | | | |||||||||||
Triple-B |
11 | 2 | | | |||||||||||
Below Investment Grade |
20 | | | | |||||||||||
Financial Guaranty Insurance Company |
|||||||||||||||
Exposure(4) |
$ | 5,385 | $ | 279 | $ | 29.1 | $ | 227.4 | |||||||
Triple-A |
| % | | % | | % | | % | |||||||
Double-A |
33 | | 64 | | |||||||||||
Single-A |
57 | 100 | 35 | 30 | |||||||||||
Triple-B |
8 | | 1 | 57 | |||||||||||
Below Investment Grade |
2 | | | 13 | |||||||||||
MBIA Insurance Corporation |
|||||||||||||||
Exposure(4) |
$ | 4,022 | $ | | $ | 938.7 | $ | 419.7 | |||||||
Triple-A |
| % | | % | | % | | % | |||||||
Double-A |
54 | | 40 | 15 | |||||||||||
Single-A |
14 | | 55 | 25 | |||||||||||
Triple-B |
32 | | 4 | 49 | |||||||||||
Below Investment Grade |
| | 1 | 11 |
Asset-backed and, to a lesser extent, public finance transactions insured by the Company may have employed 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. 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 generally maintains certain contractual rights and exercises varying degrees of influence over special purpose entity issuers of FSA-insured 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 (typically, but not always, after a significant depletion of overcollateralization, excess spread, a deductible or other credit protection).
The Company's underwriting guidelines for public finance obligations generally require that a transaction be rated investment grade when FSA's insurance is applied. The Company's underwriting
101
guidelines for asset-backed obligations, which it followed prior to its August 2008 decision to cease insuring such obligations, varied by obligation type in order to reflect different structures and types of credit support. The Company sought to insure asset-backed obligations that generally provided for one or more forms of overcollateralization or third-party protection. 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 payment 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 secondary market transactions and with refinancing underperforming, non-investment-grade transactions insured by FSA.
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 FSA. 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 outstanding exposure amounts reported.
The Company is required to consolidate special purpose entities that are considered VIEs where the Company is considered the primary beneficiary.
In determining whether the Company is the Primary Beneficiary of a particular VIE, a number of factors are considered. The significant factors considered are: the design of the entity and the risks it was created to pass-along to variable interest holders; the extent of credit risk absorbed by the Company through its insurance contract and the extent to which credit protection provided by other variable interest holders reduces this exposure; the exposure that the Company cedes to third party reinsurers, to reduce the extent of expected loss which the Company absorbs; and the portion of the VIE's total notional exposure covered by the Company's insurance policy. The Company's accounting policy is to first conduct a qualitative analysis based on the design of the VIE in order to identify whether it is the primary beneficiary. Should the qualitative analysis not provide a basis for conclusion, the Company will perform a quantitative analysis in order to determine if it is the primary beneficiary of the VIE under review.
In considering the significance of its interest in a particular VIE, the Company considers the extent to which both the variability it absorbs from the VIE and the Company's exposure to that VIE are material to the Company's own financial statements. The Company believes that its surveillance categories are an appropriate measure to use for identification of VIEs in which the Company absorbs other than insignificant variability. VIEs selected for this purpose are related to risks classified as surveillance Category IV, defined as "demonstrating sufficient deterioration to indicate that material credit losses are possible even though not yet probable" or risks classified as surveillance Category V, defined as "transactions where losses are probable." The Company believes that VIE-related risks classified as surveillance Categories IV and V are VIEs in which the Company absorbs a significant portion of the variability created by the particular VIE. For a more detailed description of the surveillance categories used by the Company, see Note 9 to the consolidated financial statements in Item 8.
VIEs in which the Company holds a significant variable interest but which are not consolidated have been aggregated according to principle line of business for the purpose of disclosing the nature and extent of the Company's exposure to such VIEs. The Company aggregates such VIEs according to principle line of business, to appropriately reflect the VIE risk and reward characteristics in an
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aggregated manner. The table below displays the Company's exposure to these VIEs at December 31, 2008.
Non-Consolidated VIEs
|
At December 31, 2008 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Liability |
|
|
|||||||||||||||
|
Net Case Reserve |
Net Non-
Specific Reserve |
Fair Value of
Credit Derivatives |
Net Par
Outstanding(1) |
Number of
VIEs |
|||||||||||||
|
(dollars in millions)
|
|
||||||||||||||||
Asset-backed: | ||||||||||||||||||
Domestic | ||||||||||||||||||
Residential mortgages | $ | 1,221.4 | $ | 36.4 | $ | 11.3 | $ | 9,130.6 | 59 | |||||||||
Consumer receivables | | 9.2 | | 88.5 | 1 | |||||||||||||
Pooled corporate | 25.8 | | 110.5 | 797.8 | 10 | |||||||||||||
Other | | | 35.0 | 125.7 | 1 | |||||||||||||
Total asset-backed | 1,247.2 | 45.6 | 156.8 | 10,142.6 | 71 | |||||||||||||
Public finance: | ||||||||||||||||||
Domestic | 0.3 | | | 0.3 | 1 | |||||||||||||
International | 11.0 | | | 509.5 | 7 | |||||||||||||
Total public finance | 11.3 | | | 509.8 | 8 | |||||||||||||
Total | $ | 1,258.5 | $ | 45.6 | $ | 156.8 | $ | 10,652.4 | 79 | |||||||||
FSA's interest in these non-consolidated VIEs is included in "losses and loss adjustment expenses" and "credit derivatives" in the Company's balance sheet.
The Company has consolidated certain VIEs for which it has determined that it is the primary beneficiary. The table below shows the carrying value and classification of the consolidated VIEs assets and liabilities in the Company's financial statements:
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At December 31, 2008 | ||||||
---|---|---|---|---|---|---|---|
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Total Assets |
Total
Liabilities |
|||||
|
(dollars in millions)
|
||||||
FSA Global Funding |
$ | 1,343.9 | $ | 1,396.3 |
FSA guarantees the assets held and the notes issued by FSA Global. As a result, FSA is exposed to the risk of non-payment of the assets held by FSA Global. There are no other arrangements, either explicit or implicit, which could require the Company to provide financial support to the VIEs.
Liquidity and Capital Resources
FSA Holdings Liquidity
At December 31, 2008, FSA Holdings had cash and investments of $53.5 million available to fund the liquidity needs of its non-insurance operations. Because the majority of the Company's operations are conducted through FSA, the long-term ability of FSA Holdings to service its debt largely depends on its receipt of dividends from FSA or FSA's ability to repurchase its own shares from FSA Holdings,
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which are subject to certain limitations. In 2008, Dexia Holdings contributed $1,012.1 million of capital to FSA Holdings, which included $4.3 million contributed by a liquidation of program shares and phantom program shares held by directors. In the first quarter of 2008, FSA Holdings contributed capital to FSA of $500 million. In the third quarter of 2008, FSA issued a non-interest bearing surplus note with no term to FSA Holdings in exchange for $300 million. In the fourth quarter of 2008, FSA Holdings contributed $207.8 million to FSAM, part of the FP segment.
At December 31, 2007, FSA repaid its entire surplus note obligation then outstanding of $108.9 million to FSA Holdings. In addition, FSA Holdings forgave all interest expense for 2007, which totaled $5.0 million, including $3.6 million already paid by FSA and $1.4 million of accrued interest. FSA Holdings then recontributed the proceeds from the repayment of the surplus notes plus the amount of interest expense already paid to FSA. All surplus note transactions were approved by the Superintendent of Insurance of the State of New York (the "New York Superintendent"). FSA paid surplus note interest of $5.4 million in 2006.
FSA Holdings paid dividends of $33.6 million in 2008, $122.0 million in 2007, and $530.0 million in 2006.
On November 22, 2006, FSA Holdings issued $300.0 million principal amount of Junior Subordinated Debentures with a scheduled maturity date of December 15, 2036 and a final repayment date of December 15, 2066. The final repayment date of December 15, 2066 may be automatically extended up to four times in five-year increments provided certain conditions are met. The debentures are redeemable, in whole or in part, at any time prior to December 15, 2036 at their principal amount plus accrued and unpaid interest to the date of redemption or, if greater, the make-whole redemption price. Interest on the debentures will accrue from November 22, 2006 to December 15, 2036 at the annual rate of 6.40%. If any amount of the debentures remains outstanding after December 15, 2036, then the principal amount of the outstanding debentures will bear interest at a floating interest rate equal to one-month LIBOR plus 2.215% until repaid. FSA Holdings may elect at one or more times to defer payment of interest on the debentures for one or more consecutive interest periods that do not exceed ten years. In connection with the completion of this offering, FSA Holdings entered into a replacement capital covenant for the benefit of persons that buy, hold or sell a specified series of FSA Holdings long-term indebtedness ranking senior to the debentures. Under the covenant, the debentures will not be repaid, redeemed, repurchased or defeased by FSA Holdings or any of its subsidiaries on or before the date that is 20 years prior to the final repayment date, except to the extent that FSA Holdings has received proceeds from the sale of replacement capital securities. The proceeds from this offering were used to pay a dividend to the shareholders of FSA Holdings.
On July 31, 2003, FSA Holdings issued $100.0 million principal amount of 5.60% Notes due July 15, 2103, which are callable without premium or penalty in whole or in part at any time on or after July 31, 2008. Debt issuance costs of $3.3 million are being amortized over the life of the debt.
On November 26, 2002, FSA Holdings issued $230.0 million principal amount of 6.25% Notes due November 1, 2102, which are callable without premium or penalty in whole or in part at any time on or after November 26, 2007. Debt issuance costs of $7.4 million are being amortized over the life of the debt. FSA Holdings used a portion of the proceeds of this issuance to redeem in whole FSA Holdings' $130.0 million principal amount of 7.375% Senior Quarterly Income Debt Securities due September 30, 2097.
On December 19, 2001, FSA Holdings issued $100.0 million of 6 7 / 8 % Quarterly Income Bond Securities due December 15, 2101, which are callable without premium or penalty on or after December 19, 2006. Debt issuance costs of $3.3 million are being amortized over the life of the debt.
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FSA's Liquidity
In its financial guaranty business, premiums, credit derivative fees and investment income are the Company's primary sources of funds to pay its operating expenses, insured losses and taxes. FSA's primary uses of funds are to pay operating expenses and dividends to its parent FSA Holdings, and pay claims under insurance policies in the event of default by an issuer of an insured obligation and the unavailability or exhaustion of other payment sources in the transaction, such as the cash flow or collateral underlying the obligations. Before withdrawing from the asset-backed securities business, FSA sought to structure asset-backed transactions to address liquidity risks by matching insured payments with available cash flow or other payment sources.
Insurance policies issued by FSA guaranteeing payments under bonds and other securities provide, in general, that payments of principal, interest and other amounts insured by FSA may not be accelerated by the holder of the obligation but are paid by FSA in accordance with the obligation's original payment schedule or, at FSA's option, on an accelerated basis. FSA insurance policies guaranteeing payments under CDS may provide for acceleration of amounts due upon the occurrence of certain credit events, subject to single risk limits specified in the insurance laws of the State of New York (the "New York Insurance Law"). These constraints prohibiting or limiting acceleration of certain claims are mandatory under Article 69 of the New York Insurance Law and serve to reduce FSA's liquidity requirements.
Payments made in settlement of the Company's obligations in its insured portfolio may, and often do, vary significantly from year to year depending primarily on the frequency and severity of payment defaults and its decisions regarding whether to exercise its right to accelerate troubled insured transactions in order to mitigate future losses. FSA has not drawn on any alternative sources of liquidity to meet its obligations in 2008 and 2007. In prior years, FSA refinanced certain transactions using funds raised through the GIC Subsidiaries.
The terms of the Company's CDS contracts generally are modified from standard CDS contract forms approved by the International Swaps and Derivatives Association, Inc. ("ISDA") in order to provide for payments on a scheduled basis and generally replicate the terms of a traditional financial guaranty insurance policy. Some CDS contracts the Company enters into as credit protection seller, however, utilize standard ISDA settlement mechanics of cash settlement (i.e., a process to value the loss of market value of a reference obligation) or physical settlement (i.e., delivery of the reference obligation against payment of principal by the protection seller) in the event of a "credit event," as defined in the terms of the contract.
At December 31, 2008, there was $68.8 billion in net par outstanding for pooled corporate CDS. At that date, approximately 46% of the obligations insured by the Company in CDS form were funded CDOs and 54% were synthetic CDOs. Potential acceleration of claims with respect to CDS obligations occur with funded CDOs and synthetic CDOs, as described below:
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credit losses of a synthetic pool of corporate obligors following the exhaustion of a deductible. In these transactions, losses are typically calculated using ISDA cash settlement mechanics. As a result, the Company's exposures to the individual corporate obligors within any synthetic transaction are constrained by the New York Insurance Law single risk limits. In these transactions, the credit events giving rise to a payment obligation are generally (a) the reference entity's bankruptcy; (b) failure by the reference entity to pay its debt obligations; and, (c) in certain transactions, the restructuring of the reference entity's debt obligations. The Company generally would not be required to make a payment until aggregate credit losses exceed the designated deductible threshold and only as each incremental default occurs.
FSA's ability to pay dividends depends, among other things, upon FSA's financial condition, results of operations, cash requirements and compliance with rating agency requirements, and is also subject to restrictions contained in the insurance laws and related regulations of New York and other states. Under the New York Insurance Law, FSA may pay dividends out of earned surplus, provided that, together with all dividends declared or distributed by FSA during the preceding 12 months, the dividends do not exceed the lesser of (a) 10% of policyholders' surplus as of its last statement filed with the New York Superintendent or (b) adjusted net investment income during this period. Based on FSA's statutory statements for 2008, the maximum amount available for payment of dividends by FSA without regulatory approval over the 12 months following December 31, 2008 is approximately $62.0 million, subject to certain limitations. FSA paid $30.0 million in dividends in 2008 and $140.0 million in 2006. FSA did not pay any dividends in 2007.
FSA may repurchase shares of its common stock from its shareholder subject to the New York Superintendent's approval. The New York Superintendent has approved the repurchase by FSA of up to $500.0 million of its shares from FSA Holdings through December 31, 2008. FSA repurchased $70.0 million of shares of its common stock during the first six months of 2008, and retired the shares. However, as the amounts paid for repurchases may not exceed cumulative statutory earnings from January 1, 2006 through the end of the quarter prior to the repurchase, FSA was unable to repurchase shares during the third and fourth quarter of 2008. FSA repurchased shares of its common stock from FSA Holdings totaling $180.0 million in 2007 and $100.0 million in 2006, respectively, and retired such shares.
Further downgrades of FSA's financial strength ratings could have a material adverse effect on its long-term competitive position and prospects for future business opportunities as well as its ability to pay dividends to or repurchase shares from FSAH and its results of operations and financial condition. Credit ratings are an important component of a financial institution's ability to compete in the financial guaranty market.
Leveraged Lease Transactions
A leveraged lease transaction (a "Leveraged Lease Transaction") transfers the tax benefits from a tax-exempt entity, such as a transit agency (lessee) to a tax-paying entity (lessor) by transferring ownership of a depreciable asset, such as subway cars, to the lessor. The municipality (lessee) remains the primary user of the asset. In 2004, Congress amended the Internal Revenue Code to expressly prohibit tax benefits derived from such Leveraged Lease Transactions.
In Leveraged Lease Transactions, the lessor typically financed the purchase of the assets through a combination of equity and debt with the taxpayer (lessor) providing the equity and sharing the benefits of the arrangement with the municipality (lessee). The lessor, to minimize credit exposure to the municipality, required that the lessee interpose a highly rated payment agent to be responsible for the lease payments. Typically the lessee prepays the lease obligation by making a deposit with a payment undertaking agent in consideration for its agreement to make scheduled lease payments, including the purchase option price due at the maturity of the lease, on the lessee's behalf.
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However, events of early termination of the lease require an early termination payment in lieu of the remaining scheduled lease rent amounts. To minimize credit exposure to the lessee municipality, the equity investor typically required that the early termination payment be guaranteed by a highly rated entity. A portion of this protection is referred to as "strip coverage" and requires payment of certain scheduled amounts if the lessee fails to make such payment when due. The Company views this risk as municipal or government risk because the lessees are credit worthy domestic or international municipal entities, such as the New York Metropolitan Transportation Authority, leasing essential equipment, such as subway cars.
As of February 28, 2009, the Company had strip par exposure of approximately $2.6 billion spread over 41 public entities. The Company's strip exposure includes $1.9 billion related to U.S. municipalities and $633 million related to European lessees. The exposure is long dated and is expected to amortize over the next 32 years. In the event an early termination event is triggered and the lessee cannot meet its contractual obligation, the Company would be obligated to make such payments and seek reimbursement from the lessee. The standard financing terms of such reimbursement are Prime +2% to +3%, so there is a financial incentive for the creditworthy lessee to finance an early termination payment if one became necessary.
Each of the following events, among others, generally may lead to an early termination of a lease:
The lessee is generally obligated to find a replacement credit enhancer within a specified period of time; failure to find a replacement could result in a lease default, and failure to cure the default within a specified period of time could lead to an early termination of the lease and a demand by the lessor for a termination payment from the lessee. However, even in the event of an early termination of the lease, there would not necessarily be an automatic draw on FSA's policy, as this would only occur to the extent the lessee does not make the required termination payment.
AIG International Group, Inc. ("AIG") and Premier International Funding Co. ("Premier"), among others, act as equity payment undertakers in a number of transactions in which FSA acts as strip coverage provider, with AIG acting as equity payment undertaker in the large majority of such transactions. AIG was downgraded in the third quarter of 2008 and FSA was downgraded by Moody's in the fourth quarter of 2008. As a result, 53 Leveraged Lease Transactions in which FSA acted as strip coverage provider have breached either a ratings trigger related to AIG or a ratings trigger related to FSA. Under Leveraged Lease Transactions, if an early termination of the lease occurs and the lessee does not make the required early termination payment, FSA would be exposed to a possible liquidity claim on the 53 transactions with a current gross exposure of approximately $1.5 billion. If FSA is further downgraded to A+ or A1 and an early termination of the lease occurs and the lessee does not make the required early termination payment, FSA would be exposed to a possible liquidity claim on a total of 77 transactions with a current gross exposure of approximately $2.6 billion.
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To date, none of the Leveraged Lease Transactions which involve FSA has experienced an early termination due to a lease default and a claim on the FSA guaranty. At February 28, 2009, $93 million of strip par exposure had been terminated on a consensual basis. The Company expects that an additional approximately $119 million of strip par exposure is likely to be terminated on a consensual basis in the future. The consensual terminations have resulted in no claims on FSA.
It is difficult to determine the probability that the Company will have to pay strip provider claims or the likely aggregate amount of such claims. The maximum amount of such claims is provided above. Because of the high interest rates due on a draw on FSA's policy and the possible loss of the use of the leased asset, the municipal lessees should have an incentive to make payments themselves to the lessors. But in the current market environment it may be costly or even impossible for some lessees to fund the termination amounts on a timely basis. Lessees report that many lessors have granted extensions of time to find replacements. Moreover, the lessees may seek assistance from the United States Department of the Treasury to avoid or mitigate such payments. The Company is unable to determine the likelihood of such federal assistance.
Sources of Liquidity
Management believes that FSA's expected operating liquidity needs over the next 12 months can be funded from its cash and short-term investment balance and its operating cash flow. The Company's primary sources of liquidity available to pay claims on a short-and long-term basis are cash flow from premiums written, FSA's investment portfolio and earnings thereon, reinsurance arrangements with third-party reinsurers, liquidity lines of credit with banks, and capital market transactions. FSA's ability to fund short- and long-term operating cash flow is also dependent on factors outside management's control such as general credit and liquidity conditions within the market.
FSA has a liquidity facility for $150.0 million, provided by commercial banks and intended for general application to transactions insured by FSA. If FSA is downgraded below Aa3 by Moody's and AA- by S&P, the lenders may terminate the commitment, and the commitment commission becomes due and payable. If FSA is downgraded below Baa3 by Moody's and BBB- by S&P, any outstanding loans become due and payable. At December 31, 2008, there were no borrowings under this arrangement, which expires on April 21, 2011.
FSA has a standby line of credit in the amount of $350.0 million with a group of international banks to provide loans to FSA after it has incurred, during the term of the facility, cumulative municipal losses (net of any recoveries) in excess of the greater of $350.0 million or the average annual debt service of the covered portfolio multiplied by 5%, which amounted to $1,612.0 million at December 31, 2008. The obligation to repay loans under this agreement is a limited recourse obligation payable solely from, and collateralized by, a pledge of recoveries realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. This commitment has a ten-year term expiring on April 30, 2015. The ratings downgrade of FSA by Moody's to Aa3 in November, 2008 resulted in an increase to the commitment fee. No amounts have been utilized under this commitment at December 31, 2008.
In June 2003, $200.0 million of CPS, money market committed preferred trust securities, were issued by trusts created for the primary purpose of issuing the CPS to investors, investing the proceeds in high-quality commercial paper and selling put options to FSA allowing FSA to issue in exchange for cash its non-cumulative redeemable perpetual preferred stock (the "Preferred Stock") of FSA. There are four trusts each with an initial aggregate face amount of $50 million. These trusts hold auctions every 28 days at which time investors submit bid orders to purchase CPS. If FSA were to exercise a put option, the applicable trust would transfer the portion of the proceeds attributable to principal received upon maturity of its assets, net of expenses, to FSA in exchange for Preferred Stock of FSA. FSA pays a floating put premium to the trusts, which represents the difference between the commercial paper
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yield and the winning auction rate (plus all fees and expenses of the trust). If any auction does not attract sufficient clearing bids, however, the auction rate is subject to a maximum rate for the next succeeding distribution period (200 basis points above LIBOR). Beginning in August 2007, the CPS required the maximum rate for each of the relevant trusts. FSA continues to have the ability to exercise its put option and cause the related trusts to purchase FSA Preferred Stock. The trusts provide FSA access to new capital at its sole discretion through the exercise of the put options. The Company does not consider itself to be the primary beneficiary of the trusts because it does not retain the majority of the residual benefits or expected losses.
FP Segment Liquidity
In its FP segment, the Company relies on net interest income to fund its net interest expense and operating expenses. The FP segment business model contemplated that operating cash flow from interest and principal payments on the FP investments would provide sufficient liquidity to pay the FP obligations on a timely basis. The Company sought to manage the FP business' liquidity risk through the maintenance of liquid collateral and liquidity agreements. To minimize the refinancing risk in the FP Investment Portfolio, bonds in the portfolio were targeted to have shorter weighted average lives than those of the related funding obligations. While this investment strategy posed a degree of reinvestment risk, the Company believed it could adequately minimize liquidity risk. These assumptions proved incorrect. During the course of 2008, the FP segment developed significant liquidity shortfalls as a result of a number of factors, including (i) greater than anticipated GIC withdrawals; (ii) slower than anticipated amortization of RMBS owned in the FP Investment Portfolio; (iii) redemption/collateralization requirements triggered by the downgrade of FSA's ratings by Moody's; and (iv) a significant decline in market value of the FP Investment Portfolio due to market dislocation, with mark-to-market losses at December 31, 2008 of $8,397.9 billion. These liquidity shortfalls were addressed by liquidity support provided by Dexia over the course of 2008 as the Company drew down on the First Dexia Line of Credit, with $1.3 billion outstanding at December 31, 2008.
Unscheduled withdrawals of principal allowed by the terms of the GICs have increased due to a number of factors, and have largely been associated with non-municipal GICs. The majority of municipal GICs insured by FSA relate to debt service reserve funds and construction funds in support of municipal bond transactions. Debt service reserve fund GICs may be drawn earlier than expected upon a payment default by the municipal issuer. Construction fund GICs usually have withdrawal schedules based on expected construction funding requirements, but may be drawn earlier or later than expected when construction of the underlying municipal project does not proceed as expected.
The majority of non-municipal GICs insured by FSA were purchased by issuers of credit-linked notes that provide credit protection with respect to CDOs of ABS and CLOs. These issuers of credit-linked notes typically sell credit protection by entering into a CDS referencing specified asset-backed or corporate obligations. Such GICs may be and in many cases have been drawn earlier than expected to fund credit protection payments due by the credit-linked note issuer under the related CDS or upon an acceleration of the related credit-linked notes following a transaction event of default. At December 31, 2008, $983.6 million of CDO of ABS GICs had been terminated due to an event of default in the CDOs of ABS transactions and subsequent liquidation of the assets of the CDO. In addition, $852.0 million of pooled corporate CDO GICs were terminated due to an event of default caused by the bankruptcy of Lehman Brothers, which was the guarantor of the CDS protection buyer in those transactions.
Further, liquidity risk related to FSA's ratings has increased as FSA has been downgraded or placed on credit watch by the three major rating agencies. Most FSA-insured GICs allow for withdrawal of GIC funds in the event of a downgrade of FSA, typically below AA- by S&P or Aa3 by Moody's, unless the GIC provider posts collateral or otherwise enhances its credit. Such a downgrade could result in the need to post a significant amount of additional collateral in order to fund GIC
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withdrawals. Some FSA-insured GICs also allow for withdrawal of GIC funds in the event of a downgrade of FSA, typically below A3 by Moody's or A- by S&P, with no right of the GIC provider to avoid such withdrawal by posting collateral or otherwise enhancing its credit.
The November 2008 downgrade to Aa3 by Moody's resulted in a trigger breach on $1.7 billion of unsecured GICs and $1.6 billion of secured GICs. In respect of unsecured GICs, the Company posted $1.0 billion of collateral, terminated $0.4 billion of GICs and modified the trigger to below Aa3 on $0.2 billion of GICs. The Company also posted $80 million of additional collateral to secured GICs. At December 31, 2008, a downgrade of FSA to below AA- by S&P or Aa3 by Moody's (A+ by S&P or A1 by Moody's) would result in withdrawal of $0.8 billion of GICs and the need to post collateral on GICs with a balance of $13.4 billion. At December 31, 2008, a downgrade of FSA to below A- by S&P or A3 by Moody's (i.e., BBB+ by S&P or Baa1 by Moody's) would result in mandatory or optional withdrawals of $5.1 billion of GICs and repayment or collateralization of the remainder of the $9.1 billion of GICs outstanding.
A downgrade could result in a significant increase in collateral required to be posted to avoid GIC terminations. In such event, the Company would be required to raise cash to fund such withdrawals by accessing lines of credit provided by Dexia, selling assets, in some cases realizing substantial market loss, or borrowing against the value of such assets. In addition, assets posted as collateral are subject to changes in market value and ratings. Such changes may reduce the value of the collateral or make the assets no longer qualify as collateral. As a result, additional collateral, to which the Company may or may not have access, may be required to be posted to meet collateral requirements.
The market value of the FP Investment Portfolio and cash held at December 31, 2008 was approximately $9.5 billion. Taken together with the liquidity resources available under the First Dexia Line of Credit, the FP segment's liquidity resources were sufficient to meet the GIC withdrawal and collateralization requirements at December 31, 2008. Further deterioration in the market value of the FP Investment Portfolio or ratings downgrades could result in the FP business having inadequate market value of securities eligible to be pledged as collateral in the event of an FSA downgrade. Should the FP segment debt become callable due to rating agency actions or other reasons, the Company would draw under the Dexia Lines of Credit or be forced to sell such assets to cover the debt calls in order to meet its liquidity needs.
The Company monitors the risk of unscheduled withdrawals with regular surveillance of the GIC agreements, including review of past activities, recently issued trustee reports, reference name performance characteristics and third party tools to analyze early withdrawal risks. GICs can be categorized according to their potential for unscheduled withdrawals of principal, as follows: contingent draw GICs which may be drawn earlier than expected due to credit deterioration; full flex GICs which allow withdrawals only for permitted purposes defined in the governing indentures; and fixed draw GICs which cannot be drawn earlier than scheduled. Fixed draw GICs include capitalized interest fund GICs that pay interest on an underlying bond issue during the construction phase of a project and
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escrow fund GICs that defease future obligations. The following table shows GIC principal balances, in millions, categorized according to potential for unscheduled withdrawals.
|
At December 31, | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||||||||||
|
Principal Balance | Number of Contracts | Principal Balance | Number of Contracts | |||||||||||
|
(dollars in millions)
|
||||||||||||||
Contingent Draw: |
|||||||||||||||
CDOs of ABS |
$ | 4,042.9 | 46 | $ | 6,099.8 | 56 | |||||||||
Corporate CDOs |
3,259.1 | 81 | 4,404.1 | 130 | |||||||||||
Debt service reserve |
2,242.8 | 254 | 2,535.8 | 264 | |||||||||||
Other |
214.7 | 2 | 606.7 | 17 | |||||||||||
Subtotal |
9,759.5 | 383 | 13,646.4 | 467 | |||||||||||
Full Flex: |
|||||||||||||||
Construction |
2,691.5 | 58 | 3,330.2 | 90 | |||||||||||
Other |
401.7 | 108 | 415.7 | 107 | |||||||||||
Subtotal |
3,093.2 | 166 | 3,745.9 | 197 | |||||||||||
Fixed Draw: |
|||||||||||||||
Escrow |
683.7 | 12 | 705.4 | 13 | |||||||||||
Capitalized interest |
358.5 | 25 | 255.1 | 16 | |||||||||||
Other |
403.4 | 12 | 415.1 | 10 | |||||||||||
Subtotal |
1,445.6 | 49 | 1,375.6 | 39 | |||||||||||
Total |
$ | 14,298.3 | 598 | $ | 18,767.9 | 703 | |||||||||
In anticipation of a need for increased liquidity resources, commencing with the fourth quarter of 2007 the Company began investing newly originated GIC proceeds into short-term investments. However, the ability to access additional funding through the issuance of GICs was hampered by a material reduction in new GIC issuances during the second half of 2008 and the Company's cessation of new GIC originations in November 2008. In order to address its liquidity needs, FSAM accessed the First Dexia Line of Credit during 2008, with $1.3 billion outstanding at December 31, 2008. FSAM expects to rely upon liquidity provided by Dexia for its on-going liquidity requirements.
Sources of Liquidity
Dexia Crédit Local and Dexia Bank Belgium provided the First Dexia Line of Credit to FSAM to address FP segment liquidity requirements under the revolving credit agreement dated as of June 30, 2008. Dexia Crédit Local subsequently assigned an 88% fractional interest in its obligations under the facility to Dexia Bank Belgium. The First Dexia Line of Credit has a continually rolling five year term, subject to termination by Dexia Crédit Local or Dexia Bank Belgium upon five years notice. At December 31, 2008, the Company had outstanding draws of $1.3 billion under the First Dexia Line of Credit.
In November 2008, the Company entered into a capital commitment agreement (the "Capital Commitment Agreement") and a global risk securities lending agreement (the "Securities Lending Agreement") with Dexia and its affiliates in support of its FP business. FSA Holdings, FSA and Dexia Holdings are parties to the Capital Commitment Agreement, pursuant to which Dexia Holdings provides for capital contributions to FSA Holdings of up to $500 million in the aggregate, equal to the estimated economic losses on assets owned by FSAM for which OTTI has been determined in accordance with the Company's accounting principles for the quarter ending immediately prior to the contribution date, less certain realized tax benefits arising from those economic losses. Upon receipt of
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a capital contribution from Dexia Holdings, the Company is required to make a capital contribution to FSAM of an equivalent amount. Dexia Crédit Local has committed to loan, contribute or otherwise convey to Dexia Holdings all amounts needed by Dexia Holdings to make the capital contributions to the Company. In the third quarter 2008, estimated economic losses incurred on assets owned by FSAM were $207.8 million which, pursuant to the Capital Commitment Agreement, Dexia Holdings contributed to FSA Holdings on December 16, 2008. In the fourth quarter 2008, estimated economic losses incurred were $273.2 million, which, pursuant to the Capital Commitment Agreement, Dexia Holdings is obligated to contribute to FSA Holdings 30 days after filing of the FSA Holdings 2008 annual report on Form 10-K.
Under the Securities Lending Agreement between Dexia Crédit Local, FSAM, FSA and FSA Insurance Company, Dexia Crédit Local agrees to lend FSAM up to $3.5 billion (based upon market value, and subject to reduction as described below) of securities eligible to be pledged as collateral for GICs. As collateral for this loan, FSAM is obligated to post securities of the same market value but that are generally ineligible to act as collateral for GICs. FSAM may only draw on the facility in the event of a downgrade of FSA to below Aa3 by Moody's or AA- by S&P. The Securities Lending Agreement has a continually rolling five year term, which becomes a fixed five year term upon notice from Dexia Crédit Local. Dexia Crédit Local can terminate the Agreement (subject to FSAM's consent, not to be unreasonably withheld) if FSAM enters into an alternative liquidity or credit enhancement agreement that serves to make the Securities Lending Agreement unnecessary or redundant. In no case will the term exceed seven years. FSA is obligated to provide a guaranty of FSAM's payment obligations under the Securities Lending Agreement, if utilized.
In November 2008, FSA, FSAM, Dexia Crédit Local and Dexia Bank Belgium entered into a Pledge and Intercreditor Agreement (the "Pledge Agreement"). Pursuant to the Pledge Agreement, Dexia Crédit Local and Dexia Bank Belgium was provided a subordinated lien on the assets of FSAM to secure borrowings by FSAM under the First Dexia Line of Credit. FSA has an existing security interest in the same collateral, which was given priority over the new lien under the Pledge Agreement. Any assets that FSAM transfers to the GIC Subsidiaries under existing intercompany agreements for use as collateral under secured GICs or that FSAM transfers to its derivative or repurchase agreement counterparties are excluded from the liens in favor of FSA, Dexia Crédit Local and Dexia Bank Belgium.
In February 2009, FSAM and Dexia Crédit Local entered into a second revolving credit agreement (the "Second Dexia Line of Credit"), pursuant to which Dexia Crédit Local provides a $3.0 billion committed standby line of credit to FSAM. The terms and conditions of the Second Dexia Line of Credit are substantially similar to those of the revolving credit agreement pursuant to which Dexia Crédit Local and Dexia Bank Belgium S.A. ("Dexia Bank Belgium") provide the $5.0 billion First Dexia Line of Credit to FSAM. The Second Dexia Line of Credit has a continually rolling five year term, subject to termination by Dexia Crédit Local upon five years notice. FSAM may only borrow under the Second Dexia Line of Credit if the entire commitment under the First Dexia Line of Credit has been borrowed and remains outstanding.
Under the terms of the First Dexia Line of Credit, FSA guaranteed FSAM's repayment of any borrowings thereunder. FSA, FSAM, Dexia Crédit Local and Dexia Bank Belgium entered into a Guarantee Release Agreement, dated as of February 20, 2009, pursuant to which such guarantee was released and terminated.
112
In February 2009, FSA, FSAM, the GIC Subsidiaries, Dexia Crédit Local and Dexia Bank Belgium entered into an Amended and Restated Pledge and Intercreditor Agreement (the "Restated Pledge Agreement"). Pursuant to the Restated Pledge Agreement, FSAM granted security interests over substantially all its assets to (a) the GIC Subsidiaries, to secure FSAM's obligations to the GIC Subsidiaries under intercompany financing arrangements, and (b) Dexia Crédit Local, to secure borrowings under the Second Revolving Credit Agreement. The new security interest in favor of the GIC Subsidiaries is equal in priority to the existing security interest previously granted to FSA to secure FSAM's reimbursement obligations to FSA in respect of FSA guaranties in favor of various FSAM creditors (some, but not all, of which guaranties remain outstanding). The new security interest granted to Dexia Crédit Local to secure borrowings under the Second Dexia Line of Credit is subordinate (a) to the existing security interest in the same collateral that secures borrowings under the First Dexia Line of Credit, and (b) to the security interests of FSA and the GIC Subsidiaries in the same collateral, which are each senior to both of the security interests securing borrowings under the First and Second Dexia Lines of Credit. In addition, the new security interest in favor of the GIC Subsidiaries has been collaterally assigned to FSA to secure their reimbursement obligations to FSA in respect of FSA's guaranties of their GICs.
In February 2009, FSA, FSAM and the GIC Subsidiaries entered into a Release and Termination Agreement (the "Termination Agreement"). Pursuant to the Termination Agreement, FSA's guaranty of certain assets held by FSAM, as well as its guaranty of FSAM's obligations under certain intercompany financing arrangements between FSAM and the GIC Subsidiaries, were released and terminated. In connection therewith, each of FSAM and the GIC Subsidiaries was released from any further obligation to pay FSA any premium in respect of the terminated guaranties or other FSA guaranties that will remain outstanding in connection with the FP business.
Certain notes held by FSA Global contain provisions that could extend the stated maturities of those notes. To ensure FSA Global will have sufficient cash flow to repay its own debt issuances that relate to such notes, FSA Global has entered into several liquidity facilities with Dexia for $419.4 million. Certain notes held by FSA Global benefit from a liquidity facility with XL Insurance Ltd. for $341.5 million.
Contractual Obligations
The following is a summary of the Company's contractual obligations at December 31, 2008:
Contractual Obligations(1)
|
Less than
1 Year |
1-3 Years | 3-5 Years |
Greater than
5 years |
Total | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(in millions)
|
||||||||||||||||
Losses and loss adjustment expenses(2) |
$ | 1,144.3 | $ | 502.5 | $ | 100.2 | $ | 472.3 | $ | 2,219.3 | |||||||
FP segment debt(3) |
5,200.3 | 2,619.9 | 3,921.9 | 11,130.5 | 22,872.6 | ||||||||||||
Notes payable(4) |
46.1 | 92.1 | 92.1 | 2,782.5 | 3,012.8 | ||||||||||||
Operating lease obligations |
9.1 | 17.1 | 16.6 | 96.0 | 138.8 | ||||||||||||
DCP and SERP liability |
69.7 | 0.7 | 0.5 | 19.8 | 90.7 | ||||||||||||
Total |
$ | 6,469.5 | $ | 3,232.3 | $ | 4,131.3 | $ | 14,501.1 | $ | 28,334.2 | |||||||
113
Cash Flow
The Company's cash flows from operations are heavily dependent on market conditions, the competitive environment and the mix of business originated. The following table summarizes cash flow from operations, investing and financing activities.
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||
|
(in millions)
|
|||||||||
Cash provided by (used for) operating activities |
$ | 1,416.6 | $ | 383.5 | $ | 611.2 | ||||
Cash provided by (used for) investing activities |
1,150.1 | (2,963.3 | ) | (3,423.7 | ) | |||||
Cash provided by (used for) financing activities |
(2,480.6 | ) | 2,571.7 | 2,800.7 | ||||||
Effect of changes in foreign exchange rates on cash balances |
(4.0 | ) | 2.2 | 0.7 | ||||||
Net (decrease) increase in cash |
82.1 | (5.9 | ) | (11.1 | ) | |||||
Cash at beginning of year |
26.6 | 32.5 | 43.6 | |||||||
Cash at end of year |
$ | 108.7 | $ | 26.6 | $ | 32.5 | ||||
Cash Flow from Operations
In 2008, cash flow from operations was positive, despite losses paid, due to strong originations in the first half, increases in cash collateral received from derivative counterparties and net investment income received. In 2007, excluding trading portfolio asset purchases, the decrease in cash flow from operations was primarily due to an increase in losses paid, as well as increases in interest paid on notes payable and taxes paid.
Premiums received were $617.1 million in 2008, $435.2 million in 2007, and $440.6 million in 2006. The increase in premiums received in 2008 and 2007 was primarily due to high origination volume through the first half of 2008. In 2008, public finance originations were the primary drivers of premiums cash inflows.
Net investment income from the General Investment Portfolio increased in 2008 largely due to increased investment balances arising from premiums received plus capital contributions. Investment income related to assets acquired in refinancing transactions declined as those assets paid down or were sold. Losses paid increased significantly in 2008 and 2007 due primarily to claim payments on insured HELOC obligations. Interest on notes payable increased from $26.9 million in 2006 to $47.3 million in 2007 due to the issuance of $300.0 million of hybrid debt in the fourth quarter of 2006. Operating expenses paid increased in 2008, primarily due to increased commissions resulting from third quarter re-assumptions, premium taxes and salary-related activity, such as severance pay, payroll taxes, bonuses and share performance payments to employees. Net cash flow from FP interest income and expense increased in 2008, primarily due to cash collateral received from derivative counterparties. The decrease from 2006 to 2007 was due to an increase in prepaid derivative payments and lower margins.
Cash Flow from Investing and Financing Activities
Investing activities consist primarily of purchases and sales of assets in the Company's various investment portfolios. The Company invested proceeds from the issuance of GICs and VIE debt in assets held within the FP Segment Investment Portfolio. Premium receipts and coupon income are invested in the General Investment Portfolio. Proceeds from issuance of debt are classified as financing
114
activities while the investment of those proceeds are classified as investing activities in the cash flow statement.
The decrease in cash from financing activities in 2008 was primarily the result of the decline in new GIC issuances resulting from the slowdown in the GIC market generally and, in November, the Company's decision to cease issuing new GICs. In 2007, the Company paid $122.0 million in dividends. In 2006, cash flow from financing activities included net cash inflow of $295.8 million related to the issuance of hybrid debt and cash outflow of $530.0 million for dividends paid to shareholders, including a $400.0 million extraordinary dividend.
Summary of Invested Assets
The Company's consolidated cash and invested assets are summarized below.
Summary of Cash and Investments
|
At December 31, 2008 | |||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial Guaranty Segment | FP Segment |
|
|
||||||||||||||||||||||||||||
|
General
Investment Portfolio |
Assets Acquired
in Refinancing Transactions(1) |
FP Investment
Portfolio |
VIE Investment
Portfolio(1) |
Total | |||||||||||||||||||||||||||
|
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
||||||||||||||||||||||
|
(in millions)
|
|||||||||||||||||||||||||||||||
Long-term bonds |
$ | 5,398.8 | $ | 5,283.2 | $ | | $ | | $ | 8,750.4 | $ | 8,760.0 | $ | 923.1 | $ | 923.3 | $ | 15,072.3 | $ | 14,966.5 | ||||||||||||
Equity securities |
1.4 | 0.4 | | | | | | | 1.4 | 0.4 | ||||||||||||||||||||||
Short-term investments |
651.1 | 651.9 | | | 463.3 | 463.3 | 8.2 | 8.2 | 1,122.6 | 1,123.4 | ||||||||||||||||||||||
Trading portfolio |
| | | | 248.6 | 147.2 | | | 248.6 | 147.2 | ||||||||||||||||||||||
Assets acquired in refinancing transactions |
| | 189.6 | 166.6 | | | | | 189.6 | 166.6 | ||||||||||||||||||||||
Subtotal |
6,051.3 | 5,935.5 | 189.6 | 166.6 | 9,462.3 | 9,370.5 | 931.3 | 931.5 | 16,634.5 | 16,404.1 | ||||||||||||||||||||||
Cash |
106.8 | 106.8 | | | 1.9 | 1.9 | | | 108.7 | 108.7 | ||||||||||||||||||||||
Total |
$ | 6,158.1 | $ | 6,042.3 | $ | 189.6 | $ | 166.6 | $ | 9,464.2 | $ | 9,372.4 | $ | 931.3 | $ | 931.5 | $ | 16,743.2 | $ | 16,512.8 | ||||||||||||
|
At December 31, 2007 | |||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial Guaranty Segment | FP Segment |
|
|
||||||||||||||||||||||||||||
|
General
Investment Portfolio |
Assets Acquired
in Refinancing Transactions(1) |
FP Investment
Portfolio |
VIE Investment
Portfolio(1) |
Total | |||||||||||||||||||||||||||
|
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
||||||||||||||||||||||
|
(in millions)
|
|||||||||||||||||||||||||||||||
Long-term bonds |
$ | 4,891.6 | $ | 5,054.6 | $ | | $ | | $ | 17,215.1 | $ | 15,796.5 | $ | 1,119.4 | $ | 1,139.6 | $ | 23,226.1 | $ | 21,990.7 | ||||||||||||
Equity securities |
40.0 | 39.9 | | | | | | | 40.0 | 39.9 | ||||||||||||||||||||||
Short-term investments |
96.3 | 97.4 | | | 1,918.7 | 1,918.7 | 8.6 | 8.6 | 2,023.6 | 2,024.7 | ||||||||||||||||||||||
Trading portfolio |
| | | | 337.2 | 349.8 | | | 337.2 | 349.8 | ||||||||||||||||||||||
Assets acquired in refinancing transactions |
| | 225.7 | 231.8 | | | | | 225.7 | 231.8 | ||||||||||||||||||||||
Subtotal |
5,027.9 | 5,191.9 | 225.7 | 231.8 | 19,471.0 | 18,065.0 | 1,128.0 | 1,148.2 | 25,852.6 | 24,636.9 | ||||||||||||||||||||||
Cash |
24.6 | 24.6 | | | 2.0 | 2.0 | | | 26.6 | 26.6 | ||||||||||||||||||||||
Total |
$ | 5,052.5 | $ | 5,216.5 | $ | 225.7 | $ | 231.8 | $ | 19,473.0 | $ | 18,067.0 | $ | 1,128.0 | $ | 1,148.2 | $ | 25,879.2 | $ | 24,663.5 | ||||||||||||
115
The Company includes variable rate demand notes ("VRDNs") in its long-term bond portfolios. 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. VRDNs totaled $286.8 million and $224.3 million at December 31, 2008 and 2007, respectively. At December 31, 2008, VRDNs consisted of obligations backed by municipal obligors. For management purposes, VRDNs have been managed as short-term investments, although recent market conditions have raised questions about the liquidity of VRDNs.
General Investment Portfolio
The following tables set forth certain information concerning securities in the Company's General Investment Portfolio based on amortized cost:
General Investment Portfolio Fixed-Income Securities by Rating
Rating (1)
|
At December 31, 2008
Percent of Bonds |
||||
---|---|---|---|---|---|
Triple-A(2) |
43.3 | % | |||
Double-A |
36.0 | ||||
Single-A |
19.1 | ||||
Triple-B |
1.5 | ||||
Not Rated |
0.1 | ||||
Total |
100.0 | % | |||
The General Investment Portfolio includes bonds insured by FSA ("FSA-Insured Investments") that were acquired in the ordinary course of business. Of the bonds included in the General Investment Portfolio at December 31, 2008, 6.6% were insured by FSA, and 28.6% were insured by other monolines. All of the FSA-Insured Investments were investment grade without giving effect to the FSA insurance. The average shadow rating of the FSA-Insured Investments, which is the rating without giving effect to the FSA guaranty, was in the Single-A range. These assets are included in the Company's surveillance process and, at December 31, 2008, no loss reserves were anticipated on any of these assets. See "Exposure to Monolines."
116
Summary of the General Investment Portfolio
|
At December 31, | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||||||||
Investment
Category |
Amortized
Cost |
Weighted
Average Yield(1) |
Fair
Value |
Amortized
Cost |
Weighted
Average Yield(1) |
Fair
Value |
||||||||||||||
|
(dollars in millions)
|
|||||||||||||||||||
Bonds: |
||||||||||||||||||||
Taxable bonds |
$ | 1,259.4 | 4.75 | % | $ | 1,226.3 | $ | 971.1 | 5.27 | % | $ | 990.0 | ||||||||
Tax-exempt bonds |
4,139.4 | 4.83 | 4,056.9 | 3,920.5 | 4.84 | 4,064.6 | ||||||||||||||
Total bonds |
5,398.8 | 4.81 | 5,283.2 | 4,891.6 | 4.93 | 5,054.6 | ||||||||||||||
Short-term investments |
651.1 | 0.38 | 651.9 | 96.3 | 4.18 | 97.4 | ||||||||||||||
Total fixed-income securities |
6,049.9 | 4.33 | 5,935.1 | 4,987.9 | 4.91 | 5,152.0 | ||||||||||||||
Equity securities |
1.4 | 0.4 | 40.0 | 39.9 | ||||||||||||||||
Total General Investment Portfolio |
$ | 6,051.3 | $ | 5,935.5 | $ | 5,027.9 | $ | 5,191.9 | ||||||||||||
General Investment Portfolio by Security Type
|
At December 31, | |||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||||||||
Investment
Category |
Amortized
Cost |
Weighted
Average Yield(1) |
Fair
Value |
Amortized
Cost |
Weighted
Average Yield(1) |
Fair
Value |
||||||||||||||
|
(dollars in millions)
|
|||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 103.7 | 3.33 | % | $ | 112.8 | $ | 97.3 | 4.53 | % | $ | 101.4 | ||||||||
Obligations of U.S. states and political subdivisions |
4,321.1 | 4.84 | 4,239.8 | 3,920.5 | 4.84 | 4,064.6 | ||||||||||||||
Mortgage-backed securities |
408.1 | 5.62 | 412.3 | 404.3 | 5.64 | 407.8 | ||||||||||||||
Corporate securities |
206.2 | 4.89 | 210.4 | 198.4 | 5.24 | 201.2 | ||||||||||||||
Foreign securities |
333.6 | 3.81 | 283.7 | 248.0 | 5.00 | 256.3 | ||||||||||||||
Asset-backed securities |
26.1 | 5.15 | 24.2 | 23.1 | 5.07 | 23.3 | ||||||||||||||
Total bonds |
5,398.8 | 4.81 | 5,283.2 | 4,891.6 | 4.93 | 5,054.6 | ||||||||||||||
Short-term investments |
651.1 | 0.38 | 651.9 | 96.3 | 4.18 | 97.4 | ||||||||||||||
Total fixed-income securities |
6,049.9 | 4.33 | 5,935.1 | 4,987.9 | 4.91 | 5,152.0 | ||||||||||||||
Equity securities |
1.4 | 0.4 | 40.0 | 39.9 | ||||||||||||||||
Total General Investment Portfolio |
$ | 6,051.3 | $ | 5,935.5 | $ | 5,027.9 | $ | 5,191.9 | ||||||||||||
117
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 the General Investment Portfolio
|
At December 31, 2008 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Aging Categories
|
Number of
Securities |
Amortized
Cost |
Unrealized
Losses |
Fair Value |
Unrealized
Loss as a Percentage of Amortized Cost |
|||||||||||||
|
(dollars in millions)
|
|||||||||||||||||
Less than Six Months(1) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 0.2 | $ | (0.0 | ) | $ | 0.2 | (0.7 | )% | |||||||||
Obligations of U.S. states and political subdivisions |
993.7 | (58.8 | ) | 934.9 | (5.9 | ) | ||||||||||||
Mortgage-backed securities |
8.7 | (0.1 | ) | 8.6 | (1.4 | ) | ||||||||||||
Corporate securities |
20.7 | (1.5 | ) | 19.2 | (7.1 | ) | ||||||||||||
Foreign securities |
220.2 | (30.4 | ) | 189.8 | (13.8 | ) | ||||||||||||
Asset-backed securities |
23.7 | (1.5 | ) | 22.2 | (6.2 | ) | ||||||||||||
Total |
311 | 1,267.2 | (92.3 | ) | 1,174.9 | (7.3 | ) | |||||||||||
More than Six Months but Less than 12 Months(2) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
0.0 | (0.0 | ) | 0.0 | (2.7 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
587.1 | (53.5 | ) | 533.6 | (9.1 | ) | ||||||||||||
Mortgage-backed securities |
31.8 | (8.3 | ) | 23.5 | (26.1 | ) | ||||||||||||
Corporate securities |
24.8 | (1.4 | ) | 23.4 | (5.8 | ) | ||||||||||||
Foreign securities |
95.9 | (18.9 | ) | 77.0 | (19.7 | ) | ||||||||||||
Asset-backed securities |
1.5 | (0.1 | ) | 1.4 | (8.0 | ) | ||||||||||||
Total |
233 | 741.1 | (82.2 | ) | 658.9 | (11.1 | ) | |||||||||||
12 Months or More(3) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
0.3 | (0.0 | ) | 0.3 | (6.3 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
407.3 | (56.1 | ) | 351.2 | (13.8 | ) | ||||||||||||
Mortgage-backed securities |
10.2 | (1.1 | ) | 9.1 | (10.5 | ) | ||||||||||||
Corporate securities |
8.4 | (0.7 | ) | 7.7 | (8.0 | ) | ||||||||||||
Foreign securities |
4.1 | (1.0 | ) | 3.1 | (23.5 | ) | ||||||||||||
Asset-backed securities |
0.9 | (0.3 | ) | 0.6 | (31.0 | ) | ||||||||||||
Total |
186 | 431.2 | (59.2 | ) | 372.0 | (13.7 | ) | |||||||||||
Total |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
0.5 | (0.0 | ) | 0.5 | (4.6 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
1,988.1 | (168.4 | ) | 1,819.7 | (8.5 | ) | ||||||||||||
Mortgage-backed securities |
50.7 | (9.5 | ) | 41.2 | (18.7 | ) | ||||||||||||
Corporate securities |
53.9 | (3.6 | ) | 50.3 | (6.6 | ) | ||||||||||||
Foreign securities |
320.2 | (50.3 | ) | 269.9 | (15.7 | ) | ||||||||||||
Asset-backed securities |
26.1 | (1.9 | ) | 24.2 | (7.2 | ) | ||||||||||||
Total |
730 | $ | 2,439.5 | $ | (233.7 | ) | $ | 2,205.8 | (9.6 | )% | ||||||||
118
|
At December 31, 2007 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Aging Categories
|
Number of
Securities |
Amortized
Cost |
Unrealized
Losses |
Fair Value |
Unrealized
Loss as a Percentage of Amortized Cost |
|||||||||||||
|
(dollars in millions)
|
|||||||||||||||||
Less than Six Months(1) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 17.0 | $ | (0.0 | ) | $ | 17.0 | (0.1 | )% | |||||||||
Obligations of U.S. states and political subdivisions |
87.7 | (1.2 | ) | 86.5 | (1.4 | ) | ||||||||||||
Mortgage-backed securities |
0.2 | (0.0 | ) | 0.2 | (0.0 | ) | ||||||||||||
Corporate securities |
4.7 | (0.0 | ) | 4.7 | (0.5 | ) | ||||||||||||
Foreign securities |
37.9 | (0.3 | ) | 37.6 | (0.8 | ) | ||||||||||||
Asset-backed securities |
| | | | ||||||||||||||
Total |
53 | 147.5 | (1.5 | ) | 146.0 | (1.1 | ) | |||||||||||
More than Six Months but Less than 12 Months(2) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
| | | | ||||||||||||||
Obligations of U.S. states and political subdivisions |
326.9 | (4.1 | ) | 322.8 | (1.3 | ) | ||||||||||||
Mortgage-backed securities |
0.2 | (0.0 | ) | 0.2 | (3.8 | ) | ||||||||||||
Corporate securities |
12.6 | (0.4 | ) | 12.2 | (3.5 | ) | ||||||||||||
Foreign securities |
| | | | ||||||||||||||
Asset-backed securities |
| | | | ||||||||||||||
Total |
121 | 339.7 | (4.5 | ) | 335.2 | (1.3 | ) | |||||||||||
12 Months or More(3) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
2.1 | (0.1 | ) | 2.0 | (3.3 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
11.4 | (0.5 | ) | 10.9 | (4.0 | ) | ||||||||||||
Mortgage-backed securities |
110.9 | (1.7 | ) | 109.2 | (1.5 | ) | ||||||||||||
Corporate securities |
28.2 | (0.7 | ) | 27.5 | (2.4 | ) | ||||||||||||
Foreign securities |
| | | | ||||||||||||||
Asset-backed securities |
3.0 | (0.0 | ) | 3.0 | (0.1 | ) | ||||||||||||
Total |
180 | 155.6 | (3.0 | ) | 152.6 | (1.9 | ) | |||||||||||
Total |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
19.1 | (0.1 | ) | 19.0 | (0.5 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
426.0 | (5.8 | ) | 420.2 | (1.4 | ) | ||||||||||||
Mortgage-backed securities |
111.3 | (1.7 | ) | 109.6 | (1.5 | ) | ||||||||||||
Corporate securities |
45.5 | (1.1 | ) | 44.4 | (2.5 | ) | ||||||||||||
Foreign securities |
37.9 | (0.3 | ) | 37.6 | (0.8 | ) | ||||||||||||
Asset-backed securities |
3.0 | (0.0 | ) | 3.0 | (0.1 | ) | ||||||||||||
Total |
354 | $ | 642.8 | $ | (9.0 | ) | $ | 633.8 | (1.4 | )% | ||||||||
119
Management has determined that the unrealized losses in fixed-income securities in the General Investment Portfolio at December 31, 2008 were primarily attributable to the current market volatility and foreign currency rates and has concluded that these unrealized losses are temporary in nature based upon: (a) the lack of principal and interest payment defaults on these securities; (b) the creditworthiness of the issuers; and (c) FSA's ability and current intent to hold these securities until maturity. At December 31, 2008 and 2007, 100% of the securities that were in a gross unrealized loss position were rated investment grade. Management has based its conclusions on current facts and circumstances. Events could occur in the future that could change management conclusions about its ability and intent to hold such securities.
The amortized cost and fair value of fixed-income securities in the General Investment Portfolio at December 31, 2008 and 2007, 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.
Distribution of Fixed-Income Securities in the General Investment Portfolio
by Contractual Maturity
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
||||||||||
|
(in millions)
|
|||||||||||||
Due in one year or less |
$ | 833.1 | $ | 837.7 | $ | 156.0 | $ | 158.0 | ||||||
Due after one year through five years |
1,036.7 | 1,046.0 | 1,354.8 | 1,425.2 | ||||||||||
Due after five years through ten years |
823.9 | 828.1 | 818.4 | 853.9 | ||||||||||
Due after ten years |
2,922.0 | 2,786.8 | 2,231.3 | 2,283.8 | ||||||||||
Mortgage-backed securities(1) |
408.1 | 412.3 | 404.3 | 407.8 | ||||||||||
Asset-backed securities(2) |
26.1 | 24.2 | 23.1 | 23.3 | ||||||||||
Total fixed-income securities in General Investment Portfolio |
$ | 6,049.9 | $ | 5,935.1 | $ | 4,987.9 | $ | 5,152.0 | ||||||
In 2008, the Company had net realized losses of $6.7 million, which included a $36.1 million loss on the sale of its investment in SGR preferred stock and an OTTI charge of $6.0 million for several municipal bonds, offset in part by realized gains on sales of assets. Realized losses from the General Investment Portfolio were $1.9 million in 2007 and $8.3 million in 2006.
The weighted average maturity of the fixed-income securities in the General Investment Portfolio at December 31, 2008 was approximately 12.5 years.
120
Distribution of Mortgage-Backed Securities
in General Investment Portfolio by Investment Category
|
At December 31, 2008 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Par Value |
Amortized
Cost |
Fair Value | ||||||||
|
(in millions)
|
||||||||||
Pass-through securitiesU.S. Government agency |
$ | 367.2 | $ | 364.3 | $ | 377.6 | |||||
CMOsU.S. Government agency |
13.5 | 13.7 | 13.7 | ||||||||
CMOsnon-agency |
30.6 | 30.1 | 21.0 | ||||||||
Total mortgage-backed securities |
$ | 411.3 | $ | 408.1 | $ | 412.3 | |||||
|
At December 31, 2007 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Par Value |
Amortized
Cost |
Fair Value | ||||||||
|
(in millions)
|
||||||||||
Pass-through securitiesU.S. Government agency |
$ | 353.2 | $ | 350.9 | $ | 354.0 | |||||
CMOsU.S. Government agency |
16.7 | 16.9 | 16.9 | ||||||||
CMOsnon-agency |
37.1 | 36.5 | 36.9 | ||||||||
Total mortgage-backed securities |
$ | 407.0 | $ | 404.3 | $ | 407.8 | |||||
At December 31, 2008, the Company's investments in mortgage-backed securities in its General Investment Portfolio primarily consisted of pass-through certificates and collateralized mortgage obligations ("CMOs"), which are backed by mortgage loans guaranteed or insured by agencies of, or sponsored by, the federal government. These securities are highly liquid with readily determinable market prices. The Company also held $23.0 million of Triple-A-rated CMOs in its General Investment Portfolio at December 31, 2008 that are not guaranteed by government agencies. Secondary-market quotations are available for these securities, although they are not as liquid as government agency-backed securities.
These CMOs held at December 31, 2008 have stated maturities ranging from nine to 29 years and expected average lives ranging from one to 14 years based on anticipated prepayments of principal.
Mortgage-backed securities differ from traditional fixed-income bonds because they are subject to prepayments at par value without penalty when the underlying mortgage loans are prepaid at the borrower's option. Prepayment rates on mortgage-backed securities are influenced primarily by the general level of prevailing mortgage interest rates, with prepayments increasing when prevailing loan interest rates are lower than the rates on the underlying mortgage loans, and by the terms of the loans. When prepayments occur, the proceeds must be reinvested at then-current market rates, which may be below the yield on the prepaid securities.
FP Investment Portfolio
The FP Investment Portfolio is broadly comprised of short-term investments, agency and non-agency RMBS, securities issued or guaranteed by U.S. government sponsored agencies, taxable municipal bonds, securities issued by utilities, infrastructure-related securities, CDOs of ABS, and other asset-backed securities. Non-agency RMBS comprise the majority of the FP Investment Portfolio and include securities backed by pools of the following types of mortgage loans: first lien loans to subprime borrowers, Alt-A loans, Option ARMs, closed-end second lien, HELOCs and prime loans. The FP Investment Portfolio also includes NIM securitizations.
121
The Company carries debt securities designated as "available-for-sale" on its balance sheet at fair value in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The Company records unrealized gains and losses net of deferred tax, as a component of accumulated other comprehensive income unless such securities have been other-than-temporarily impaired.
Historically, the Company had the ability and intent to hold the FP Segment Investment Portfolio to maturity. However, the Company no longer has the intent to hold such securities to maturity, due to Dexia's Purchase Agreement covenant to retain the FP operations and segregate or separate the FP operations from the Company's financial guaranty operations. As a result, the Company was required to record an OTTI charge for all assets in the Portfolio in an unrealized loss position at December 31, 2008. The OTTI recorded in 2008 was $8,397.9 million, compared to $11.1 million in 2007. In the FP Investment Portfolio, pre-tax unrealized gains of $9.6 million at December 31, 2008 were recorded in other comprehensive income.
In 2008, unrealized pre-tax losses of $202.6 million were recorded in the consolidated statements of operations and comprehensive income related to its trading portfolio. In 2007 and 2006, unrealized pre-tax gains of $14.0 million and $3.6 million, respectively, were recorded in the consolidated statements of operations and comprehensive income related to that portion of the portfolio designated trading.
For a discussion of these unrealized losses, as well as the risks inherent in the FP Investment Portfolio, see "Liquidity and Capital ResourcesFP Segment Liquidity" and "Item 7A. Quantitative and Qualitative Disclosures about Market Risk."
The following tables set forth certain information concerning the FP Investment Portfolio based on amortized cost:
FP Investment Portfolio Fixed-Income Securities by Rating
Rating(1)
|
At December 31, 2008
Percentage of FP Investment Portfolio |
||||
---|---|---|---|---|---|
Triple-A |
49.0 | % | |||
Double-A |
15.7 | ||||
Single-A |
7.2 | ||||
Triple-B |
12.8 | ||||
Below investment grade |
15.3 | ||||
Total |
100.0 | % | |||
The FP Investment Portfolio includes FSA-Insured Investments bought in the ordinary course of business. Of the bonds included in the available-for-sale FP Investment Portfolio at December 31, 2008, 4.5% were insured by FSA. At that date, 98.1% of the FSA-Insured Investments were investment grade without giving effect to the FSA insurance. The average shadow rating of the FSA-Insured Investments, which is the rating without giving effect to the FSA guaranty, was in the Triple-B range. Of the bonds included in the FP Investment Portfolio at December 31, 2008, 15.7% were insured by other monoline guarantors. These assets are included in the Company's surveillance process and, at December 31, 2008, no loss reserves were anticipated on any of these assets. See "Exposure to Monolines."
122
Summary of the Available-for-Sale Securities in the FP Investment Portfolio
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Amortized
Cost(1) |
Fair
Value |
Amortized
Cost |
Fair
Value |
||||||||||
|
(in millions)
|
|||||||||||||
Taxable bonds |
$ | 8,750.4 | $ | 8,760.0 | $ | 17,215.1 | $ | 15,796.5 | ||||||
Short-term investments |
463.3 | 463.3 | 1,918.7 | 1,918.7 | ||||||||||
Total available-for-sale bonds and short-term investments |
$ | 9,213.7 | $ | 9,223.3 | $ | 19,133.8 | $ | 17,715.2 | ||||||
Available-for-Sale Securities in the FP Investment Portfolio by Security Type
|
At December 31, | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||||||||||
Investment Category
|
Amortized
Cost(1) |
Fair
Value |
Amortized
Cost |
Fair
Value |
|||||||||||
|
(in millions)
|
||||||||||||||
Mortgage-backed securities: |
|||||||||||||||
Non-agency U.S. RMBS |
$ | 5,212.0 | $ | 5,212.8 | $ | 13,016.0 | $ | 11,714.6 | |||||||
Agency RMBS(2) |
1,230.1 | 1,230.1 | 1,064.3 | 1,058.2 | |||||||||||
U.S. Municipal bonds |
333.7 | 333.7 | 556.2 | 555.4 | |||||||||||
Corporate |
357.5 | 360.3 | 521.7 | 519.2 | |||||||||||
Asset-backed and other securities: |
|||||||||||||||
Collateralized bond obligations, CDO, CLO |
206.1 | 206.1 | 471.0 | 431.6 | |||||||||||
Other(3) |
1,411.0 | 1,417.0 | 1,585.9 | 1,517.5 | |||||||||||
Total available-for-sale bonds |
8,750.4 | 8,760.0 | 17,215.1 | 15,796.5 | |||||||||||
Short-term investments |
463.3 | 463.3 | 1,918.7 | 1,918.7 | |||||||||||
Total available-for-sale bonds and short-term investments |
$ | 9,213.7 | $ | 9,223.3 | $ | 19,133.8 | $ | 17,715.2 | |||||||
123
The table below shows the composition of the non-agency RMBS within the FP Investment Portfolio by credit rating, WAL and the related unrealized gains and losses included in accumulated other comprehensive income.
Selected Information for the Mortgage-Backed Non-Agency U.S. RMBS
Securities in the FP Investment Portfolio
|
At December 31, 2008 | ||||||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Credit Ratings(1) |
|
|
|
|
|
|||||||||||||||||||||||||||
|
Triple-A | Double-A | Single-A | Triple-B |
Below
Investment Grade |
WAL(1) |
Amortized
Cost |
Unrealized
Gains (Losses) |
Fair
Value |
% of
Portfolio |
|||||||||||||||||||||||
|
|
|
|
|
|
(in years)
|
(dollars in millions)
|
|
|||||||||||||||||||||||||
Collateral type: |
|||||||||||||||||||||||||||||||||
Subprime |
39 | % | 18 | % | 7 | % | 9 | % | 27 | % | 3.6 | $ | 3,847.7 | $ | 0.7 | $ | 3,848.4 | 74 | % | ||||||||||||||
Alt-A |
40 | 20 | 7 | 6 | 27 | 5.5 | 765.5 | | 765.5 | 15 | |||||||||||||||||||||||
Option ARMs |
68 | 8 | 12 | 2 | 10 | 3.9 | 291.4 | | 291.4 | 5 | |||||||||||||||||||||||
Closed-end second liens |
| | | 71 | 29 | 7.2 | 51.1 | | 51.1 | 1 | |||||||||||||||||||||||
HELOCs |
| 4 | | 71 | 25 | 5.6 | 106.3 | 0.1 | 106.4 | 2 | |||||||||||||||||||||||
NIM securitizations |
| 7 | | 7 | 86 | 2.8 | 114.9 | | 114.9 | 2 | |||||||||||||||||||||||
Prime |
97 | 3 | | | | 1.4 | 35.1 | | 35.1 | 1 | |||||||||||||||||||||||
Total |
$ | 5,212.0 | $ | 0.8 | $ | 5,212.8 | 100 | % | |||||||||||||||||||||||||
|
At December 31, 2007 | |||||||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Credit Ratings(1) |
|
|
|
|
|
||||||||||||||||||||||||
|
|
Amortized
Cost |
Unrealized
Gains (Losses) |
Fair
Value |
% of
Portfolio |
|||||||||||||||||||||||||
|
Triple-A | Double-A | Single-A | Triple-B | WAL(1) | |||||||||||||||||||||||||
|
|
|
|
|
(in years)
|
(dollars in millions)
|
|
|||||||||||||||||||||||
Collateral type: |
||||||||||||||||||||||||||||||
Subprime |
91 | % | 8 | % | 1 | % | | % | 2.9 | $ | 8,140.6 | $ | (855.8 | ) | $ | 7,284.8 | 62 | % | ||||||||||||
Alt-A |
99 | 1 | | | 4.3 | 2,917.7 | (265.8 | ) | 2,651.9 | 23 | ||||||||||||||||||||
Option ARMs |
100 | | | | 2.3 | 930.2 | (54.1 | ) | 876.1 | 7 | ||||||||||||||||||||
Closed-end second liens |
97 | | | 3 | 2.1 | 214.0 | (22.0 | ) | 192.0 | 2 | ||||||||||||||||||||
HELOCs |
100 | | | | 2.3 | 314.2 | (27.5 | ) | 286.7 | 2 | ||||||||||||||||||||
NIM securitizations |
9 | 91 | | | 1.5 | 336.9 | (68.9 | ) | 268.0 | 3 | ||||||||||||||||||||
Prime |
100 | | | | 4.4 | 162.4 | (7.3 | ) | 155.1 | 1 | ||||||||||||||||||||
Total |
$ | 13,016.0 | $ | (1,301.4 | ) | $ | 11,714.6 | 100 | % | |||||||||||||||||||||
The amortized costs and fair values of the available-for-sale securities in the FP Investment Portfolio 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. At December 31, 2008, the estimated weighted average expected life of the FP Investment Portfolio was 7.0 years.
124
Distribution of Available-for-Sale Securities in
the FP Investment Portfolio by Contractual Maturity
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Amortized
Cost(1) |
Fair
Value |
Amortized
Cost |
Fair
Value |
||||||||||
|
(in millions)
|
|||||||||||||
Due in one year or less |
$ | 463.3 | $ | 463.3 | $ | 1,918.7 | $ | 1,918.7 | ||||||
Due after one year through five years |
649.5 | 649.8 | | | ||||||||||
Due after ten years |
904.1 | 912.6 | 1,317.8 | 1,316.9 | ||||||||||
Mortgage-backed securities(2) |
6,442.1 | 6,442.9 | 14,080.3 | 12,772.8 | ||||||||||
Asset-backed and other securities(3) |
754.7 | 754.7 | 1,817.0 | 1,706.8 | ||||||||||
Total available-for-sale bonds and short-term investments |
$ | 9,213.7 | $ | 9,223.3 | $ | 19,133.8 | $ | 17,715.2 | ||||||
125
The following table shows the gross unrealized losses and fair values of the available-for-sale bonds in the FP Investment Portfolio for December 31, 2007, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position. There were no unrealized losses recorded in accumulated other comprehensive income at December 31, 2008 related to the FP Investment Portfolio because all the securities in this portfolio that were in an unrealized loss position were recorded in income as OTTI.
Aging of Unrealized Losses of Available-for-Sale Bonds
in FP Investment Portfolio
|
At December 31, 2007 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Aging Categories
|
Number of
Securities |
Amortized
Cost |
Unrealized
Losses |
Fair Value |
Unrealized Loss as a
Percentage of Amortized Cost |
|||||||||||||
|
(dollars in millions)
|
|||||||||||||||||
Less than Six Months(1) |
||||||||||||||||||
Obligations of U.S. states and political subdivisions |
$ | 159.3 | $ | (4.0 | ) | $ | 155.3 | (2.5 | )% | |||||||||
Mortgage-backed securities |
7,913.7 | (723.2 | ) | 7,190.5 | (9.1 | ) | ||||||||||||
Corporate securities |
335.0 | (14.4 | ) | 320.6 | (4.3 | ) | ||||||||||||
Other securities (primarily asset-backed) |
1,323.9 | (90.8 | ) | 1,233.1 | (6.9 | ) | ||||||||||||
Total |
533 | 9,731.9 | (832.4 | ) | 8,899.5 | (8.6 | ) | |||||||||||
More than Six Months but Less than 12 Months(2) |
||||||||||||||||||
Obligations of U.S. states and political subdivisions |
| | | | ||||||||||||||
Mortgage-backed securities |
5,232.7 | (568.3 | ) | 4,664.4 | (10.9 | ) | ||||||||||||
Corporate securities |
82.2 | (3.7 | ) | 78.5 | (4.5 | ) | ||||||||||||
Other securities (primarily asset-backed) |
211.0 | (26.2 | ) | 184.8 | (12.4 | ) | ||||||||||||
Total |
223 | 5,525.9 | (598.2 | ) | 4,927.7 | (10.8 | ) | |||||||||||
12 Months or More(3) |
||||||||||||||||||
Obligations of U.S. states and political subdivisions |
64.1 | (2.4 | ) | 61.7 | (3.8 | ) | ||||||||||||
Mortgage-backed securities |
282.6 | (25.0 | ) | 257.6 | (8.8 | ) | ||||||||||||
Corporate securities |
| | | | ||||||||||||||
Other securities (primarily asset-backed) |
57.8 | (1.7 | ) | 56.1 | (2.9 | ) | ||||||||||||
Total |
39 | 404.5 | (29.1 | ) | 375.4 | (7.2 | ) | |||||||||||
Total |
||||||||||||||||||
Obligations of U.S. states and political subdivisions |
223.4 | (6.4 | ) | 217.0 | (2.9 | ) | ||||||||||||
Mortgage-backed securities |
13,429.0 | (1,316.5 | ) | 12,112.5 | (9.8 | ) | ||||||||||||
Corporate securities |
417.2 | (18.1 | ) | 399.1 | (4.3 | ) | ||||||||||||
Other securities (primarily asset-backed) |
1,592.7 | (118.7 | ) | 1,474.0 | (7.5 | ) | ||||||||||||
Total |
795 | $ | 15,662.3 | $ | (1,459.7 | ) | $ | 14,202.6 | (9.3 | )% | ||||||||
126
The table below provides the composition of the FP Investment Portfolio OTTI charge by asset class.
Other-Than-Temporary Impairment Charge of the FP Investment Portfolio
|
Year Ended
December 31, 2008 |
At
December 31, 2008 Number of Securities |
|||||||
---|---|---|---|---|---|---|---|---|---|
|
(dollars in millions)
|
||||||||
Non-agency U.S. RMBS: |
|||||||||
Subprime |
$ | 3,700.5 | 404 | ||||||
Alt-A first-lien |
1,836.8 | 150 | |||||||
Option ARM |
493.1 | 57 | |||||||
Alt-A CES |
117.6 | 9 | |||||||
HELOCs |
140.1 | 14 | |||||||
NIMs |
161.6 | 39 | |||||||
Prime |
112.2 | 8 | |||||||
Other: |
|||||||||
Municipals |
342.2 | 40 | |||||||
Collateralized bond obligations |
241.1 | 22 | |||||||
Utilities |
197.4 | 7 | |||||||
Agency RMBS |
125.9 | 43 | |||||||
Other |
929.4 | 59 | |||||||
Total |
$ | 8,397.9 | 852 | ||||||
The amount of the OTTI charge recorded in the statement of operations and comprehensive income is not necessarily indicative of management's estimate of economic loss, but instead represents the write-down to current fair-value. In 2007, the OTTI charge was $11.1 million.
Review of the FP Investment Portfolio for Economic Impairment
The Company continues to evaluate and measure the economic loss of each position in this portfolio as discussed below.
In its evaluation of securities in the FP Investment Portfolio for economic loss, management uses judgment in reviewing the specific facts and circumstances of individual securities and uses estimates and assumptions of expected default rates, liquidation rates, loss severity rates and prepayment speeds to determine PV of expected losses. The Company uses both proprietary and third-party cash flow models to analyze the underlying collateral of asset-backed securities and the cash flows generated by the collateral to determine whether a security's performance is consistent with the expectation that all payments of principal and interest will be made as contractually required. The Company evaluates each security in the FP Investment Portfolio for economic loss on a quarterly basis.
The following are the Company's assumptions used in the cash flow models.
First-Lien Subprime, Alt-A and Option ARM: For first-lien subprime, Alt-A and Option ARM securities, the Company applied liquidation rates to each of the delinquency categories over an 18 month liquidation horizon starting at 40% for delinquencies between 30 and 59 days overdue and
127
increasing to 100% for collateral repossessed. Upon liquidation, loss severity rates were assumed to be 55% initially for Alt-A and 50% for Option ARM securities, declining linearly over 12 months to 45% for Alt-A and 40% for Option ARMs, where they were assumed to remain constant for 21 months and then decline over the next 12 months. The Company used assumptions (prepayment rates) consistent with those used in the loss reserving process for the Company's insured portfolio of first and second-lien RMBS securities.
HELOC and CES: All of the HELOC securities and all but three of the CES securities in the FP Investment Portfolio were insured by other monolines as of December 31, 2008. The HELOC and CES securities that are insured by financial guarantors that were below investment grade at December 31, 2008 were modeled giving 30% benefit to the insurance policy.
CDOs of ABS: The sole CDO of ABS in the FP Investment Portfolio was wrapped by a below investment grade financial guarantor. In the first quarter of 2009, the insurance policy was extinguished in exchange for cash and equity distributions of $3.4 million and $0.4 million, respectively. Concentrations of lower-quality RMBS collateral led the Company to believe that not all contractual payments due under the investment would be made.
For the sensitivity of the FP Investment Portfolio to changes in credit spreads based upon the Portfolio at December 31, 2008 and 2007, refer to "Item 7A. Quantitative and Qualitative Disclosures About Market RiskFinancial Products SegmentFP Investment Portfolio."
Capital Adequacy
S&P, Moody's and Fitch Ratings periodically make an assessment of FSA, which may include an assessment of the credits insured by FSA and of the reinsurers and other providers of capital support to FSA, to confirm that FSA continues to satisfy the rating agencies' capital adequacy criteria. Capital adequacy assessments by the rating agencies are generally based on FSA's qualified statutory capital, which is the aggregate of policyholders' surplus and contingency reserves determined in accordance with statutory accounting principles.
Rating agency capital models, the assumptions used in the models and the components of the capital adequacy calculations, including ratings and, in the case of S&P, capital charges, are subject to change by the rating agencies at any time. FSA employs considerable reinsurance in its business to manage its single-risk exposures on insured credits, and downgrades by rating agencies of FSA's reinsurers could be expected to have a negative effect on the "cushion" FSA has above the minimum Triple-A requirement in the models.
In the case of S&P, their assessment of the credits insured by FSA are reflected in defined "capital charges." S&P's capital model simulates the effect of a four-year depression occurring three years in the future, during which losses equal 100% of capital charges. The insurer is required to survive this "depression scenario" with 25% more statutory capital than necessary to cover 100% of losses. Credit provided for reinsurance under the S&P capital adequacy model is generally a function of the S&P rating of the reinsurer and the qualification of the reinsurer as a "monoline" or "multiline" company. The downgrade of a reinsurer by S&P from the Triple-A to the Double-A category results in a decline in the credit allowed for reinsurance by S&P from 100% or 95% to 70% or 65%, while a downgrade to the Single-A category results in 50% or 45% credit under present criteria. S&P has also announced plans to introduce an additional capital adequacy model using a Monte Carlo distribution methodology. It has indicated it intends to retain the depression model as well.
Capital adequacy is one of the financial strength measures under Moody's financial guarantor model. The model uses a Monte Carlo distribution methodology and includes a penalty for risk concentration and recognizes a benefit for diversification. Moody's assesses capital adequacy by comparing FSA's claims-paying resources to a Moody's-derived probability of potential credit losses.
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Moody's loss distribution reflects FSA's current distribution of risk by sector, the credit quality of insured exposures, correlations that exist between transactions, the credit quality of FSA's reinsurers and the term to maturity of FSA's insured portfolio. The published results compare levels of theoretical loss in the tail of this distribution to various measures of FSA's claims-paying resources. Like S&P, Moody's allows FSA "credit" for reinsurance based upon Moody's rating of the reinsurer. Generally, 100% credit is allowed for Triple-A reinsurance, 80% to 90% credit is allowed for Double-A reinsurance and 40% to 60% credit is allowed for Single-A reinsurance.
Fitch's Matrix model also uses a Monte Carlo distribution methodology, employing correlation factors and concentration factors. Its primary measure is the "Core Capital Adequacy Ratio," which is the ratio of claims-paying resources adjusted by Fitch to reflect its view of their availability to the amount that it calculates (to a Triple-A level of confidence) would be required to pay claims. Fitch's Matrix model applies reinsurance credit on a transaction level based on Fitch's ratings of the provider, Fitch's correlation factor and the probability of a dispute over the claims, which probability varies depending on whether or not the reinsurer is a monoline.
Capital Expenditures
The Company incurred approximately $3.4 million in capital expenditures in 2008 for property, plant and equipment, which were funded by cash flows from operations.
The Company's critical accounting policies and/or estimates are as follows:
The Company's critical accounting policies and estimates are described in Note 2 to the Consolidated Financial Statements in Item 8. Note 2 to the Consolidated Financial Statements also includes a discussion of the effect of recently issued accounting standards, including the new financial guaranty insurance accounting standard issued by the Financial Accounting Standards Board and effective as of January 1, 2009, that will change the Company's recognition of claims liabilities and premium revenue.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to various types of risk including market risk which represents the potential for loss due to adverse changes in the fair value of financial instruments caused by:
The Company has exposure to market risk in:
Qualitative Disclosures about Market Risk
Credit Risk
Credit risk is risk due to uncertainty in a counterparty's ability to meet its financial obligations. The Company is exposed to credit risk in its investment portfolios and its insured portfolios. Beginning in 2007, market perception of these risks, together with certain market dislocations, began having an adverse effect on the fair value of securities held in the investment portfolios, particularly the FP Investment Portfolio, of which more than half is invested in non-agency RMBS. The Company also has exposure to RMBS in its insured portfolio. Continued deterioration in 2008 of the housing markets and other consumer receivable markets has further eroded the credit protection embedded in the FP Investment Portfolio and ABS insured portfolio.
Financial Guaranty Segment: The Company's insured portfolio exposure to RMBS was concentrated in highly rated categories at origination. There has been wide spread credit deterioration in most if not all RMBS sectors. In the HELOC sector, the Company estimates, as of December 31, 2008, an expected ultimate loss of $1.2 billion, net of reinsurance and recoveries, across ten transactions. The Company's Risk Management Group reviewed all other mortgage exposures, as well as its exposure to automobile and credit card receivable insured obligations, as of December 31, 2008 and does not expect an ultimate loss on such transactions.
Financial Products Segment: The Company monitors the FP Investment Portfolio utilizing both proprietary and third-party models to facilitate analysis, focusing on the cash flows generated by the collateral to determine if a security's performance is consistent with its ability to pay principal and interest as contractually required.
The Company regularly reviews the FP Segment Investment Portfolio to determine if there is expected economic loss. The Company has made assumptions based on current market conditions and expected borrower behavior that could change, adversely affecting the performance of its securities, and, as a result, future reviews could result in additional economic losses for security positions management currently expects to perform fully.
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Interest Rate Risk
Interest rate risk is the risk that financial instruments' value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. As interest rates rise for an available-for-sale portfolio, the fair value of fixed-income securities decreases.
Financial Guaranty Segment: The Company is subject to interest rate risk in all of its investment portfolios. However, the Company's policy is generally to hold assets in the General Investment Portfolio to maturity. Therefore, barring credit deterioration, interest rate movements do not result in realized gains or losses unless assets are sold prior to maturity.
When interest rates are lower or when the market is otherwise relatively less risk averse, the spread between insured and uninsured obligations typically narrows and, as a result, financial guaranty insurance typically provides lower cost savings to issuers than it would during periods of relatively wider spreads. These lower cost savings generally lead to a corresponding decrease in demand and premiums obtainable for financial guaranty insurance.
Conversely, in a deteriorating credit environment, credit spreads widen and pricing for financial guaranty insurance typically improves. However, if the weakening environment is sudden, pronounced or prolonged, the stresses on the insured portfolio may result in claims payments in excess of normal or historical expectations. In addition, increases in prevailing interest rate levels can lead to a decreased volume of capital markets activity and, correspondingly, a decreased volume of insured transactions.
Financial Products Segment: The Company's objective for its FP segment is to generate net interest margin by borrowing funds in the municipal GIC and other markets and investing the proceeds in fixed income investments satisfying the Company's investment criteria. Accordingly, the Company's GICs are issued at or are converted into LIBOR-based floating rate obligations, with proceeds invested in or converted into LIBOR-based floating rate investments intended to result in profits from a higher investment rate than the borrowing rate. This investment and funding strategy minimizes the Company's exposure to interest rate changes as long as the portfolio of assets and liabilities matures according to the expected schedule.
Foreign Exchange Risk
Foreign exchange risk is the risk that a financial instrument's value will change due to a change in the foreign currency exchange rates. To minimize foreign exchange risk in the FP segment, the Company enters into cross-currency swaps to convert all foreign-denominated cash flows into U.S.-dollar cash flows. The General Investment Portfolio is invested in foreign denominated investments with exposure to changes in value relative to the U.S. dollar. Less than 6% of this portfolio was exposed to such risk at December 31, 2008.
Liquidity Risk
Liquidity risk relates to the possible inability to satisfy contractual obligations when due and includes the inability to manage unplanned decreases or changes in funding sources. Liquidity risk also arises from the failure to recognize or address changes in market conditions that affect the ability to liquidate assets quickly and with minimal loss in value.
For information regarding the liquidity risks inherent to the FP business and the liquidity resources available to it, see "Item 7. Liquidity and Capital ResourcesFP Segment Liquidity."
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Operational Risk
Operational risk is the risk of loss resulting from inadequate or failed internal processes, controls, people and systems, or from external events. The definition includes legal risk, which is the risk of loss resulting from failure to comply with laws as well as prudent ethical standards and contractual obligations. It also includes the exposure to litigation from all aspects of an institution's activities. The Company mitigates operational risk by maintaining and testing critical systems (and their system backup) and performing ongoing control procedures to monitor transactions and positions, maintain documentation, confirm transactions and ensure compliance with Company policy and regulations.
General Investment Portfolio
Over 99% of the Company's General Investment Portfolio was invested in fixed-income securities at December 31, 2008. All investments in the General Investment Portfolio are designated as available-for-sale, with changes in fair value recorded in other comprehensive income unless such positions are deemed OTTI.
Management's primary objective in managing the Company's General Investment Portfolio is to generate an optimal level of after-tax investment income while preserving capital, maintaining adequate liquidity and meeting rating agency capital adequacy criteria that apply discount factors to investments based on their ratings. The Company bases its investment strategies on many factors, including the Company's tax position, anticipated changes in interest rates, regulatory and rating agency criteria and other market factors. One internal investment manager and two external investment managers buy investments on behalf of the Company, primarily in the fixed-income market. Management, with the approval of the Board of Directors, establishes guidelines for investment decisions.
The sensitivity of the General Investment Portfolio to interest rate movements can be estimated by projecting a hypothetical increase in interest rates of 1.0%. Based on market values and interest rates at year-end 2008 and 2007, this hypothetical increase in interest rates of 1.0% across the entire yield curve, also known as a "parallel shift" of the yield curve, would result in an estimated after-tax decrease of $291.7 million and $150.9 million, respectively, in the fair value of the Company's fixed-income portfolio, which would be recorded in other comprehensive income unless such positions are deemed OTTI.
In calculating the sensitivity to interest rates for the taxable securities, U.S. Treasury rates are instantaneously increased at year-end by 1.0%. Tax-exempt securities are subjected to a parallel shift in the municipal Triple-A obligation curve that would be equivalent to a 1.0% taxable interest rate change based on the average taxable/tax-exempt ratios for the prior 12 months. The tax-exempt simulation utilizes duration, which takes into account the applicable call date if the bond is priced at a premium or the maturity date if the bond is priced at a discount.
The sensitivity of the General Investment Portfolio to foreign exchange rate movements can be estimated by projecting a hypothetical decrease of 1.0% in the foreign exchange rates of each foreign currency ( i.e. , relative dollar strengthening) represented in the portfolio. Foreign currencies currently represented in the General Investment Portfolio are the British pound, euro, Australian dollar, Japanese yen and Mexican peso. A large majority of the foreign currency securities were denominated in British pounds during 2008 and 2007. Based on the market values of foreign-denominated securities at year-end 2008 and 2007, a hypothetical decrease in foreign exchange rates of 1.0% would result in an estimated after-tax decrease of $1.8 million and $2.1 million, respectively, in the fair value of the Company's fixed-income portfolio, which would be recorded in other comprehensive income unless deemed OTTI.
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Financial Products Segment
FP Investment Portfolio
The primary objective managing the FP Investment Portfolio was to generate a stable net interest margin, to maintain liquidity and to optimize risk-adjusted returns. Fixed rate assets and liabilities supporting the GIC business are hedged to LIBOR floating rates using interest rate swaps or futures. Certain categories of assets and liabilities are naturally floating rate without the use of derivatives. The after-tax effect of a hypothetical increase in interest rates of 1% as of year-end is shown in the table below. The tables and discussions below assume the ability to recognize the full tax benefit with no further valuation allowance. As a result of the FSAM Risk Transfer Transaction effective in February 2009, the Company will deconsolidate FSAM and therefore would not be subject to or record in its financial statements the effects of the movements in fair value of the assets or derivatives in the table below.
Effect of a Hypothetical Increase in Interest Rates of 1%
|
2008 | 2007 | ||||||
---|---|---|---|---|---|---|---|---|
|
(in millions)
|
|||||||
Change in fair value of assets classified as available-for-sale(1) |
$ | (182.9 | ) | $ | (119.4 | ) | ||
Change in fair value of assets classified as trading(2) |
(62.2 | ) | (31.3 | ) | ||||
Change in fair value of derivatives hedging assets(2) |
152.5 | 128.4 | ||||||
Change in fair value of derivatives hedging trading assets(2) |
66.7 | | ||||||
Change in fair value of liabilities(3) |
371.9 | 295.7 | ||||||
Change in fair value of derivatives hedging liabilities(2) |
(340.1 | ) | (272.2 | ) | ||||
Net changes in fair value |
$ | 5.9 | $ | 1.2 | ||||
At December 31, 2008, there were no liabilities in a designated SFAS 133 hedging relationship and certain fixed rate liabilities were at FVO. At December 31, 2007, certain fixed rate liabilities were in a designated SFAS 133 hedging relationship.
At December 31, 2008, certain assets were in a designated SFAS 133 hedging relationship. At December 31, 2007, there were no assets in designated SFAS 133 hedging relationships. See Notes 3 and 4 to the Consolidated Financial Statements in Item 8.
A 1% increase in interest rates would have resulted in a lower reported net income of approximately $27.3 million in 2008, which represents the change in fair value on all derivatives used to economically hedge the assets and liabilities, change in the value of assets and change in value of liabilities that are carried at fair value. A 1% increase in interest rates would have resulted in higher reported net income of approximately $56.1 million in 2007, which represents the change in fair value on all derivatives used to economically hedge the assets and liabilities, as well as the change in the value on liabilities in SFAS 133-qualifying hedging relationships.
FSAM generally converts all fixed rate assets and liabilities to floating U.S.-dollar interest rates using hedging instruments. As interest rates change, and assuming an economically effective fair-value hedging arrangement, the change in value of the fixed-income securities will be substantially offset by a
133
similar but opposite change in value of the related hedging instruments. To the extent the Company does not qualify for hedge accounting, such economic offsets cannot be presented in the financial statements, resulting in greater reported volatility arising from changes in interest rates.
The Company does not hedge credit risk and evaluated the sensitivity in the FP Investment Portfolio to changes in credit spreads based upon the FP Investment Portfolio at December 31, 2008 and 2007. The table below shows the estimated reduction in fair value for a one-basis-point widening of credit spread by type of security. Actual amounts may differ from the amounts in the table below.
Effect of a One Basis Point of Credit Spread Widening
in the FP Investment Portfolio
|
Estimated After-Tax
Loss at December 31, |
|||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in millions)
|
|||||||
Obligations of U.S. states and political subdivisions |
$ | 0.2 | $ | 0.5 | ||||
Mortgage-backed securities |
1.2 | 2.7 | ||||||
Other(1) |
0.6 | 1.6 | ||||||
Total available-for-sale |
2.0 | 4.8 | ||||||
Trading securities |
0.1 | 0.7 | ||||||
Total |
$ | 2.1 | $ | 5.5 | ||||
The effect of changes in credit spreads on fair value is recorded in other comprehensive income for available-for-sale securities unless deemed OTTI and through the consolidated statements of operations and comprehensive income for trading securities.
The following table summarizes the estimated change in fair values of the Company's FP liabilities that would result from changes in the Company's spread. Actual results may differ from the amounts in the table below.
Pre-Tax Effect of a Change in FSA's Spread on FP Liabilities
|
Tighter spread | Wider spread | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
20% | 10% | 10% | 20% | |||||||||
|
(dollars in millions)
|
||||||||||||
Gain (loss) on GICs carried at fair value |
$ | (2.8 | ) | $ | (1.2 | ) | $ | 0.9 | $ | 1.5 | |||
Gain (loss) on GICs not carried at fair value |
(217.6 | ) | (104.5 | ) | 92.8 | 179.6 |
VIE Investment Portfolio
The VIE fixed rate liabilities are economically hedged against changes in interest rates largely through the use of swap contracts, which convert fixed interest rates to LIBOR floating U.S.-dollar interest rates.
The VIE fixed rate investments and liabilities are economically hedged against changes in interest rates largely through the use of interest rate swap contracts, which convert fixed interest rates to floating rates. A hypothetical increase in interest rates of 1% would result in an approximate after-tax loss of $104.9 million in 2008 and $84.7 million in 2007 on the derivatives used to economically hedge the VIE asset and liability portfolios, and the loss would be recorded in net income.
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The following table summarizes the estimated change in fair values of the Company's VIE liabilities that would result from changes in the Company's spread. Actual results may differ from the amounts in the table below.
Pre-Tax Effect of a Change in FSA's Spread on VIE Liabilities
|
Tighter spread | Wider spread | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
20% | 10% | 10% | 20% | |||||||||
|
(dollars in millions)
|
||||||||||||
Gain (loss) on VIE debt carried at fair value |
$ | (119.4 | ) | $ | (56.6 | ) | $ | 51.4 | $ | 98.4 |
Foreign Exchange Sensitivity in the FP Segment
A hypothetical increase in foreign exchange rates of 1% (the weakening of the U.S. dollar relative to the foreign currency) on the overall FP segment portfolio would result in a de minimis amount of income at December 31, 2008. Within the FP segment, the effect on assets would be a $2.5 million gain, the effect on the FP debt would be a $16.5 million loss, and the effect on the derivatives that economically hedge the foreign exchange risk would be a $14.1 million gain.
A hypothetical increase in foreign exchange rates of 1% on the overall FP segment portfolio would result in a de minimis amount of income at December 31, 2007. Within the FP segment, however, the effect on assets would be a $6.2 million gain, the effect on the derivatives that economically hedge the foreign exchange risk would be a $13.9 million gain, and the effect on the FP debt would be a $20.1 million loss.
Assets Acquired in Refinancing Transactions
At December 31, 2008 and 2007, hypothetically increasing interest rates by 1.0% would result in an estimated after-tax decrease of $5.2 million and $5.9 million, respectively, in the fair value of certain assets acquired under refinancing transactions, offset by an after-tax gain of $7.4 million and $8.1 million, respectively, on derivatives used to hedge the portfolio of assets acquired under refinancing transactions.
Insured Portfolio
Credit Default Swaps
Because the Company generally provides credit protection under contracts defined as derivatives for accounting purposes, widening credit spreads have an adverse mark-to-market effect on the Company's consolidated statements of operations and comprehensive income while tightening credit spreads have a positive effect. If credit spreads for the underlying reference obligations change, the fair value of the related structured CDS typically changes too. Changes in credit spreads are generally caused by changes in the market's perception of the credit quality of the underlying referenced obligations and by supply and demand factors.
Because the CDS contracts in the Company's portfolio are not traded, the Company has developed a series of asset credit-spread algorithms to estimate fair value for the majority of its portfolio. These algorithms derive fair value by using as significant inputs price information from several publicly available indices, depending on the types of assets referenced by the CDS. See Note 3 to the Company's Consolidated Financial Statements in Item 1.
The effect of any change in credit spreads on the fair value of the CDS contracts is recognized in current income. The Company has evaluated the sensitivity of the CDS contracts by calculating the effect of changes in pricing or credit spreads. Absent any claims under the Company's guaranty, any "losses" recorded in marking the guaranty to fair value will be reversed by an equivalent "gain" at or
135
prior to the expiration of the guaranty, and any "gain" recorded will be reversed by an equal "loss" over the remaining life of the transaction, with the cumulative changes in fair value of the CDS summing to zero by the time of each contract's maturity.
The following table summarizes the estimated reduction in the fair value of the Company's portfolio of CDS contracts that would result from an increase of one basis point in market credit spreads assuming the non-collateral posting factor remains constant. Actual results may differ from the amounts in the table below.
Effect of One-Basis-Point of Credit Spread Widening in the CDS Portfolio
|
Estimated After-tax Loss at December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in millions)
|
|||||||
Pooled corporate CDS: |
||||||||
Investment grade |
$ | 5.5 | $ | 7.2 | ||||
High yield |
3.6 | 4.6 | ||||||
Total pooled corporate CDS |
9.1 | 11.8 | ||||||
Funded CLOs and CDOs |
5.2 | 6.7 | ||||||
Other structured obligations |
1.7 | 1.6 | ||||||
Total |
$ | 16.0 | $ | 20.1 | ||||
The Company believes that providing an estimate of the impact of a one basis point increase in credit spreads would be on the fair value of the Company's CDS portfolio provides the data necessary to calculate the impact would be under any change scenario that may occur. The Company has not provided estimates related to reasonably likely change scenarios because it believes that sufficient uncertainty about changes in future credit spreads currently exists such that it is unable to predict, what the range of changes in future credit spreads might be.
The fair value of credit derivatives liabilities includes the effect of the Company's current CDS spread, which reflects market perceptions of the Company's ability to satisfy its obligations as they become due. The inclusion of the Company's CDS spread in the determination of the fair value of the Company's CDS contracts is described in Note 3 to the consolidated financial statements in Item 8. Incorporating the Company's credit spread through the non-collateral posting factor of 70% in the determination of the fair value of the Company's CDS contracts at December 31, 2008 resulted in a $3.1 billion reduction in the Company's liability for credit derivatives. The following table summarizes the estimated change in fair values of the Company's portfolio of CDS contracts that would result from changes in the Company's CDS spread assuming market credit spreads remain constant. Actual results may differ from the amounts in the table below.
Pre-Tax Effect of a Change in FSA's CDS Spread
|
Tighter spread | Wider spread | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
20% | 10% | 10% | 20% | |||||||||||
|
(dollars in millions)
|
||||||||||||||
Pooled Corporate CDS: |
|||||||||||||||
Investment grade |
$ | (77.1 | ) | $ | (33.1 | ) | $ | 33.1 | $ | 77.1 | |||||
High yield |
(78.8 | ) | (33.7 | ) | 33.7 | 78.8 | |||||||||
Total Pooled Corporate CDS |
(155.9 | ) | (66.8 | ) | 66.8 | 155.9 | |||||||||
Funded CDOs and CLOs |
(126.2 | ) | (54.1 | ) | 54.1 | 126.2 | |||||||||
Other structured obligations |
(23.9 | ) | (10.2 | ) | 10.2 | 23.9 | |||||||||
Total gain (loss) |
$ | (306.0 | ) | $ | (131.1 | ) | $ | 131.1 | $ | 306.0 | |||||
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Item 8. Financial Statements and Supplementary Data.
Financial Security Assurance Holdings Ltd. and Subsidiaries
Index to Consolidated Financial Statements and Schedule
|
Page | |
---|---|---|
138 | ||
Consolidated Balance Sheets as of December 31, 2008 and 2007 |
139 | |
140 | ||
141 | ||
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006 |
142 | |
144 | ||
Schedule: |
||
282 |
137
Report of Independent Registered Public Accounting Firm
To
Board of Directors and Shareholders
of Financial Security Assurance Holdings Ltd.:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Financial Security Assurance Holdings Ltd. and Subsidiaries (the "Company") at December 31, 2008 and December 31, 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with 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.
As discussed in Note 1 to the consolidated financial statements, in November 2008, Dexia S.A. ("Dexia"), the Company's ultimate parent, entered into an agreement to sell the Company. In February 2009, Dexia assumed significant credit and liquidity risk arising from the Company's Financial Products operations. As discussed in Notes 3 and 4 to the consolidated financial statements, the Company has adopted SFAS No. 157, "Fair Value Measurements" and SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" in 2008.
/s/
PricewaterhouseCoopers LLP
New York, New York
March 18, 2009
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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
|
At December 31, | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||||
ASSETS |
|||||||||
General investment portfolio, available for sale: |
|||||||||
Bonds at fair value (amortized cost of $5,398,841 and $4,891,640) |
$ | 5,283,248 | $ | 5,054,664 | |||||
Equity securities at fair value (cost of $1,434 and $40,020) |
374 | 39,869 | |||||||
Short-term investments (cost of $651,090 and $96,263) |
651,856 | 97,366 | |||||||
Financial products segment investment portfolio: |
|||||||||
Available-for-sale bonds at fair value (amortized cost of $9,673,475 and $18,334,417) |
9,683,298 | 16,936,058 | |||||||
Short-term investments (at cost which approximates fair value) |
471,480 | 1,927,347 | |||||||
Trading portfolio at fair value |
147,241 | 349,822 | |||||||
Assets acquired in refinancing transactions (includes $152,527 and $22,433 at fair value) |
166,600 | 229,264 | |||||||
Total investment portfolio |
16,404,097 | 24,634,390 | |||||||
Cash |
108,686 | 26,551 | |||||||
Deferred acquisition costs |
299,321 | 347,870 | |||||||
Prepaid reinsurance premiums |
1,011,949 | 1,119,565 | |||||||
Reinsurance recoverable on unpaid losses |
302,124 | 76,478 | |||||||
Deferred tax asset |
863,956 | 412,170 | |||||||
Financial products segment derivatives |
511,524 | 837,676 | |||||||
Credit derivatives |
287,449 | 126,749 | |||||||
Other assets (includes $190,704 and $142,642 at fair value) (See Note 19) |
468,948 | 737,210 | |||||||
TOTAL ASSETS |
$ | 20,258,054 | $ | 28,318,659 | |||||
LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY |
|||||||||
Deferred premium revenue |
$ | 3,044,678 | $ | 2,870,648 | |||||
Losses and loss adjustment expenses |
1,778,994 | 274,556 | |||||||
Financial products segment debt (includes $8,030,909 at fair value at December 31, 2008) |
16,432,283 | 21,400,207 | |||||||
Notes payable |
730,000 | 730,000 | |||||||
Related party borrowings |
1,310,000 | | |||||||
Financial products segment derivatives at fair value |
125,973 | 99,457 | |||||||
Credit derivatives |
1,543,809 | 689,746 | |||||||
Other liabilities and minority interest (includes $(112) and $173 at fair value) (See Note 19) |
476,791 | 676,231 | |||||||
TOTAL LIABILITIES AND MINORITY INTEREST |
25,442,528 | 26,740,845 | |||||||
COMMITMENTS AND CONTINGENCIES (See Note 20) |
|||||||||
Common stock (200,000,000 shares authorized; 33,517,995 issued; par value of $.01 per share) |
335 | 335 | |||||||
Additional paid-in capital |
1,922,422 | 909,800 | |||||||
Accumulated other comprehensive income (loss), net of deferred tax (benefit) provision of $(37,108) and $(430,778) |
(68,922 | ) | (799,914 | ) | |||||
Accumulated earnings (deficit) |
(7,038,309 | ) | 1,467,593 | ||||||
Deferred equity compensation |
14,137 | 19,663 | |||||||
Less treasury stock at cost (172,002 and 244,395 shares held) |
(14,137 | ) | (19,663 | ) | |||||
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) |
(5,184,474 | ) | 1,577,814 | ||||||
TOTAL LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY |
$ | 20,258,054 | $ | 28,318,659 | |||||
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
139
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands)
|
Year Ended December 31, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||||
REVENUES |
|||||||||||||
Net premiums written |
$ | 658,358 | $ | 447,139 | $ | 441,827 | |||||||
Net premiums earned |
$ | 376,573 | $ | 317,756 | $ | 301,509 | |||||||
Net investment income from general investment portfolio |
264,181 | 236,659 | 218,850 | ||||||||||
Net realized gains (losses) from general investment portfolio |
(6,669 | ) | (1,887 | ) | (8,328 | ) | |||||||
Net change in fair value of credit derivatives: |
|||||||||||||
Realized gains (losses) and other settlements |
126,891 | 102,800 | 87,200 | ||||||||||
Net unrealized gains (losses) |
(744,963 | ) | (642,609 | ) | 31,823 | ||||||||
Net change in fair value of credit derivatives |
(618,072 | ) | (539,809 | ) | 119,023 | ||||||||
Net interest income from financial products segment |
647,366 | 1,079,577 | 858,197 | ||||||||||
Net realized gains (losses) from financial products segment |
(8,644,183 | ) | 1,867 | 108 | |||||||||
Net realized and unrealized gains (losses) on derivative instruments |
1,424,522 | 62,801 | 131,379 | ||||||||||
Net unrealized gains (losses) on financial instruments at fair value |
130,363 | 13,991 | 3,575 | ||||||||||
Income from assets acquired in refinancing transactions |
11,154 | 20,907 | 24,661 | ||||||||||
Net realized gains (losses) from assets acquired in refinancing transactions |
(4,260 | ) | 4,660 | 12,729 | |||||||||
Other income (loss) |
(11,939 | ) | 32,770 | 29,321 | |||||||||
TOTAL REVENUES |
(6,430,964 | ) | 1,229,292 | 1,691,024 | |||||||||
EXPENSES |
|||||||||||||
Losses and loss adjustment expenses |
1,877,699 | 31,567 | 23,303 | ||||||||||
Interest expense |
46,335 | 46,336 | 29,096 | ||||||||||
Amortization of deferred acquisition costs |
65,700 | 63,442 | 63,012 | ||||||||||
Foreign exchange (gains) losses from financial products segment |
1,652 | 138,479 | 159,424 | ||||||||||
Net interest expense from financial products segment |
794,308 | 989,246 | 768,739 | ||||||||||
Other operating expenses |
98,871 | 142,090 | 124,622 | ||||||||||
TOTAL EXPENSES |
2,884,565 | 1,411,160 | 1,168,196 | ||||||||||
INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST |
(9,315,529 | ) | (181,868 | ) | 522,828 | ||||||||
Provision (benefit) for income taxes: |
|||||||||||||
Current |
(43,097 | ) | 77,601 | 85,454 | |||||||||
Deferred |
(829,262 | ) | (193,815 | ) | 65,226 | ||||||||
Total provision (benefit) |
(872,359 | ) | (116,214 | ) | 150,680 | ||||||||
NET INCOME (LOSS) BEFORE MINORITY INTEREST |
(8,443,170 | ) | (65,654 | ) | 372,148 | ||||||||
Less: Minority interest |
| | (52,006 | ) | |||||||||
NET INCOME (LOSS) |
(8,443,170 | ) | (65,654 | ) | 424,154 | ||||||||
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX |
|||||||||||||
Unrealized gains (losses) on available-for-sale securities arising during the period, net of deferred income tax provision (benefit) of $(2,633,039), $(511,238) and $5,438 |
(4,890,039 | ) | (949,442 | ) | 10,202 | ||||||||
Less: reclassification adjustment for gains (losses) included in net income, net of deferred income tax provision (benefit) of $(3,026,709), $5,659, and $3,442 |
(5,621,031 | ) | 10,510 | 6,393 | |||||||||
Other comprehensive income (loss) |
730,992 | (959,952 | ) | 3,809 | |||||||||
COMPREHENSIVE INCOME (LOSS) |
$ | (7,712,178 | ) | $ | (1,025,606 | ) | $ | 427,963 | |||||
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
140
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands, except share data)
|
Common Stock |
|
Accumulated
Other Comprehensive Income (Loss) |
|
|
Treasury Stock |
|
|||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Additional
Paid-In- Capital |
Accumulated
Earnings (Deficit) |
Deferred
Equity Compensation |
Total
Shareholders' Equity (Deficit) |
||||||||||||||||||||||||
|
Shares | Amount | Shares | Amount | ||||||||||||||||||||||||
BALANCE, December 31, 2005 |
33,517,995 | $ | 335 | $ | 905,190 | $ | 156,229 | $ | 1,761,148 | $ | 20,177 | 254,736 | $ | (20,177 | ) | $ | 2,822,902 | |||||||||||
Net income for the year |
424,154 | 424,154 | ||||||||||||||||||||||||||
Other comprehensive income (loss), net of deferred income tax provision (benefit) of $1,996 |
3,809 | 3,809 | ||||||||||||||||||||||||||
Capital contribution |
1,497 | 1,497 | ||||||||||||||||||||||||||
Dividends paid on common stock |
(530,050 | ) | (530,050 | ) | ||||||||||||||||||||||||
Cost of shares acquired |
(952 | ) | (12,758 | ) | 952 | | ||||||||||||||||||||||
BALANCE, December 31, 2006 |
33,517,995 | 335 | 906,687 | 160,038 | 1,655,252 | 19,225 | 241,978 | (19,225 | ) | 2,722,312 | ||||||||||||||||||
Net income (loss) for the year |
(65,654 | ) | (65,654 | ) | ||||||||||||||||||||||||
Other comprehensive income (loss), net of deferred income tax provision (benefit) of $(516,897) |
(959,952 | ) | (959,952 | ) | ||||||||||||||||||||||||
Dividends paid on common stock |
(122,005 | ) | (122,005 | ) | ||||||||||||||||||||||||
Cost of shares acquired |
438 | 2,417 | (438 | ) | | |||||||||||||||||||||||
Other |
3,113 | 3,113 | ||||||||||||||||||||||||||
BALANCE, December 31, 2007 |
33,517,995 | 335 | 909,800 | (799,914 | ) | 1,467,593 | 19,663 | 244,395 | (19,663 | ) | 1,577,814 | |||||||||||||||||
Cumulative effect of change in accounting principle, net of deferred income tax provision (benefit) of $(15,683) |
(29,126 | ) | (29,126 | ) | ||||||||||||||||||||||||
Balance at beginning of the year, adjusted |
33,517,995 | 335 | 909,800 | (799,914 | ) | 1,438,467 | 19,663 | 244,395 | (19,663 | ) | 1,548,688 | |||||||||||||||||
Net income (loss) for the year |
(8,443,170 | ) | (8,443,170 | ) | ||||||||||||||||||||||||
Capital contribution |
1,012,111 | 1,012,111 | ||||||||||||||||||||||||||
Other comprehensive income (loss), net of deferred income tax provision (benefit) of $393,670 |
730,992 | 730,992 | ||||||||||||||||||||||||||
Dividends paid on common stock |
(33,606 | ) | (33,606 | ) | ||||||||||||||||||||||||
Cost of shares acquired |
(5,526 | ) | (72,393 | ) | 5,526 | | ||||||||||||||||||||||
Other |
511 | 511 | ||||||||||||||||||||||||||
BALANCE, December 31, 2008 |
33,517,995 | $ | 335 | $ | 1,922,422 | $ | (68,922 | ) | $ | (7,038,309 | ) | $ | 14,137 | 172,002 | $ | (14,137 | ) | $ | (5,184,474 | ) | ||||||||
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
|
Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||
Cash flows from operating activities: |
||||||||||||
Premiums received, net |
$ | 617,115 | $ | 435,201 | $ | 440,556 | ||||||
Credit derivative fees received, net |
113,292 | 108,710 | 82,860 | |||||||||
Other operating expenses paid, net |
(260,900 | ) | (181,234 | ) | (176,425 | ) | ||||||
Salvage and subrogation received (paid) |
(527 | ) | 292 | 1,745 | ||||||||
Losses and loss adjustment expenses paid, net |
(602,870 | ) | (68,634 | ) | (405 | ) | ||||||
Net investment income received from general investment
|
256,414 | 233,335 | 215,656 | |||||||||
Federal income taxes received (paid) |
169,820 | (105,321 | ) | (92,394 | ) | |||||||
Interest paid on notes payable |
(46,050 | ) | (47,276 | ) | (26,878 | ) | ||||||
Interest paid on financial products segment debt |
(542,652 | ) | (719,127 | ) | (511,226 | ) | ||||||
Interest received on financial products segment investment portfolio |
613,565 | 961,374 | 784,480 | |||||||||
Interest paid on related party borrowings |
(3,276 | ) | | | ||||||||
Financial products segment net derivative receipts (payments) |
1,042,313 | (50,144 | ) | (48,457 | ) | |||||||
Purchases of trading portfolio securities in financial products segment |
| (216,404 | ) | (117,483 | ) | |||||||
Income received from assets acquired in refinancing transactions |
12,001 | 19,979 | 41,525 | |||||||||
Other |
48,405 | 12,737 | 17,597 | |||||||||
Net cash provided by (used for) operating activities |
1,416,650 | 383,488 | 611,151 | |||||||||
Cash flows from investing activities: |
||||||||||||
General investment portfolio: |
||||||||||||
Proceeds from sales of bonds |
4,011,447 | 3,568,207 | 1,637,339 | |||||||||
Proceeds from maturities of bonds |
519,205 | 189,195 | 163,257 | |||||||||
Purchases of bonds |
(5,013,796 | ) | (4,099,953 | ) | (2,161,561 | ) | ||||||
Net (increase) decrease in short-term investments |
(549,985 | ) | 3,975 | 64,296 | ||||||||
Financial products segment investment portfolio: |
||||||||||||
Proceeds from sales of bonds |
38 | 2,971,662 | 4,512,453 | |||||||||
Proceeds from maturities of bonds |
1,777,892 | 3,464,878 | 4,509,784 | |||||||||
Purchases of bonds |
(1,243,415 | ) | (7,915,700 | ) | (12,830,545 | ) | ||||||
Change in securities under agreements to resell |
152,875 | (2,874 | ) | 200,000 | ||||||||
Net (increase) decrease in short-term investments |
1,455,867 | (1,267,643 | ) | 358,481 | ||||||||
Other: |
||||||||||||
Net purchases of property, plant and equipment |
(2,889 | ) | (826 | ) | (3,441 | ) | ||||||
Paydowns of assets acquired in refinancing transactions |
36,727 | 110,581 | 88,477 | |||||||||
Proceeds from sales of assets acquired in refinancing transactions |
5,193 | 7,956 | 13,642 | |||||||||
Other investments |
939 | 7,256 | 24,100 | |||||||||
Net cash provided by (used for) investing activities |
1,150,098 | (2,963,286 | ) | (3,423,718 | ) | |||||||
Cash flows from financing activities: |
||||||||||||
Capital contribution |
1,012,111 | | | |||||||||
Related-party borrowings |
1,412,910 | | | |||||||||
Issuance of notes payable |
| | 295,788 | |||||||||
Dividends paid |
(33,606 | ) | (122,005 | ) | (530,050 | ) | ||||||
Proceeds from issuance of financial products segment debt |
2,500,496 | 6,371,723 | 6,751,556 | |||||||||
Repayment of financial products segment debt |
(7,264,726 | ) | (3,676,147 | ) | (3,715,670 | ) | ||||||
Repayment of related-party borrowings |
(102,910 | ) | | | ||||||||
Capital issuance costs |
(4,920 | ) | (1,829 | ) | (964 | ) | ||||||
Net cash provided by (used for) financing activities |
(2,480,645 | ) | 2,571,742 | 2,800,660 | ||||||||
Effect of changes in foreign exchange rates on cash balances |
(3,968 | ) | 2,136 | 749 | ||||||||
Net (decrease) increase in cash |
82,135 | (5,920 | ) | (11,158 | ) | |||||||
Cash at beginning of year |
26,551 | 32,471 | 43,629 | |||||||||
Cash at end of year |
$ | 108,686 | $ | 26,551 | $ | 32,471 | ||||||
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(in thousands)
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||
Reconciliation of net income (loss) to net cash flows from operating activities: |
||||||||||
Net income (loss) |
$ | (8,443,170 | ) | $ | (65,654 | ) | $ | 424,154 | ||
Change in accrued investment income |
19,545 | (34,705 | ) | (25,516 | ) | |||||
Change in deferred premium revenue, net of prepaid reinsurance premiums |
281,646 | 139,920 | 138,467 | |||||||
Change in deferred acquisition costs |
48,549 | (7,197 | ) | (5,544 | ) | |||||
Change in current federal income taxes payable |
126,607 | (27,743 | ) | (11,935 | ) | |||||
Change in unpaid losses and loss adjustment expenses, net of reinsurance recoverable |
1,278,792 | 7,298 | 21,401 | |||||||
Provision (benefit) for deferred income taxes |
(829,262 | ) | (193,815 | ) | 65,226 | |||||
Net realized losses (gains) on investments |
8,660,920 | (18,071 | ) | (5,734 | ) | |||||
Depreciation and accretion of discount |
156,742 | 116,246 | 102,818 | |||||||
Minority interest and equity in earnings of unconsolidated affiliates |
| | (52,006 | ) | ||||||
Change in other assets and liabilities |
116,281 | 683,613 | 77,303 | |||||||
Purchases of trading portfolio securities in financial products segment |
| (216,404 | ) | (117,483 | ) | |||||
Cash provided by operating activities |
$ | 1,416,650 | $ | 383,488 | $ | 611,151 | ||||
The Company received tax benefits of $4.7 million in 2008, $1.3 million in 2007 and no tax benefits in 2006 from its parent company. See Note 14 for disclosure of non-cash transactions relating to restricted treasury stock transactions.
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
143
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Holdings Ltd. ("FSA Holdings") is a holding company incorporated in the State of New York. The Company, through its insurance company subsidiaries, engages in providing financial guaranty insurance on public finance obligations in domestic and international markets. The Company's principal insurance company subsidiary is Financial Security Assurance Inc. ("FSA"), a wholly owned New York insurance company. Historically, the Company also provided financial guaranty insurance on asset-backed obligations. In August 2008, the Company announced that it would cease insuring asset-backed obligations and instead participate exclusively in the global public finance financial guaranty business. References to the "Company" are to Financial Security Assurance Holdings Ltd. together with its subsidiaries.
In addition to its financial guaranty business, the Company historically offered FSA-insured guaranteed investment contracts and other investment agreements ("GICs") as well as medium-term notes to municipalities and other market participants through consolidated entities in its financial products ("FP") segment. In November 2008, the Company ceased issuing GICs in contemplation of the sale of the Company to Assured Guaranty Ltd. ("Assured"). While the Company has ceased new originations of asset-backed financial guaranty business and GICs, a substantial portfolio of such obligations remains outstanding.
At December 31, 2008, Dexia Holdings Inc. ("Dexia Holdings") owned over 99% of outstanding FSA Holdings shares; the only other holders of FSA Holdings common stock were directors of FSA Holdings who owned shares of FSA Holdings common stock or economic interests therein under the Company's Director Share Purchase Program.
The Company is a subsidiary of 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 primarily engaged in the business of public finance, banking and investment management in France, Belgium, Luxembourg and other European countries, as well as in the United States. Dexia Crédit Local is a wholly owned subsidiary of Dexia.
The Company conducted its GIC business through its non-insurance subsidiaries 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 Subsidiaries"). FSACM conducted substantially all the Company's GIC business since April 2003, following its receipt of an exemption from the requirements of the Investment Company Act of 1940. When the GIC Subsidiaries sold GICs, they loaned the proceeds to FSA Asset Management LLC ("FSAM"), which invests the funds in fixed-income obligations that satisfy the Company's investment criteria. FSAM wholly owns FSA Portfolio Asset Limited ("FSA-PAL"), a U.K. company that invests in non-U.S. securities.
Expected Sale of the Company
Purchase Agreement with Assured Guaranty Ltd.
In November 2008, Dexia Holdings entered into a purchase agreement (the "Purchase Agreement") providing for the sale of all Company shares owned by Dexia to Assured (the "Acquisition"), subject to the consummation of specified closing conditions, including regulatory approvals, absence of rating impairment and segregation or separation of the Company's FP operations from the Company's financial guaranty operations.
144
Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act") and the rules promulgated thereunder by the Federal Trade Commission (the "FTC"), the Acquisition may not be consummated until notifications have been given and certain information has been furnished to the FTC and the Department of Justice (the "DOJ") and specified waiting period requirements have been satisfied. The HSR Act waiting period expired on January 21, 2009. In addition, under the insurance holding company laws and regulations applicable to the insurance subsidiaries of the Company and Assured, before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance commissioner of the state where the insurer is domiciled. Assured has informed the Company that Assured filed applications with the insurance departments of the States of New York and Oklahoma and the U.K. Financial Services Authority; that the applications to the New York Insurance Department and the U.K. Financial Services Authority have been approved; and that it has made pre-acquisition filings regarding the potential competitive impact of the acquisition, which are deemed to have been approved. Dexia has informed the Company that it has filed an application with the U.K. Financial Services Authority in connection with its acquisition of Assured common shares pursuant to the Purchase Agreement, which has been approved, and that it has filed disclaimers of control with the insurance departments of the states of Maryland, New York, and Oklahoma.
Satisfying all three rating agencies that the necessary steps have or will be taken to transfer the FP segment credit and liquidity risk to Dexia is one of the last conditions to the Purchase Agreement closing. Rating agency confirmation that the Acquisition will not have a negative impact on the financial strength ratings of Assured's insurance company subsidiaries or the Company's insurance company subsidiaries is a condition for closing, and is beyond the Company's control.
The Company cannot estimate whether or when the remaining closing conditions will be satisfied or relevant agreements negotiated, whether the Acquisition will be completed and, if completed, whether it will be structured as currently contemplated, or what the effects of the change in control or removal of the FP business will be on the Company and its results of operations. If the Acquisition is not carried out, Dexia may explore other options with respect to the Company, including selling the Company or some of its operations to a third party or ceasing to write new business, which may have a material adverse effect on the Company.
Dexia's Retention of the FP Business
Under the Purchase Agreement, Dexia is expected to retain the Company's FP business after the Acquisition. The Purchase Agreement provides that Dexia will provide guarantees with respect to the FP business' assets and liabilities, including derivative contracts and anticipates that some of its guarantees will benefit from guarantees provided by the French and Belgian states. Dexia Holdings, the Company's parent, agreed that if such sovereign guarantees are provided, it will cause FSA Holdings to transfer the ownership interests of certain of the subsidiaries that conduct the FP business, or all the assets and liabilities of such subsidiaries, to Dexia Holdings or one of its affiliates in form reasonably acceptable to Assured.
Transfer of Credit and Liquidity Risk of the GIC Business
When the GIC Subsidiaries sold a GIC, they loaned the proceeds to FSAM. The terms governing FSAM's repayment of those proceeds to the GIC Subsidiaries match the payment terms under the related GIC. FSAM invests the proceeds in securities and enters into derivative transactions to convert any fixed-rate assets and liabilities into London Interbank Offered Rate ("LIBOR")-based floating rate assets and liabilities. Most of FSAM's assets consist of residential mortgage-backed securities ("RMBS") that have suffered significant market value declines and, in more limited cases, credit deterioration resulting in a shareholders' deficit for FSAM at December 31, 2008. The market value declines of FSAM's assets subject FSAM to significant liquidity risk insofar as the GICs are in most cases subject to redemption or collateralization upon the downgrade of FSA below certain thresholds,
145
with a significant number of GICs subject to redemption or collateralization should FSA be downgraded below Aa3 by Moody's Investors Service, Inc. ("Moody's") (FSA's current Moody's rating) or below AA- by Standard & Poor's Ratings Service ("S&P"). Dexia had previously announced its intention to assume the credit and liquidity risk associated with the Company's FP business, and provided significant support to the FP business in the course of 2008.
As a result of the significant decline in asset value and the November 2008 cessation of issuing GICs, the GIC business changed from a business model managed by the Company focused on attaining positive net interest margin, to a run-off business managed by Dexia seeking to minimize liquidity risk and optimize asset recovery values.
Subsequent Event
In February 2009, Dexia entered into several agreements that transfer credit and liquidity risk of the GIC operations to Dexia (the "FSAM Risk Transfer Transaction"). Each of the agreements executed under the FSAM Risk Transfer Transaction directly affect (1) FSAM and (2) the entities that absorb the risks created by FSAM. These agreements provide for the (i) elimination of FSA's guaranty of repayment of FSAM's borrowings under the credit facilities provided by Dexia's bank subsidiaries; (ii) elimination of FSA's guaranty of certain of FSAM's investments; and (iii) increase in the credit facilities provided to FSAM by Dexia's bank subsidiaries from $5 billion to $8 billion.
As a result, the FSAM Risk Transfer Transaction was deemed a reconsideration event for FSAM under FASB Interpretation 46 (R), "Consolidation of Variable Interest Entities" ("FIN 46"). There was no reconsideration event for any of the GIC Subsidiaries. Upon the reconsideration event, management determined that Dexia is now absorbing the majority of the variability of expected losses of FSAM, which resulted in deconsolidation of FSAM as of February 24, 2009, the effective date of the FSAM Risk Transfer Transaction.
The GIC subsidiaries, unlike FSAM, remain part of the Company's consolidated financial statements, notwithstanding the FSAM Risk Transfer Transaction, which means that the GICs issued to third parties and the note receivable from FSAM will represent the primary liabilities and assets of the FP business in the Company's consolidated financial statements. Since some of the GICs were designated as fair value option, they will continue to be marked to market; however, derivatives are maintained within FSAM, so contracts meant to hedge the interest rate risk of those GICs will no longer be included in the Company's consolidated financial statements, increasing the volatility of the Company's net income (loss).
See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital ResourcesFP Segment LiquiditySources of Liquidity" for more information on the FSAM Risk Transfer Transaction.
Financial Guaranty
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 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.
Obligations insured by the Company are generally awarded ratings on the basis of the financial strength ratings given to the Company's insurance company subsidiaries by the major securities rating agencies. On December 31, 2008, the Company was rated Triple-A (negative credit watch) by S&P and Fitch Ratings ("Fitch") and Aa3 (developing outlook) by Moody's. Prior to the third quarter of 2008,
146
the Company's insurance company subsidiaries, as well as the obligations they insured, had been awarded Triple-A ratings by the three major rating agencies.
During 2007 and 2008, the global financial crisis that began in the U.S. subprime residential mortgage market transformed the financial guaranty industry. By the end of November 2008, all of the monoline guarantors that had been rated Triple-A at the beginning of the year had been downgraded in varying degrees by Moody's, and all but one had been either downgraded or placed on negative outlook or negative credit watch by S&P and Fitch. FSA and the Company's other insurance company subsidiaries were among the last companies to be affected, and were rated "Triple-A/stable" by all three rating agencies until July 2008. Rating agencies raised concerns about the stability of FSA's rating during the second half of 2008, and Moody's lowered FSA's Aaa rating to Aa3 (developing outlook) in November. These developments, combined with illiquidity in the capital markets, led to a marked reduction in FSA's production in the second half of 2008.
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 were 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 insured synthetic asset-backed obligations that generally took the form of credit default swap ("CDS") obligations or credit-linked notes that reference asset-backed securities ("ABS") or pools of securities or other obligations, with a defined deductible to cover credit risks associated with the referenced securities or loans.
The Company has refinanced certain poorly performing transactions by employing refinancing vehicles to raise funds, prepay the claim obligations and take control of the assets. These refinancing vehicles are consolidated with the Company and considered part of the financial guaranty segment.
Financial Products
Under the Purchase Agreement, Dexia is expected to retain the Company's FP business after the Acquisition. In contemplation of this change, FSACM, FSA Capital Markets Services, LLC and FSAM became direct subsidiaries of a newly formed subsidiary, FSA Financial Products Inc. ("FSA Financial Products"), in December 2008. Previously they had been direct subsidiaries of FSA Holdings. FSA Financial Products is owned by FSA Holdings.
In the third quarter of 2008, to address FP segment liquidity requirements, Dexia entered into an agreement to provide a $5 billion committed, unsecured, standby line of credit (the "First Dexia Line of Credit") to FSAM. At December 31, 2008, FSAM had $1.3 billion in draws outstanding under the First Dexia Line of Credit. In addition, on November 13, 2008, the Company entered into two new agreements with Dexia and its affiliates in support of its FP business, which provide additional protection through a $3.5 billion collateral swap facility and a $500 million capital facility to cover economic losses beyond the $316.5 million of pre-tax loss estimated at the end of June 2008. In February 2009, Dexia increased the credit facilities provided to FSAM from $5 billion to $8 billion. At March 2, 2009, the outstanding amount drawn by the Company had increased to $2.7 billion.
The Company consolidates the results of certain variable interest entities ("VIEs"), which include FSA Global Funding Limited ("FSA Global") and Premier International Funding Co. ("Premier"). FSA
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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 sale 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 note proceeds. Premier is principally engaged in leveraged lease transactions. The GIC Subsidiaries, FSAM, FSA-PAL, FSA Global and Premier are collectively referred to as the "FP segment."
The Company's management believes that the assets held by FSA Global and Premier, including those that are eliminated in consolidation, are beyond the reach of the Company's creditors, even in bankruptcy or other receivership. Substantially all of the assets of FSA Global are pledged to secure the repayment, on a pro rata basis, of FSA Global's notes and its other obligations.
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, for the insurance company subsidiaries, differ in certain material respects from the accounting practices prescribed or permitted by insurance regulatory authorities (see Note 25). 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, 2008 and 2007, the reported amounts of revenues and expenses in the consolidated statements of operations and comprehensive income during the years ended December 31, 2008, 2007 and 2006 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 determination of other-than-temporary impairment ("OTTI"), 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 FSA Holdings and its direct and indirect subsidiaries, (collectively, the "Subsidiaries"), principally including:
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The consolidated financial statements also include the accounts of certain VIEs and refinancing vehicles. Intercompany accounts and transactions have been eliminated. Certain prior year balances have been reclassified to conform to the current year's presentation.
Significant accounting policies under GAAP are described below. To the extent the accounting policy calls for fair value measurement, see Note 3 for a discussion of how fair value is measured for each financial instrument.
Investments
The Company segregates its investments into the following portfolios:
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, unless deemed to be OTTI. OTTI is reflected in earnings as a realized loss. 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 on financial products segment."
Investments in debt and equity securities designated as trading are carried at fair value. The unrealized gain or loss on trading investments is recognized in the consolidated statements of operations and comprehensive income in "net unrealized gains (losses) on financial instruments at fair value."
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. 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.
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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. Auction Rate Securities are long-term securities with interest rate reset features and are traded in the marketplace through a bidding process. 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.
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. 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.
Effective January 1, 2009, the Company's recognition of premium revenue will change due to the adoption of Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standard ("SFAS") No. 163, "Accounting for Financial Guarantee Insurance Contracts" ("SFAS 163"), as described in "Recently Issued Accounting Standards that are Not Yet Effective."
Losses and Loss Adjustment Expenses
The financial guaranty industry has emerged over the past 35 years. Management believes that accounting literature in effect for 2008, including insurance accounting under 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 loss 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 loss 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.
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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 automobile 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 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 statistically estimated using 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. Management's best estimate of inherent losses associated with providing credit protection at each balance sheet date is evaluated by applying the Moody's expected loss algorithm as an estimate of the reserve required for non-investment grade risks not requiring a core reserve. If such amount is greater than 10% of the statistical product then an additional contribution to the non-specific reserve is made.
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
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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 1970-2007, 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.
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.
In order to determine any adjustment to the non-specific reserve, management uses a methodology that references a calculation of expected loss for risks that are below-investment-grade according to the Company's ratings. The calculation of expected loss relies on the following assumptions and parameters:
In 2008, management recorded additional non-specific reserves as a result of such analysis.
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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 accounting literature in effect for 2008 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.
Effective January 1, 2009, the Company's measurement and recognition of claims liabilities will change due to the adoption of SFAS 163, as described in "Recently Issued Accounting Standards."
Deferred Costs
Financial Guaranty
Deferred acquisition costs comprise expenses primarily related to the production of business, including commissions paid on reinsurance assumed, compensation and related costs of underwriting, 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.
Derivatives
The Company enters into derivative contracts to manage interest rate and foreign currency risks associated with the Company's FP Segment Investment Portfolio and FP segment debt. The derivatives are recorded at fair value and generally include interest rate futures and interest rate and currency swap agreements, which are primarily utilized to convert the Company's fixed rate securities in the FP Segment Investment Portfolio and FP segment debt into U.S.-dollar floating rate assets and liabilities.
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Cash collateral received from derivative counterparties is netted with derivative receivables from the same counterparties when the right of offset exists under master netting agreements.
The 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 from financial products segment" or "net interest expense from financial products segment," as appropriate, along with the offsetting change in the fair value of the risk being hedged. Hedge accounting is applied to fair value hedges provided certain criteria are met. See Note 16 for more information. All cash flows from derivative instruments are classified as "financial products segment net derivative receipts (payments)" on the statement of cash flows, regardless of their designation as fair-value hedges.
The Company also has a portfolio of insured derivatives (primarily CDS). It considers these agreements to be a normal part of its financial guaranty insurance business, although they are considered derivatives for accounting purposes. It ceased issuing asset-backed guarantees in August 2008. These agreements are recorded at fair value. Changes in fair value are recorded in "net change in fair value of credit derivatives."
In consultation with the Securities and Exchange Commission (the "SEC"), members of the financial guaranty industry have collaborated to develop a presentation of credit derivatives issued by financial guaranty insurers that is more consistent with that of non-insurers. Prior-period balances have been reclassified to conform to the current presentation. The reclassifications do not affect net income or equity, although they do affect various revenue, asset and liability line items. Changes in fair value are recorded in "net change in fair value of credit derivatives" in the consolidated statements of operations and comprehensive income. The "realized gains (losses) and other settlements" component of this income statement line includes premiums received and receivable on written CDS contracts and premiums paid and payable on purchased contracts. If a credit event occurred that required a payment under the contract terms, this line item would also include losses paid and payable to CDS contract counterparties due to the credit event and losses recovered and recoverable on purchased contracts.
Securities Purchased under Agreements to Resell and Securities Sold under Agreements to Repurchase
Securities purchased under agreements to resell and securities sold under agreements to repurchase are accounted for as collateralized transactions and recorded at contract value plus accrued interest. It is the Company's policy to take possession of securities borrowed under agreements to resell.
Financial Products Segment Debt
FP segment debt is recorded at amortized cost or fair value, if the fair value option was elected. Certain VIE liabilities include embedded derivatives. Prior to the adoption of SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159") on January 1, 2008, changes in fair value of embedded derivatives in VIE debt were recorded in "net realized and unrealized gains (losses) on derivative instruments." In 2008, the fair value option was elected for all VIE liabilities containing embedded derivatives and the change in fair value of the entire debt instrument is recorded in "net unrealized gains (losses) on financial instruments at fair value."
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 recorded 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 resulting from translating investments
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denominated in foreign currencies are recorded in accumulated other comprehensive income unless the security is deemed OTTI. Gains and losses from transactions in foreign currencies are 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 amounts reported in the financial statements. 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. Deferred tax assets are evaluated for recoverability and a valuation allowance is established if a deferred tax asset is determined to be non-recoverable.
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 recognizes tax benefits only if a tax position is "more likely than not" to prevail.
Special Purpose Entities
Asset-backed and, to a lesser extent, public finance transactions insured by the Company may employ special purpose entities ("SPEs") for a variety of purposes. A typical asset-backed transaction, for example, employs an SPE as the purchaser of the securitized assets and as the issuer of the insured obligations. SPEs are typically owned by transaction sponsors or charitable trusts, although the Company may have an ownership interest in some cases. The Company generally maintains certain contractual rights and exercises varying degrees of influence over SPE issuers of FSA-insured obligations.
The Company also bears some of the "risks and rewards" associated with the performance of those SPE's assets. Specifically, as issuer of the financial guaranty insurance policy insuring a given SPE's obligations, the Company bears the risk of asset performance (typically, but not always, after a significant depletion of overcollateralization, excess spread, a deductible or other credit protection).
The Company's underwriting guidelines for public finance obligations generally require that a transaction be rated investment grade when FSA's insurance is applied. The Company's underwriting guidelines for asset-backed obligations, which it followed prior to its August 2008 decision to cease insuring such obligations, varied by obligation type in order to reflect different structures and types of credit support. The Company sought to insure asset-backed obligations that generally provided for one or more forms of overcollateralization or third-party protection. In addition, the SPE typically pays a periodic premium to the Company in consideration of the issuance by the Company of its insurance policy, with the SPE's assets typically serving as the source of payment of such premium, thereby providing some of the "rewards" of the SPE's assets to the Company. SPEs are also employed by the Company in connection with secondary market transactions and with refinancing underperforming, non-investment-grade transactions insured by FSA. See Note 7 for more information.
The degree of influence exercised by FSA over these SPEs varies from transaction to transaction, as does the degree to which "risks and rewards" associated with asset performance are assumed by FSA. 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 outstanding exposure amounts reported.
The Company is required to consolidate SPEs that are considered VIEs where the Company is considered the primary beneficiary.
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In determining whether the Company is the Primary Beneficiary of a particular VIE, a number of factors are considered. The significant factors considered are: the design of the entity and the risks it was created to pass-along to variable interest holders; the extent of credit risk absorbed by the Company through its insurance contract and the extent to which credit protection provided by other variable interest holders reduces this exposure; the exposure that the Company cedes to third party reinsurers, to reduce the extent of expected loss which the Company absorbs; and the portion of the VIE's total notional exposure covered by the Company's insurance policy. The Company's accounting policy is to first conduct a qualitative analysis based on the design of the VIE in order to identify whether it is the primary beneficiary. Should the qualitative analysis not provide a basis for conclusion, the Company will perform a quantitative analysis in order to determine if it is the primary beneficiary of the VIE under review.
In considering the significance of its interest in a particular VIE, the Company considers the extent to which both the variability it absorbs from the VIE and the Company's exposure to that VIE are material to the Company's own financial statements. The Company believes that its surveillance categories are an appropriate measure to use for identification of VIEs in which the Company absorbs other than insignificant variability. VIEs selected for this purpose are related to risks classified as surveillance Category IV, defined as "demonstrating sufficient deterioration to indicate that material credit losses are possible even though not yet probable" or risks classified as surveillance Category V, defined as "transactions where losses are probable." The Company believes that VIE-related risks classified as surveillance Categories IV and V are VIEs in which the Company absorbs a significant portion of the variability created by the particular VIE. For a more detailed description of the surveillance categories used by the Company, see Note 9.
VIEs in which the Company holds a significant variable interest, but which are not consolidated, have been aggregated according to principle line of business for the purpose of disclosing the nature and extent of the Company's exposure to such VIEs. The Company aggregates such VIEs according to principle line of business to appropriately reflect the VIE risk and reward characteristics in an aggregated manner. The table below displays the Company's exposure to these VIEs at December 31, 2008.
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Non-Consolidated VIEs
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At December 31, 2008 | ||||||||||||||||||
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|
Liability |
|
|
||||||||||||||||
|
Net Case
Reserve |
Net Non-
Specific Reserve |
Fair Value of
Credit Derivatives |
Net Par
Outstanding(1) |
Number
of VIEs |
||||||||||||||
|
(dollars in thousands)
|
||||||||||||||||||
Asset-backed: |
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Domestic |
|||||||||||||||||||
Residential mortgages |
$ | 1,221,410 | $ | 36,422 | $ | 11,263 | $ | 9,130,637 | 59 | ||||||||||
Consumer receivables |
| 9,163 | | 88,438 | 1 | ||||||||||||||
Pooled corporate |
25,866 | | 110,488 | 797,835 | 10 | ||||||||||||||
Other |
| | 34,981 | 125,710 | 1 | ||||||||||||||
Total asset-backed |
1,247,276 | 45,585 | 156,732 | 10,142,620 | 71 | ||||||||||||||
Public finance: |
|||||||||||||||||||
Domestic |
263 | | | 239 | 1 | ||||||||||||||
International |
10,960 | | | 509,520 | 7 | ||||||||||||||
Total public finance |
11,223 | | | 509,759 | 8 | ||||||||||||||
Total |
$ | 1,258,499 | $ | 45,585 | $ | 156,732 | $ | 10,652,379 | 79 | ||||||||||
FSA's interest in these non-consolidated VIEs is included in "losses and loss adjustment expenses" and "credit derivatives" in the Company's balance sheet.
The Company has consolidated certain VIEs for which it has determined that it is the primary beneficiary. The table below shows the carrying value and classification of the consolidated VIE assets and liabilities in the Company's financial statements:
Consolidated VIEs
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At December 31, 2008 | ||||||
---|---|---|---|---|---|---|---|
|
Total
Assets |
Total
Liabilities |
|||||
|
(in thousands)
|
||||||
FP segment VIEs |
$ | 1,343,888 | $ | 1,396,261 |
FSA has provided financial guarantee insurance contracts on the assets held and the notes issued by FSA Global Funding and, as such, FSA is exposed to the risk of non-payment of the assets held by FSA Global Funding. In addition, aside from the financial guarantee insurance contracts provided by FSA, there are no arrangements, either explicit or implicit, which could require the Company to provide financial support to the VIEs.
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 14.
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Under SFAS No. 123, "Share-Based Payment" (revised 2004), the Company recorded $1.2 million and $1.0 million in additional after-tax expense related to the Dexia Employee Share Plans in 2007 and 2006, respectively. There was no expense recorded in 2008.
Recently Issued Accounting Standards
In October 2008, the FASB issued FSP No. FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active" ("FSP 157"). FSP 157 clarifies the application of SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), in an inactive market, without changing its existing principles. The FSP was effective immediately upon issuance. The adoption of FSP No. FAS 157-3 did not have an effect on the Company's financial position or results of operations or cash flows.
Recently Issued Accounting Standards that are Not Yet Effective
In May 2008, the FASB issued SFAS 163. This statement addresses accounting standards applicable to existing and future financial guaranty insurance and reinsurance contracts issued by insurance companies, including accounting for claims liability measurement and recognition and premium recognition and related disclosures. SFAS 163 requires 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 net cash flows. The premium earnings methodology under SFAS 163 will be based on a constant rate methodology. SFAS 163 does not apply to financial guarantee insurance contracts accounted for as derivatives within the scope of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 163 also requires the Company to provide expanded disclosures relating to factors affecting the recognition and measurement of financial guaranty contracts. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, except for the presentation and disclosure requirements related to claim liabilities which were effective for financial statements prepared as of September 30, 2008. The cumulative effect of initially applying SFAS 163 is required to be recognized as an adjustment to the opening balance of retained earnings. The Company is currently assessing the impact of SFAS 163 on the Company's consolidated financial position and results of operations.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS 133" ("SFAS 161"). This statement amends and expands the disclosure requirements for derivative instruments and hedging activities by requiring companies to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. This statement is effective for fiscal years and interim periods beginning after November 15, 2008. Since SFAS 161 only requires additional disclosures concerning derivatives and hedging activities, adoption of SFAS 161 will not affect the Company's consolidated financial position and results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements" ("SFAS 160"). SFAS 160 will change the accounting for minority interests, which will be recharacterized as noncontrolling interests and classified by the parent company as a component of equity. SFAS 160 also addresses the accounting for deconsolidations of certain subsidiaries. This statement is effective for fiscal years beginning on or after December 15, 2008, with early adoption prohibited. Upon adoption, SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests and prospective adoption for all other requirements. The Company is currently assessing the impact of SFAS 160 on the Company's consolidated financial position, results of operations and cash flows.
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3. FAIR VALUE MEASUREMENT
The Company adopted SFAS 157, effective January 1, 2008. SFAS 157 addresses how companies should measure fair value when required to use fair value measures under GAAP. SFAS 157:
In February 2007 the FASB issued SFAS 159. SFAS 159 provides an option to elect fair value as an alternative measurement for selected financial assets and financial liabilities not previously recorded at fair value. The Company adopted SFAS 159 on January 1, 2008 and elected fair value accounting for certain FP segment debt and certain assets acquired in refinancing FSA-insured transactions not previously carried at fair value. For more information regarding the fair value option, see Note 4.
The Company applied its valuation methodologies for its assets and liabilities measured at fair value to all of the assets and liabilities carried at fair value effective January 1, 2008, whether those instruments are carried at fair value as a result of the adoption of SFAS 159 or in compliance with other authoritative accounting guidance. The Company has fair value committees to review and approve valuations and assumptions used in its models. These committees meet quarterly prior to the Company issuing its financial statements.
Fair value is based upon pricing received from dealer quotes or alternative pricing sources with reasonable levels of price transparency, internally developed estimates that employ credit-spread algorithms or models that use market-based or independently sourced market data inputs, including yield curves, interest rates, volatilities, debt prices, foreign exchange rates and credit curves. In addition to market information, models also incorporate instrument-specific data, such as maturity date.
Considerable judgment is necessary to interpret the data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company would realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair-value amounts.
The transition adjustment in connection with the adoption of SFAS 157 was an increase of $26.6 million after-tax to beginning retained earnings, which relates to day one gains that had been deferred under EITF 02-03.
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The following table summarizes the components of the fair-value adjustments included in the consolidated statements of operations and comprehensive income:
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Year Ended December 31, | |||||||||||||||
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2008 | 2007 | 2006 | |||||||||||||
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(in thousands)
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REVENUES Gains/(Losses): |
||||||||||||||||
Net realized gains (losses) from general investment portfolio: |
||||||||||||||||
Fair-value adjustment attributable to impairment charges in general investment portfolio |
$ | (5,977 | ) | $ | | $ | (3,292 | ) | ||||||||
Net change in fair value of credit derivatives (See Note 15) |
$ | (618,072 | ) | $ | (539,809 | ) | $ | 119,023 | ||||||||
Net interest income from financial products segment(1): |
||||||||||||||||
Fair-value adjustments on FP segment investment portfolio |
$ | 448,343 | $ | | $ | | ||||||||||
Fair-value adjustments on FP segment derivatives |
(460,256 | ) | | | ||||||||||||
Net interest income from financial products segment |
$ | (11,913 | ) | $ | | $ | | |||||||||
Net realized gains (losses) from financial products segment: |
||||||||||||||||
Fair-value adjustments attributable to impairment charges in FP segment investment portfolio |
$ | (8,634,065 | ) | $ | (11,100 | ) | $ | | ||||||||
Net realized and unrealized gains (losses) on derivative instruments: |
||||||||||||||||
FP segment derivatives(2) (See Note 16) |
$ | 1,424,237 | $ | 62,058 | $ | 130,150 | ||||||||||
Other financial guaranty segment derivatives |
285 | 743 | 1,229 | |||||||||||||
Net realized and unrealized gains (losses) on derivative instruments |
$ | 1,424,522 | $ | 62,801 | $ | 131,379 | ||||||||||
Net unrealized gains (losses) on financial instruments at fair value: |
||||||||||||||||
Financial guaranty segment: |
||||||||||||||||
Assets acquired in refinancing transactions |
$ | (17,200 | ) | $ | | $ | | |||||||||
Committed preferred trust securities |
100,000 | | | |||||||||||||
Net unrealized gains (losses) on financial instruments at fair value in the financial guaranty segment |
82,800 | | | |||||||||||||
FP segment: |
||||||||||||||||
Assets designated as trading portfolio |
(202,582 | ) | 13,991 | 3,575 | ||||||||||||
Fixed-rate FP segment debt: |
||||||||||||||||
Fair-value adjustments other than the Company's own credit risk |
(1,127,059 | ) | | | ||||||||||||
Fair-value adjustments attributable to the Company's own credit risk |
1,377,204 | | | |||||||||||||
Net unrealized gains (losses) on financial instruments at fair value in the FP segment |
47,563 | 13,991 | 3,575 | |||||||||||||
Net unrealized gains (losses) on financial instruments at fair value |
$ | 130,363 | $ | 13,991 | $ | 3,575 | ||||||||||
Net realized gains (losses) from assets acquired in refinancing transactions: |
||||||||||||||||
Fair-value adjustments attributable to assets acquired in refinancing transactions portfolio |
$ | (7,723 | ) | $ | | $ | (2,523 | ) | ||||||||
Other income(3) |
$ | (38,920 | ) | $ | (6,380 | ) | $ | 5,307 | ||||||||
EXPENSES (Gains)/Losses: |
||||||||||||||||
Net interest expense from financial products segment(4): |
||||||||||||||||
Fair-value adjustments on FP segment debt |
$ | | $ | 146,893 | $ | (56,655 | ) | |||||||||
Fair-value adjustments on FP segment derivatives |
| (174,074 | ) | 39,932 | ||||||||||||
Net interest expense from financial products segment |
$ | | $ | (27,181 | ) | $ | (16,723 | ) | ||||||||
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Valuation Hierarchy
SFAS 157 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
A financial instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Inputs to Valuation Techniques
Inputs refer broadly to the assumptions that market participants use in pricing assets or liabilities, including assumptions about risk. Inputs may be observable or unobservable.
Valuation Techniques
Valuation techniques used for assets and liabilities accounted for at fair value are generally categorized into three types:
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The Company uses valuation techniques that it concludes are appropriate in the specific circumstances and for which sufficient data are available. In selecting the valuation technique to apply, management considers the definition of an exit price and considers the nature of the asset or liability being valued.
The following is a description of the valuation methodologies the Company uses for financial instruments including the general classification of such instruments within the valuation hierarchy.
General Investment Portfolio
The fair value of bonds in the General Investment Portfolio is generally based on quoted market prices received from dealer quotes or alternative pricing sources with reasonable levels of price transparency. Such quotes generally consider a variety of factors, including recent trades of the same and similar securities. If quoted market prices are not available, the valuation is based on pricing models that use dealer price quotations, price activity for traded securities with similar attributes and other relevant market factors as inputs, including security type, rating, vintage, tenor and its position in the capital structure of the issuer. Assets in this category are primarily categorized as Level 2.
At December 31, 2008, the Company's equity securities were comprised of common stock of Dexia. The fair value of the common stock is based upon quoted prices and is categorized as Level 1. At December 31, 2007, the fair value of the Company's equity investment in Syncora Guarantee Re Ltd. ("SGR") was based on redemption value and other inputs.
For short-term investments in the General Investment Portfolio, which are those investments with a maturity of less than one year at time of purchase, the carrying amount approximates fair value. These short-term investments include money-market funds and other highly liquid short-term investments, which are categorized as Level 1 on the valuation hierarchy, and foreign government and agency securities, which are categorized as Level 2.
FP Segment Investment Portfolio
The FP Segment Investment Portfolio is comprised of investments made with the proceeds of FSA-insured GICs. Together with the VIE Investment Portfolio, it forms the FP Segment Investment Portfolio. The available-for-sale FP Investment Portfolio is broadly comprised of short-term investments, non-agency RMBS, securities issued or guaranteed by U.S. government sponsored agencies, taxable municipal bonds, securities issued by utilities, infrastructure-related securities, collateralized debt obligations ("CDOs"), and other asset backed securities. In addition to its available-for-sale portfolio, the FP Investment Portfolio includes foreign currency denominated securities classified as "trading."
The fair value of bonds in the FP Segment Investment Portfolio is generally based on quoted market prices received from dealer quotes or alternative pricing sources with reasonable levels of price transparency. Such quotes generally consider a variety of factors, including recent trades of the same and similar securities. If quoted market prices are not available, the valuation is based on pricing models that use dealer price quotations, price activity for traded securities with similar attributes and other relevant market factors as inputs, including security type, rating, vintage, tenor and its position in the capital structure of the issuer. For assets not valued by quoted market prices received from dealer quotes or alternative pricing sources, fair value is based on either internally developed models using market based inputs or based on broker quotes for identical or similar assets. Valuation results, particularly those derived from valuation models and quotes on certain mortgage and asset-backed securities, could differ materially from amounts that would actually be realized in the market. Non-agency mortgage-backed and other asset-backed investments are generally categorized as Level 3 due to the reduced liquidity that exists for such assets, which increases use of unobservable inputs.
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For short-term investments in the FP Segment Investment Portfolio, which are those investments with a maturity of less than one year at time of purchase, the carrying amount is fair value. These short-term investments include overnight federal funds and money market funds, which are categorized as Level 1 on the valuation hierarchy.
The trading portfolio is comprised of U.K. pound sterling-denominated inflation-linked bonds for which fair value is based on broker quotes that are derived from their internally-developed models that use observable market inputs to the extent possible. The investments are classified as Level 3.
Cash
For cash, the carrying amount equals fair value.
Assets Acquired in Refinancing Transactions
For certain assets acquired in refinancing transactions, fair value is either the present value of expected cash flows or a quoted market price as of the reporting date. This portfolio is comprised primarily of bonds, securitized loans, common stock, mortgage loans, real estate and short term investments, of which bonds, common stocks and certain securitized loans are carried at fair value. Mortgage loans are accounted for at fair value when lower than cost. The majority of the assets in this portfolio are categorized as Level 3 in the valuation hierarchy, except for the short-term investments, which are categorized as Level 2.
Credit Derivatives in the Insured Portfolio
The Company's insured portfolio includes contracts accounted for as derivatives, namely,
The Company considers all such agreements to be a normal part of its financial guaranty insurance business but, for accounting purposes, these contracts are deemed to be derivative instruments and therefore must be recorded at fair value, with changes in fair value recorded in the consolidated statements of operations and comprehensive income in "net change in fair value of credit derivatives."
Credit Default Swap Contracts
In the case of CDS contracts, a trust that is consolidated by the Company writes a derivative contract that provides for payments to be made if certain credit events occur related to certain specified reference obligations, in exchange for a fee. The need to interpose a trust is a regulatory requirement imposed by the New York State Insurance Department as an exception to its general rule, in order to allow the financial guarantors to sell credit protection by entering into credit derivative contracts (albeit indirectly by guaranteeing the trust), while other types of insurance enterprises may neither directly enter into such credit derivative contracts, nor provide such guarantees to a trust. The trust's obligation on the CDS contracts it writes are guaranteed by a financial guaranty contract written by FSA that provides payments to the insured if the trust defaults on its payments under the derivative
163
contract. In these transactions, FSA is considered the counterparty to a financial guaranty contract that is defined as a derivative. The credit event is typically based upon failure to pay or the insolvency of a referenced obligation. In such cases, the claim represents payment for the shortfall amount.
The Company's accounting policy regarding CDS contract valuations requires management to make numerous complex and subjective judgments relating to amounts that are inherently uncertain. CDS contracts are valued using proprietary models because such instruments are unique, complex and are typically highly customized transactions. Valuation models and the related assumptions are continuously reevaluated by management and enhanced, as appropriate, based on market developments and improvements in modeling techniques and the availability of market observable data. Due to the significance of unobservable inputs required to value CDS contracts, they are considered to be Level 3 under the SFAS 157 fair value hierarchy.
Significant assumptions that, if changed, could result in materially different fair values include:
Market perceptions of credit deterioration of the underlying referenced obligation would result in an increase in the expected exit value (the amount required to be paid to exit the transaction due to wider credit spreads).
Fair Value of CDS Contracts in which the Company Sells Protection
Determination of Current Exit Value Premium: The estimation of the current exit value premium is derived using a unique credit-spread algorithm for each defined CDS category that utilizes various publicly available credit indices, depending on the types of assets referenced by the CDS contract and the duration of the contract. The "exit price" derived is technically an "entry price" and not an "exit price" (i.e., the price that would be received to sell an asset or paid to transfer a liability that is required under SFAS 157). This is because a monoline insurer cannot observe "exit prices" for the CDS contract that it writes in a principal market since these contracts are not transferable. While SFAS 157 provides that the transaction (entry) price and the exit price may not be equal if the transaction price includes transaction costs, the Company believes those transaction costs would be the same in an "entry" market and a hypothetical "exit" market and thus it would be inappropriate to record a day one gain when using the estimated "entry price" to determine the exit value premium.
Management applies judgment when developing these estimates and considers factors such as current prices charged for similar agreements, if available, performance of underlying assets, changes in internal credit assessments or rating agency-based shadow ratings, and 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.
In a financial guaranty insurance policy, a deductible is the portion of a loss under that policy that is not covered by the policy, or in other words, the amount of the loss for which the insurer is not responsible. In a CDS contract, the deductible is quoted as a percentage of the contract's notional amount, and is also referred to as the contract's attachment point. For example, for a CDS with a $1 billion notional amount and a 15% deductible, the Company would only be obligated to make a claim payment after the insured incurred more than $150 million (15% of $1 billion) of losses (net of
164
recoveries). The attachment points for each of the Company's CDS contracts vary, as the deductibles are negotiated on a contract-by-contract basis.
In the ordinary course, the Company does not post collateral to the counterparty as security for the Company's obligation under CDS contracts. As a result, the Company receives a smaller fee than it would for a CDS contract that required the posting of collateral. In order to calculate the exit value premium for CDS that do not require collateral to be posted, the Company applies a factor (the "non-collateral posting factor") to the indicated market premium for CDS contracts that require collateral to be posted. The non-collateral posting factor was 70% for the year ended December 31, 2008.
The Company calculates the non-collateral posting factor quarterly based in part on observable market inputs. In the market where transactions are executed, the Company has observed since the beginning of 2008 that when a collateral posting counterparty executes a CDS contract purchasing protection from a non-collateral posting counterparty, it will hold back a minimum of 20% of the CDS premium it charged to provide the CDS protection. The Company believes that the non-collateral posting factor has the effect of adjusting the fair value of these contracts for the Company's credit quality in addition to adjusting the contract to a collateral posting basis. Accordingly, the Company adds to the 20% minimum an additional amount to reflect the market price of CDS protection on FSA. The Company estimated the additional amount as of December 31, 2008 to be 50% using an algorithm that uses as an input FSA's current annual five-year CDS credit spread, which was approximately 1,421 basis points as of December 31, 2008. The Company uses the current five-year CDS credit spread based on its observation that the five-year instrument is the standard term for CDS contracts used to hedge counterparty credit risk. Quoted prices for shorter or longer terms are typically not available and, when available, are less reliable.
The underlying securities of the Company's CDS contracts are predominantly corporate obligations, specifically investment grade pooled corporate CDS, high yield pooled corporate CDS and collateralized loan obligations ("CLOs"). The Company's exposure to underlying securities such as those backed by domestic RMBS and CDOs of ABS was less than one percent of the total CDS par outstanding as of December 31, 2008.
Below is an explanation of how the Company determines the current exit value for each of the following types of CDS contracts:
For each of these types of CDS contracts, the price the Company charges when entering into such contract sometimes differs from the fair value determined by the Company's fair value model at the time when the Company enters into the CDS contract. The Company refers to this difference as the "initial model adjustment," and is not an indicator of a day one gain. The initial model adjustment is needed because of differences between the CDS contract being valued and the reference index. The initial model adjustment is calculated at the inception of a CDS contract in order to calibrate the indicated model fair value of the CDS contract to the contractual premium rate on the trade date.
Pooled Corporate CDS Contracts: A pooled corporate CDS contract insures the default risk of a pool of referenced 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 the mid-point of the bid and ask prices (the "mid-market price") of dealer quotes on specific indexes as inputs to its pricing model, principally the Dow Jones CDX for domestic corporate CDS ("DJ CDX")
165
and iTraxx for European corporate CDS ("iTraxx"). The mid-market price is a practical expedient for the fair-value measurement within a bid-ask spread. For those pooled corporate CDS contracts that include both domestic and foreign reference entities, the Company applies the iTraxx price in proportion to the pool of applicable foreign reference entities comprising the pool by calculating a weighted average of the DJ CDX and iTraxx quoted prices.
The Company's valuation process for pooled corporate CDS involves stratifying the pools into either investment grade credits or high-yield credits and then by remaining term to maturity, consistent with the reference indexes. Within maturity bands, further distinction is made for contracts that have higher attachment points. Both the DJ CDX and iTraxx indices provide quoted prices 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.
Investment-Grade Pooled Corporate CDS Contracts: The Company applies quoted prices to its investment-grade pooled corporate CDS contracts ("IG CDS") by stratifying its IG CDS contracts into four maturity bands: less than 3.5 years; 3.5 to 5.5 years; 5.5 to 7.5 years; and 7.5 to 10 years. Within the maturity bands, further distinction is made for contracts that have a significantly higher starting attachment point (usually 30% or higher).
The CDX North America IG Index ("CDX IG Index") is comprised of prices sourced from 125 North American investment grade CDS quoted (each, an "Index CDS") and is supported by at least 10 of the largest CDS dealers. In addition to the full capital structure, the CDX IG Index also provides price quotes for various tranches delineated by attachment and detachment points: 0 to 3%; 3 to 7%; 7 to10%; 10 to 15%; 15 to 30% and 30 to 100%. Approximately every six months, a new "series" of the CDX IG Index is published ("on-the-run") based on a new grouping of 125 Index CDS, which changes the composition of the 125 Index CDS of older ("off-the-run") series. Each quarter, the Company compares the composition of the 125 Index CDS in both the on-the-run and off-the run series of the CDX IG Index to the CDS pool referenced by the Company's IG CDS contracts (the "reference CDS pool") and uses the average of the series of the CDX IG Index and the comparable iTraxx Index that most closely relates to the credit characteristics of the Company's IG CDS contracts, mainly the Weighted-Average Rating Factor ("WARF"), of the Company's IG CDS contracts. The Company also remodels each of its contracts to determine if the credit quality remains Super Triple-A and compares the WARF of the index to the WARF of each of the Company's IG CDS contracts. A "Super Triple-A" credit rating indicates a level of first-loss protection generally exceeding 1.3 times the level required by a rating agency for a Triple-A rating. WARF is a 10,000 point scale developed by Moody's that is used as an indicator of collateral pool risk. A higher WARF indicates a lower average collateral rating.
The Company calibrates the quoted index price to the approximate attachment points for its IG CDS contracts by calculating the weighted average of the given quoted tranche prices for IG CDS of a given maturity using the CDX IG Index and iTraxx quoted tranche widths. The relevant widths of the quoted tranches used by the two indices differ. DJ CDX uses tranches of 10 to 15%, 15 to 30%, and 30 to 100%, resulting in tranche widths of five, 15 and 70 percentage points, whereas iTraxx uses tranches of 9 to 12%, 12 to 22% and 22 to 100%, resulting in tranche widths of three, 10 and 78 percentage points.
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The Company's IG CDS contracts typically attach at 10% or higher. The following table indicates FSA's typical attachment points and total tranche widths:
Portfolio Classification
|
Index Quoted
Duration |
FSA's Typical
Attachment Point |
FSA's Total
Tranche Width |
||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
(in years)
|
|
|
||||||||
Less than 3.5 Yrs |
3 | 10 | % | 90 | % | ||||||
3.5 to 5.5 Yrs |
5 | 10 | 90 | ||||||||
5.5 to 7.5 Yrs: |
|||||||||||
Lower attachment |
7 | 15 | 85 | ||||||||
Higher attachment |
7 | 30 | 70 | ||||||||
7.5 to 10 Yrs: |
|||||||||||
Lower attachment |
10 | 15 | 82.5 | ||||||||
Higher attachment |
10 | 30 | 70 |
To calculate the weighted average price for the entire tranche width of the Company's IG CDS (the "total tranche width"), a price is obtained for each quoted tranche comprising the total tranche width, and the sum of the weighted average prices is divided by the total tranche width. The price for each quoted tranche is the mid-market of the quoted price for that tranche, weighted by the width of that tranche. The following table illustrates the calculation of the weighted-average price of the Company's IG CDS contracts with a maturity of up to 3.5 years, given quoted CDX IG tranche prices of 332 basis points, 83.5 basis points and 68.4 basis points for the 10 to 15%, 15 to 30%, and 30 to 100% tranches, respectively.
FSA Portfolio
Classification |
|
|
|
|
|
|
||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
CDX IG Mid-Market Price Multiplied by the Tranche Width |
|
|
||||||||||||||
Attachment/
Detachment |
Total
Tranche Width |
Weighted
Average Price |
||||||||||||||
10 to 15% | 15 to 30% | 30 to 100% | Total | |||||||||||||
Less than 3.5
Yrs |
332 bps × 5 =
1,660.0 |
83.5 bps × 15 =
1,252.5 |
68.4 bps × 70 =
4,788.0 |
7,700.5 | 90 | 85.6 bps |
The Company applies a factor to the quoted prices (the "IG calibration factor"). The calibration factor is intended to calibrate the index price to each of the Company's pooled corporate investment grade CDS contracts, which reference pools of entities that are typically of lower average credit quality than those reflected in the CDX IG Index. The IG calibration factor is determined for each IG CDS contract by calibrating the WARF of the index so that it approximately equals the WARF of each IG CDS contract. To do so, the Company recalculates the index price after removing from the index the reference obligations that have the highest ratings. This recalculated index price is then divided by the unadjusted index to arrive at the IG calibration factor. As of December 31, 2008, the IG calibration factor applied to the Company's IG CDS contracts ranged from 112% to 530% of the WARF of the index.
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The Company's Transaction Oversight Department reviews the pooled corporate CDS portfolio regularly and no less than quarterly and factors in any rating changes. Any new reported credit events under a given CDS contract are factored into the contract's deductible level. As such credit events occur, the contract's attachment point is recalculated based on the revised deductible amount to determine if the attachment point for each contract in the portfolio continues to be at a "Super Triple-A" credit rating.
To arrive at the exit value premium applied to each of the Company's IG CDS contracts, the Company:
Below is an example of the pricing algorithm that is applied to the Company's domestic IG CDS contracts with durations of 3.5 to 5.5 years, assuming an average IG calibration factor of 296%, to determine the exit premium value as of December 31, 2008:
Index Duration |
Unadjusted
Quoted Price |
After IG
Calibration Factor |
Adjusted to Non-Collateral
Posting Contract Value |
|||
---|---|---|---|---|---|---|
5 yrs | 85.1 bps | 251.9 bps | 75.6 bps |
High-Yield Pooled Corporate CDS Contracts: In order to estimate the market price for high-yield pooled corporate CDS contracts ("HY CDS"), the Company uses the average of the dealer mid-market prices obtained for the most senior quoted of the respective three-year, five-year and seven-year tranches of the CDX North America High Yield Index ("CDX HY Index"). The CDX HY Index is comprised of prices sourced from 100 of the most liquid North American high yield CDS quoted (each, an "Index CDS") and is supported by more than 10 of the largest CDS dealers. In addition to the full capital structure, the CDX HY Index also provides price quotes for various tranches delineated by attachment and detachment points: 0 to 10%; 10 to 15%; 15 to 25%; 25 to 35%; and 35 to 100%. The Company uses an average of the dealer mid-market quotes of the index because the Company believes that dealer price quotes have historically been indicative of where trades have been executed in the high-yield market.
The Company applies a factor to the quoted prices (the "HY calibration factor"). The HY calibration factor is intended to calibrate the index price to each of the Company's pooled corporate high-yield CDS contracts, which reference pools of entities that are typically of higher average credit quality than those reflected in the CDX HY Index. The HY calibration factor is determined for each HY CDS contract by calibrating the WARF of the index so that it approximately equals the WARF of each HY CDS contract. To do so, the Company recalculates the index price after removing from the index the reference obligations that have the lowest ratings. This recalculated index price is then divided by the unadjusted index to arrive at the HY calibration factor. At December 31, 2008, the HY calibration factor applied to the Company's HY CDS contracts ranged from 28% to 100% of the WARF of the index.
Approximately every six months, a new "series" of the CDX HY Index is published ("on-the-run") based on a new grouping of 100 single name CDS, which changes the composition of the Index of older ("off-the-run") series. The Company compares the composition of the Index in both the on-the-run and off-the run series of the HY index to each CDS pool (i.e., "reference entities" or companies included in each contract) referenced by the Company's contracts (the "reference CDS pool"). Based on that comparison, the Company determines which of the actively quoted series most
168
closely relates to the credit characteristics, mainly with reference to the WARF, of the Company's HY CDS contracts, and then uses the average of dealer quotes of that series. The Company also remodels each of its contracts to determine if the credit quality remains Super Triple-A and compares the WARF of the index to the WARF of each of the Company's HY CDS contracts.
To arrive at the exit value premium that is applied to each of the Company's CDS contracts in a given maturity band, the non-collateral posting factor is applied to the weighted-average market price determined for that maturity band.
Below is an example of the pricing algorithm that is applied to the Company's domestic HY CDS contracts with durations of 3.5 to 5.5 years, assuming an average HY calibration factor of 100% to determine the exit premium value as of December 31, 2008:
Index Duration |
Unadjusted
Quoted Price |
After HY
Calibration Factor |
Adjusted to Non-Collateral
Posting Contract Value |
|||
---|---|---|---|---|---|---|
5 yrs | 266.3 bps | 266.3 bps | 79.9 bps |
CDS of Funded CDOs and CLOs : Prior to August 2008, the Company sold protection to financial institutions in a principal-to-principal market in which transactions are highly customized and negotiated independently. The Company therefore cannot observe "exit" prices for the CDS contracts it writes in this market since these contracts are not transferable. In the absence of a principal exit market, the Company determines the fair value of a CDS contract it writes by using an internally-developed estimate of an "exit price" that a hypothetical market participant (i.e., a similarly rated monoline financial guarantee insurer, or "monoline insurer") would accept to assume the risk from the CDS writer on the measurement date, on terms identical to the contract written by the CDS writer. The Company believes this approach is reasonable because the hypothetical exit market has been defined as other monoline insurers. In essence, the exit market participants are the same as the monoline participants competing in the entry market.
As with pooled corporate CDS, there is no observable exchange trading of CDS of funded CDOs and CLOs. The price of protection charged by a CDS writer is based on the "credit spread component" of the "all-in credit spread" of funded CLOs, as quoted by underwriter participants. As the all-in credit spread for a given CLO may not always be observable in the market, the CDS writer often utilizes an index, published by an underwriter participant, such as the "all-in" London Interbank Offered Rate ("LIBOR") spread for Triple-A rated cash-funded CLOs (the "Triple-A CLO Funded Rate") as published by J.P. Morgan Chase & Co. The Triple-A CLO Rate is an all-in credit spread that includes both a funding and credit spread component.
The CDS protection of a CLO provided by the Company is priced to capture only the credit spread component, as the CDS writer is not providing funding for the CLO, only credit protection. The contracts on which the Company has provided credit protection are regularly evaluated to ascertain whether or not the original Triple-A credit rating is still considered appropriate. The Company determines the exit value premium for all these CDS of CLO contracts in its portfolio that are rated Triple-A with reference to the Triple-A CLO Funded Rate, which is currently the only regularly and frequently quoted rate observable in the market. The Triple-A CLO Funded Rate was 500 bps as of
169
December 31, 2008. The Company applies a credit component factor to the Triple-A CLO Funded Rate as a means of estimating the fair value of its Triple-A rated contract, which only refers to the credit component. The credit and funding components were 50% each as of December 31, 2008. The components are determined judgmentally and can vary based on estimates provided to the Company by external market participants, specifically purchasers of CDS protection on Triple-A CLO risk and investors in Triple-A CLO bonds.
To arrive at the exit value premium that is applied to each of the Company' CDO and CLO CDS contracts, the non-collateral posting factor is applied to the weighted-average market price determined for each maturity band.
The determination of the exit value premium is summarized as follows:
|
Triple-A CLO
Funded Rate |
After Credit
Component Factor |
After Non-Collateral
Posting Factor |
|||
---|---|---|---|---|---|---|
Rate |
500 bps | 250 bps | 75 bps |
Other Structured Obligations Valuation: For CDS for which observable market value information is not available, management applies its best judgment to estimate the appropriate current exit value premium, and takes into consideration the Company's estimation of the price at which the Company would currently charge to provide similar protection, and other factors such as the nature of the underlying reference credit, the Company's attachment point, and the tenor of the CDS contract.
Fair Value of CDS Contracts in which the Company Purchases Protection
The Company generally utilizes reinsurance to purchase protection for CDS contracts it writes in the same way that it employs reinsurance in respect of other financial guaranty insurance policies. The Company's uses of reinsurance to mitigate risk exposures for CDS contracts and financial guaranty insurance policies are nearly identical as they involve the same reinsurers, the same underwriting process evaluating the reinsurers and the same credit risk management and surveillance processes supporting the reinsurance function. The Company enters into reinsurance agreements on CDS contracts primarily on a quota share basis. Under a quota share reinsurance agreement with a reinsurer, the Company cedes to the assuming reinsurer a proportionate share of the risk and premium.
The determination of the hypothetical exit market is a key factor in determining the fair value of protection purchased (the "ceded" or "reinsurance" contract) with respect to a CDS contract written by a financial guarantor (the "direct contract"). SFAS 157 requires that the valuation premise, used to measure the fair value of an asset, must consider the asset's "highest and best use" from the perspective of market participants. Generally, the valuation premise used for a financial asset is "in-exchange" since this type of asset provides maximum value to market participants on a stand-alone basis. The maximum value of a ceded contract to the CDS writer's exit market participants is in combination with the CDS writer's direct contract. Therefore the appropriate valuation premise to use for a ceded contract is the "in-use" premise.
The Company determines the fair value of a CDS contract in which it purchases protection from a reinsurer (the "ceded CDS contract") as the proportionate percentage of the fair value of the related written CDS contracts, adjusted for any ceding commission and consideration of counterparty risk. In quota share reinsurance agreements, the assuming reinsurer typically pays a ceding commission periodically over the life of the CDS contract to the ceding company that is intended to defray the ceding company's costs for the services it provides to the reinsurer, such as risk selection, underwriting activities and ongoing servicing and reporting. As an element of the fair value of the ceded CDS contract, the ceding commission paid to the ceding company represents the ceding company's profit on the ceded CDS contract after considering counterparty credit risk, (i.e., the difference between (a) the price of the protection the ceding company purchased from the reinsurer, which is net of the ceding commission, and (b) the price that the ceding company would receive to exit the ceded CDS contract
170
in its principal market, which is comprised of other ceding insurers of comparable credit standing). The Company applies a credit valuation adjustment to the fair value of a ceded CDS contract due from a reinsurer if the reinsurer's credit quality (as determined by CDS price if available, or if not, its credit rating) is less than that of the Company's based upon the premise that the exit market for these contracts would be another monoline financial guarantee insurer that has similar credit rating or spread as the Company.
Insured Interest Rate Swaps and Financial Guarantee Contracts Deemed to be Derivatives
The Company insures IR swaps entered into in connection with the issuance of certain public finance obligations. Because the financial guaranty contract insures a derivative, the financial guaranty contract is deemed to be a derivative. Therefore, the contract is required to be carried at fair value, with the change in fair value being recorded in the determination of net income (loss). As there is no observable market for these policies, the fair value of these contracts is determined by using an internally-developed model and, therefore, they are classified as Level 3 in the valuation hierarchy.
Insured NIM securitizations issued in connection with certain mortgage-backed security financings and financial guaranty contracts with embedded derivatives are deemed to be hybrid instruments that contain an embedded derivative if they were issued after January 1, 2007. The Company elected to record these financial instruments at fair value under SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments." Changes in the fair value of these contracts are recorded in the consolidated statements of operations and comprehensive income. As there is no observable market for these policies, the fair value of these contracts is based on internally-derived estimates and they are, therefore, classified as Level 3 in the valuation hierarchy.
FP Segment Derivatives
Derivatives in the FP segment, except for those used to hedge the VIE debt, are valued using a pricing model that uses observable market inputs, such as interest rate curves, foreign exchange rates and inflation indices. These derivatives are therefore classified as Level 2 in the valuation hierarchy, except for exchange traded futures contracts, which are classified as Level 1, or Level 3 if any of the significant model inputs were not observable in the market. On the date of adoption, all derivatives used to hedge VIE debt were valued by obtaining prices from brokers or counterparties, and accordingly were classified as Level 3 in the valuation hierarchy. At December 31, 2008, the majority of these derivatives were valued using a pricing model that uses observable market inputs such as interest rate curves, foreign exchange rates and inflation indices. Therefore, these derivatives are classified as Level 2 in the valuation hierarchy at December 31, 2008. If a significant model input had been used that was not observable in the market, the derivative would have been classified as a Level 3 in the valuation hierarchy.
Other Assets and Other Liabilities and Minority Interest
Other assets primarily include receivables for securities sold, deferred compensation plans ("DCP"), supplemental executive retirement plans ("SERP"), and committed preferred trust securities ("CPS"). As there is no observable market for the Company's CPS, fair value of the CPS is based on internally-derived estimates and, therefore, is categorized as Level 3 in the fair value hierarchy.
The Company determined the fair value of the CPS by estimating the fair value of a floating rate security with an estimated market yield reflective of the underlying committed preferred security structure and the relevant coupon based on the capped auction rate.
Other liabilities and minority interest include payables for securities purchased and derivative obligations. For receivable for securities sold and payable for securities purchased, the carrying amount is cost, which approximates fair value because of the short maturity.
FP Segment Debt
The fair value of the FP segment debt is determined based on a discounted cash flow model. Fair value calculated by these models includes assumptions for interest rate curves based on selected
171
benchmark securities and weighted average expected lives. In addition, the valuation of the fair-valued liabilities includes an adjustment to reflect the credit quality of FSA that represents the impact of changes in market credit spreads on these liabilities. The fair-valued liabilities are categorized as Level 3 in the valuation hierarchy. See Note 4 for a description of the FP segment debt for which the Company elected fair value option.
Net Financial Guarantee Contracts Written
The fair value of net financial guarantees written is based on the estimated cost to the Company of transferring the outstanding insured portfolio to another financial guarantor of comparable credit standing, under current market conditions. The fair value of net financial guarantees written incorporates (i) deferred premium revenue, (ii) amounts recoverable from reinsurers on unpaid losses, (iii) estimated future installment premiums receivable, and (iv) losses and loss adjustment expenses. These fair values are based on inputs observable in the market, where available, as well as inputs which are not readily observable in the market. SFAS 157 requires the risk of nonperformance to be included in the estimation of fair value of financial liabilities. The Company's credit risk, as measured by the credit spread on its CDS, has been factored into the fair value of the financial guarantees written in order to account for the risk of nonperformance.
Notes Payable
For notes payable, the carrying amount represents the principal amount due at maturity. The fair value is based on the quoted market price or other third party sources.
The following table presents the financial instruments carried at fair value at December 31, 2008, by caption on the consolidated balance sheet and SFAS 157 valuation hierarchy.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
|
At December 31, 2008 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Level 1 | Level 2 | Level 3 |
FIN 39
Netting(1) |
Total | |||||||||||||
|
(in thousands)
|
|||||||||||||||||
Assets: |
||||||||||||||||||
General investment portfolio, available for sale: |
||||||||||||||||||
Bonds |
$ | | $ | 5,238,081 | $ | 45,167 | $ | | $ | 5,283,248 | ||||||||
Equity securities |
374 | | | | 374 | |||||||||||||
Short-term investments |
12,502 | 639,354 | | | 651,856 | |||||||||||||
Financial products segment investment portfolio: |
||||||||||||||||||
Available-for sale bonds |
| 2,390,325 | 7,292,973 | | 9,683,298 | |||||||||||||
Short-term investments |
471,480 | | | | 471,480 | |||||||||||||
Trading portfolio |
| | 147,241 | | 147,241 | |||||||||||||
Assets acquired in refinancing transactions |
| 20,962 | 117,814 | | 138,776 | |||||||||||||
FP segment derivatives |
63,972 | 1,622,201 | (116,781 | ) | (1,057,868 | ) | 511,524 | |||||||||||
Credit derivatives(2) |
| | 287,449 | | 287,449 | |||||||||||||
Other assets: |
||||||||||||||||||
DCP and SERP |
90,616 | 88 | | | 90,704 | |||||||||||||
CPS |
| | 100,000 | | 100,000 | |||||||||||||
Total assets at fair value |
$ | 638,944 | $ | 9,911,011 | $ | 7,873,863 | $ | (1,057,868 | ) | $ | 17,365,950 | |||||||
172
|
At December 31, 2008 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Level 1 | Level 2 | Level 3 |
FIN 39
Netting(1) |
Total | |||||||||||||
|
(in thousands)
|
|||||||||||||||||
Liabilities: |
||||||||||||||||||
FP segment debt |
$ | | $ | | $ | 8,030,909 | $ | | $ | 8,030,909 | ||||||||
FP segment derivatives |
| 102,617 | 23,356 | | 125,973 | |||||||||||||
Credit derivatives |
| | 1,543,809 | | 1,543,809 | |||||||||||||
Other liabilities: |
||||||||||||||||||
Other financial guarantee segment derivatives |
| (112 | ) | | | (112 | ) | |||||||||||
Total liabilities at fair value |
$ | | $ | 102,505 | $ | 9,598,074 | $ | | $ | 9,700,579 | ||||||||
Non-Recurring Fair Value Measurements
Mortgage loans in the portfolio of assets acquired in refinancing transactions are carried at the lower of cost or market on an aggregate basis. At December 31, 2008, such investments were carried at their market value of $13.8 million. The mortgage loans are classified as Level 3 of the fair value hierarchy as there are significant unobservable inputs used in the valuation of such loans. An indicative dealer quote is used to price the non-performing portion of these mortgage loans. The performing loans are valued using management's determination of future cash flows arising from these loans, discounted at the rate of return that would be required by a market participant. This rate of return is based on indicative dealer quotes.
Changes in Level 3 Recurring Fair Value Measurements
The table below includes a rollforward of the balance sheet amounts for financial instruments classified by the Company within Level 3 of the valuation hierarchy for the year ended December 31, 2008. When a determination is made to classify a financial instrument within Level 3, the determination is based upon the significance of the unobservable data to the overall fair value measurement. However, Level 3 financial instruments may include, in addition to the unobservable or Level 3 components, observable components. Accordingly, the gains and losses in the table below include changes in fair value due in part to observable factors that are part of the valuation methodology.
173
Level 3 assets were 38.9% of total assets at December 31, 2008. Level 3 liabilities were 37.7% of total liabilities at December 31, 2008.
Level 3 Rollforward
|
Year Ended December 31, 2008 | ||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
|
|
|
|
Change in
Unrealized Gains/(Losses) Related to Financial Instruments Held at December 31, 2008 |
||||||||||||||||
|
|
Total Pre-tax Realized/
Unrealized Gains/(Losses)(1) Recorded in: |
|
|
|
||||||||||||||||||
|
Fair
Value at January 1, 2008 |
Purchases,
Issuances, Settlements, net |
Transfers
in and/or out of Level 3(2) |
Fair
Value at December 31, 2008 |
|||||||||||||||||||
|
Net Income
(Loss) |
Other
Comprehensive Income (Loss) |
|||||||||||||||||||||
|
(in thousands)
|
||||||||||||||||||||||
General investment portfolio, available for sale: |
|||||||||||||||||||||||
Bonds |
$ | 60,273 | $ | (720 | )(3) | $ | (10,968 | ) | $ | (3,418 | ) | $ | | $ | 45,167 | $ | | ||||||
Equity securities |
39,000 | (36,075 | )(3) | | (2,925 | ) | | | | ||||||||||||||
FP segment available-for sale bonds |
14,764,502 | (7,661,700 | )(4) | 1,399,432 | (1,430,909 | ) | 221,648 | 7,292,973 | (7,672,799 | ) | |||||||||||||
FP trading portfolio |
250,575 | (193,721 | )(5) | | | 90,387 | 147,241 | (193,721 | ) | ||||||||||||||
Assets acquired in refinancing transactions |
170,492 | (17,200 | )(6) | (3,564 | ) | (31,914 | ) | | 117,814 | (17,200 | ) | ||||||||||||
FP segment debt |
(9,367,135 | ) | 50,568 | (7) | | 1,285,658 | | (8,030,909 | ) | 99,653 | |||||||||||||
Net FP segment derivatives(8) |
591,325 | (108,149 | )(9) | | (623,314 | ) | (140,138 | ) | (94,995 | ) | |||||||||||||
CPS |
| 100,000 | (5) | | | | 100,000 | 100,000 | |||||||||||||||
Net credit derivatives(8) |
(522,033 | ) | (618,072 | )(10) | | (116,255 | ) | | (1,256,360 | ) | (632,678 | ) |
174
The table below shows the carrying amount and fair value of the Company's other financial instruments:
Other Financial Instruments(2)
|
At December 31, 2008 | At December 31, 2007 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Carrying
Amount |
Fair Value |
Carrying
Amount |
Fair Value | |||||||||
|
(in thousands)
|
||||||||||||
Assets acquired in refinancing transactions |
$ | 14,073 | $ | 14,073 | $ | 229,264 | $ | 231,801 | |||||
Other assets |
278,244 | 278,244 | 594,568 | 594,568 | |||||||||
Net financial guarantee contracts written |
(3,509,599 | ) | (3,256,605 | ) | (1,949,161 | ) | (1,748,668 | ) | |||||
FP segment debt (1) |
(8,401,374 | ) | (6,115,799 | ) | (17,870,128 | ) | (17,952,258 | ) | |||||
Notes payable |
(730,000 | ) | (186,700 | ) | (730,000 | ) | (551,820 | ) | |||||
Other liabilities and minority interest |
(476,903 | ) | (476,903 | ) | (676,058 | ) | (676,058 | ) |
4. FAIR VALUE OPTION
The Company adopted SFAS 159 effective January 1, 2008. SFAS 159 provides an option to elect fair value as an alternative measurement for selected financial assets and financial liabilities not previously carried at fair value. The fair-value option may be applied to single eligible instruments, is irrevocable and is applied only to entire instruments and not to portions of instruments. For a discussion of the Company's valuation methodologies, see Note 3.
The Company's fair value elections were intended to mitigate the volatility in earnings that had been created by recording financial instruments and the related risk management instruments on a different basis of accounting, to eliminate the operational complexities of applying hedge accounting or to conform to the fair value elections made by the Company in 2006 under its International Financial Reporting Standards reporting to Dexia. The requirement, under SFAS 157, to incorporate a reporting entity's own credit risk in the valuation of liabilities which are carried at fair value, has created additional volatility in earnings as credit risk is not hedged. The following table provides detail regarding the Company's elections by consolidated balance sheet line at January 1, 2008.
|
Carrying Value
of Financial Instruments |
Transition
Gain/(Loss) Recorded in Retained Earnings |
Adjusted
Carrying Value of Financial Instruments |
||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
(in thousands)
|
||||||||||
Assets acquired in refinancing transactions |
$ | 163,285 | $ | 2,537 | (1) | $ | 165,822 | ||||
FP segment debt |
(9,470,797 | ) | (88,310 | ) | (9,559,107 | ) | |||||
Pretax cumulative effect of adoption of SFAS 159 |
(85,773 | ) | |||||||||
Deferred income taxes |
30,021 | ||||||||||
Cumulative effect of adoption of SFAS 159 |
$ | (55,752 | ) | ||||||||
175
Elections
On January 1, 2008, the Company elected to record the following at fair value:
Changes in Fair Value under the Fair Value Option Election
The following table presents the pre-tax changes in fair value included in the consolidated statements of operations and comprehensive income for the year ended December 31, 2008, for items for which the SFAS 159 fair value election was made.
Net Unrealized Gains (Losses) on Financial Instruments at Fair Value
|
Year Ended December 31, 2008 | |||
---|---|---|---|---|
|
(in thousands)
|
|||
Assets acquired in refinancing transactions |
$ | (17,200 | ) | |
FP segment debt |
250,145 |
The table above includes gains of approximately $1.4 billion for the year ended December 31, 2008, that are attributable to changes in the Company's own credit spread.
Aggregate Fair Value and Aggregate Remaining Contractual Principal Balance Outstanding
The following table reflects the aggregate fair value and the aggregate remaining contractual principal balance outstanding at December 31, 2008, for certain assets acquired in refinancing transactions and FP segment debt for which the SFAS 159 fair value option has been elected.
|
At December 31, 2008 | ||||||
---|---|---|---|---|---|---|---|
|
Remaining Aggregate
Contractual Principal Amount Outstanding |
Fair Value | |||||
|
(in thousands)
|
||||||
Assets acquired in refinancing transactions |
$ | 133,124 | (1) | $ | 117,796 | ||
FP segment debt(2) |
7,998,048 | 8,030,909 |
176
5. GENERAL INVESTMENT PORTFOLIO
The following table summarizes the components of the net investment income generated by the General Investment Portfolio:
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in thousands)
|
||||||||||
Bonds and short-term investments |
$ | 265,256 | $ | 236,510 | $ | 217,253 | |||||
Equity securities |
1,609 | 3,483 | 4,523 | ||||||||
Investment expenses |
(2,684 | ) | (3,334 | ) | (2,926 | ) | |||||
Net investment income from general investment portfolio |
$ | 264,181 | $ | 236,659 | $ | 218,850 | |||||
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
Rating(1)
|
At
December 31, 2008 Percent of Bonds |
||||
---|---|---|---|---|---|
AAA(2) |
43.3 | % | |||
AA |
36.0 | ||||
A |
19.1 | ||||
BBB |
1.5 | ||||
Not Rated |
0.1 | ||||
Total |
100.0 | % | |||
The General Investment Portfolio includes bonds insured by FSA ("FSA-Insured Investments") that were acquired in the ordinary course of business. Of the bonds included in the General Investment Portfolio at December 31, 2008, 6.6% were insured by FSA and 28.6% were insured by other monolines. All of the FSA-Insured Investments were investment grade without giving effect to the FSA insurance. The average shadow rating of the FSA-Insured Investments, which is the rating without giving effect to the FSA guaranty, was in the Single-A range. These assets are included in the Company's surveillance process and, at December 31, 2008, no loss reserves were anticipated on any of these assets. See Note 26 for more information.
177
The amortized cost and fair value of the securities in the General Investment Portfolio were as follows:
General Investment Portfolio by Security Type
|
At December 31, 2008 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Investment Category
|
Amortized
Cost |
Gross
Unrealized Gains |
Gross
Unrealized Losses |
Fair Value | ||||||||||
|
(in thousands)
|
|||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 103,725 | $ | 9,127 | $ | (23 | ) | $ | 112,829 | |||||
Obligations of U.S. states and political subdivisions |
4,321,118 | 87,081 | (168,414 | ) | 4,239,785 | |||||||||
Mortgage-backed securities |
408,083 | 13,758 | (9,492 | ) | 412,349 | |||||||||
Corporate securities |
206,188 | 7,745 | (3,562 | ) | 210,371 | |||||||||
Foreign securities(1) |
333,646 | 334 | (50,271 | ) | 283,709 | |||||||||
Asset-backed securities |
26,081 | | (1,876 | ) | 24,205 | |||||||||
Total bonds |
5,398,841 | 118,045 | (233,638 | ) | 5,283,248 | |||||||||
Short-term investments(2) |
651,090 | 825 | (59 | ) | 651,856 | |||||||||
Total fixed-income securities |
6,049,931 | 118,870 | (233,697 | ) | 5,935,104 | |||||||||
Equity securities |
1,434 | | (1,060 | ) | 374 | |||||||||
Total General Investment Portfolio |
$ | 6,051,365 | $ | 118,870 | $ | (234,757 | ) | $ | 5,935,478 | |||||
|
At December 31, 2007 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Investment Category
|
Amortized
Cost |
Gross
Unrealized Gains |
Gross
Unrealized Losses |
Fair Value | ||||||||||
|
(in thousands)
|
|||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 97,335 | $ | 4,201 | $ | (87 | ) | $ | 101,449 | |||||
Obligations of U.S. states and political subdivisions |
3,920,509 | 149,893 | (5,837 | ) | 4,064,565 | |||||||||
Mortgage-backed securities |
404,334 | 5,161 | (1,698 | ) | 407,797 | |||||||||
Corporate securities |
198,379 | 3,943 | (1,133 | ) | 201,189 | |||||||||
Foreign securities(1) |
248,006 | 8,584 | (285 | ) | 256,305 | |||||||||
Asset-backed securities |
23,077 | 286 | (4 | ) | 23,359 | |||||||||
Total bonds |
4,891,640 | 172,068 | (9,044 | ) | 5,054,664 | |||||||||
Short-term investments |
96,263 | 2,260 | (1,157 | ) | 97,366 | |||||||||
Total fixed-income securities |
4,987,903 | 174,328 | (10,201 | ) | 5,152,030 | |||||||||
Equity securities |
40,020 | 4 | (155 | ) | 39,869 | |||||||||
Total General Investment Portfolio |
$ | 5,027,923 | $ | 174,332 | $ | (10,356 | ) | $ | 5,191,899 | |||||
178
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
|
At December 31, 2008 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Aging Categories
|
Number
of Securities |
Amortized
Cost |
Unrealized
Losses |
Fair
Value |
Unrealized
Loss as a Percentage of Amortized Cost |
|||||||||||||
|
(dollars in thousands)
|
|||||||||||||||||
Less than Six Months(1) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 137 | $ | (1 | ) | $ | 136 | (0.7 | )% | |||||||||
Obligations of U.S. states and political subdivisions |
993,745 | (58,846 | ) | 934,899 | (5.9 | ) | ||||||||||||
Mortgage-backed securities |
8,684 | (118 | ) | 8,566 | (1.4 | ) | ||||||||||||
Corporate securities |
20,654 | (1,459 | ) | 19,195 | (7.1 | ) | ||||||||||||
Foreign securities |
220,257 | (30,425 | ) | 189,832 | (13.8 | ) | ||||||||||||
Asset-backed securities |
23,713 | (1,476 | ) | 22,237 | (6.2 | ) | ||||||||||||
Total |
311 | 1,267,190 | (92,325 | ) | 1,174,865 | (7.3 | ) | |||||||||||
More than Six Months but Less than 12 Months(2) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
37 | (1 | ) | 36 | (2.7 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
587,069 | (53,447 | ) | 533,622 | (9.1 | ) | ||||||||||||
Mortgage-backed securities |
31,793 | (8,310 | ) | 23,483 | (26.1 | ) | ||||||||||||
Corporate securities |
24,813 | (1,428 | ) | 23,385 | (5.8 | ) | ||||||||||||
Foreign securities |
95,887 | (18,890 | ) | 76,997 | (19.7 | ) | ||||||||||||
Asset-backed securities |
1,456 | (117 | ) | 1,339 | (8.0 | ) | ||||||||||||
Total |
233 | 741,055 | (82,193 | ) | 658,862 | (11.1 | ) | |||||||||||
12 Months or More(3) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
331 | (21 | ) | 310 | (6.3 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
407,344 | (56,121 | ) | 351,223 | (13.8 | ) | ||||||||||||
Mortgage-backed securities |
10,157 | (1,064 | ) | 9,093 | (10.5 | ) | ||||||||||||
Corporate securities |
8,403 | (675 | ) | 7,728 | (8.0 | ) | ||||||||||||
Foreign securities |
4,072 | (956 | ) | 3,116 | (23.5 | ) | ||||||||||||
Asset-backed securities |
912 | (283 | ) | 629 | (31.0 | ) | ||||||||||||
Total |
186 | 431,219 | (59,120 | ) | 372,099 | (13.7 | ) | |||||||||||
Total |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
505 | (23 | ) | 482 | (4.6 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
1,988,158 | (168,414 | ) | 1,819,744 | (8.5 | ) | ||||||||||||
Mortgage-backed securities |
50,634 | (9,492 | ) | 41,142 | (18.7 | ) | ||||||||||||
Corporate securities |
53,870 | (3,562 | ) | 50,308 | (6.6 | ) | ||||||||||||
Foreign securities |
320,216 | (50,271 | ) | 269,945 | (15.7 | ) | ||||||||||||
Asset-backed securities |
26,081 | (1,876 | ) | 24,205 | (7.2 | ) | ||||||||||||
Total |
730 | $ | 2,439,464 | $ | (233,638 | ) | $ | 2,205,826 | (9.6 | )% | ||||||||
179
|
At December 31, 2007 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Aging Categories
|
Number
of Securities |
Amortized
Cost |
Unrealized
Losses |
Fair
Value |
Unrealized
Loss as a Percentage of Amortized Cost |
|||||||||||||
|
(dollars in thousands)
|
|||||||||||||||||
Less than Six Months(1) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 17,043 | $ | (17 | ) | $ | 17,026 | (0.1 | )% | |||||||||
Obligations of U.S. states and political subdivisions |
87,782 | (1,247 | ) | 86,535 | (1.4 | ) | ||||||||||||
Mortgage-backed securities |
220 | (0 | ) | 220 | (0.0 | ) | ||||||||||||
Corporate securities |
4,652 | (23 | ) | 4,629 | (0.5 | ) | ||||||||||||
Foreign securities |
37,836 | (285 | ) | 37,551 | (0.8 | ) | ||||||||||||
Asset-backed securities |
| | | | ||||||||||||||
Total |
53 | 147,533 | (1,572 | ) | 145,961 | (1.1 | ) | |||||||||||
More than Six Months but Less than 12 Months(2) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
| | | | ||||||||||||||
Obligations of U.S. states and political subdivisions |
326,960 | (4,132 | ) | 322,828 | (1.3 | ) | ||||||||||||
Mortgage-backed securities |
158 | (6 | ) | 152 | (3.8 | ) | ||||||||||||
Corporate securities |
12,669 | (442 | ) | 12,227 | (3.5 | ) | ||||||||||||
Foreign securities |
| | | | ||||||||||||||
Asset-backed securities |
| | | | ||||||||||||||
Total |
121 | 339,787 | (4,580 | ) | 335,207 | (1.3 | ) | |||||||||||
12 Months or More(3) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
2,099 | (70 | ) | 2,029 | (3.3 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
11,324 | (458 | ) | 10,866 | (4.0 | ) | ||||||||||||
Mortgage-backed securities |
110,896 | (1,692 | ) | 109,204 | (1.5 | ) | ||||||||||||
Corporate securities |
28,226 | (668 | ) | 27,558 | (2.4 | ) | ||||||||||||
Foreign securities |
| | | | ||||||||||||||
Asset-backed securities |
2,985 | (4 | ) | 2,981 | (0.1 | ) | ||||||||||||
Total |
180 | 155,530 | (2,892 | ) | 152,638 | (1.9 | ) | |||||||||||
Total |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
19,142 | (87 | ) | 19,055 | (0.5 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
426,066 | (5,837 | ) | 420,229 | (1.4 | ) | ||||||||||||
Mortgage-backed securities |
111,274 | (1,698 | ) | 109,576 | (1.5 | ) | ||||||||||||
Corporate securities |
45,547 | (1,133 | ) | 44,414 | (2.5 | ) | ||||||||||||
Foreign securities |
37,836 | (285 | ) | 37,551 | (0.8 | ) | ||||||||||||
Asset-backed securities |
2,985 | (4 | ) | 2,981 | (0.1 | ) | ||||||||||||
Total |
354 | $ | 642,850 | $ | (9,044 | ) | $ | 633,806 | (1.4 | )% | ||||||||
In 2008, the Company had realized gains for sales of bonds, offset in part by an OTTI charge of $6.0 million for several municipal bonds. There were no OTTI charges in the General Investment Portfolio in 2007 and 2006.
180
Management has determined that the remaining unrealized losses in fixed-income securities at December 31, 2008 are primarily attributable to the current interest rate environment and has concluded that these unrealized losses are temporary in nature based upon (a) the lack of principal or interest payment defaults on these securities, (b) the creditworthiness of the issuers, and (c) the Company's ability and current intent to hold these securities until a recovery in fair value or maturity. As of December 31, 2008 and 2007, 100% of the securities that were in a gross unrealized loss position were rated investment grade. Management has based its conclusions on current facts and circumstances. Events could occur in the future that could change management conclusions about its ability and intent to hold such securities.
The amortized cost and fair value of fixed-income securities in the General Investment Portfolio at December 31, 2008 and 2007, 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.
Distribution of Fixed-Income Securities in General Investment Portfolio
by Contractual Maturity
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
||||||||||
|
(in thousands)
|
|||||||||||||
Due in one year or less |
$ | 833,163 | $ | 837,658 | $ | 155,988 | $ | 158,007 | ||||||
Due after one year through five years |
1,036,673 | 1,046,008 | 1,354,829 | 1,425,246 | ||||||||||
Due after five years through ten years |
823,928 | 828,063 | 818,382 | 853,861 | ||||||||||
Due after ten years |
2,922,003 | 2,786,821 | 2,231,293 | 2,283,760 | ||||||||||
Mortgage-backed securities(1) |
408,083 | 412,349 | 404,334 | 407,797 | ||||||||||
Asset-backed securities(2) |
26,081 | 24,205 | 23,077 | 23,359 | ||||||||||
Total fixed-income securities in General Investment Portfolio |
$ | 6,049,931 | $ | 5,935,104 | $ | 4,987,903 | $ | 5,152,030 | ||||||
Proceeds from sales of long-term bonds from the General Investment Portfolio during 2008, 2007 and 2006 were $4,011.4 million, $3,568.2 million and $1,637.3 million, respectively. Proceeds from maturities of bonds for the General Investment Portfolio during 2008, 2007 and 2006 were $519.2 million, $189.2 million and $163.3 million, respectively. Gross gains of $51.8 million, $5.6 million and $0.9 million and gross losses of $52.2 million, $7.5 million and $5.8 million were realized on sales in 2008, 2007 and 2006, respectively.
Bonds and short-term investments at an amortized cost of $10.0 million and cash of $1.8 million at December 31, 2008 and bonds and short-term investments at an amortized cost of $10.1 million and cash of $1.8 million at December 31, 2007, were on deposit with regulatory authorities as required by insurance regulations.
181
Equity Investments
In 2008, the Company sold its investment in SGR Redeemable Preferred Shares. Amounts recorded by the Company in connection with SGR are as follows:
|
As of and for the Year Ended
December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||
|
(in thousands)
|
|||||||||
Equity securities |
$ | | $ | 39,000 | $ | 54,016 | ||||
Dividends earned from SGR |
1,609 | 3,465 | 4,518 | |||||||
Realized gain (loss) on sale |
(36,100 | ) | | |
6. FP SEGMENT INVESTMENT PORTFOLIO
Within the FP Investment Portfolio, the Company classifies all securities as available-for-sale, except for securities owned by FSA-PAL which are classified as trading securities. The assets in the trading portfolio are bonds denominated in foreign currencies. The VIE Investment Portfolio is classified as available-for-sale at December 31, 2008.
FP Investment Portfolio
The following table sets forth the FP Investment Portfolio fixed income securities based on ratings:
FP Investment Portfolio Fixed Income Securities by Rating
Rating(1)
|
At December 31, 2008
Percentage of FP Investment Portfolio |
||||
---|---|---|---|---|---|
AAA |
49.0 | % | |||
AA |
15.7 | ||||
A |
7.2 | ||||
BBB |
12.8 | ||||
Below investment grade |
15.3 | ||||
Total |
100.0 | % | |||
The FP Investment Portfolio includes FSA-Insured Investments bought in the ordinary course of business. Of the bonds included in the available-for-sale FP Investment Portfolio at December 31, 2008, 4.5% were insured by FSA. At that date, 98.1% of the FSA-Insured Investments were investment grade without giving effect to the FSA insurance. The average shadow rating of the FSA-Insured Investments, which is the rating without giving effect to the FSA guaranty, was in the Triple-B range. Of the bonds included in the FP Investment Portfolio at December 31, 2008, 15.7% were insured by other monoline guarantors. These assets are included in the Company's surveillance process and, at December 31, 2008, no loss reserves were anticipated on any or these assets. See Note 26.
Trading Securities
During 2008, the Company recorded unrealized losses of $202.6 million in income related to the assets in the trading portfolio, compared with unrealized gains of $14.0 million in 2007 and $3.6 million in 2006.
182
Available-for-Sale Securities
The following tables present the amortized cost and fair value of available-for-sale bonds and short-term investments held in the FP Investment Portfolio:
Available-for-Sale Securities in the FP Investment Portfolio by Security Type
|
At December 31, 2008 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Investment Category
|
Amortized
Cost(1) |
Gross
Unrealized Gains |
Gross
Unrealized Losses(2) |
Fair Value | ||||||||||
|
(in thousands)
|
|||||||||||||
Obligations of U.S. states and political subdivisions |
$ | 333,660 | $ | | $ | | $ | 333,660 | ||||||
Mortgage-backed securities |
6,442,144 | 815 | | 6,442,959 | ||||||||||
Corporate securities |
357,501 | 2,786 | | 360,287 | ||||||||||
Other securities(3) |
1,617,077 | 5,983 | | 1,623,060 | ||||||||||
Total available-for-sale bonds |
8,750,382 | 9,584 | | 8,759,966 | ||||||||||
Short-term investments |
463,259 | | | 463,259 | ||||||||||
Total available-for-sale bonds and short-term investments |
$ | 9,213,641 | $ | 9,584 | $ | | $ | 9,223,225 | ||||||
|
At December 31, 2007 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Investment Category
|
Amortized
Cost(1) |
Gross
Unrealized Gains |
Gross
Unrealized Losses |
Fair Value | ||||||||||
|
(in thousands)
|
|||||||||||||
Obligations of U.S. states and political subdivisions |
$ | 556,241 | $ | 5,608 | $ | (6,367 | ) | $ | 555,482 | |||||
Mortgage-backed securities |
14,080,222 | 8,998 | (1,316,493 | ) | 12,772,727 | |||||||||
Corporate securities |
521,727 | 15,569 | (18,074 | ) | 519,222 | |||||||||
Other securities(primarily asset-backed) |
2,056,868 | 10,963 | (118,772 | ) | 1,949,059 | |||||||||
Total available-for-sale bonds |
17,215,058 | 41,138 | (1,459,706 | ) | 15,796,490 | |||||||||
Short-term investments |
1,918,729 | | | 1,918,729 | ||||||||||
Total available-for-sale bonds and short-term investments |
$ | 19,133,787 | $ | 41,138 | $ | (1,459,706 | ) | $ | 17,715,219 | |||||
The following table shows the gross unrealized losses recorded in accumulated other comprehensive income and fair values of the available-for-sale bonds in the FP Investment Portfolio as of December 31, 2007, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position. There were no unrealized losses recorded in 2008. All securities in an unrealized loss position as of December 31, 2008, were recorded in OTTI.
183
Aging of Unrealized Losses of Available-for-Sale Bonds in the FP Investment Portfolio
|
At December 31, 2007 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Aging Categories
|
Number
of Securities |
Amortized
Cost |
Unrealized
Losses |
Fair
Value |
Unrealized
Loss as a Percentage of Amortized Cost |
|||||||||||||
|
(dollars in thousands)
|
|||||||||||||||||
Less than Six Months(1) |
||||||||||||||||||
Obligations of U.S. states and political subdivisions |
$ | 159,215 | $ | (3,958 | ) | $ | 155,257 | (2.5 | )% | |||||||||
Mortgage-backed securities |
7,913,682 | (723,166 | ) | 7,190,516 | (9.1 | ) | ||||||||||||
Corporate securities |
335,000 | (14,412 | ) | 320,588 | (4.3 | ) | ||||||||||||
Other securities (primarily asset-backed) |
1,324,000 | (90,845 | ) | 1,233,155 | (6.9 | ) | ||||||||||||
Total |
533 | 9,731,897 | (832,381 | ) | 8,899,516 | (8.6 | ) | |||||||||||
More than Six Months but Less than 12 Months(2) |
||||||||||||||||||
Obligations of U.S. states and political subdivisions |
| | | | ||||||||||||||
Mortgage-backed securities |
5,232,805 | (568,375 | ) | 4,664,430 | (10.9 | ) | ||||||||||||
Corporate securities |
82,161 | (3,662 | ) | 78,499 | (4.5 | ) | ||||||||||||
Other securities (primarily asset-backed) |
211,025 | (26,231 | ) | 184,794 | (12.4 | ) | ||||||||||||
Total |
223 | 5,525,991 | (598,268 | ) | 4,927,723 | (10.8 | ) | |||||||||||
12 Months or More(3) |
||||||||||||||||||
Obligations of U.S. states and political subdivisions |
64,087 | (2,409 | ) | 61,678 | (3.8 | ) | ||||||||||||
Mortgage-backed securities |
282,554 | (24,952 | ) | 257,602 | (8.8 | ) | ||||||||||||
Corporate securities |
| | | | ||||||||||||||
Other securities (primarily asset-backed) |
57,826 | (1,696 | ) | 56,130 | (2.9 | ) | ||||||||||||
Total |
39 | 404,467 | (29,057 | ) | 375,410 | (7.2 | ) | |||||||||||
Total |
||||||||||||||||||
Obligations of U.S. states and political subdivisions |
223,302 | (6,367 | ) | 216,935 | (2.9 | ) | ||||||||||||
Mortgage-backed securities |
13,429,041 | (1,316,493 | ) | 12,112,548 | (9.8 | ) | ||||||||||||
Corporate securities |
417,161 | (18,074 | ) | 399,087 | (4.3 | ) | ||||||||||||
Other securities (primarily asset-backed) |
1,592,851 | (118,772 | ) | 1,474,079 | (7.5 | ) | ||||||||||||
Total |
795 | $ | 15,662,355 | $ | (1,459,706 | ) | $ | 14,202,649 | (9.3 | )% | ||||||||
For the year ended December 31, 2008, the OTTI charge in the FP Investment Portfolio was $8,397.9 million and was recorded in net realized gains (losses) from financial products segment. The amount of the OTTI charge recorded in the statement of operations and comprehensive income is not necessarily indicative of management's estimate of economic loss, but instead represents the write-down to current fair-value. Historically, the Company had the ability and intent to hold the FP Segment Investment Portfolio to maturity. However, the Company no longer has the intent to hold such securities to maturity, due to Dexia's agreement under the Purchase Agreement to retain the FP
184
operations and segregate or separate the FP operations from the Company's financial guaranty operations. As a result, the Company is required to record an OTTI charge for all assets in the Portfolio in an unrealized loss position at December 31, 2008.
The table below provides the composition of the OTTI charge by asset class.
Other-than-Temporary Impairment Charge
|
Year Ended
December 31, 2008 |
At
December 31, 2008 Number of Securities |
|||||||
---|---|---|---|---|---|---|---|---|---|
|
(dollars in thousands)
|
||||||||
Non-agency U.S. RMBS: |
|||||||||
Subprime |
$ | 3,700,514 | 404 | ||||||
Alt-A first lien |
1,836,733 | 150 | |||||||
Option ARM |
493,079 | 57 | |||||||
Alt-A CES |
117,594 | 9 | |||||||
HELOCs |
140,135 | 14 | |||||||
NIMs |
161,617 | 39 | |||||||
Prime |
112,204 | 8 | |||||||
Other: |
|||||||||
Municipals |
342,189 | 40 | |||||||
Collateralized bond obligations |
241,090 | 22 | |||||||
Utilities |
197,415 | 7 | |||||||
Agency RMBS |
125,885 | 43 | |||||||
Other |
929,390 | 59 | |||||||
Total |
$ | 8,397,845 | 852 | ||||||
The amortized cost and fair value of the available-for-sale securities in the FP Investment Portfolio are shown below by contractual maturity. 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. At December 31, 2008, the estimated weighted average expected life of the FP Investment Portfolio was 7.0 years.
Distribution of Available-for-Sale Securities
in the FP Investment Portfolio by Contractual Maturity
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Amortized
Cost(1) |
Fair
Value |
Amortized
Cost |
Fair
Value |
||||||||||
|
(in thousands)
|
|||||||||||||
Due in one year or less |
$ | 463,259 | $ | 463,259 | $ | 1,918,729 | $ | 1,918,729 | ||||||
Due after one year through five years |
649,409 | 649,742 | | | ||||||||||
Due after ten years |
904,128 | 912,564 | 1,317,809 | 1,316,947 | ||||||||||
Mortgage-backed securities(2) |
6,442,144 | 6,442,959 | 14,080,222 | 12,772,727 | ||||||||||
Asset-backed and other securities(3) |
754,701 | 754,701 | 1,817,027 | 1,706,816 | ||||||||||
Total available-for-sale bonds and short-term investments |
$ | 9,213,641 | $ | 9,223,225 | $ | 19,133,787 | $ | 17,715,219 | ||||||
185
Proceeds from sales of available-for-sale bonds held in the FP Investment Portfolio during 2007 and 2006 were $2,971.7 million and $4,512.5 million, respectively. Sales were de minimus in 2008. Proceeds from maturities of bonds for the FP Investment Portfolio during 2008, 2007 and 2006 were $1,777.9 million, $3,299.0 million and $4,485.1 million, respectively. Gross losses were realized on sales during 2008 of $0.7 million. Gross gains were realized on sales during 2007 and 2006 of $13.0 million and $0.1 million, respectively.
VIE Investment Portfolio
All the investments supporting VIE liabilities are insured by FSA. The credit quality of the available-for-sale securities in the VIE Investment Portfolio, without the benefit of FSA's insurance, was as follows:
Available-for-Sale Securities in the VIE Investment Portfolio by Rating
Rating(1)
|
At
December 31, 2008 Percent of Bonds |
||||
---|---|---|---|---|---|
AAA |
0.9 | % | |||
A |
80.0 | ||||
BBB |
19.1 | ||||
Total |
100.0 | % | |||
The amortized cost and fair value of available-for-sale bonds and short-term investments in the VIE Investment Portfolio were as follows:
Available-for-Sale Securities in the VIE Investment Portfolio by Security Type
|
At December 31, 2008 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Investment Category
|
Amortized
Cost |
Gross
Unrealized Gains |
Fair
Value |
||||||||
|
(in thousands)
|
||||||||||
Obligations of U.S. states and political subdivisions |
$ | 12,931 | $ | | $ | 12,931 | |||||
Foreign securities |
9,300 | 239 | 9,539 | ||||||||
Asset-backed securities |
900,862 | | 900,862 | ||||||||
Total available-for-sale bonds |
923,093 | 239 | 923,332 | ||||||||
Short-term investments |
8,221 | | 8,221 | ||||||||
Total available-for-sale bonds and short-term investments |
$ | 931,314 | $ | 239 | $ | 931,553 | |||||
186
|
At December 31, 2007 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Investment Category
|
Amortized
Cost |
Gross
Unrealized Gains |
Fair
Value |
||||||||
|
(in thousands)
|
||||||||||
Obligations of U.S. states and political subdivisions |
$ | 15,443 | $ | 729 | $ | 16,172 | |||||
Foreign securities |
9,177 | 430 | 9,607 | ||||||||
Asset-backed securities |
1,094,739 | 19,050 | 1,113,789 | ||||||||
Total available-for-sale bonds |
1,119,359 | 20,209 | 1,139,568 | ||||||||
Short-term investments |
8,618 | | 8,618 | ||||||||
Total available-for-sale bonds and short-term investments |
$ | 1,127,977 | $ | 20,209 | $ | 1,148,186 | |||||
Historically, the Company had the ability and intent to hold the FP Segment Investment Portfolio to maturity. However, the Company no longer has the intent to hold such securities to maturity, due to Dexia's agreement under the Purchase Agreement to retain the FP operations and segregate or separate the Company's FP operations from the Company's financial guaranty operations. As a result, the Company was required to record an OTTI charge for all assets in the portfolio in an unrealized loss position at December 31, 2008.
OTTI of $236.2 million was recorded in "net realized gains (losses) from financial products segment" on the VIE Investment Portfolio in 2008. At December 31, 2007, there were no securities in an unrealized loss position.
The amortized cost and fair value of available-for-sale bonds and short-term investments in the VIE Investment Portfolio 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.
Distribution of Available-for-Sale Securities
in the VIE Investment Portfolio by Contractual Maturity
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
||||||||||
|
(in thousands)
|
|||||||||||||
Due in one year or less |
$ | 17,521 | $ | 17,760 | $ | 8,618 | $ | 8,618 | ||||||
Due after one year through five years |
| | 9,177 | 9,607 | ||||||||||
Due after ten years |
12,931 | 12,931 | 15,443 | 16,172 | ||||||||||
Asset-backed securities(1) |
900,862 | 900,862 | 1,094,739 | 1,113,789 | ||||||||||
Total available-for-sale bonds and short-term investments |
$ | 931,314 | $ | 931,553 | $ | 1,127,977 | $ | 1,148,186 | ||||||
Proceeds from maturities of bonds for the VIE Investment Portfolio during 2007 and 2006 were $165.9 million and $24.7 million, respectively. There were no maturities for the VIE Investment Portfolio in 2008.
The Company pledges and receives collateral related to certain business lines or transactions. The following is a description of those arrangements by transaction type.
187
Securities Pledged to Note Holders
In the normal course of business, the Company may hold securities purchased under agreements to resell. A portion of these securities may be pledged to the Company's investment agreement counterparties (including counterparties with agreements structured as investment repurchase agreements). However, such securities generally may not be rehypothecated by the investment agreement counterparty. The Company also pledges investments held in the FP Investment Portfolio to investment agreement counterparties. At December 31, 2008, $6,120.5 million of the assets held in the FP Investment Portfolio, together with related accrued interest, were pledged as collateral to investment agreement counterparties.
With respect to transactions governed by ISDA master agreements, FP Risk Management monitors net counterparty credit exposure and, when the exposure exceeds an agreed to limit, demands collateral from the counterparty in accordance with the relevant master agreement.
Securities Pledged to Derivative Counterparties
Securities purchased under agreements to resell are eligible to be pledged to certain interest rate swap counterparties. In general, under the terms of each of these counterparty-specific derivative agreements, the Company and its counterparty may be required to pledge collateral or transfer assets as a result of changes in the fair value of those derivative agreements. The timing and amount are generally dependent on which entity is exposed, as well as the credit rating of the party in the payable position. The Company and the counterparty typically have identical rights and obligations to pledge and rehypothecate collateral according to the terms included within each of the counterparty-specific derivative agreements. At December 31, 2008, $18.2 million of the assets held in the FP Investment Portfolio and related accrued interest were pledged as collateral to margin accounts. FSA Global, under the terms of its derivative agreements, is not required to pledge collateral. Its counterparties, however, may be required to pledge collateral or transfer assets to FSA Global.
At December 31, 2008, the Company had received $1,057.9 million of collateral from counterparties to reduce its net derivative exposure to such parties.
7. ASSETS ACQUIRED IN REFINANCING TRANSACTIONS
The Company has rights under certain of its financial guaranty insurance policies and indentures that allow it to accelerate the insured notes and pay claims under its insurance policies upon the occurrence of predefined events of default. To mitigate financial guaranty insurance losses, the Company may elect to purchase the outstanding insured obligation or its underlying collateral. Generally, refinancing vehicles reimburse FSA in whole for its claims payments in exchange for assignments of certain of FSA's rights against the trusts. The refinancing vehicles obtain their funds from the proceeds of FSA-insured GICs issued in the ordinary course of business by the GIC Subsidiaries. The refinancing vehicles are consolidated into the Company's financial statements.
188
The following table presents the balance sheet components of the assets acquired in refinancing transactions:
Summary of Assets Acquired in Refinanced Transactions
|
At December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in thousands)
|
|||||||
Bonds |
$ | 886 | $ | 5,949 | ||||
Securitized loans |
130,056 | 177,810 | ||||||
Other assets |
35,658 | 45,505 | ||||||
Total |
$ | 166,600 | $ | 229,264 | ||||
The accretable yield on the securitized loans at December 31, 2008, 2007 and 2006 was $7.5 million, $148.8 million and $157.3 million, respectively.
The bonds within the refinanced asset portfolio all have contractual maturities of less than five years. 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.
8. DEFERRED ACQUISITION COSTS
Acquisition costs deferred and the related amortization charged to expense are as follows:
Rollforward of Deferred Acquisition Costs
|
Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||
|
(in thousands)
|
|||||||||||
Balance, beginning of period |
$ | 347,870 | $ | 340,673 | $ | 335,129 | ||||||
Costs deferred during the period: |
||||||||||||
Ceded and assumed commissions |
(10,526 | ) | (83,252 | ) | (79,713 | ) | ||||||
Premium taxes |
13,856 | 13,182 | 14,032 | |||||||||
Compensation and other acquisition costs |
13,821 | 140,709 | 134,237 | |||||||||
Total |
17,151 | 70,639 | 68,556 | |||||||||
Costs amortized during the period |
(65,700 | ) | (63,442 | ) | (63,012 | ) | ||||||
Balance, end of period |
$ | 299,321 | $ | 347,870 | $ | 340,673 | ||||||
9. LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for losses and loss adjustment expenses, which consist of the case and non-specific reserves, is summarized below. Adjustments to reserves represent management's estimate of the amount required to cover the present value of the net cost of claims based on statistical provisions for new originations.
189
Reconciliation of Net Losses and Loss Adjustment Expenses
|
Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||
|
(in thousands)
|
|||||||||||
Case Reserve Activity: |
||||||||||||
Gross balance at January 1 |
$ | 174,557 | $ | 90,306 | $ | 89,984 | ||||||
Less reinsurance recoverable |
76,478 | 37,342 | 36,339 | |||||||||
Net balance at January 1 |
98,079 | 52,964 | 53,645 | |||||||||
Transfer from non-specific reserve |
1,823,253 | 69,384 | 1,221 | |||||||||
Paid (net of recoveries) related to: |
||||||||||||
Current year recovery (paid) |
16,682 | (8,248 | ) | | ||||||||
Prior year |
(615,589 | ) | (16,021 | ) | (1,902 | ) | ||||||
Total paid |
(598,907 | ) | (24,269 | ) | (1,902 | ) | ||||||
Net balance at December 31 |
1,322,425 | 98,079 | 52,964 | |||||||||
Plus reinsurance recoverable |
283,973 | 76,478 | 37,342 | |||||||||
Gross balance at December 31 |
1,606,398 | 174,557 | 90,306 | |||||||||
Non-Specific Reserve Activity: |
||||||||||||
Gross balance at January 1 |
99,999 | 137,816 | 115,734 | |||||||||
Provision for losses |
||||||||||||
Current year |
1,338 | 25,797 | 17,837 | |||||||||
Prior year |
1,876,361 | 5,770 | 5,466 | |||||||||
Transfers to case reserves |
(1,823,253 | ) | (69,384 | ) | (1,221 | ) | ||||||
Net balance at December 31 |
154,445 | 99,999 | 137,816 | |||||||||
Plus reinsurance recoverable |
18,151 | | | |||||||||
Gross balance at December 31 |
172,596 | 99,999 | 137,816 | |||||||||
Total gross case and non-specific reserves |
$ | 1,778,994 | $ | 274,556 | $ | 228,122 | ||||||
The following table shows the gross and net par outstanding on transactions with case reserves, the gross and net case reserves recorded and the number of transactions comprising case reserves.
190
Case Reserve Summary
|
At December 31, 2008 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Par
Outstanding |
Net Par
Outstanding |
Gross Case
Reserve |
Net Case
Reserve |
Number
of Risks |
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
Asset-backedHELOCs |
$ | 4,833,059 | $ | 3,853,788 | $ | 745,790 | $ | 593,752 | 10 | ||||||||
Asset-backedAlt-A CES |
999,475 | 954,296 | 245,702 | 234,158 | 5 | ||||||||||||
Asset-backedOption ARM |
1,674,743 | 1,587,145 | 282,131 | 260,599 | 9 | ||||||||||||
Asset-backedAlt-A first lien |
1,226,480 | 1,122,333 | 106,545 | 96,327 | 10 | ||||||||||||
Asset-backedNIMs |
90,070 | 85,341 | 15,961 | 15,817 | 3 | ||||||||||||
Asset-backedSubprime |
298,457 | 280,128 | 24,521 | 20,757 | 5 | ||||||||||||
Asset-backedother |
54,491 | 50,969 | 13,685 | 12,933 | 3 | ||||||||||||
Public finance |
1,238,816 | 698,708 | 172,063 | 88,082 | 6 | ||||||||||||
Total |
$ | 10,415,591 | $ | 8,632,708 | $ | 1,606,398 | $ | 1,322,425 | 51 | ||||||||
|
At December 31, 2007 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Par
Outstanding |
Net Par
Outstanding |
Gross Case
Reserve(1) |
Net Case
Reserve(1) |
Number
of Risks |
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
Asset-backedHELOCs |
$ | 1,803,340 | $ | 1,442,657 | $ | 69,633 | $ | 56,913 | 5 | ||||||||
Asset-backedSubprime |
22,280 | 18,335 | 3,399 | 1,583 | 2 | ||||||||||||
Asset-backedother |
24,905 | 22,219 | 4,890 | 4,684 | 2 | ||||||||||||
Public finance |
1,164,248 | 560,610 | 96,635 | 34,899 | 4 | ||||||||||||
Total |
$ | 3,014,773 | $ | 2,043,821 | $ | 174,557 | $ | 98,079 | 13 | ||||||||
The table below presents certain assumptions inherent in the calculations of the case and non-specific reserves:
Assumptions for Case and Non-Specific Reserves
|
At December 31, | |||
---|---|---|---|---|
|
2008 | 2007 | ||
Case reserve discount rate |
1.90%5.90% | 3.13%5.90% | ||
Non-specific reserve discount rate |
6.00% | 1.20%7.95% | ||
Current experience factor |
18.5 | 2.0 |
During 2008, loss and loss adjustment expenses was $1,877.7 million. The increase for the year was driven primarily by deteriorating credit performance in home equity lines of credit ("HELOCs"), Alt-A closed end second lien mortgage securities ("CES"), Option adjustable rate mortgage loan ("Option ARMs"), Alt-A first lien and public finance transactions. "Alt-A" refers to borrowers whose credit falls between prime and subprime. In addition, the net non-specific reserves increased by $54.5 million for the year. Management's current reserve estimates assume loss levels for transactions backed by second-lien mortgage products will remain at their peaks until mid-2009 and slowly recover to more normal rates by mid-2010. For first-lien mortgage transactions, where losses take longer to develop than in second-lien mortgage transactions, peak conditional default rates are assumed to continue until mid-2010 and then decline linearly over 12 months to 25% of the peak, remain there for three years and then taper down to 5% of peak rates over several years.
191
The increase in losses paid is driven by payments on HELOC transactions. Generally, once the overcollateralization is exhausted on an insured HELOC transaction, the Company pays a claim if losses in a period exceed spread for the period, and, to the extent spread exceeds losses, the Company is reimbursed for any losses paid to date. In 2008, the Company paid net HELOC claims of $577.7 million. This brought the inception to date net claim payments on HELOC transactions to $625.3 million. There were no claims paid on most other classes of insured transactions through December 31, 2008. Most claim payments on Alt-A CES are not payable until 2037 or later. Option ARM claim payments are expected to occur between 2010 and 2012.
During 2007, the Company charged $31.6 million to loss expense, consisting of $25.8 million for originations of new business and $5.8 million related to accretion on the reserve for in-force business. Net case reserves increased $45.1 million in 2007 due primarily to the establishment of new case reserves for HELOC and public finance transactions, offset in part by the settlement of several pooled corporate collateralized bond obligations ("CBOs"), which were accrued for in prior years. As of December 31, 2007, an estimated ultimate loss (discounted to present value) of $65.0 million on HELOC transactions had been transferred from the non-specific reserve to case reserves, which increased the experience factor. Such estimate of loss is net of reinsurance and anticipated recoveries and is reevaluated on a quarterly basis. In the second half of 2007, the Company paid a total of $47.6 million in HELOC claims, of which $39.5 million represented what the Company deemed to be recoverable and was recorded as salvage and subrogation ("S&S") recoverable as of December 31, 2007.
During 2006, the Company charged $23.3 million to loss expense, consisting of $17.8 million for originations of new business and $5.5 million related to accretion on the reserve for in-force business. Net case reserves decreased $0.7 million due primarily to loss payments and some improvement in CBO transactions, offset in part by the establishment of a new case reserve for a municipal health care transaction.
The Company assigns each insured credit to one of five designated surveillance categories to facilitate the appropriate allocation of resources to monitoring, loss mitigation efforts and rating the credit condition of each risk exposure. Such categorization is determined in part by the risk of loss and in part by the level of routine involvement required. The surveillance categories are organized as follows:
192
The tables below present the gross and net par and interest outstanding and deferred premium revenue in the insured portfolio for risks classified as described above:
Par and Interest Outstanding
Excluding Credit Derivatives
|
At December 31, 2008 | |||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross
Par |
Gross
Interest |
Net
Par |
Net
Interest |
No. of
risks |
Weighted
Avg Life |
Gross
Deferred Premium Revenue |
Net
Deferred Premium Revenue |
||||||||||||||||||
|
(dollars in millions)
|
|||||||||||||||||||||||||
Categories I and II |
$ | 419,643 | $ | 269,433 | $ | 316,920 | $ | 192,502 | 11,189 | 13.5 | $ | 2,891 | $ | 1,956 | ||||||||||||
Category III |
13,487 | 5,902 | 9,845 | 3,427 | 117 | 8.0 | 109 | 50 | ||||||||||||||||||
Category IV |
1,260 | 321 | 1,181 | 289 | 8 | 4.5 | 0 | 0 | ||||||||||||||||||
Category V with no claim payments |
5,360 | 2,226 | 4,701 | 1,866 | 34 | 8.0 | 41 | 25 | ||||||||||||||||||
Category V with claim payments |
5,153 | 899 | 4,023 | 661 | 20 | 3.9 | 4 | 2 | ||||||||||||||||||
Total |
$ | 444,903 | $ | 278,781 | $ | 336,670 | $ | 198,745 | 11,368 | 13.1 | $ | 3,045 | $ | 2,033 | ||||||||||||
Case Reserves
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Gross | Net | Gross | Net | ||||||||||
|
(in thousands)
|
|||||||||||||
Category V with no claim payments |
$ | 818,472 | $ | 708,030 | $ | 112,629 | $ | 64,430 | ||||||
Category V with claim payments |
787,926 | 614,395 | 61,928 | 33,649 | ||||||||||
Total |
$ | 1,606,398 | $ | 1,322,425 | $ | 174,557 | $ | 98,079 | ||||||
|
At December 31, 2008
Category V |
||||
---|---|---|---|---|---|
|
(in thousands)
|
||||
Gross undiscounted cash outflows expected in future |
$ | 3,532,525 | |||
Less: Gross estimated recoveries (S&S) in future |
1,515,903 | ||||
Subtotal |
2,016,622 | ||||
Less: Discount taken on subtotal |
410,224 | ||||
Gross case reserve |
1,606,398 | ||||
Less: Reinsurance recoverable on unpaid losses (net of discount of $35.3 million) |
283,973 | ||||
Net case reserve |
$ | 1,322,425 | |||
Management periodically evaluates its estimates for losses and LAE and establishes reserves that management believes are adequate to cover the present value of the ultimate net cost of claims. The Company will continue, on an ongoing basis, to monitor these reserves and may periodically adjust such reserves, upward or downward, based on the Company's actual loss experience, its mix of business and economic conditions. However, because of the uncertainty involved in developing these estimates, the ultimate liability may differ materially from current estimates.
193
10. FINANCIAL PRODUCTS SEGMENT DEBT
FP segment debt consists of GIC and VIE debt. The obligations under GICs issued by the GIC Subsidiaries may be called at various times prior to maturity based on certain agreed-upon events. As of December 31, 2008, interest rates were between 1.18% and 8.71% per annum on outstanding GICs and between 1.98% and 6.22% per annum on VIE debt. Payments due under GICs are based on expected withdrawal dates, which are subject to change, and include accretion of $825.7 million. VIE debt includes $692.2 million of future interest accretion on zero-coupon obligations. The following table presents the combined principal amounts due under FP segment debt for 2009 and each of the next four years ending December 31, and thereafter:
Expected Maturity Schedule of FP Segment Debt(1)
Year
|
Principal Amount | ||||
---|---|---|---|---|---|
|
(in thousands)
|
||||
2009 |
$ | 4,587,091 | |||
2010 |
2,173,782 | ||||
2011 |
699,229 | ||||
2012 |
1,225,591 | ||||
2013 |
983,840 | ||||
Thereafter |
8,248,041 | ||||
Total |
$ | 17,917,574 | |||
11. LONG-TERM DEBT
On November 22, 2006, FSA Holdings issued $300.0 million principal amount of Junior Subordinated Debentures with a scheduled maturity date of December 15, 2036 and a final repayment date of December 15, 2066. The final repayment date of December 15, 2066 may be automatically extended up to four times in five-year increments provided certain conditions are met. The debentures are redeemable, in whole or in part, at any time prior to December 15, 2036 at their principal amount plus accrued and unpaid interest to the date of redemption or, if greater, the make-whole redemption price. Interest on the debentures will accrue from November 22, 2006 to December 15, 2036 at the annual rate of 6.40%. If any amount of the debentures remains outstanding after December 15, 2036, then the principal amount of the outstanding debentures will bear interest at a floating interest rate equal to one-month LIBOR plus 2.215% until repaid. FSA Holdings may elect at one or more times to defer payment of interest on the debentures for one or more consecutive interest periods that do not exceed ten years. In connection with the completion of this offering, FSA Holdings entered into a replacement capital covenant for the benefit of persons that buy, hold or sell a specified series of FSA Holdings long-term indebtedness ranking senior to the debentures. Under the covenant, the debentures will not be repaid, redeemed, repurchased or defeased by FSA Holdings or any of its subsidiaries on or before the date that is 20 years prior to the final repayment date, except to the extent that FSA Holdings has received proceeds from the sale of replacement capital securities. The proceeds from this offering were used to pay a dividend to the shareholders of FSA Holdings. The Junior Subordinated Debentures were issued at a discount of $1.2 million.
On July 31, 2003, the Company issued $100.0 million principal amount of 5.60% Notes due July 15, 2103, which are callable without premium or penalty in whole or in part at any time on or after July 31, 2008. Debt issuance costs of $3.3 million are being amortized over the life of the debt.
194
On November 26, 2002, the Company issued $230.0 million principal amount of 6.25% Notes due November 1, 2102, which are callable without premium or penalty in whole or in part at any time on or after November 26, 2007. Debt issuance costs of $7.4 million are being amortized over the life of the debt.
On December 19, 2001, the Company issued $100.0 million of 6 7 / 8 % notes due December 15, 2101, which are callable without premium or penalty on or after December 19, 2006. Debt issuance costs of $3.3 million are being amortized over the life of the debt.
12. OUTSTANDING EXPOSURE
The Company's insurance policies typically guarantee the scheduled payments of principal and interest on public finance and asset-backed (including credit derivatives in the insured portfolio) obligations. The gross amount of financial guaranties in force (principal and interest) was $813.9 billion at December 31, 2008 and $833.2 billion at December 31, 2007. The net amount of financial guaranties in force was $611.4 billion at December 31, 2008 and $598.3 billion at December 31, 2007.
The Company seeks to limit its exposure to losses from writing financial guarantees by underwriting investment-grade obligations, diversifying its portfolio and maintaining rigorous collateral requirements on asset-backed obligations, as well as through reinsurance.
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. The expected maturities for asset-backed obligations are, in general, considerably shorter than the contractual maturities for such obligations. For asset-backed obligations, the full par outstanding for each insured risk is shown in the maturity category that corresponds to the final legal maturity of such risk:
Contractual Terms to Maturity of Net Par Outstanding of Insured Obligations
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
Terms to Maturity
|
Public
Finance |
Asset-
Backed |
Public
Finance |
Asset-
Backed |
||||||||||
|
(in millions)
|
|||||||||||||
0 to 5 years |
$ | 59,744 | $ | 36,797 | $ | 54,037 | $ | 42,714 | ||||||
5 to 10 years |
64,224 | 29,068 | 58,719 | 34,628 | ||||||||||
10 to 15 years |
59,381 | 17,818 | 53,676 | 19,332 | ||||||||||
15 to 20 years |
46,735 | 737 | 44,446 | 2,644 | ||||||||||
20 years and above |
76,148 | 17,878 | 71,642 | 24,619 | ||||||||||
Total |
$ | 306,232 | $ | 102,298 | $ | 282,520 | $ | 123,937 | ||||||
Contractual Terms to Maturity of Ceded Par Outstanding of Insured Obligations
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
Terms to Maturity
|
Public
Finance |
Asset-
Backed |
Public
Finance |
Asset-
Backed |
||||||||||
|
(in millions)
|
|||||||||||||
0 to 5 years |
$ | 15,407 | $ | 6,223 | $ | 16,500 | $ | 7,211 | ||||||
5 to 10 years |
17,555 | 6,822 | 17,895 | 7,792 | ||||||||||
10 to 15 years |
18,270 | 2,722 | 19,617 | 1,664 | ||||||||||
15 to 20 years |
16,810 | 119 | 19,143 | 1,857 | ||||||||||
20 years and above |
34,721 | 2,432 | 42,635 | 3,420 | ||||||||||
Total |
$ | 102,763 | $ | 18,318 | $ | 115,790 | $ | 21,944 | ||||||
The par outstanding of insured obligations in the public finance insured portfolio includes the following amounts by type of issue:
195
Summary of Public Finance Insured Portfolio
|
At December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Par
Outstanding |
Ceded Par
Outstanding |
Net Par
Outstanding |
||||||||||||||||||
Types of Issues
|
2008 | 2007 | 2008 | 2007 | 2008 | 2007 | |||||||||||||||
|
(in millions)
|
||||||||||||||||||||
Domestic obligations |
|||||||||||||||||||||
General obligation |
$ | 155,249 | $ | 146,883 | $ | 30,186 | $ | 32,427 | $ | 125,063 | $ | 114,456 | |||||||||
Tax-supported |
73,593 | 69,409 | 18,272 | 19,453 | 55,321 | 49,956 | |||||||||||||||
Municipal utility revenue |
63,454 | 57,913 | 13,175 | 13,610 | 50,279 | 44,303 | |||||||||||||||
Health care revenue |
21,841 | 25,843 | 9,656 | 11,796 | 12,185 | 14,047 | |||||||||||||||
Housing revenue |
9,310 | 9,898 | 1,876 | 2,187 | 7,434 | 7,711 | |||||||||||||||
Transportation revenue |
32,493 | 29,189 | 11,189 | 11,782 | 21,304 | 17,407 | |||||||||||||||
Education/University |
9,560 | 7,178 | 1,658 | 1,710 | 7,902 | 5,468 | |||||||||||||||
Other domestic public finance |
2,858 | 2,773 | 677 | 900 | 2,181 | 1,873 | |||||||||||||||
Subtotal |
368,358 | 349,086 | 86,689 | 93,865 | 281,669 | 255,221 | |||||||||||||||
International obligations |
40,637 | 49,224 | 16,074 | 21,925 | 24,563 | 27,299 | |||||||||||||||
Total public finance obligations |
$ | 408,995 | $ | 398,310 | $ | 102,763 | $ | 115,790 | $ | 306,232 | $ | 282,520 | |||||||||
The par outstanding of insured obligations in the asset-backed insured portfolio includes the following amounts by type of collateral:
Summary of Asset-Backed Insured Portfolio
|
At December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Par
Outstanding |
Ceded Par
Outstanding |
Net Par
Outstanding |
||||||||||||||||||
Types of Collateral
|
2008 | 2007 | 2008 | 2007 | 2008 | 2007 | |||||||||||||||
|
(in millions)
|
||||||||||||||||||||
Domestic obligations |
|||||||||||||||||||||
Residential mortgages |
$ | 19,453 | $ | 22,882 | $ | 2,401 | $ | 3,108 | $ | 17,052 | $ | 19,774 | |||||||||
Consumer receivables |
6,814 | 12,401 | 899 | 1,060 | 5,915 | 11,341 | |||||||||||||||
Pooled corporate |
63,764 | 69,317 | 8,861 | 10,110 | 54,903 | 59,207 | |||||||||||||||
Other domestic asset-backed |
3,194 | 4,000 | 1,626 | 2,024 | 1,568 | 1,976 | |||||||||||||||
Subtotal |
93,225 | 108,600 | 13,787 | 16,302 | 79,438 | 92,298 | |||||||||||||||
International obligations |
27,391 | 37,281 | 4,531 | 5,642 | 22,860 | 31,639 | |||||||||||||||
Total asset-backed obligations |
$ | 120,616 | $ | 145,881 | $ | 18,318 | $ | 21,944 | $ | 102,298 | $ | 123,937 | |||||||||
In its asset-backed business, the Company considers geographic concentration as a factor in underwriting insurance covering securitizations of pools of such assets as residential mortgages or consumer receivables. However, after the initial issuance of an insurance policy relating to such securitizations, the geographic concentration of the underlying assets may not remain fixed over the life of the policy. In addition, in writing insurance for other types of asset-backed obligations, such as securities primarily backed by government or corporate debt, geographic concentration is not deemed by the Company to be significant, given other more relevant measures of diversification, such as issuer or industry diversification.
196
The Company seeks to maintain a diversified portfolio of insured public finance obligations designed to spread its risk across a number of geographic areas. The following table sets forth those states in which municipalities located therein issued an aggregate of 2% or more of the Company's net par amount outstanding of insured public finance securities:
Public Finance Insured Portfolio by Location of Exposure
|
At December 31, 2008 | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Number
of Risks |
Net
Par Amount Outstanding |
Percent of
Total Net Par Amount Outstanding |
Ceded
Par Amount Outstanding |
|||||||||||
|
(dollars in millions)
|
||||||||||||||
Domestic obligations |
|||||||||||||||
California |
1,121 | $ | 40,868 | 13.3 | % | $ | 12,864 | ||||||||
New York |
774 | 23,033 | 7.5 | 10,221 | |||||||||||
Pennsylvania |
892 | 20,475 | 6.7 | 4,488 | |||||||||||
Texas |
826 | 19,525 | 6.4 | 4,604 | |||||||||||
Illinois |
756 | 16,612 | 5.4 | 6,083 | |||||||||||
Florida |
291 | 15,585 | 5.1 | 4,620 | |||||||||||
Michigan |
639 | 13,093 | 4.3 | 2,157 | |||||||||||
New Jersey |
659 | 12,509 | 4.1 | 6,063 | |||||||||||
Washington |
344 | 10,225 | 3.3 | 3,754 | |||||||||||
Massachusetts |
241 | 7,896 | 2.6 | 4,289 | |||||||||||
Ohio |
452 | 7,242 | 2.4 | 1,678 | |||||||||||
Georgia |
129 | 7,000 | 2.3 | 1,482 | |||||||||||
Indiana |
300 | 6,674 | 2.2 | 1,199 | |||||||||||
All other U.S. locations |
3,405 | 80,932 | 26.4 | 23,187 | |||||||||||
Subtotal |
10,829 | 281,669 | 92.0 | 86,689 | |||||||||||
International obligations |
173 | 24,563 | 8.0 | 16,074 | |||||||||||
Total |
11,002 | $ | 306,232 | 100.0 | % | $ | 102,763 | ||||||||
13. FEDERAL INCOME TAXES
Dexia Holdings, FSA Holdings and its Subsidiaries, except FSA International, file a consolidated U.S. federal income tax return. Under the terms of a tax-sharing agreement, each company pays taxes on a separate return basis.
In addition, the Company and its subsidiaries or branches file separate tax returns in various states and local and foreign jurisdictions, including the United Kingdom, Japan, Mexico and Australia. With limited exceptions, the Company and its subsidiaries are no longer subject to income tax examinations for its 2004 and prior tax years for U.S. federal, state and local, or non-U.S. jurisdictions.
In connection with Dexia's acquisition of the Company in July 2000, the Company became the successor, for tax purposes, to White Mountains Holdings, Inc. ("WMH"). WMH had previously sold an insurance subsidiary to a third party that was indemnified by White Mountains Insurance Group, Ltd. ("White Mountains") for certain future adverse loss development up to $50.0 million. In 2004, the Company made an indemnity payment of $47.0 million to the third party with funds provided for such purpose by White Mountains. While the Company had no legal liability in connection with the indemnity payment, the payment was treated for tax purposes as a $47.0 million loss deduction to the Company, as successor to WMH. The Company therefore recorded a tax benefit of $16.5 million. In
197
addition, the Company shared 50% of the tax benefit with White Mountains when the required circumstances were satisfied in the third quarter of 2008.
The cumulative balance sheet effects of deferred federal tax consequences are as follows:
Components of Deferred Tax Assets and Liabilities
|
At December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in thousands)
|
|||||||
Loss and loss adjustment expense reserves |
$ | 367,632 | $ | 37,650 | ||||
Deferred compensation |
54,267 | 95,569 | ||||||
Unrealized capital losses |
2,916,003 | 430,778 | ||||||
Derivative fair-value adjustments |
| 58,948 | ||||||
Undistributed earnings |
30,578 | | ||||||
White Mountains indemnity payment |
| 16,450 | ||||||
Foreign currency transaction loss |
117,367 | 116,789 | ||||||
Tax credits |
40,865 | | ||||||
Other |
15,869 | 14,585 | ||||||
Total deferred federal income tax assets |
3,542,581 | 770,769 | ||||||
Deferred acquisition costs |
(90,249 | ) | (109,517 | ) | ||||
Deferred premium revenue adjustments |
(44,502 | ) | (67,562 | ) | ||||
Contingency reserves |
| (162,686 | ) | |||||
Undistributed earnings |
| (5,340 | ) | |||||
Derivative fair-value adjustments |
(64,900 | ) | | |||||
Other |
(484 | ) | (13,494 | ) | ||||
Total deferred federal income tax liabilities |
(200,135 | ) | (358,599 | ) | ||||
Net deferred federal income tax asset |
3,342,446 | 412,170 | ||||||
Valuation allowance |
(2,478,490 | ) | | |||||
Net deferred federal income tax asset after valuation allowance |
$ | 863,956 | $ | 412,170 | ||||
At December 31, 2008 and 2007, the Company had a net deferred tax asset before valuation allowance of $3.3 billion and $0.4 billion, respectively. A valuation allowance is required when it is more likely than not that a portion or all of a deferred tax asset will not be realized. All evidence, both positive and negative, needs to be identified and considered in making the determination. Future realization of the existing deferred tax asset will depend on the Company's ability to generate sufficient taxable income of appropriate character (i.e., ordinary income versus capital gains) within the carryback and carryforward periods available under the tax law.
The economic conditions adversely affecting the Company did not fully materialize and the Purchase Agreement was not entered into until 2008 and, thus, the Company did not provide any valuation allowance on its net deferred tax assets at December 31, 2007.
The net deferred tax asset of $3.3 billion at December 31, 2008 consists primarily of unrealized capital losses and foreign exchange losses of $3.0 billion, $368 million related to loss reserves, and $453 million related to mark to market on CDS, offset by other net liabilities. The unrealized losses were primarily generated from OTTI losses recognized in the FP investment portfolio. The Company's
198
management has concluded that a valuation allowance of $2.5 billion is required based on the following factors:
The Company treats its CDS contracts as insurance contracts for U.S. tax purposes. The current federal tax treatment of CDS contracts is an unsettled area of tax law. Market participants are generally treating CDS contracts for tax purposes as either: (1) notional principal contract ("NPC") derivative instruments, (2) guarantees, (3) insurance contracts, or (4) capital assets. The Company believes that it is more likely than not that its CDS contracts are either NPC or insurance contracts. Both receipts and payments arising from NPC and insurance contracts are characterized as ordinary income (although a termination of a CDS contract as an NPC may be treated as a capital transaction). Although the Company believes it is properly treating potential losses on its CDS contracts as ordinary, there are no assurances that the Internal Revenue Service ("IRS") will agree with the Company. Should the IRS disagree with the Company and characterize such losses, if any, as capital losses, the Company's ability to realize a related tax asset would be more limited, possibly leading to a reduction or elimination of the related deferred tax asset.
In 2008 and 2007, the Company recognized a tax benefit of $5.6 million and $4.2 million respectively, which include the benefit of $1.4 million and $0.7 million of interest, respectively, from the expiration of the statute of limitations for the 2004 and 2003 tax years.
199
A reconciliation of the effective tax rate (before minority interest and equity in earnings of unconsolidated affiliates) with the federal statutory rate follows:
Effective Tax Rate Reconciliation
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
Tax provision (benefit) at statutory rate |
(35.0 | )% | (35.0 | )% | 35.0 | % | |||||
Tax-exempt investments |
(0.6 | ) | (29.4 | ) | (10.4 | ) | |||||
Fair-value adjustment for CPS |
(0.4 | ) | | | |||||||
Valuation allowance |
26.6 | | | ||||||||
Minority interest and equity in unconsolidated subsidiaries |
| | 3.5 | ||||||||
Other |
0.0 | 0.5 | 0.7 | ||||||||
Provision (benefit) for income taxes |
(9.4 | )% | (63.9 | )% | 28.8 | % | |||||
The 2008 effective tax rate reflects a lower than expected benefit of 35% due to the establishment of valuation allowance of $2.5 billion, offset by benefits from tax-exempt interest income and the tax-exempt fair value adjustments related to the Company's committed preferred securities. The 2007 and 2006 rates differ from the statutory rate of 35% due primarily to tax-exempt interest. The 2007 rate reflects an unusually high benefit due to the disproportionately low amount of pre-tax income to tax-exempt interest.
The total amount of unrecognized tax benefits at December 31, 2008 and December 31, 2007 was $15.1 million and $19.2 million, respectively. If recognized, the entire amount would favorably affect the effective tax rate. The Company recognizes interest and penalties related to unrecognized tax benefits as part of income taxes. For the year ended December 31, 2008 and 2007, the Company recognized a benefit of $0.9 million and an expense of approximately $0.4 million, respectively, related to interest and penalties. Cumulative interest and penalties of approximately $1.4 million and $2.3 million have been accrued on the Company's balance sheet at December 31, 2008 and December 31, 2007, respectively. A reconciliation of the beginning to ending unrecognized tax benefits follows:
Reconciliation of Unrecognized Tax Benefit
|
Year Ended December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in thousands)
|
|||||||
Balance at January 1, 2008 |
$ | 19,249 | $ | 22,824 | ||||
Reductions as a result of a lapse in the statute of limitations |
(4,189 | ) | (3,575 | ) | ||||
Balance at December 31, 2008 |
$ | 15,060 | $ | 19,249 | ||||
The Company believes that within the next 12 months, it is reasonably possible that unrecognized tax benefits for positions taken on previously filed tax returns will become recognized as a result of the expiration of statute of limitations for the 2005 tax year, which absent any extension, will close in September 2009.
14. EMPLOYEE BENEFIT PLANS
Defined Contribution Plans
The Company maintains both qualified and non-qualified, non-contributory defined contribution pension plans for the benefit of eligible employees. Contributions are based on a fixed percentage of
200
employee compensation. Pension expense, which is funded annually, amounted to $6.8 million, $7.7 million and $7.5 million for the years ended December 31, 2008, 2007 and 2006, respectively.
The Company has an employee retirement savings plan for the benefit of eligible employees. The plan permits employees to contribute a percentage of their salaries up to limits prescribed by Internal Revenue Code Section 401(k). Contributions by the Company are discretionary, and none have been made.
Equity Participation Plans
Through 2004, performance shares were awarded under the 1993 Equity Participation Plan (the "1993 Equity Plan"). The 1993 Equity Plan authorized the discretionary grant of performance shares by the Human Resources Committee to key employees. The amount earned for each performance share depends on the attainment of certain growth rates of adjusted book value as defined by the 1993 Equity Plan, and book value per outstanding share over specified three-year performance cycles.
Performance shares issued prior to January 1, 2005 permitted the participant to elect, at the time of award, growth rates including or excluding realized and unrealized gains and losses on the investment portfolios. Performance shares issued after January 1, 2005 do not offer the option to include the impact of unrealized gains and losses on the investment portfolios. No payout occurs if the compound annual growth rate of adjusted book value and book value per outstanding share over specified three-year performance cycles is less than 7%, and a 200% payout occurs if the compound annual growth rate is 19% or greater. Payout percentages are interpolated for compound annual growth rates between 7% and 19%.
In 2004, the Company adopted the 2004 Equity Participation Plan (the "2004 Equity Plan"), which continues the incentive compensation program formerly provided under the Company's 1993 Equity Participation Plan. The 2004 Equity Plan provides for performance share units comprised 90% of performance shares (which provide for payment based upon the Company's performance over two specified three-year performance cycles) and 10% of shares of Dexia restricted stock. Performance shares have generally been awarded on the basis of two sequential three-year performance cycle, with one-third of each award allocated to the first cycle, which commences on the date of grant, and two-thirds of each award allocated to the second cycle, which commences one year after the date of grant. The Company recognizes expense ratably over the course of each three-year performance cycle. The total number of performance shares authorized under this plan was 3.3 million. At December 31, 2008, 2.3 million performance shares remained available for distribution.
The Dexia restricted stock component is a fixed plan, where the Company purchases Dexia shares and establishes a prepaid expense for the amount paid, which is amortized over 2.5-year and 3.5-year vesting periods. In 2008 and 2007, FSA purchased shares that economically defeased its liability for $3.8 million and $4.7 million, respectively. These amounts are being amortized to expense over the employees' vesting periods. For the years ended December 31, 2008, 2007 and 2006, the after-tax amounts amortized into income were $3.1 million, $2.7 million and $1.9 million, respectively.
Performance shares granted under the 1993 Equity Plan and 2004 Equity Plan are as follows:
Performance Shares
|
Outstanding
at Beginning of Year |
Granted
During the Year |
Paid out
During the Year |
Forfeited
During the Year |
Outstanding
at End of Year |
Price per
Share at Grant Date |
Paid
During the Year |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
|
|
|
|
(in thousands)
|
|||||||||||||||
2006 |
1,195,978 | 370,441 | 340,429 | 15,696 | 1,210,294 | $ | 139.22 | $ | 60,993 | |||||||||||||
2007 |
1,210,294 | 306,368 | 364,510 | 37,550 | 1,114,602 | 145.61 | 61,872 | |||||||||||||||
2008 |
1,114,602 | 313,245 | 349,533 | 100,901 | 977,413 | 156.99 | 46,590 |
201
At December 31, 2008, 276,842 outstanding performance shares were fully vested, with a value of $0. At December 31, 2008, the total compensation cost related to non-vested performance shares (not yet recognized) was $0.
At December 31, 2007, 349,533 outstanding performance shares were fully vested, with a value of $46.6 million. These amounts were paid in the first quarter of 2008. At December 31, 2007, the total compensation cost related to non-vested performance shares not yet recognized was $130.2 million.
The estimated final cost of these performance shares is accrued over the performance period. The after-tax benefit of $42.6 million for the year ended December 31, 2008 and expense of $40.0 million and $37.3 million for the years ended December 31, 2007 and 2006, respectively, was recorded for the performance shares. In 2008, the accrual for performance shares was completely written off to reflect the Company's performance, resulting in a benefit to income.
Awards of Dexia restricted stock remain restricted for an additional six months after the end of each vesting period. Shares of Dexia restricted stock purchased under the 2004 Equity Plan are as follows:
Dexia Restricted Stock Shares
|
Outstanding
at Beginning of Year |
Purchased
During the Year |
Vested
During the Year |
Forfeited
During the Year |
Outstanding
at End of Year |
Price per
Share at Purchase Date |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2006 |
180,296 | 190,572 | 22,146 | 4,574 | 344,148 | $ | 24.17 | ||||||||||||
2007 |
344,148 | 158,096 | 65,524 | 17,607 | 419,113 | 29.80 | |||||||||||||
2008 |
419,113 | 248,886 | 178,449 | 50,170 | 439,380 | 23.61 |
Director Share Purchase Program
In the fourth quarter of 2000, the Company purchased 304,757 shares of its common stock from Dexia Holdings for $24.0 million. Additional purchases are intended to fund obligations relating to the Company's Director Share Purchase Program ("DSPP"), which enables its participants to make deemed investments in the Company's common stock under the Deferred Compensation Plan and Supplemental Executive Retirement Plan. Under the DSPP, the deemed investments in the Company's stock are irrevocable, settlement of the deemed investments must be in stock and, after receipt, the participants must generally hold the stock for at least six months. Restricted treasury stock is distributed to a director as a DSPP payout at the end of applicable restriction periods.
The Company purchased and distributed shares of its common stock under the DSPP in the following amounts:
Director Share Purchase Program Shares
|
Outstanding
at Beginning of Year |
Purchased
During the Year |
Payouts/
Liquidations During the Year |
Outstanding
at End of Year |
Purchase
Amount |
Cost
of Shares Distributed |
Fair Value
of Shares Distributed |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(dollars in thousands)
|
|||||||||||||||||||||
2006 |
254,736 | 532 | 13,290 | 241,978 | $ | 95 | $ | 1,047 | $ | 2,438 | ||||||||||||
2007 |
241,978 | 2,417 | | 244,395 | 438 | | | |||||||||||||||
2008 |
244,395 | 1,317 | 81,501 | 164,211 | 281 | 6,419 | 17,567 |
202
15. CREDIT DERIVATIVES IN THE INSURED PORTFOLIO
The components of the net change in the fair value of credit derivatives are shown in the table below:
Summary of the Net Change in the Fair Value of Credit Derivatives
|
Year Ended December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||||||
|
(in thousands)
|
|||||||||||||||
Net change in fair value of credit derivatives: |
||||||||||||||||
Realized gains (losses) and other settlements(1) |
$ | 126,891 | $ | 102,800 | $ | 87,200 | ||||||||||
Net unrealized gains (losses): |
||||||||||||||||
CDS: |
||||||||||||||||
Pooled corporate CDS: |
||||||||||||||||
Investment grade |
(165,295 | ) | (159,748 | ) | 21,034 | |||||||||||
High yield |
(242,294 | ) | (151,779 | ) | 8,057 | |||||||||||
Total pooled corporate CDS |
(407,589 | ) | (311,527 | ) | 29,091 | |||||||||||
Funded CLOs and CDOs |
(226,530 | ) | (288,762 | ) | 0 | |||||||||||
Other structured obligations |
(77,939 | ) | (35,474 | ) | 1,900 | |||||||||||
Total CDS |
(712,058 | ) | (635,763 | ) | 30,991 | |||||||||||
IR swaps and FG contracts with embedded derivatives |
(32,905 | ) | (6,846 | ) | 832 | |||||||||||
Subtotal |
(744,963 | ) | (642,609 | ) | 31,823 | |||||||||||
Net change in fair value of credit derivatives |
$ | (618,072 | ) | $ | (539,809 | ) | $ | 119,023 | ||||||||
The fair value of credit derivatives is reported in the balance sheet as "other assets" or "other liabilities and minority interest" based on the net gain or loss position with each counterparty. The unrealized component includes the market appreciation or depreciation of the derivative contracts, as discussed in Note 3.
Unrealized Gains (Losses) of the Credit Derivative Portfolio(1)
|
At December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||
|
(in thousands)
|
|||||||||
Pooled corporate CDS: |
||||||||||
Investment grade |
$ | (255,980 | ) | $ | (116,175 | ) | ||||
High yield(2) |
(374,249 | ) | (144,419 | ) | ||||||
Total pooled corporate CDS |
(630,229 | ) | (260,594 | ) | ||||||
Funded CLOs and CDOs |
(478,904 | ) | (263,422 | ) | ||||||
Other structured obligations(2) |
(108,841 | ) | (32,954 | ) | ||||||
Total CDS |
(1,217,974 | ) | (556,970 | ) | ||||||
IR swaps and FG contracts with embedded derivatives(2) |
(38,386 | ) | (6,027 | ) | ||||||
Total net credit derivatives |
$ | (1,256,360 | ) | $ | (562,997 | ) | ||||
203
Prior to the adoption of SFAS 157 on January 1, 2008 (the "Adoption Date"), the Company followed EITF 02-03. Under EITF 02-03, the Company was prohibited from recognizing a profit at the inception of its CDS contracts (referred to as "day one" gains) because the fair value of those derivatives is based on a valuation technique that incorporated unobservable inputs. Accordingly, the Company deferred approximately $40.9 million pre-tax of day one gains related to the fair value of CDS contracts purchased that were not permitted to be recognized under EITF 02-03. As SFAS 157 nullified the guidance in EITF 02-03, the Company recognized a transition adjustment totaling $40.9 million of previously deferred day one gains (pre-tax) in beginning retained earnings on the Adoption Date. See Note 3 for further discussion of the Company's adoption of SFAS 157.
The negative fair-value adjustments for the year ended December 31, 2008 were a result of continued widening of credit spreads in the insured CDS portfolio, offset in part by the positive income effects of the Company's own credit spread widening. Despite the structural protections associated with CDS contracts written by FSA, the significant widening of credit spreads on pooled corporate CDS and funded CDOs and CLOs, as with other structured credit products, resulted in a decline in the fair value of these contracts compared with December 31, 2007.
As the fair value of a CDS contract incorporates all the remaining future payments to be received over the life of the CDS contract, the fair value of that contract will change, in part, solely from the passage of time as fees are received.
The Company's typical CDS contract is different from CDS contracts entered into by parties that are not financial guarantors because:
CDS contracts in the asset-backed portfolio represent 71.2% of total asset-backed par outstanding. The Company has grouped CDS contracts by major category of underlying instrument for purposes of internal risk management and external reporting. The tables below summarize the credit rating, net par outstanding and remaining weighted average lives for the primary components of the Company's CDS portfolio. Net par outstanding in the table below is also included in the tables in Note 12.
204
Selected Information for CDS Portfolio
|
At December 31, 2008 | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Credit Ratings |
|
|
|||||||||||||||||||||
|
|
Remaining
Weighted Average Life |
||||||||||||||||||||||
|
Triple-A*(1) | Triple-A | Double-A |
Other
Investment Grades(2) |
Below
Investment Grade(3) |
Net Par
Outstanding(4) |
||||||||||||||||||
|
|
|
|
|
|
(in millions)
|
(in years)
|
|||||||||||||||||
Pooled Corporate CDS: |
||||||||||||||||||||||||
Investment grade |
100 | % | | % | | % | | % | | % | $ | 17,464 | 4.1 | |||||||||||
High yield |
41 | 54 | | | 5 | 15,467 | 2.4 | |||||||||||||||||
Funded CDOs and CLOs |
27 | 65 | (5) | 7 | 1 | | 31,681 | 2.6 | ||||||||||||||||
Other structured obligations(6) |
53 | 11 | (5) | 8 | 27 | 1 | 8,272 | 2.6 | ||||||||||||||||
Total |
50 | 41 | 4 | 4 | 1 | $ | 72,884 | 2.9 | ||||||||||||||||
|
At December 31, 2007 | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Credit Ratings |
|
|
|||||||||||||||||||||
|
|
Remaining
Weighted Average Life |
||||||||||||||||||||||
|
Triple-A*(1) | Triple-A | Double-A |
Other
Investment Grades(2) |
Below
Investment Grade |
Net Par
Outstanding(4) |
||||||||||||||||||
|
|
|
|
|
|
(in millions)
|
(in years)
|
|||||||||||||||||
Pooled Corporate CDS: |
||||||||||||||||||||||||
Investment grade |
91 | % | 1 | % | 8 | % | | % | | % | $ | 22,883 | 4.1 | |||||||||||
High yield |
95 | | | 5 | | 14,765 | 3.3 | |||||||||||||||||
Funded CDOs and CLOs |
28 | 72 | (5) | | | | 33,000 | 3.4 | ||||||||||||||||
Other structured obligations(6) |
62 | 36 | (5) | 1 | 1 | | 13,529 | 2.1 | ||||||||||||||||
Total |
62 | 34 | 3 | 1 | | $ | 84,177 | 3.4 | ||||||||||||||||
16. FINANCIAL PRODUCTS SEGMENT DERIVATIVE INSTRUMENTS AND HEDGE ACCOUNTING
The Company enters into derivative contracts to manage interest rate and foreign currency exposure in its FP Segment Investment Portfolio and FP segment debt.
As a result of market interest rate fluctuations, fixed-rate assets and liabilities appreciate or depreciate in market value. Gains or losses on the derivative instruments that are linked to the fixed-rate assets and liabilities being hedged are expected to substantially offset this unrealized appreciation or depreciation relating to the risk being hedged.
205
The Company uses foreign currency contracts to manage the foreign exchange risk associated with certain foreign currency-denominated assets and liabilities. Gains or losses on the derivative instruments that are linked to the foreign currency denominated assets or liabilities being hedged are expected to substantially offset this variability.
In order for a derivative to qualify for hedge accounting, it must be highly effective at reducing the risk associated with the exposure being hedged. In order for a derivative to be designated as a hedge, there must be documentation of the risk management objective and strategy, including identification of the hedging instrument, the hedged item and the risk exposure, and how effectiveness is to be assessed prospectively and retrospectively. To assess effectiveness, the Company uses analysis of the sensitivity of fair values to changes in the risk being hedged, as well as dollar value comparisons of the change in the fair value of the derivative to the change in the fair value of the hedged item that is attributable to the risk being hedged. The extent to which a hedging instrument has been and is expected to continue to be effective at achieving offsetting changes in fair value must be assessed and documented at least quarterly. Any ineffectiveness must be reported in current-period earnings. If it is determined that a derivative is not highly effective at hedging the designated exposure, hedge accounting is discontinued.
An effective fair-value hedge is defined as one whose periodic change in fair value is 80% to 125% correlated with the change in fair value of the hedged item. The difference between a perfect hedge (i.e., the change in fair value of the hedge and hedged item offset one another so that there is zero effect on the consolidated statements of operations and comprehensive income, referred to as being "100% correlated") and the actual correlation within the 80% to 125% effectiveness range is the ineffective portion of the hedge. A failed hedge is one whose correlation falls outside of the 80% to 125% effectiveness range.
The net gain related to the ineffective portion of the Company's fair-value hedges including changes in fair value of hedging instruments related to the passage of time, which was excluded from the assessment of hedge ineffectiveness, was $2.8 million in 2007 and $9.3 million in 2006. For 2008, this measure is not meaningful as substantially all assets in fair value hedging relationships have been recorded in the statement of operations and comprehensive income as OTTI.
The inception-to-date net unrealized gain on derivatives (excluding accrued interest and collateral) in the FP segment of $1,278.4 million and $560.4 million at December 31, 2008 and 2007, respectively, is recorded in "other assets" or "other liabilities and minority interest," as applicable.
Changes in Hedge Accounting Designations
In 2007, the Company designated certain IR swaps, which economically hedged FP segment GIC liabilities, as being in fair value hedging relationships. All derivative income, expense and fair value adjustments were reflected in the caption "Net interest expense from financial products segment" in order to offset interest expense and fair value adjustments on the hedged interest rate risk of the GICs, which were also recorded in that caption. With the adoption of SFAS 159 on January 1, 2008, the Company elected to discontinue hedge accounting for these GICs and elected the fair value option for certain liabilities in the FP segment debt portfolio, as described in Note 4. The fair value option allows the fair value adjustment on these liabilities to be recorded in earnings without hedge documentation and effectiveness testing requirements prescribed under SFAS 133. However, when the fair value option is elected, the fair value adjustment of liabilities must incorporate all components of fair value, including valuation adjustments related to the reporting entity's own credit risk. Under hedge accounting, only the component of fair value attributable to the hedged risk (i.e., market interest rate risk) was recorded in earnings.
As of January 1, 2008, fixed-rate assets in the available-for-sale FP Segment Investment Portfolio that were economically hedged with interest rate swaps were designated in fair value hedging relationships. Prior to January 1, 2008, changes in the fair value of these economically hedged assets
206
were recorded in "accumulated other comprehensive income," whereas the corresponding changes in fair value of the related hedging instrument were recorded in earnings. Under fair value hedge accounting, the fair value adjustments related to the hedged risk are recorded in earnings and adjust the amortized cost basis of the related assets. The interest and fair value adjustments on the derivatives and the interest income and fair value adjustment on the assets attributable to the hedged interest rate risk are recorded in "net interest income from financial products segment" in the consolidated statements of operations and comprehensive income, thereby offsetting each other and reflecting economic inefficiency on the hedging relationship in earnings. The Company does not seek to apply hedge accounting to all of its economic hedges.
Other Derivatives
The Company enters into various other derivative contracts that do not qualify for hedge accounting treatment. These derivatives may include swaptions, caps and other derivatives, which are used principally as protection against large interest rate movements. Gains and losses on these derivatives are reflected in "net realized and unrealized gains (losses) on other derivative instruments" in the consolidated statements of operations and comprehensive income.
17. MINORITY INTEREST IN FSA GLOBAL
On April 28, 2006, the Company increased its ownership of the ordinary shares of FSA Global from 29% to 49% through an acquisition of shares from an unaffiliated third party. Immediately thereafter, FSA Global's charter documents were amended to create a new class of nonvoting preference shares, which was issued to the Company. Holders of such preference shares have exclusive rights to any future dividends and, upon any winding up of FSA Global, all net assets available for distribution to shareholders (after a distribution of $250,000 to the ordinary shareholder). As a result of the issuance of such preference shares, (a) a substantive sale and purchase of an interest took place between the ordinary shareholders of FSA Global and the Company, resulting in an assessment and recording of the fair value of the assets and liabilities sold and purchased at the time of such transaction, and (b) the Company's minority interest liability associated with FSA Global was eliminated. In the second quarter of 2006, the Company realized a pre-tax gain of $1.8 million as a result of this transaction. Prior to this transaction, the Company recorded minority interest for the 71% of FSA Global common equity not owned by the Company.
18. REINSURANCE
The Company obtains reinsurance to increase its policy-writing capacity on both an aggregate-risk and a single-risk basis; to meet rating agency, internal and state insurance regulatory limits; to diversify risk; to reduce the need for additional capital; and to strengthen financial ratios. The Company reinsures portions of its risks with affiliated (see Note 24 for more information) and unaffiliated reinsurers under quota share, first-loss and excess-of-loss treaties and on a facultative basis.
Reinsurance does not relieve the Company of its obligations to policyholders. In the event that any or all of the reinsuring companies are unable to meet their obligations, or contest such obligations, the Company may be unable to recover amounts due. A number of FSA's reinsurers are required to pledge collateral to secure their reinsurance obligations to FSA in an amount equal to their statutory unearned premium, loss and contingency reserves associated with the ceded business. FSA requires collateral from reinsurers primarily to (a) receive statutory credit for the reinsurance, (b) provide liquidity to FSA in the event of claims on the reinsured exposures, and (c) enhance rating agency credit for the reinsurance.
207
Amounts of ceded and assumed business were as follows:
Summary of Reinsurance
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||
|
(in thousands)
|
|||||||||
Written premiums ceded |
$ | 32,084 | $ | 273,155 | $ | 275,175 | ||||
Written premiums assumed |
1,848 | 5,015 | 10,793 | |||||||
Earned premiums ceded |
139,531 | 146,801 | 141,232 | |||||||
Earned premiums assumed |
14,331 | 5,226 | 3,356 | |||||||
Losses and loss adjustment expense payments ceded |
214,833 | 5,052 | 3,486 | |||||||
Losses and loss adjustment expense payments assumed |
694 | 13 | 8 |
|
At December 31, | ||||||
---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||
|
(in thousands)
|
||||||
Principal outstanding ceded |
$ | 121,081,670 | $ | 137,733,688 | |||
Principal outstanding assumed |
6,152,541 | 4,433,549 | |||||
Deferred premium revenue assumed |
17,604 | 30,087 | |||||
Losses and loss adjustment expense reserves assumed |
| 579 |
The Company cedes approximately 23% of its gross par insured to a diversified group of reinsurers, including other monolines. Based on ceded par outstanding at December 31, 2008, 56.1% of FSA's reinsurers were rated Double-A- or higher at March 13, 2009. Some are still under review by rating agencies. The Company's reinsurance contracts generally allow the Company to recapture ceded business after certain triggering events, such as reinsurer downgrades. Included in the table below is $12,099 million in ceded par outstanding related to insured CDS.
Reinsurance Recoverable and Ceded Par Outstanding by Reinsurer and Ratings
|
Ratings at March 13, 2009 | At December 31, 2008 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Reinsurer
|
Moody's
Reinsurer Rating |
S&P
Reinsurer Rating |
Reinsurance
Recoverable |
Ceded Par
Outstanding |
Ceded Par
Outstanding as a % of Total |
||||||||||||
|
(dollars in millions)
|
||||||||||||||||
Assured Guaranty Re Ltd. |
Aa3 | AA | $ | 82.5 | $ | 32,842 | 27 | % | |||||||||
Tokio Marine and Nichido Fire Insurance Co., Ltd. |
Aa2 | (1) | AA | (1) | 133.6 | 31,478 | 26 | ||||||||||
Radian Asset Assurance Inc. |
Ba1 | BBB+ | 37.2 | 24,447 | 20 | ||||||||||||
RAM Reinsurance Co. Ltd. |
Baa3 | A+ | 22.3 | 11,929 | 10 | ||||||||||||
Syncora Guarantee Inc |
Ca | CC | | 4,135 | 4 | ||||||||||||
Swiss Reinsurance Company. |
A1 | A+ | 11.0 | 4,097 | 3 | ||||||||||||
R.V.I. Guaranty Co., Ltd. |
Baa3 | A- | | 4,109 | 3 | ||||||||||||
Mitsui Sumitomo Insurance Co. Ltd. |
Aa3 | AA | (1) | 8.9 | 2,658 | 2 | |||||||||||
CIFG Assurance North America Inc. |
Ba3 | BB | 17.9 | 1,901 | 2 | ||||||||||||
Ambac Assurance Corporation |
Baa1 | A | 0.2 | 1,075 | 1 | ||||||||||||
Other(2) |
Various | Various | 1.0 | 2,410 | 2 | ||||||||||||
Valuation allowance |
N/A | N/A | (12.5 | ) | | | |||||||||||
Total |
$ | 302.1 | $ | 121,081 | 100 | % | |||||||||||
208
In 2008, $28.5 million of net premiums earned resulted from commutations or cancellations of reinsurance contracts. The largest such transactions were with SGR and Bluepoint Re. Limited ("Bluepoint").
In July 2008, FSA agreed to re-assume all reinsurance ceded to SGR, which consisted of $8.4 billion in outstanding par, in exchange for the June 30, 2008 statutory basis ceded unearned premium, net of its applicable ceding commission, any case basis reserves established at that date and a $35.0 million commutation premium. FSA agreed to cede a portion of this business, approximately $6.4 billion of outstanding par with no outstanding case basis reserves, to Syncora Guarantee Inc. ("SGI") (formerly XL Capital Assurance), an affiliate of SGR, as of the re-assumption date. Ceded net unearned premiums and future ceded case reserves are secured by collateral then held in a trust. Since SGI was an affiliate of SGR, FSA did not consider the portion of the business bought back from SGR and subsequently ceded to SGI as commuted and as a result did not record any commutation gain on that portion of the business. FSA recorded a commutation gain of $10.0 million on the business it retained, which was recorded in "other income" in the statement of operations and comprehensive income. In 2008, $14.8 million of earned premium related to this commutation.
In September 2008, FSA agreed to re-assume a portion of the business it ceded to SGI in July for the statutory basis ceded unearned premium, net of its applicable ceding commissions. This resulted in a commutation gain of $10.0 million, which was recorded in "other income" in the statement of operations and comprehensive income. In 2008, $1.5 million of earned premium related to this commutation.
Due to a liquidation order against Bluepoint, FSA is treating all reinsurance ceded to Bluepoint as cancelled as of the August 29, 2008 date of the liquidation order. Subsequent to September 30, 2008, in accordance with guidance obtained from the New York Insurance Department, FSA drew down from collateral maintained in trust by Bluepoint an amount equal to the net statutory basis unearned premium and case basis reserves and, as a result, FSA was able to take credit for such balances. In 2008, $9.4 million of earned premium related to this commutation.
19. OTHER ASSETS AND OTHER LIABILITIES AND MINORITY INTEREST
The detailed balances that comprise "other assets" and "other liabilities and minority interest" at December 31, 2008 and 2007 are as follows:
Other Assets
|
At December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in thousands)
|
|||||||
Other assets: |
||||||||
VIE other invested assets |
25,395 | 24,091 | ||||||
Securities purchased under agreements to resell |
| 152,875 | ||||||
DCP and SERP at fair value |
90,704 | 142,642 | ||||||
Tax and loss bonds |
| 153,844 | ||||||
Accrued interest in FP segment investment portfolio |
27,869 | 52,776 | ||||||
Accrued interest income on general investment portfolio |
70,586 | 63,546 | ||||||
Salvage and subrogation recoverable |
10,431 | 39,669 | ||||||
CPS at fair value |
100,000 | | ||||||
Federal income tax receivable |
23,896 | | ||||||
Other assets |
120,067 | 107,767 | ||||||
Total other assets |
$ | 468,948 | $ | 737,210 | ||||
209
Other Liabilities and Minority Interest
|
At December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in thousands)
|
|||||||
Other liabilities and minority interest: |
||||||||
DCP and SERP payable |
90,704 | 142,653 | ||||||
Accrued interest on FP segment debt |
151,173 | 186,854 | ||||||
Equity participation plan |
| 112,151 | ||||||
Other liabilities and minority interest |
234,914 | 234,573 | ||||||
Total other liabilities and minority interest |
$ | 476,791 | $ | 676,231 | ||||
20. COMMITMENTS AND CONTINGENCIES
Leases
Effective June 2004, the Company entered into a 21-year sublease agreement with Deutsche Bank AG for office space at 31 West 52 nd Street, New York, New York, to be used as the Company's headquarters. The Company moved to this space in June 2005. The lease contains scheduled rent increases every five years after a 19-month rent-free period, as well as lease incentives for initial construction costs of up to $6.0 million, as defined in the sublease. The lease contains provisions for rent increases related to increases in the building's operating expenses. The lease also contains a renewal option for an additional ten-year period and an option to rent additional office space at various points in the future, in each case at then-current market rents. In addition, the Company and its Subsidiaries lease additional office space under non-cancelable operating leases, which expire at various dates through 2013.
Future Minimum Rental Payments
Year
|
At
December 31, 2008 |
||||
---|---|---|---|---|---|
|
(in thousands)
|
||||
2009 |
$ | 9,076 | |||
2010 |
8,720 | ||||
2011 |
8,439 | ||||
2012 |
8,444 | ||||
2013 |
8,144 | ||||
Thereafter |
96,009 | ||||
Total |
$ | 138,832 | |||
Rent expense was $10.6 million in 2008, $10.2 million in 2007 and $10.7 million in 2006.
Insured Portfolio
In connection with its financial guaranty business, the Company had outstanding commitments to provide guarantees of $4,639.4 million as of December 31, 2008. These commitments are typically short term and principally relate to primary and secondary public finance debt issuances. Commitments are contingent on the satisfaction of all conditions set forth in the contract. These commitments may expire unused or be cancelled at the counterparty's request. Therefore, the total commitment amount does not necessarily reflect actual future guaranteed amounts.
Legal Proceedings
The entitlements of the Chief Executive Officer and the President of the Company under their employment agreements with the Company are in dispute. In addition, holders of shares under the
210
Director Share Purchase Program are in discussions with Dexia regarding the proper valuation of such shares, which may lead to mediation or arbitration of the dispute.
In November 2006, (i) the Company received a subpoena from the Antitrust Division of the U.S. Department of Justice issued in connection with an ongoing criminal investigation of bid rigging of awards of municipal GICs and other municipal derivatives and (ii) FSA received a subpoena from the SEC related to an ongoing industry-wide investigation concerning the bidding of municipal GICs and other municipal derivatives. Pursuant to the subpoenas the Company has furnished to the DOJ and SEC records and other information with respect to the Company's municipal GIC business. On February 4, 2008, the Company received a "Wells Notice" from the staff of the Philadelphia Regional Office of the SEC relating to the foregoing matter. The Wells Notice indicates that the SEC staff is considering recommending that the SEC authorize the staff to bring a civil injunctive action and/or institute administrative proceedings against the Company, alleging violations of Section 10(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and Rule 10b-5 thereunder and Section 17(a) of the Securities Act of 1933, as amended. The Company has had ongoing discussions with the DOJ and the SEC. The ultimate loss that may arise from these investigations remains uncertain.
During 2008 nine putative class action lawsuits were filed in federal court alleging federal antitrust violations in the municipal derivatives industry, seeking damages and alleging, among other things, a conspiracy to fix the pricing of, and manipulate bids for, municipal derivatives, including GICs. These cases have been coordinated and consolidated for pretrial proceedings in the U.S. District Court for the Southern District of New York as MDL 1950, In re Municipal Derivatives Antitrust Litigation, Case No. 1:08-cv-2516 ("MDL 1950").
Five of these cases name both the Company and FSA: (a) Hinds County, Mississippi v. Wachovia Bank, N.A. (filed on or about March 13, 2008); (b) Fairfax County, Virginia v. Wachovia Bank, N.A. (filed on or about March 12, 2008); (c) Central Bucks School District, Pennsylvania v. Wachovia Bank N.A. (filed on or about June 4, 2008); (d) Mayor & City Counsel of Baltimore, Maryland v. Wachovia Bank N.A. (filed on or about July 3, 2008); and (e) Washington County, Tennessee v. Wachovia Bank N.A. (filed on or about July 14, 2008). Four of the cases name only the Company and also allege that the defendants violated state antitrust law and common law by engaging in illegal bid-rigging and market allocation, thereby depriving the cities of competition in the awarding of GICs and ultimately resulting in the cities paying higher fees for these products: (a) City of Oakland, California v. AIG Financial Products Corp. (filed on or about April 23, 2008); (b) County of Alameda, California v. AIG Financial Products Corp. (filed on or about July 8, 2008); (c) City of Fresno, California v. AIG Financial Products Corp. (filed on or about July 17, 2008); and (d) Fresno County Financing Authority v. AIG Financial Products Corp . (filed on or about December 24, 2008).
Interim lead counsel for the MDL 1950 plaintiffs filed a Consolidated Class Action Complaint ("Consolidated Complaint") in August 2008 alleging violations of the federal antitrust laws. Defendants filed motions to dismiss the Consolidated Complaint. The MDL 1950 court has determined that it will handle federal claims alleged in the Consolidated Complaint before addressing state claims. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
The Company and FSA also are named in five non-class actions originally filed in the California Superior Courts alleging violations of California law related to the municipal derivatives industry:
211
These cases have been transferred to the S.D.N.Y. and consolidated with MDL 1950 for pretrial proceedings. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
The Company has received various regulatory inquiries and requests for information regarding a variety of subjects. These include subpoenas duces tecum and interrogatories from the State of Connecticut Attorney General and the Attorney General of the State of California related to antitrust concerns associated with the methodologies used by rating agencies for determining the credit rating of municipal debt, including a proposal by Moody's to assign corporate equivalent ratings to municipal obligations, and the Company's communications with rating agencies. The Company is in the process of satisfying such requests. The Company may receive additional inquiries from these or other regulators and expects to provide additional information to such regulators regarding their inquiries in the future.
In December 2008 and January 2009, FSA and various other financial guarantors were named in three complaints filed in the Superior Court, San Francisco County: (a) City of Los Angeles Department of Water and Power v. Ambac Financial Group et. al (filed on or about December 31, 2008), Case No. CG-08-483689; Sacramento Municipal Utility District v. Ambac Financial Group et. al (filed on or about December 31, 2008), Case No. CGC-08-483691; and (c) City of Sacramento v. Ambac Financial Group Inc. et. al (filed on or about January 6, 2009), Case No. CGC-09-483862. These complaints alleged participation in a conspiracy in violation of California's antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and created market demand for municipal bond insurance and participation in risky financial transactions in other lines of business that damaged each bond insurer's financial condition (thereby undermining the value of each of their guaranties), and a failure to adequately disclose the impact of those transactions on their financial condition. These latter allegations form the predicate for five separate causes of action against each of the Insurers: breach of contract, breach of the covenant of good faith and fair dealing, fraud, negligence, and negligent misrepresentation. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
In August 2008 a number of financial institutions and other parties, including FSA, were named as defendants in a civil action brought in the circuit court of Jefferson County, Alabama relating to the County's problems meeting its debt obligations on its $3.2 billion sewer debt: Charles E. Wilson vs. JPMorgan Chase & Co et al (filed on or about August 8, 2008 in the Circuit Court of Jefferson County, Alabama), Case No. 01-CV-2008-901907.00, a putative class action. The action was brought on
212
behalf of rate payers, tax payers and citizens residing in Jefferson County, and alleges conspiracy and fraud in connection with the issuance of the County's debt. The complaint in this lawsuit seeks unspecified monetary damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss or range of loss that may arise from this lawsuit. FSA was also named as a defendant in a second civil action regarding Jefferson County, Alabama, but was dismissed from such action in January 2009.
There are no other material legal proceedings pending to which the Company is subject.
21. DIVIDENDS AND CAPITAL REQUIREMENTS
Because the majority of the Company's operations are conducted through FSA, the long-term ability of FSA Holdings to service its debt will largely depend on its ability to extract cash from FSA in the form of FSA's repurchase of its stock or receipt of dividends from FSA.
FSA's ability to pay dividends or repurchase shares depends on FSA's financial condition, results of operations, cash requirements, rating agency capital adequacy and other related factors, and is also subject to restrictions contained in the insurance laws and related regulations of New York and other states. Under the insurance laws of the State of New York, FSA may pay dividends out of earned surplus, provided that, together with all dividends declared or distributed by FSA during the preceding 12 months, the dividends do not exceed the lesser of (a) 10% of policyholders' surplus as of its last statement filed with the Superintendent of Insurance of the State of New York (the "New York Superintendent") or (b) adjusted net investment income during this period. FSA paid dividends of $30.0 million in 2008, no dividends in 2007 and $140.0 million in 2006. Based upon FSA's statutory statements for December 31, 2008, the maximum amount normally available for payment of dividends by FSA without regulatory approval over the following 12 months would be approximately $62.0 million, subject to certain limitations.
In lieu of dividends, FSA may repurchase shares of its common stock from shareholders, subject to the New York Superintendent's approval. The New York Superintendent has approved the repurchase by the Company of up to $500.0 million of its shares from FSA Holdings through December 31, 2008. FSA repurchased $70.0 million of its common stock during the first six months of 2008, and retired the shares. As the amounts paid for repurchases may not exceed cumulative statutory earnings from January 1, 2006 through the end of the quarter prior to the repurchase, FSA was unable to make repurchases during the third and fourth quarter of 2008. In 2007 and 2006, FSA repurchased $180.0 million and $100.0 million of shares of its common stock, respectively, from FSA Holdings and retired such shares.
FSA Holdings paid dividends of $33.6 million in 2008, $122.0 million in 2007 and $530.0 million in 2006.
At December 31, 2007, FSA repaid its entire surplus note obligation of $108.9 million to FSA Holdings. In addition, FSA Holdings forgave all interest expense for 2007, which totaled $5.0 million, including $3.6 million already paid by FSA and $1.4 million of accrued interest. FSA Holdings recontributed to FSA the proceeds from the repayment of the surplus note plus the amount of interest expense already paid. All surplus note transactions were approved by the New York Superintendent. FSA paid surplus note interest of $5.4 million in 2006.
In 2008, Dexia Holdings contributed $1,012.1 million of capital to FSA Holdings, which included $4.3 million contributed by a liquidation of program shares and phantom program shares held by directors. In the first quarter of 2008, FSA Holdings contributed capital to FSA of $500 million. In the third quarter of 2008, FSA issued a non-interest bearing surplus note with no term to FSA Holdings in exchange for $300 million. In the fourth quarter of 2008, FSA Holdings contributed $207.8 million to FSAM, part of the FP segment.
213
22. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES
FSA has a credit arrangement aggregating $150.0 million provided by commercial banks and intended for general application to insured transactions. If FSA is downgraded below Aa3 by Moody's and AA- by S&P, the lenders may terminate the commitment, and the commitment commission becomes due and payable. If FSA is downgraded below Baa3 by Moody's and BBB- by S&P, any outstanding loans become due and payable. At December 31, 2008, there were no borrowings under this arrangement, which expires on April 21, 2011.
FSA has a standby line of credit in the amount of $350.0 million with a group of international banks to provide loans to FSA after it has incurred, during the term of the facility, cumulative municipal losses (net of any recoveries) in excess of the greater of $350.0 million or the average annual debt service of the covered portfolio multiplied by 5%, which amounted to $1,612.0 million at December 31, 2008. The obligation to repay loans under this agreement is a limited recourse obligation payable solely from, and collateralized by, a pledge of recoveries realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. This commitment has a ten-year term expiring on April 30, 2015. The ratings downgrade of FSA by Moody's to Aa3 in November 2008 resulted in an increase to the commitment fee. No amounts have been utilized under this commitment at December 31, 2008.
In June 2003, $200.0 million of CPS, money market committed preferred trust securities, were issued by trusts created for the primary purpose of issuing the CPS, investing the proceeds in high-quality commercial paper and providing FSA with put options for issuing to the trusts non-cumulative redeemable perpetual preferred stock (the "Preferred Stock") of FSA. There are four trusts, each with an initial aggregate face amount of $50 million. These trusts hold auctions every 28 days at which time investors submit bid orders to purchase CPS. If FSA were to exercise a put option, the applicable trust would transfer the portion of the proceeds attributable to principal received upon maturity of its assets, net of expenses, to FSA in exchange for Preferred Stock of FSA. FSA pays a floating put premium to the trusts, which represents the difference between the commercial paper yield and the winning auction rate (plus all fees and expenses of the trust). If an auction does not attract sufficient clearing bids, however, the auction rate will be subject to a maximum rate of 200 basis points above LIBOR for the next succeeding distribution period. Beginning in August 2007, the CPS required the maximum rate for each of the relevant trusts. FSA continues to have the ability to exercise its put option and cause the related trusts to purchase FSA Preferred Stock. The cost of the facility was $4.9 million, $1.8 million and $1.0 million for 2008, 2007 and 2006, respectively, and was recorded within other operating expenses. The trusts are vehicles for providing FSA access to new capital at its sole discretion through the exercise of the put options. The Company does not consider itself to be the primary beneficiary of the trusts because it does not retain the majority of the residual benefits or expected losses.
Certain notes held by FSA Global contain provisions that could extend the stated maturities of those notes. To ensure FSA Global will have sufficient cash flow to repay its own debt issuances that relate to such notes, it entered into several liquidity facilities with Dexia for $419.4 million. Certain notes held by FSA Global benefit from a liquidity facility with XL Insurance Ltd. for $341.5 million.
In the third quarter of 2008, to address FP segment liquidity requirements, Dexia entered into an agreement to provide FSAM the First Dexia Line of Credit, a $5 billion committed, unsecured, standby line of credit. At December 31, 2008, there were $1.3 billion in draws outstanding under the First Dexia Line of Credit. In February 2009, Dexia and FSAM entered into an agreement for a second committed, unsecured, standby line of credit of $3 billion (the "Second Dexia Line of Credit"). At March 2, 2009, the amount outstanding on the First Dexia Line of Credit had increased to $2.7 billion.
In addition, on November 13, 2008, the Company entered into two agreements with Dexia and its affiliates in support of its FP business, which provide a $3.5 billion collateral swap facility and a $500 million capital facility to cover economic losses beyond the $316.5 million of pre-tax loss estimated at the end of June 2008.
214
23. SEGMENT REPORTING
The Company operates in two business segments: financial guaranty and financial products. The financial guaranty segment is primarily in the business of providing financial guaranty insurance on public finance and asset-backed obligations. The FP segment includes the VIEs and the GIC operations of the Company, which historically issued medium term notes through a reverse inquiry process to institutional investors and GICs to municipalities and other market participants. Since the November 2008 execution of the Purchase Agreement, no new GICs have been issued. See Note 1 for a description of each segment's business. The following tables summarize the financial information by segment as of and for the years ended December 31, 2008, 2007 and 2006:
Financial Information Summary by Segment
|
For the Year Ended December 31, 2008 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Financial
Products |
Intersegment
Eliminations |
Total | ||||||||||
|
(in thousands)
|
|||||||||||||
Revenues: |
||||||||||||||
External |
$ | 82,075 | $ | (6,513,039 | ) | $ | | $ | (6,430,964 | ) | ||||
Intersegment |
(1,228 | ) | 16,301 | (15,073 | ) | | ||||||||
Expenses: |
||||||||||||||
External |
(2,043,242 | ) | (841,323 | ) | | (2,884,565 | ) | |||||||
Intersegment |
(12,120 | ) | (2,953 | ) | 15,073 | | ||||||||
Income (loss) before income taxes |
(1,974,515 | ) | (7,341,014 | ) | | (9,315,529 | ) | |||||||
GAAP income to segment operating earnings adjustments |
431,938 | 6,594,610 | (1) | | 7,026,548 | |||||||||
Pre-tax segment operating earnings (losses) |
$ | (1,542,577 | ) | $ | (746,404 | ) | $ | | $ | (2,288,981 | ) | |||
Segment assets |
$ | 9,396,877 | $ | 11,068,019 | $ | (206,842 | ) | $ | 20,258,054 |
|
For the Year Ended December 31, 2007 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Financial
Products |
Intersegment
Eliminations |
Total | ||||||||||
|
(in thousands)
|
|||||||||||||
Revenues: |
||||||||||||||
External |
$ | 73,541 | $ | 1,155,751 | $ | | $ | 1,229,292 | ||||||
Intersegment |
3,002 | 16,369 | (19,371 | ) | | |||||||||
Expenses: |
||||||||||||||
External |
(258,431 | ) | (1,152,729 | ) | | (1,411,160 | ) | |||||||
Intersegment |
(16,369 | ) | (3,002 | ) | 19,371 | | ||||||||
Income (loss) before income taxes |
(198,257 | ) | 16,389 | | (181,868 | ) | ||||||||
GAAP income to segment operating earnings adjustments |
628,954 | 60,460 | | 689,414 | ||||||||||
Pre-tax segment operating earnings (losses) |
$ | 430,697 | $ | 76,849 | $ | | $ | 507,546 | ||||||
Segment assets |
$ | 8,062,758 | $ | 20,486,744 | $ | (230,843 | ) | $ | 28,318,659 |
215
|
For the Year Ended December 31, 2006 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Financial
Products |
Intersegment
Eliminations |
Total | ||||||||||
|
(in thousands)
|
|||||||||||||
Revenues: |
||||||||||||||
External |
$ | 698,213 | $ | 992,811 | $ | | $ | 1,691,024 | ||||||
Intersegment |
3,584 | 20,055 | (23,639 | ) | | |||||||||
Expenses: |
||||||||||||||
External |
(217,019 | ) | (951,177 | ) | | (1,168,196 | ) | |||||||
Intersegment |
(20,055 | ) | (3,584 | ) | 23,639 | | ||||||||
Income (loss) before income taxes |
464,723 | 58,105 | | 522,828 | ||||||||||
GAAP income to segment operating earnings adjustments |
(1,823 | ) | (11,026 | ) | | (12,849 | ) | |||||||
Pre-tax segment operating earnings (losses) |
$ | 462,900 | $ | 47,079 | $ | | $ | 509,979 | ||||||
Segment assets |
$ | 7,150,643 | $ | 18,935,399 | $ | (321,371 | ) | $ | 25,764,671 |
Reconciliations of the Segments' Pre-Tax Operating Earnings (Losses) to Net Income (Loss)
|
For the Year Ended December 31, 2008 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Financial
Products |
Intersegment
Eliminations |
Total | |||||||||
|
(in thousands)
|
||||||||||||
Pre-tax segment operating earnings (losses) |
$ | (1,542,577 | ) | $ | (746,404 | ) | $ | | $ | (2,288,981 | ) | ||
Segment operating earnings to GAAP income adjustments |
(431,938 | ) | (6,594,610 | ) | | (7,026,548 | ) | ||||||
Tax (provision) benefit |
872,359 | ||||||||||||
Net income (loss) |
$ | (8,443,170 | ) | ||||||||||
|
For the Year Ended December 31, 2007 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Financial
Products |
Intersegment
Eliminations |
Total | |||||||||
|
(in thousands)
|
||||||||||||
Pre-tax segment operating earnings (losses) |
$ | 430,697 | $ | 76,849 | $ | | $ | 507,546 | |||||
Segment operating earnings to GAAP income adjustments |
(628,954 | ) | (60,460 | ) | | (689,414 | ) | ||||||
Tax (provision) benefit |
116,214 | ||||||||||||
Net income (loss) |
$ | (65,654 | ) | ||||||||||
|
For the Year Ended December 31, 2006 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Financial
Products |
Intersegment
Eliminations |
Total | |||||||||
|
(in thousands)
|
||||||||||||
Pre-tax segment operating earnings (losses) |
$ | 462,900 | $ | 47,079 | $ | | $ | 509,979 | |||||
Segment operating earnings to GAAP income adjustments |
1,823 | 11,026 | | 12,849 | |||||||||
Tax (provision) benefit |
(150,680 | ) | |||||||||||
Minority interest |
52,006 | ||||||||||||
Net income (loss) |
$ | 424,154 | |||||||||||
216
The intersegment assets consist primarily of intercompany notes issued by FSA and held within the FP Investment Portfolio. The intersegment revenues and expenses relate to interest income and interest expense on intercompany notes and premiums paid by FSA Global on FSA-insured notes.
GAAP income to operating earnings adjustments are primarily comprised of fair-value adjustments deemed to be non-economic. Such adjustments relate to (1) non-economic fair-value adjustments for credit derivatives in the insured portfolio, (2) non-economic impairment charges on investments, (3) fair-value adjustments for instruments with economically hedged risks and (4) fair-value adjustments attributable to the Company's own credit risk. Management believes that by making such adjustments the measure more closely reflects the underlying economic performance of segment operations.
The GIC Subsidiaries and VIEs in the FP segment pay premiums to FSA, which is in the financial guaranty segment. In addition, management of FSA provides management, oversight and administrative support services ("indirect FP expenses") to the entities in the FP segment. The Company's management evaluates the FP segment based on the separate results of operation of the GIC Subsidiaries and FSAM, excluding the premium paid to FSA and including the indirect FP expenses. For the VIEs, the premium paid approximates the indirect expenses incurred by FSA.
Net Premiums Earned by Geographic Distribution
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||
|
(in thousands)
|
|||||||||
United States |
$ | 298,932 | $ | 263,641 | $ | 258,106 | ||||
International |
77,641 | 54,115 | 43,403 | |||||||
Total premiums |
$ | 376,573 | $ | 317,756 | $ | 301,509 | ||||
24. RELATED PARTY TRANSACTIONS
The Company enters into various related party transactions, primarily with Dexia and, until mid-2008, SGR. The primary related party transactions during 2008 between the Company and Dexia are as follows:
217
SGR had an equity interest in FSA International until 2005, at which time the Company repurchased shares in FSA International held by SGR. The Company had a preferred stock investment in SGR until third quarter of 2008. The primary related party transactions with SGR are as follows.
The table below summarizes amounts included in the financial statement captions resulting from various types of transactions executed with related parties, as well as outstanding exposures with related parties:
Amounts Reported for Related Party Transactions
in the Consolidated Balance Sheets
|
At December 31, | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||||
|
(in thousands)
|
||||||||
Dexia(1) |
|||||||||
FP segment investment portfolio |
$ | 100,537 | $ | 200,252 | |||||
Net FP segment derivatives |
74,879 | 302,914 | |||||||
Other assets |
25,464 | 24,460 | |||||||
Deferred premium revenue |
(2,541 | ) | (2,839 | ) | |||||
FP segment debt |
(115,049 | ) | (199,739 | ) | |||||
Net credit derivatives |
(226,973 | ) | (66,072 | ) | |||||
Related party borrowings |
(1,310,000 | ) | | ||||||
Other liabilities |
(9,709 | ) | (2,554 | ) | |||||
Exposure: |
|||||||||
Gross par outstanding |
14,498,129 | 18,234,174 | |||||||
SGR(2) |
|||||||||
Prepaid reinsurance |
N/A | 132,560 | |||||||
Reinsurance recoverable for unpaid losses |
N/A | 10,172 | |||||||
Investment in SGR |
| 39,000 |
218
Amounts Reported for Related Party Transactions
in the Consolidated Statements of Operations and Comprehensive Income
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in thousands)
|
||||||||||
Dexia(1) |
|||||||||||
Gross premiums earned |
$ | 2,795 | $ | 1,579 | $ | 2,708 | |||||
Net change in fair value of credit derivatives |
(138,727 | ) | (42,792 | ) | 22,749 | ||||||
Net interest income (expense) from FP segment investment portfolio |
(138,172 | ) | 1,205 | 4,355 | |||||||
Net realized and unrealized gains (losses) from FP segment derivatives |
(223,339 | ) | (51,959 | ) | 42,619 | ||||||
Net unrealized gains (losses) on financial instruments at fair value |
(81,932 | ) | | | |||||||
Net interest income (expense) from FP segment debt |
(18,625 | ) | 39,246 | (42,301 | ) | ||||||
Other operating expenses |
(10,457 | ) | (750 | ) | (358 | ) | |||||
SGR(2) |
|||||||||||
Ceded premiums written |
(127,074 | ) | 39,828 | 46,069 | |||||||
Dividends received from SGR. |
1,609 | 3,465 | 4,518 |
25. STATUTORY ACCOUNTING PRACTICES
GAAP differs in certain significant respects from statutory accounting practices, applicable to insurance companies, that are prescribed or permitted by insurance regulatory authorities. The principal differences result from the following statutory accounting practices:
219
Consolidated statutory net loss was $1,376.7 million for 2008 and net income of $312.9 million for 2007 and $339.6 million for 2006. Statutory surplus totaled $710.7 million for 2008 and $1,608.8 million for 2007. Statutory contingency reserves totaled $1,281.6 million for 2008 and $1,094.3 million for 2007.
26. EXPOSURE TO MONOLINES
The tables below summarize the exposure to each financial guaranty monoline insurer by exposure category and the underlying ratings of the Company's insured risks.
Summary of Exposure to Monolines
|
At December 31, 2008 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Insured Portfolios | Investment Portfolios | ||||||||||||
|
FSA
Insured Par Outstanding (1) |
Ceded Par
Outstanding |
General
Investment Portfolio(2) |
FP Segment
Investment Portfolio(2) |
||||||||||
|
(in millions)
|
(in thousands)
|
||||||||||||
Assured Guaranty Re Ltd. |
$ | 972 | $ | 32,842 | $ | 81,324 | $ | 84,899 | ||||||
Radian Asset Assurance Inc. |
96 | 24,447 | 1,941 | 99,188 | ||||||||||
RAM Reinsurance Co. Ltd. |
| 11,929 | | | ||||||||||
Syncora Guarantee Inc. |
1,364 | 4,135 | 26,385 | 192,336 | ||||||||||
CIFG Assurance North America Inc. |
195 | 1,901 | 23,955 | 29,807 | ||||||||||
Ambac Assurance Corporation |
4,976 | 1,075 | 626,288 | 431,173 | ||||||||||
ACA Financial Guaranty Corporation |
19 | 943 | | | ||||||||||
Financial Guaranty Insurance Company |
5,385 | 279 | 29,119 | 227,434 | ||||||||||
MBIA Insurance Corporation |
4,022 | | 938,700 | 419,700 | ||||||||||
Total |
$ | 17,029 | $ | 77,551 | $ | 1,727,712 | $ | 1,484,537 | ||||||
220
Exposures to Monolines
and Ratings of Underlying Risks
|
At December 31, 2008 | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Insured Portfolios(1) | Investment Portfolios | |||||||||||||
|
FSA
Insured Par Outstanding(2) |
Ceded Par
Outstanding |
General
Investment Portfolio(3) |
FP Segment
Investment Portfolio(1) |
|||||||||||
|
(dollars in millions)
|
(dollars in thousands)
|
|||||||||||||
Assured Guaranty Re Ltd. |
|||||||||||||||
Exposure(4) |
$ | 972 | $ | 32,842 | $ | 81,324 | $ | 84,899 | |||||||
Triple-A |
| % | 5 | % | 2 | % | | % | |||||||
Double-A |
10 | 40 | | 45 | |||||||||||
Single-A |
24 | 38 | 81 | 49 | |||||||||||
Triple-B |
8 | 15 | 17 | | |||||||||||
Below Investment Grade |
58 | 2 | | 6 | |||||||||||
Radian Asset Assurance Inc. |
|||||||||||||||
Exposure(4) |
$ | 96 | $ | 24,447 | $ | 1,941 | $ | 99,188 | |||||||
Triple-A |
4 | % | 8 | % | | % | | % | |||||||
Double-A |
| 43 | 100 | | |||||||||||
Single-A |
14 | 38 | | | |||||||||||
Triple-B |
57 | 10 | | | |||||||||||
Below Investment Grade |
25 | 1 | | 100 | |||||||||||
RAM Reinsurance Co. Ltd. |
|||||||||||||||
Exposure(4) |
$ | | $ | 11,929 | $ | | $ | | |||||||
Triple-A |
| % | 13 | % | | % | | % | |||||||
Double-A |
| 41 | | | |||||||||||
Single-A |
| 32 | | | |||||||||||
Triple-B |
| 12 | | | |||||||||||
Below Investment Grade |
| 2 | | | |||||||||||
Syncora Guarantee Inc. |
|||||||||||||||
Exposure(4) |
$ | 1,364 | $ | 4,135 | $ | 26,385 | $ | 192,336 | |||||||
Triple-A |
30 | % | | % | | % | 1 | % | |||||||
Double-A |
| 8 | 22 | | |||||||||||
Single-A |
21 | 36 | 75 | 16 | |||||||||||
Triple-B |
25 | 56 | | 52 | |||||||||||
Below Investment Grade |
24 | | | 31 | |||||||||||
Not Rated |
| | 3 | | |||||||||||
CIFG Assurance North America Inc. |
|||||||||||||||
Exposure(4) |
$ | 195 | $ | 1,901 | $ | 23,955 | $ | 29,807 | |||||||
Triple-A |
| % | 2 | % | | % | | % | |||||||
Double-A |
2 | 27 | | 41 | |||||||||||
Single-A |
9 | 37 | 100 | 6 | |||||||||||
Triple-B |
89 | 30 | | | |||||||||||
Below Investment Grade |
| 4 | | 53 | |||||||||||
Ambac Assurance Corporation |
|||||||||||||||
Exposure(4) |
$ | 4,976 | $ | 1,075 | $ | 626,288 | $ | 431,173 | |||||||
Triple-A |
6 | % | | % | | % | 5 | % | |||||||
Double-A |
42 | 9 | 42 | 9 | |||||||||||
Single-A |
32 | 39 | 53 | 36 | |||||||||||
Triple-B |
11 | 52 | 4 | 41 | |||||||||||
Below Investment Grade |
9 | 0 | 1 | 9 |
221
|
At December 31, 2008 | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Insured Portfolios(1) | Investment Portfolios | |||||||||||||
|
FSA
Insured Par Outstanding(2) |
Ceded Par
Outstanding |
General
Investment Portfolio(3) |
FP Segment
Investment Portfolio(1) |
|||||||||||
|
(dollars in millions)
|
(dollars in thousands)
|
|||||||||||||
ACA Financial Guaranty Corporation |
|||||||||||||||
Exposure(4) |
$ | 19 | $ | 943 | $ | | $ | | |||||||
Triple-A |
| % | | % | | % | | % | |||||||
Double-A |
69 | 72 | | | |||||||||||
Single-A |
| 26 | | | |||||||||||
Triple-B |
11 | 2 | | | |||||||||||
Below Investment Grade |
20 | | | | |||||||||||
Financial Guaranty Insurance Company |
|||||||||||||||
Exposure(4) |
$ | 5,385 | $ | 279 | $ | 29,119 | $ | 227,434 | |||||||
Triple-A |
| % | | % | | % | | % | |||||||
Double-A |
33 | | 64 | | |||||||||||
Single-A |
57 | 100 | 35 | 30 | |||||||||||
Triple-B |
8 | | 1 | 57 | |||||||||||
Below Investment Grade |
2 | | | 13 | |||||||||||
MBIA Insurance Corporation |
|||||||||||||||
Exposure(4) |
$ | 4,022 | $ | | $ | 938,700 | $ | 419,700 | |||||||
Triple-A |
| % | | % | | % | | % | |||||||
Double-A |
54 | | 40 | 15 | |||||||||||
Single-A |
14 | | 55 | 25 | |||||||||||
Triple-B |
32 | | 4 | 49 | |||||||||||
Below Investment Grade |
| | 1 | 11 |
222
27. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly Financial Information
|
First
Quarter |
Second
Quarter |
Third
Quarter |
Fourth
Quarter |
Full Year | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(in thousands)
|
|||||||||||||||||||
2008 |
||||||||||||||||||||
REVENUES |
||||||||||||||||||||
Net premiums written |
$ | 195,382 | $ | 267,377 | $ | 176,624 | $ | 18,975 | $ | 658,358 | ||||||||||
Net premiums earned |
72,905 | 84,628 | 123,742 | 95,658 | 376,573 | |||||||||||||||
Net investment income from general investment portfolio |
64,846 | 67,412 | 67,078 | 64,845 | 264,181 | |||||||||||||||
Net change in fair value of credit derivatives: |
||||||||||||||||||||
Realized gains (losses) and other settlements |
36,179 | (1) | 32,660 | 29,925 | 28,127 | 126,891 | ||||||||||||||
Net unrealized gains (losses) |
(489,134 | ) | 215,425 | (194,196 | ) | (277,058 | ) | (744,963 | ) | |||||||||||
Net change in fair value of credit derivatives |
(452,955 | ) | 248,085 | (164,271 | ) | (248,931 | ) | (618,072 | ) | |||||||||||
Net interest income from financial products segment |
208,764 | 148,949 | 165,802 | 123,851 | 647,366 | |||||||||||||||
Net realized gains (losses) from financial products segment |
| (1,042,413 | ) | (417,419 | ) | (7,184,351 | ) | (8,644,183 | ) | |||||||||||
Net realized and unrealized gains (losses) on derivative instruments |
430,766 | (274,246 | ) | 25,184 | 1,242,818 | 1,424,522 | ||||||||||||||
Net unrealized gains (losses) on financial instruments at fair value |
(411,390 | )(2) | 1,037,976 | 320,804 | (817,027 | ) | 130,363 | |||||||||||||
EXPENSES |
||||||||||||||||||||
Losses and loss adjustment expenses |
300,429 | 602,842 | 327,633 | 646,795 | 1,877,699 | |||||||||||||||
Amortization of deferred acquisition costs |
15,829 | 16,602 | 19,004 | 14,265 | 65,700 | |||||||||||||||
Net interest expense from financial products segment |
239,267 | 187,189 | 182,030 | 185,822 | 794,308 | |||||||||||||||
Other operating expenses |
19,854 | (4,164 | ) | 40,064 | 43,117 | 98,871 | ||||||||||||||
Income (loss) before income taxes and minority interest |
(685,392 | ) | (541,854 | ) | (437,731 | ) | (7,650,552 | ) | (9,315,529 | ) | ||||||||||
Net income (loss) |
(421,576 | ) | (330,500 | ) | (333,481 | ) | (7,357,613 | ) | (8,443,170 | ) |
223
|
First
Quarter |
Second
Quarter |
Third
Quarter |
Fourth
Quarter |
Full Year | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
(in thousands)
|
|||||||||||||||||||
2007 |
||||||||||||||||||||
REVENUES |
||||||||||||||||||||
Net premiums written |
$ | 78,681 | $ | 87,927 | $ | 130,078 | $ | 150,453 | $ | 447,139 | ||||||||||
Net premiums earned |
76,773 | 82,860 | 72,446 | 85,677 | 317,756 | |||||||||||||||
Net investment income from general investment portfolio |
57,709 | 58,117 | 60,472 | 60,361 | 236,659 | |||||||||||||||
Net change in fair value of credit derivatives: |
||||||||||||||||||||
Realized gains (losses) and other settlements |
22,239 | 23,161 | 27,000 | 30,400 | 102,800 | |||||||||||||||
Net unrealized gains (losses) |
(13,206 | ) | (45,587 | ) | (293,718 | ) | (290,098 | ) | (642,609 | ) | ||||||||||
Net change in fair value of credit derivatives |
9,033 | (22,426 | ) | (266,718 | ) | (259,698 | ) | (539,809 | ) | |||||||||||
Net interest income from financial products segment |
250,791 | 260,810 | 288,389 | 279,587 | 1,079,577 | |||||||||||||||
Net realized gains (losses) from financial products segment |
534 | 1,208 | 125 | | 1,867 | |||||||||||||||
Net realized and unrealized gains (losses) on derivative instruments |
31,577 | 1,053 | (43,923 | ) | 74,094 | 62,801 | ||||||||||||||
Net unrealized gains (losses) on financial instruments at fair value |
(3,113 | ) | 9,431 | 10,115 | (2,442 | ) | 13,991 | |||||||||||||
EXPENSES |
||||||||||||||||||||
Losses and loss adjustment expenses |
4,390 | 4,678 | 10,060 | 12,439 | 31,567 | |||||||||||||||
Amortization of deferred acquisition costs |
15,951 | 18,055 | 13,583 | 15,853 | 63,442 | |||||||||||||||
Net interest expense from financial products segment |
241,683 | 248,441 | 260,014 | 239,108 | 989,246 | |||||||||||||||
Other operating expenses |
30,262 | 38,760 | 33,474 | 39,594 | 142,090 | |||||||||||||||
Income (loss) before income taxes and minority interest |
113,455 | 75,622 | (211,062 | ) | (159,883 | ) | (181,868 | ) | ||||||||||||
Net income (loss) |
85,196 | 62,827 | (121,809 | ) | (91,868 | ) | (65,654 | ) |
Fourth quarter 2008 results include OTTI charges on FP Segment Investment Portfolio of $8.6 billion (See Note 6) and loss expense of $1.9 billion (see Note 9).
224
28. OTHER INCOME
The following table shows the components of "other income." In 2008, other income includes $20.1 million related to commutation gains. See Note 26 for more information.
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in thousands)
|
||||||||||
DCP and SERP interest income(1) |
$ | 1,429 | $ | 12,458 | 9,106 | ||||||
DCP and SERP asset fair-value gain (loss)(1) |
(38,920 | ) | (6,380 | ) | 5,307 | ||||||
Realized foreign exchange gain (loss) |
(3,573 | ) | 13,431 | 2,880 | |||||||
Commutation gain |
20,127 | | | ||||||||
Other |
8,998 | 13,261 | 12,028 | ||||||||
Subtotal |
$ | (11,939 | ) | $ | 32,770 | 29,321 | |||||
225
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
There have been no changes in accountants, or any disagreements with accountants on accounting and financial disclosure within the two years in the period ended December 31, 2008.
Item 9AT. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, completed an evaluation of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended) as of December 31, 2008. Based on that evaluation, the Company's management, including the Chief Executive Officer and the Chief Financial Officer, have concluded that as of such date the Company's disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the SEC and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, in a manner that allows timely decisions regarding required disclosure.
Management's Report on Internal Control Over Financial Reporting
The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company's internal control over financial reporting is a process designed under the supervision of the chief executive officer and chief financial officer and effected by the Board of Directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. The Company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
As of December 31, 2008, management conducted an assessment of the effectiveness of the Company's internal control over financial reporting based on the framework established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Based on its evaluation in relation to the criteria established in Internal ControlIntegrated Framework , management concluded that the Company's internal control over financial reporting was effective as of December 31, 2008.
This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report.
226
Changes in Internal Control over Financial Reporting
There has been no change in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the Exchange Act) during the year ended December 31, 2008 that has materially affected, or that is reasonably likely to materially affect, the Company's internal control over financial reporting.
There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. The Company will continue to improve the design and effectiveness of its disclosure controls and procedures and internal control over financial reporting to the extent necessary in the future to provide management with timely access to such material information and to correct any deficiencies that may be discovered in the future.
None.
227
Item 10. Directors and Executive Officers of the Registrant.
Directors
On May 21, 2008, the Company's shareholders appointed twelve directors to serve until the later of the Company's next annual meeting of shareholders or until their successors have been duly elected and qualified. Upon resignation of some of the existing board members, new members were elected in special meetings of the Board of Directors of the Company on August 6, 2008 (Messrs Delouis and Piret), November 7, 2008 (Mr. Joly) and December 22, 2008 (Messrs Buysschaert and Poupelle), increasing the total number of directors to thirteen. Information about the directors as of December 31, 2008 is set forth below and in "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersDirectors and Executive Officers."
Robert P. Cochran
|
Chairman of the Board of Directors of the Company since November 1997, and Chief Executive Officer and a Director of the Company since August 1990. Mr. Cochran served as President of the Company and FSA from August 1990 until November 1997. He has been Chief Executive Officer of FSA since August 1990, Chairman of FSA since July 1994, and a director of FSA since July 1988. Prior to joining the Company in 1985, Mr. Cochran was Managing Partner of the Washington, D.C. office of the Kutak Rock law firm. Mr. Cochran is a Director of White Mountains Insurance Group, Ltd. |
|
Michel Buysschaert
|
|
|
Michèle Colin
|
|
228
Robert N. Downey
|
|
|
John W. Everets
|
|
|
Alexandre Joly
|
|
229
Rembert von Lowis
|
|
|
Séan W. McCarthy
|
|
|
James H. Ozanne
|
|
230
Claude Piret
|
|
|
Pascal Poupelle
|
|
|
Roger K. Taylor
|
|
231
Xavier de Walque
|
|
Executive Officers of the Company
In addition to Messrs. Cochran and McCarthy (who are described above under the caption "Directors"), the Company's other executive officers are described below. The Company's executive officers consist of the members of the Executive Management Committee.
Name
|
Age | Position | ||
---|---|---|---|---|
Bruce E. Stern | 55 | Managing Director, General Counsel and Secretary of the Company and FSA; Director of FSA | ||
Joseph W. Simon |
|
50 |
|
Managing Director and Chief Financial Officer of the Company and FSA; Director of FSA |
Russell B. Brewer II |
|
52 |
|
Managing Director of the Company and FSA; Chief Risk Management Officer and Director of FSA |
The present principal occupation and five-year employment history of each of the above-named executive officers of the Company, as well as other directorships of corporations currently held by each such person, are set forth below.
Mr. Stern has been a Managing Director, the Secretary and the General Counsel of the Company since April 1993. Since April 1993, he has been the Secretary of FSA, and since March 1989, he has been a Managing Director of FSA. He has been a director of FSA since August 1990. Prior to joining FSA as General Counsel in 1987, Mr. Stern was an attorney with Cravath, Swaine & Moore.
Mr. Simon has been a Managing Director and the Chief Financial Officer of the Company and FSA since September 2002, having joined the Company in such capacity in April 2002. Prior to joining the Company, Mr. Simon was Chief Financial Officer of Intralinks, a technology company serving the financial markets. From 1993 to 1999, he was a senior financial officer, last serving as the Chief Financial Officer, of Cantor Fitzgerald. From 1986 to 1993 he was a senior member of Morgan Stanley's controller department. Mr. Simon, a certified public accountant, began his professional career at Price Waterhouse in 1983.
232
Mr. Brewer has been a Managing Director of FSA since March 1989 and the Chief Risk Management Officer of FSA since September 2003. Mr. Brewer was the Chief Underwriting Officer of FSA from September 1990 until September 2003. He has been a Managing Director of the Company since May 1999 and a director of FSA since September 1993. From March 1989 to August 1990, Mr. Brewer was Managing Director, Asset Finance Group, of FSA. Prior to joining FSA in 1986, Mr. Brewer was an Associate Director of Moody's Investors Service, Inc.
Audit Committee
The Company has a separately designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. During 2008, the Audit Committee consisted of Mr. Ozanne (Chairman), Mr. Everets and Mr. Taylor.
All members of the Audit Committee are independent within the meaning of Rule 10A-3(b)(1) of the Exchange Act. Because the Company has only debt securities listed on the NYSE, it is not subject to the additional independence standards for directors imposed by the NYSE.
The Board of Directors of the Company has determined that Audit Committee members James H. Ozanne and John W. Everets are audit committee financial experts as defined by item 407(d)(5) of Regulation S-K of the Exchange Act.
Code of Ethics
The Company has adopted a code of ethics for directors, officers (including the Company's principal executive officer, principal financial officer, and principal accounting officer and controller) and employees, known as the Code of Conduct. The Company has posted its Code of Conduct on its Internet website, www.fsa.com. The Company intends to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding amendments to, or waivers from, provisions of its code of ethics that applies to its principal executive officer, principal financial officer and principal accounting officer and controller, or persons performing similar functions, and that relates to any element of the code of ethics definition enumerated in paragraph (b) of Item 406 of Regulation S-K of the Exchange Act, by posting such information on its website, www.fsa.com.
Nomination of Directors
Holders of the Company's registered debt securities are not entitled to recommend nominees to the Company's Board of Directors.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16 of the Exchange Act requires periodic reporting by beneficial owners of more than 10% of any equity security registered under Section 12 of the Exchange Act and directors and executive officers of issuers of such equity securities. Upon its merger with a subsidiary of Dexia in July 2000, the Company's common stock ceased to be registered under Section 12 of the Exchange Act or listed on the NYSE. Consequently, the reporting obligations of Section 16 of the Exchange Act do not apply.
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Item 11. Executive Compensation.
Compensation Discussion and Analysis
The Company's compensation program was historically designed to attract, motivate and retain employees while, at the same time, aligning the interests of the Company's employees with those of the Company's shareholders. The Company's compensation program was established in substantially its current form in 1994, in connection with the initial public offering by the Company. When the Company was acquired by Dexia in 2000, the acquisition documents expressly provided for continuation of the Company's existing compensation program through 2004, with specified changes to the compensation program to reflect the fact that the Company's shares were no longer publicly traded. In 2004, the Human Resources Committee (the "HR Committee") of the Board of Directors of the Company reviewed the Company's compensation program with the advice of the HR Committee's independent compensation consultants, Hewitt Associates, and on the basis of that advice determined to continue the Company's compensation program with only minor changes, concluding that the existing program was successful in achieving its intended purposes. The proposed sale of the Company and the significant losses incurred by the Company in 2008 have had a material impact on the Company compensation program. Since the Company employed considerable performance based compensation for its senior management, 2008 compensation payouts were materially reduced, as was the value of outstanding vested and unvested equity based compensation awards.
Historical Compensation Philosophy
The objectives underlying the Company's compensation program historically included the following:
Non-GAAP Measures of Value Creation Underlying the Company's Compensation Program
The Company measures its overall success on the basis of a number of factors, including growth in adjusted book value ("ABV") per share, growth in book value per share (adjusted as described below), present value ("PV") financial guaranty originations, PV net interest margin ("PV NIM") and "operating earnings." ABV, PV financial guaranty originations, PV NIM and operating earnings are non-GAAP measures. Although measures identified as non-GAAP should not be considered substitutes for GAAP measures, management considers them key performance indicators and employs them in determining compensation. Non-GAAP measures therefore provide investors with important information about the way management analyzes its business and rewards performance.
ABV and book value growth are measures of value creation. ABV growth emphasizes new business production, since it captures the present value of insurance premiums and financial products net interest margin originated during a specified period. Book value growth, which emphasizes operating
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earnings, can be considerably more volatile than ABV growth, and will, for example, be more influenced by negative events such as increases in loss reserves. In applying these measures for compensation purposes, certain aspects of GAAP are eliminated that, in the view of management and the Board of Directors, distort the Company's economic results, most notably the impact of (i) marking to market investment grade FSA-insured credit default swaps under Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), (ii) not applying hedge accounting treatment for economic hedges under SFAS 133 and (iii) unrealized gains and losses on investments and liabilities. Growth in ABV and book value are applied on a per share basis. In order to incentivize management to return capital to the Company's shareholders to the extent such capital is not being deployed, the calculation of the rate of growth per share is adjusted to offset the effects of dividends and capital contributions, which do not affect the number of shares outstanding.
For a discussion of the non-GAAP measures PV financial guaranty originations and PV NIM originated for the FP segment, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsExecutive OverviewNew Business Production."
Adjusted Book Value
To calculate ABV, the following adjustments, on an after-tax basis, are made to book value:
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ABV is reconciled to book value in the table that follows.
Reconciliation of Book Value to Non-GAAP Adjusted Book Value
|
At December 31, | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||||
|
(in millions)
|
||||||||
Shareholders' equity (GAAP) |
$ | (5,184.5 | ) | $ | 1,577.8 | ||||
After-tax adjustments: |
|||||||||
Plus net unearned financial guaranty revenues |
2,061.5 | 1,788.3 | |||||||
Plus PV outstanding(1) |
1,062.0 | 1,319.7 | |||||||
Less net deferred acquisition costs |
299.3 | 347.9 | |||||||
Less fair-value adjustments for credit derivatives in insured portfolio |
(1,105.0 | ) | (553.4 | ) | |||||
Less fair-value adjustments attributable to the Company's own credit risk |
1,522.3 | | |||||||
Less fair-value adjustments for instruments with economically hedged risks |
(220.5 | ) | 130.7 | ||||||
Less fair-value adjustments and amortization attributable to non-economic impairment charges |
(7,803.5 | ) | | ||||||
Less unrealized gains (losses) on investments |
(106.3 | ) | (1,305.3 | ) | |||||
Less other |
(7.7 | ) | | ||||||
Less taxes |
1,455.2 | 1,570.8 | |||||||
Subtotal |
3,905.2 | 4,495.1 | |||||||
IFRS adjustments |
0.6 | 0.2 | |||||||
Adjusted book value |
$ | 3,905.8 | $ | 4,495.3 | |||||
Management considers ABV an operating measure of the Company's intrinsic value. Book value includes an estimate of loss for all insured risks made at the time of contract origination. ABV adds back certain GAAP liabilities and deducts certain GAAP assets (adjustments 1, 4, 5, 6, 7 and 8 in the calculation above), and also captures the estimated value of future contractual cash flows related to transactions in force as of the balance sheet date (adjustments 2 and 3 in the calculation above) because installment payment contracts, whether in the form of future premiums or future NIM, are generally non-cancelable and represent a claim to future cash flows. ABV also reflects certain IFRS adjustments in order to better align the interests of employees with the interests of Dexia, the Company's principal shareholder, whose accounts are maintained under IFRS. An investor attempting to evaluate the Company using GAAP measures alone would not have the benefit of this information. In addition, investors may consider the growth of ABV to be a performance measure indicating the degree to which management has succeeded in building a reliable source of future earnings. The Company's compensation formulas are based, in part, on the ABV growth rate.
The ABV metric has certain limitations. It reflects the accelerated realization of certain assets and liabilities through equity, and relies on an estimate of the amount and timing of receipt of installment premiums and credit derivative fees and future NIM. Actual installment premium and credit derivative receipts could vary from the estimate due to differences between actual and estimated insured debt balances outstanding and foreign exchange rate fluctuations. Actual NIM results could vary from the amount estimated based on changes in expected lives of assets and variances in the actual timing and amount of repayment associated with flexible-draw GICs that the Company issues. ABV excludes the
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fair-value adjustments deemed non-economic because they are expected to sum to zero over the lives of the related contracts.
Adjustments 1, 2 and 3 above represent the sum of cumulative years' reported PV financial guaranty originations and PV NIM originated, as described below, less what has been earned or adjusted due to changes in estimates as described above. Installment payment contracts, whether in the form of premiums, credit derivatives or NIM, are generally non-cancelable by the Company and represent a claim to future cash flows. Therefore, management includes these amounts in its estimate of ABV. PV NIM outstanding is adjusted for management's estimate of transaction and hedging related costs. Adjustments 1 and 2 in the calculation of ABV represent unearned financial guaranty revenues that have been collected and the Company's best estimate of the present value of its future installments (comprising current- and prior-period originations that have not yet been earned). Debt schedules related to installment transactions can change from time to time. Critical assumptions underlying adjustment 2 are discussed below under "Present Value Financial Guaranty Originations."
The Company calculates PV NIM originated because net interest income and net interest expense reflected in the consolidated statements of operations and comprehensive income are limited to current-period earnings. The Company's future positive interest rate spread from outstanding FP segment business (adjustment 3) can be estimated and generally relates to contracts or security instruments that are expected to be held for multiple years. Management therefore includes the present value of the expected economic effect in ABV as another element of intrinsic value not found in GAAP book value.
Adjustment 4 reflects the realization of costs deferred and associated with premium originated.
Adjustments 5 through 8 reflect the effect of certain items excluded from operating earnings, as described below, and ABV because, absent credit impairment that would cause a payment under the contract, these fair value adjustments will sum to zero over time. Any credit impairments, defined as the present value of estimated economic losses, would be included in operating earnings and ABV. ABV and operating earnings drive management compensation payouts. As the Company's objective is to optimize long-term stable growth in economic value, management generally seeks to minimize turnover and therefore any unrealized gain or loss, unless economic, is subtracted from book value to exclude it from the ABV metric. In the event that an investment is liquidated prior to its maturity, any related gain or loss is reflected in both earnings and ABV without further adjustment.
Adjustment 9 reflects IFRS adjustments, which are differences that relate primarily to foreign exchange gains or losses related to foreign-denominated investments and to contingencies and certain fair-value adjustments.
Operating Earnings
The Company defines operating earnings as net income excluding the effects of fair-value adjustments considered to be non-economic and, beginning in 2008, IFRS adjustments. IFRS is the basis of accounting used by Dexia and is the basis on which all of FSA's compensation plans are referenced in 2008 and forward. The fair-value adjustments excluded from operating earnings are itemized below.
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Operating earnings (losses) are reconciled to net income (loss) as follows:
Reconciliation of Net Income (Loss) to Non-GAAP Operating Earnings (Losses)
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in millions)
|
||||||||||
Net income (loss) |
$ | (8,443.2 | ) | $ | (65.7 | ) | $ | 424.2 | |||
Less non-economic adjustments: |
|||||||||||
Fair-value adjustments for instruments with economically hedged risks(1) |
(149.0 | ) | (39.9 | ) | 62.3 | ||||||
Fair-value adjustments for credit derivatives in insured portfolio |
(592.6 | ) | (642.6 | ) | 31.8 | ||||||
Fair-value adjustments attributable to the Company's own credit risk(2) |
1,477.2 | | | ||||||||
Fair-value adjustments and amortization attributable to impairment charges |
(7,808.0 | ) | | | |||||||
Other |
(7.7 | ) | | | |||||||
Tax (provision) benefit |
253.7 | 238.8 | (32.9 | ) | |||||||
Subtotal |
(1,616.8 | ) | 378.0 | 363.0 | |||||||
IFRS adjustments |
(24.9 | ) | 4.5 | 19.0 | |||||||
Operating earnings (losses) |
$ | (1,641.7 | ) | $ | 382.5 | $ | 382.0 | ||||
Pre-tax Fair-Value Adjustments for Instruments with Economically Hedged Risks
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in millions)
|
||||||||||
Fair-value adjustment for instruments with economically hedged risks |
$ | (149.0 | ) | $ | (39.9 | ) | $ | 10.3 | |||
VIE minority interest |
| | 52.0 | ||||||||
Total fair-value adjustments for instruments with economically hedged risks |
$ | (149.0 | ) | $ | (39.9 | ) | $ | 62.3 | |||
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Components of Compensation Provided by the Company
The Company's compensation program in 2008 included the following basic elements (described in more detail below): (i) salary; (ii) cash bonus; (iii) equity compensation in the form of performance share units under the Company's 2004 Equity Compensation Plan (the "2004 Equity Plan"); (iv) health and other customary benefit plans; and (v) optional participation in Employee Share Plans sponsored by Dexia. In addition, the Company has employment agreements with its two most senior executive officers. For the more highly compensated employees within the Company, equity compensation historically represented the largest component of compensation, followed by cash bonus and salary.
Salaries
Employee salaries are generally established on the basis of competitive market standards, and are thereafter generally changed to reflect cost of living adjustments and changes in responsibility.
Cash Bonuses
Cash bonuses are paid on an annual basis out of a bonus pool (the "Bonus Pool") determined pursuant to a guideline formula intended to provide employees with a percentage of the growth in value in the Company during the preceding calendar year. In 2008, the Company experienced significant losses and did not experience a growth in value. Therefore, the guideline Bonus Pool for bonuses in respect of 2008 was $0. However, in establishing the Bonus Pool guideline, the HR Committee recognized that non-distributed Bonus Pool amounts from prior years may to a limited extent be accumulated and memorialized in future years as a "Rainy Day Fund" that would be available in subsequent years to fund bonus payments to employees in excess of the guideline Bonus Pool. The Committee also recognized that adjustments to the Bonus Pool guideline may be recommended by management, subject to approval of the HR Committee, to reflect changes in circumstances. Notwithstanding the Bonus Pool guideline, bonuses remain within the discretion of the HR Committee, except insofar as otherwise provided in the Company's employment agreements. Specifically, aggregate bonuses in any year may be more or less than the guideline Bonus Pool for that year, and individual employee bonuses are not directly tied to the guideline Bonus Pool, except insofar as provided in the Company's employment agreements. The HR Committee did not award a 2008 bonus to Mr. Cochran or Mr. McCarthy. The HR Committee determined that it was appropriate to award bonuses to the other members of the Executive Management Committee contingent on the closing of the sale to Assured in reduced amounts as compared to their 2007 bonuses.
The current Bonus Pool guideline operates as follows. The guideline provides for an annual Bonus Pool equal to a predetermined percentage (the "Specified Percentage") of the increase in ABV of the Company during the applicable year (as derived from the Company's IFRS financial statements), excluding unrealized gains and losses on investments, net of tax, and excluding the mark-to-market, net of tax, of investment grade credit derivatives, but including a transaction return on equity ("Transaction ROE") modifier described below. ABV growth is considered by management and the HR Committee as a proxy for value creation. For the 2004 Bonus Pool, the HR Committee set the Specified Percentage at 11.25%. The increase in ABV during the applicable year is equal to (a) the percentage growth in ABV per share during such year, with credit given for dividends paid, multiplied by (b) ABV as of the beginning of such year.
The HR Committee retained the right to evaluate the Bonus Pool formula annually; however, the intent was to maintain the Bonus Pool formula as long as practicable to promote stability. Since 2004, the Specified Percentage remained unchanged until February 2008, when the HR Committee reduced the Specified Percentage to 9.5%, since the Company's larger than anticipated ABV growth in recent years had been disproportionate with the growth in the number of employees and their compensation
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requirements. The revised Specified Percentage would have generated a 2007 guideline bonus pool approximately equal to the guideline Bonus Pool actually distributed in 2008 in respect of 2007.
The Transaction ROE modifier adjusts downward the percentage growth in ABV per share if the Transaction ROE achieved in the aggregate for all transactions insured during the applicable year (the "Actual Average Transaction ROE") is less than the "Target Transaction ROE," with a maximum adjustment of 2%. The Actual Average Transaction ROE is a measure of the return on equity expected from transactions insured and GICs written by the Company during a specified period, based upon the Company's internal proprietary capital model. The "Target Transaction ROE" equals the after-tax book yield on the Company's investment portfolio (excluding the investment portfolios for financial products, variable interest entities and refinanced transactions) (determined as of the December 31 immediately preceding the compensation year) plus 9%, with a maximum Target Transaction ROE of 15%. In the event that the Actual Average Transaction ROE is less than the Target Transaction ROE for any year, then percentage growth in ABV per share for such year is reduced by an amount equal to one half the excess of the Target Transaction ROE (expressed as a percentage) over the Actual Average Transaction ROE (expressed as a percentage), subject to a maximum reduction of 2%. The Transaction ROE modifier was intended to motivate management to use the Company's capital prudently in building ABV per share. At the time of establishing the 9% figure, the HR Committee concluded that 9% over the Company's insurance company investment portfolio yield represented a reasonable target for aggregate transaction returns under the Company's internal capital model based upon the historical performance of the Company and its industry peers.
Amounts of the Bonus Pool in respect of any year, determined as provided above, that are not distributed to employees for that year are credited, but not accrued for accounting purposes, to a "Rainy Day Fund" that will be available in subsequent years to fund bonus payments to employees in excess of the Bonus Pool determined as provided above, provided that the Rainy Day Fund may not exceed an amount equal to $25.0 million, adjusted to reflect increases in the Consumer Price Index from and after January 1, 2005. The Rainy Day Fund concept was employed to allow management to "save" Bonus Pool allocations for future years when the formula dictates a reduced Bonus Pool although staff retention and other considerations might support larger bonuses than the formula would dictate. At December 31, 2008, the Rainy Day Fund balance was $28 million. Neither the Rainy Day Fund nor the guideline Bonus Pool, however, provides any entitlement to employees, since the HR Committee retains full discretion to award or decline to award bonuses, subject, in the case of the Chief Executive Officer and the President, to provisions of their employment agreements with the Company. Prior to payment of 2008 bonuses discussed below, the Rainy Day Fund had not been used to supplement the guideline Bonus Pool for any year.
In January 2006, the HR Committee decided that determinations under the Bonus Pool Guideline would be made in accordance with IFRS rather than GAAP, subject to the HR Committee's obligation to make adjustments to reflect a change in, or a change in the interpretation or application by the Company of, such accounting principles to preserve the value of the Bonus Pool consistent with the intent that such value should reflect true economic financial performance of the Company, with any such adjustment determined by the HR Committee (or, if any director objects to any such adjustment, by the Board of Directors of the Company). IFRS was chosen in order to better align the interests of employees with the interests of Dexia, the Company's principal shareholder, whose accounts are maintained under IFRS.
Section 404 of the Sarbanes-Oxley Act of 2002 ("SOX Section 404") provides that if the Company must prepare an accounting restatement due to the Company's material noncompliance, as a result of misconduct, with any financial reporting requirement under the securities laws, the principal executive and financial officers must reimburse the Company for any bonus or other incentive-based or equity-based compensation received from the Company during the 12-month period following the first public issuance or filing with the SEC of the financial document embodying the financial reporting
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requirement, and any profits realized from the sale of securities of the Company during that 12-month period. The Company does not have any other express policy regarding the adjustment or recovery of bonuses if the relevant Company performance measures upon which the guideline Bonus Pool is based are restated or otherwise adjusted following the bonus payment date in a manner that would reduce the size of the guideline Bonus Pool.
Performance Share Units
The 2004 Equity Plan provides for awards of performance share units, which represent awards of both performance shares and shares of Dexia restricted stock. The Company has employed performance shares as its principal form of equity compensation since implementation by the Company of its 1993 Equity Participation Plan (the "1993 Equity Plan") in connection with its 1994 initial public offering. In 2004, the Company adopted the 2004 Equity Plan to replace the 1993 Equity Plan and ceased making further awards under the 1993 Equity Plan. The 2004 Equity Plan added Dexia restricted stock as a component of equity awards in order to further align the interests of the Company's employees with its parent, and to give Company employees a greater sense of membership in the Dexia group. The 2004 Equity Plan also provides that book value measurements employed in valuing performance shares are determined in accordance with IFRS, whereas valuations under the 1993 Equity Plan were in accordance with GAAP. Again, IFRS was chosen in order to better align the interests of employees with the interests of the Company's parent, whose accounts are maintained under IFRS.
Performance share units awarded under the 2004 Equity Plan are comprised 90% of performance shares and 10% of Dexia restricted stock. Specifically, in order to determine the number of shares of Dexia restricted stock allocable to an award of performance share units, the recipient receives the number of Dexia shares that can be purchased with the proceeds of 10% of the units. For these purposes, the Dexia shares are valued at a purchase price per share historically equal to the average cost in dollars paid by the Company to acquire such shares, and each unit is given the value of one outstanding share of the Company's common stock valued as of the preceding year-end, as described below with respect to performance shares. Historically, performance share units have been awarded to Company employees in the first calendar quarter of each year and no more frequently than once per calendar year. The HR Committee has not awarded performance share units or performance shares in 2009 to date. Performance share units that were awarded in 2008 are described in the Company's 2007 Annual Report on Form 10-K.
Performance Shares. Performance shares are designed to provide recipients with an interest in the growth in value of the Company's shares during specified performance cycles. Performance shares have generally been awarded on the basis of two sequential three-year performance cycles, with 1 / 3 of each award allocated to the first cycle and 2 / 3 of each award allocated to the second cycle. For example, an award of 300 performance shares made in 2008 represents 100 performance shares allocated to the 2008/2009/2010 performance cycle and 200 performance shares allocated to the 2009/2010/2011 performance cycle. The length of the cycles are intended to provide employees with a "longer term" view of the Company's financial performance and to provide the Company with retentive value insofar as employees generally forfeit performance share awards should they voluntarily terminate employment with the Company prior to the completion of the related performance cycle.
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Each performance share represents a right to receive up to two shares of the Company's common stock (or the cash value thereof), with the actual number of common shares receivable determined on the basis of the change in ABV and book value per share over a specified performance cycle. The performance shares were designed to provide less compensation to participants than stock options if the Company performs poorly and more compensation to participants if the Company performs well. In particular, the performance shares were designed to have no value if the Company fails to generate growth in "value" per share in excess of 7%, which at the time of initial program implementation was a proxy for the risk-free yield on treasury securities. The actual dollar value received by a holder of performance shares, in general, varies in accordance with the annualized rate of ABV growth and book value growth per share (the "Internal Rate of Return" or "IRR") of the Company's common stock during an applicable "performance cycle" and the estimated value of the common stock at the time of payout of such performance shares.
For purposes of the foregoing, ABV per share and book value per share are adjusted to exclude the after-tax change in "accumulated other comprehensive income" and any mark-to-market adjustments on investment grade CDS and economic interest rate hedges. Accumulated other comprehensive income includes, for example, unrealized gains and losses in the Company's investment portfolio. Specifically,
If the IRR is between 7% and 19%, the payout percentage is interpolated. The median IRR allowing for a 100% payout was set at 13%, which was considered reasonably acceptable Company performance.
So long as the Company's common stock is not publicly traded, the Company expects to pay amounts due under performance share awards (if any) in cash rather than stock, with shares having a value (the "Share Value") equal to the greater of:
The 1.15 times ABV and 14 times operating earnings multiples were based upon the multiples of ABV and operating earnings prevailing in the marketplace for the Company's industry peers when Dexia acquired the Company in 2000, representing a discount to the multiples (1.4676 times ABV and 17 times operating earnings) paid by Dexia when it acquired the Company in 2000. The 0.85 ABV floor in share value was intended to reflect a minimum value for shares in the face of an adverse earnings environment.
Except as otherwise provided in the employment agreements described below, performance shares (i) are generally forfeited in the event of a voluntary termination of employment prior to completion of the performance cycle; (ii) vest pro-rata in the event of termination without cause or retirement (generally at age 55 plus five years of service); (iii) vest fully in the event of death or disability; and (iv) vest fully in the event of termination without cause or constructive termination of employment following a "change in control."
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Since the inception of the 2004 Equity Plan, up to 3,300,000 shares of common stock have been available for distribution in respect of performance shares. Such shares may be newly issued shares, treasury shares or shares purchased in the open market. If performance shares awarded under the 2004 Equity Plan are forfeited, the shares allocated to such awards are again available for distribution in connection with future awards under the Plan.
Except as provided by SOX Section 404, the Company does not have any express policy regarding the adjustment or recovery of performance share payouts if the relevant Company performance measures upon which they are based are restated or otherwise adjusted following the payment date in a manner that would reduce the amount of a performance share payout.
Dexia Restricted Stock. Shares of Dexia restricted stock awarded under the 2004 Equity Plan represent ordinary shares of Dexia, including the right to receive dividends thereon. Dexia restricted stock associated with a performance share unit award is allocated (i) 1 / 3 to a 2.5-year vesting period and 3-year restricted period and (ii) 2 / 3 to a 3.5-year vesting period and 4-year restricted period. Except as otherwise provided in the employment agreements described below, unvested Dexia restricted stock (i) is generally forfeited in the event of a voluntary termination of employment prior to completion of the performance cycle; (ii) vests pro-rata in the event of termination without cause or eligibility for retirement (generally at age 55 plus five years of service); and (iii) vests in the event of death or disability. The restricted period (during which Dexia restricted stock may not be traded) lapses six months after vesting. Short sales of Dexia stock by any Company employee are prohibited as a matter of corporate policy, absent prior approval of the Company's Executive Management Committee.
Benefit Plans and Programs
Benefit plans and programs generally available at the Company for all full time U.S. resident employees are, for the most part, customary in nature, and include:
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The Company also maintains "top hat" plans, which are unfunded and unsecured non-qualified plans restricted under the tax laws to a limited number of highly compensated employees, and consist of
The Company maintains two SERPs and two DCPs due to tax law changes adopted in 2004 under Section 409A of the Internal Revenue Code with respect to "deferred compensation arrangements." The Company adopted a new SERP and new DCP in 2004 that conform with the 2004 tax law requirements to receive all new contributions, while the pre-existing SERP and DCP were "grandfathered" under the pre-existing tax law but were closed to further contributions. The pre-existing DCP was subsequently amended to conform to the new tax law. As described in more detail below, the Company maintains a separate severance plan for members of its Executive Management Committee and has employment agreements providing severance arrangements for its two most senior executive officers.
Different benefit plans and programs may apply to Company employees who are not United States residents.
Dexia Employee Share Plans
Company employees were historically entitled to participate in Employee Share Plans sponsored and funded by Dexia. Dexia did not offer an Employee Share Plan in 2008, but investments remain outstanding under Dexia Share Plans offered in prior years.
Under the Dexia Employee Share Plans, Company employees are generally entitled to invest up to 25% of their prior year compensation (comprised primarily of salary, bonus and performance share payout for such year) in Dexia shares subject to a 5-year minimum investment period (with specified rights to withdraw funds in the event of termination of employment or special circumstances). The investment alternatives include:
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Employment Agreements and Arrangements
Each of Messrs. Cochran and McCarthy entered into four-year employment agreements with the Company effective with the July 2000 acquisition of the Company by Dexia. Upon expiration of these initial agreements, each of Messrs. Cochran and McCarthy entered into similar employment agreements with the Company effective July 5, 2004, which agreements were amended January 1, 2005 and February 14, 2008 to address provisions of Section 409A of the Internal Revenue Code applicable to severance and other deferred compensation arrangements. Each of the employment agreements generally guaranteed continuation of compensation and benefits through December 31, 2007, and provides for extensions of their initial term for two-year terms, subject to notice of termination from either party at least six months prior to the end of the expiring term. These agreements were automatically extended in accordance with their terms during 2007 and will expire on December 31, 2009 if notice of termination is provided on or prior to June 30, 2009 or will extend until December 31, 2011 if such notice is not provided. At any point after the initial term has expired, Mr. Cochran may elect to become Non-Executive Chairman of the Company for the remainder of the term and any extensions.
Under the agreements, compensation consists of:
Their employment agreements provide that Messrs. Cochran and McCarthy are entitled to receive an annual cash bonus equal to at least 5.0% and 4.0%, respectively, of the Company's annual Bonus Pool. The employment agreements provide that an additional 2.0% of the annual Bonus Pool will be allocated among those two executive officers as determined by the HR Committee.
For a discussion of the terms of the employment agreements relating to payments to Messrs. Cochran and McCarthy at, following or in connection with any termination of employment with the Company, retirement or change in control of the Company, see "Potential Payments Upon Termination of Employment, Retirement or Change-in-Control."
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Tax and Accounting Considerations Bearing on the Company's Compensation Program
The Company designed performance shares so that the cost to the Company is fully expensed, based upon the principal that fully expensed compensation properly reflects the financial performance of the Company, while noting that such treatment puts the Company at a disadvantage in comparing its financial results to those of its industry peers that employ stock options or other equity compensation that is not fully expensed. The Company designed Dexia restricted stock awarded under the 2004 Equity Plan to qualify as equity (as opposed to liability) awards under Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123-R"). The Company is not subject to Section 162(m) of the Internal Revenue Code, which limits the deductibility of non-performance based compensation paid to executives of corporations having common equity securities required to be registered under Section 12 of the Exchange Act. The Company's various benefit programs described above are intended to comply with applicable tax requirements, including Section 409A of the Internal Revenue Code governing deferred compensation arrangements.
Purchase Agreement Provisions Bearing on the 2008 Compensation Process
The Purchase Agreement providing for the sale of the Company to Assured provides a number of provisions bearing on the Company's 2008 compensation process. The Purchase Agreement imposes restrictions on the Company doing any of the following without Assured's consent:
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Purchase Agreement Provisions Bearing on the Post-Closing Compensation Matters
The Purchase Agreement includes provisions bearing on compensation of Company employees post-closing, including the following:
The Company's 2008 Compensation Process
The HR Committee determines the compensation of the Chief Executive Officer and the Chief Operating Officer and reviews and approves management's compensation recommendations for other employees of the Company. In December 2008, four additional directors designated by Dexia were appointed to the HR Committee. Following the appointment of the new HR Committee members, the HR Committee was comprised of Messrs. Downey (Chairman), Cochran, Taylor, Joly, Buysschaert, Piret and Poupelle. Mr. Cochran recuses himself from HR Committee deliberations concerning his own compensation.
Historically, the HR Committee engaged compensation consultants to review market compensation levels. Johnson Associates, Inc. ("Johnson Associates") prepared a report for the HR Committee in connection with compensation decisions made in February 2008, as described in the Company's Annual Report on Form 10-K for 2007. Johnson Associates did not provide a similar report in connection with the HR Committee's compensation decisions made in January and February 2009 with respect to 2008 bonuses and 2009 salaries and performance share unit awards, since these decisions were made under unique circumstances for the Company, and were subject to the constraints and requirements applicable to the Company's compensation provided by the Purchase Agreement.
The Company's Executive Management Committee (comprised of Messrs. Cochran, McCarthy, Brewer, Stern and Simon) provides input to the Human Resources Committee on compensation matters. Generally, managers within the Company prepared compensation recommendations of year-end bonuses, new year salaries and new year performance share unit awards for employees under their supervision, in what management characterized as a "bottom-up" compensation process, with
247
initial compensation recommendations originating from lower levels of management. This process was not followed in arriving at 2008 bonuses, 2009 salaries and 2009 performance share unit awards. For 2008 bonus determinations, the Company's Executive Management Committee prepared recommendations taking into account the requirements of the Purchase Agreement. Specifically, the Purchase Agreement allowed for customary salary increases and a 2008 bonus pool of up to $28 million, which was based upon the "Rainy Day Fund" established under the Company's bonus guideline. Given the performance-based parameters of the Company's bonus guideline, adverse 2008 financial performance eliminated the guideline Bonus Pool but allowed for a "Rainy Day Fund" bonus pool comprised, as described above, of non-distributed amounts from prior year guideline bonus pools. The Rainy Day Fund bonus pool allowed at best for significantly reduced cash bonuses compared to prior years. The Executive Management Committee recommended a distribution of substantially the entire Rainy Day Fund bonus pool to employees of the Company (excluding the Executive Management Committee), and thereafter obtained an understanding, agreed by Assured, that up to an additional $3 million was available for bonuses to Executive Management Committee members to the extent that the HR Committee approved such bonuses. The HR Committee approved 2008 bonuses at its January 2009 meeting. 2008 bonus payouts for the named executive officers are described under "Summary Compensation TableDiscussion of 2008 Compensation for the Named Executive Officers2008 Cash Bonuses."
At its January 2009 meeting, the HR Committee was provided with (i) the 2008 bonus and 2009 salary recommendations for Company employees (other than members of the Executive Management Committee); (ii) the Chief Executive Officer's recommendation of compensation for the Company's General Counsel and Chief Financial Officer and advice with respect to compensation of the Company's Chief Risk Management Officer and Chief Operating Officer; and (iii) the provisions of the Company's employment agreements with the Chief Executive Officer and Chief Operating Officer with respect to their entitlements for salary, bonus and performance share awards. On the basis of the foregoing, the HR Committee approved 2008 bonuses and 2009 salaries for employees of the Company, and declined to award performance share units or performance shares, as discussed in further detail below.
Compensation Committee Report
The HR Committee has reviewed and discussed with management the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K. Based on such review and discussions, the HR Committee recommended to the Board of Directors of the Company that the Compensation Discussion and Analysis be included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.
Robert N. Downey (Chairman)
Michel Buysschaert Robert P. Cochran Alexandre Joly Claude Piret Pascal Poupelle Roger K. Taylor |
248
The table below sets forth a summary of all compensation paid to the chief executive officer, the principal financial officer and the three most highly compensated other executive officers of the Company, in each case for services rendered in all capacities to the Company for the three years ended December 31, 2008, 2007 and 2006.
2008 Summary Compensation Table(1)
Name and Principal Position
|
Year | Salary | Bonus(2) |
Stock
Awards(3) |
Nonqualified
Deferred Compensation Earnings(4) |
All Other
Compensation(5) |
Total | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Robert P. Cochran
|
2008
2007 2006 |
$
|
500,000
500,000 500,000 |
$
|
3,600,000 3,300,000 |
$
|
(6,450,107
8,754,952 6,721,121 |
)
|
$
|
1,039,410 491,881 |
$
|
169,862
547,451 357,889 |
(6)
(6) (6) |
$
|
(5,780,245
14,441,813 11,370,891 |
)
|
||||||
Séan W. McCarthy
|
2008 2007 2006 |
350,000 340,000 330,000 |
3,300,000 3,000,000 |
(4,723,999 6,442,752 4,773,490 |
) |
317,773 150,380 |
171,523 135,159 116,162 |
(4,202,476 10,535,684 8,370,032 |
) |
|||||||||||||
Bruce E. Stern
|
2008 2007 2006 |
280,000 270,000 260,000 |
500,000 1,000,000 900,000 |
(1,702,304 2,283,763 1,738,733 |
) |
|
117,380 106,063 99,419 |
(804,924 3,659,826 2,998,152 |
) |
|||||||||||||
Joseph W. Simon
|
2008 2007 2006 |
280,000 270,000 260,000 |
500,000 1,000,000 900,000 |
(1,616,317 2,031,984 1,255,879 |
) |
|
116,829 105,440 98,895 |
(719,488 3,407,424 2,514,774 |
) |
|||||||||||||
Russell B. Brewer II
|
2008 2007 2006 |
280,000 270,000 260,000 |
300,000 1,200,000 900,000 |
(1,697,510 2,283,763 1,738,733 |
) |
|
118,330 106,063 99,419 |
(999,180 3,859,826 2,998,152 |
) |
249
covered by the table. Amounts included under this column are attributable to performance shares and Dexia restricted stock as set forth below:
Name
|
Year |
Performance
Share Compensation |
Dexia Restricted
Stock Compensation |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
Robert P. Cochran |
2008
2007 2006 |
$
|
(6,931,835
8,324,185 6,427,750 |
)
|
$
|
481,728
430,767 293,371 |
||||
Séan W. McCarthy |
2008 2007 2006 |
(5,121,264 6,121,443 4,557,777 |
) |
397,264 321,309 215,713 |
||||||
Bruce E. Stern |
2008 2007 2006 |
(1,834,898 2,169,737 1,661,075 |
) |
132,594 114,026 77,658 |
||||||
Joseph W. Simon |
2008 2007 2006 |
(1,747,631 1,921,422 1,182,648 |
) |
131,314 110,562 73,231 |
||||||
Russell B. Brewer II |
2008 2007 2006 |
(1,834,898 2,169,737 1,661,075 |
) |
137,387 114,026 77,658 |
250
Name
|
Year | Pension Plan | SERPs | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Robert P. Cochran |
2008
2007 2006 |
$
|
20,700
20,250 19,800 |
$
|
69,300
69,750 70,200 |
|||||
Séan W. McCarthy |
2008 2007 2006 |
20,700 20,250 19,800 |
69,300 69,750 70,200 |
|||||||
Bruce E. Stern |
2008 2007 2006 |
20,700 20,250 19,800 |
69,300 69,750 70,200 |
|||||||
Joseph W. Simon |
2008 2007 2006 |
20,700 20,250 19,800 |
69,300 69,750 70,200 |
|||||||
Russell B. Brewer II |
2008 2007 2006 |
20,700 20,250 19,800 |
69,300 69,750 70,200 |
Pension Plan and SERP amounts shown were accrued during 2007 and 2008 and paid in February of 2008 and 2009, respectively. The Pension Plan provides for a Company funded contribution equal to 9% of cash compensation (salary and bonus) up to the compensation limit specified by the Internal Revenue Service. The SERPs provide for an unfunded Company contribution equal to 9% of cash compensation over and above the Pension Plan compensation limit but limited to $1.0 million of compensation. The Pension Plan and SERPs provide for vesting of contributions over a six-year employment period, after which all subsequent contributions are 100% vested. Given the tenure with the Company of the named executive officers, all contributions to the Pension Plan and SERPs on behalf of the named executive officers are fully vested when made.
251
All other compensation includes dividends on unvested shares of Dexia restricted stock paid (without adjustment for withholding taxes) by Dexia during 2006, 2007 and 2008 in the amounts set forth below:
Name
|
Year |
Dollar Value of
Dividends |
|||||
---|---|---|---|---|---|---|---|
Robert P. Cochran |
2008
2007 2006 |
$
|
79,862
40,126 26,930 |
||||
Séan W. McCarthy |
2008 2007 2006 |
81,523 45,159 26,162 |
|||||
Bruce E. Stern |
2008 2007 2006 |
27,380 16,063 9,419 |
|||||
Joseph W. Simon |
2008 2007 2006 |
26,829 15,440 8,895 |
|||||
Russell B. Brewer II |
2008 2007 2006 |
28,330 16,063 9,419 |
All other compensation does not include the dollar value of the Company's Travel Incentive Program, Transit Chek Program, Health Club Program or group life, health, hospitalization and medical reimbursement plans that do not discriminate in scope, terms or operation in favor of the named executive officers and that are available generally to all salaried employees. All other compensation also does not include payments contributed under the Company's Matching Gift Program. Neither Mr. Cochran nor Mr. McCarthy receive additional compensation for their services as directors of the Company, although such service entitles them to participate in the Director Share Purchase Program described below.
252
Performance shares generally vest upon completion of the related 3-year performance cycle. The dollar value of performance share awards reported in the Summary Compensation Table for 2006, 2007 and 2008 vest as follows, absent termination of employment, death or retirement:
Name
|
Year | 2006 | 2007 | 2008 | 2009 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Robert P. Cochran |
2008
2007 2006 |
$
|
2,909,760 |
$
|
3,003,390 2,013,487 |
$
|
(6,931,835)
2,839,552 1,504,503 |
(1)
|
$
|
2,481,243 |
||||||
Séan W. McCarthy |
2008 2007 2006 |
1,986,263 |
2,184,768 1,465,261 |
(5,121,264) 2,087,906 1,106,253 |
(1) |
1,848,769 |
||||||||||
Bruce E. Stern |
2008 2007 2006 |
751,619 |
761,291 511,206 |
(1,834,898) 751,646 398,250 |
(1) |
656,799 |
||||||||||
Joseph W. Simon |
2008 2007 2006 |
429,418 |
568,413 384,479 |
(1,747,631) 696,210 368,751 |
(1) |
656,799 |
||||||||||
Russell B. Brewer II |
2008 2007 2006 |
751,619 |
761,291 511,206 |
(1,834,898) 751,646 398,250 |
(1) |
656,799 |
Generally, one third of a Dexia restricted stock award vests after 2.5 years and two thirds vests after 3.5 years, with transfer restrictions lapsing six months after the vesting date. The 2004 Equity Plan provides that, when a participant becomes eligible for retirement at age 55, shares of Dexia restricted stock vest thereafter to the extent the shares would have vested had the employee actually retired. Commencing in 2007, however, an exception to this general provision was adopted providing for delayed vesting for any employee over the age of 55 who is not entitled to retire pursuant to the terms of an employment agreement with the Company, as is the case with Mr. Cochran. Prior to adoption of this exception, shares of Dexia restricted stock held by Mr. Cochran vested in 2006 as set forth in the table below. The dollar value of Dexia restricted stock reported in the Summary Compensation Table
253
for 2006, 2007 and 2008 for Messrs. Cochran, McCarthy, Brewer, Stern and Simon have vested or will vest as follows, absent termination of employment, death or retirement:
Name
|
Year | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Robert P. Cochran |
2008
2007 2006 |
$
|
293,371 |
$
|
30,782 |
$
|
76,188
152,375 |
$
|
405,541
247,610 |
$
|
|
$
|
|
|||||||||
Séan W. McCarthy |
2008 2007 2006 |
|
22,634 36,923 |
56,020 112,040 108,827 |
121,547 117,077 69,963 |
135,441 69,558 |
84,256 |
|||||||||||||||
Bruce E. Stern |
2008 2007 2006 |
|
8,148 13,292 |
20,167 40,335 39,178 |
112,426 65,543 25,188 |
|
|
|||||||||||||||
Joseph W. Simon |
2008 2007 2006 |
|
7,244 11,817 |
18,888 37,775 36,226 |
43,014 41,467 25,188 |
44,134 24,076 |
25,278 |
|||||||||||||||
Russell B. Brewer II |
2008 2007 2006 |
|
8,148 13,292 |
20,167 40,335 39,178 |
43,014 41,467 25,188 |
74,206 24,076 |
|
Discussion of 2008 Compensation for the Named Executive Officers
Set forth below is a discussion of the 2008 bonuses and 2009 salaries for the named executive officers. For the Chief Executive Officer and the President, these amounts were determined with reference to their agreements with the Company, about which there is a dispute. The compensation of the General Counsel, Chief Risk Management Officer and Chief Financial Officer was determined on the premise that the services of these senior officers are required to effectuate a closing of the sale of the Company under the Purchase Agreement. The HR Committee of the Board of Directors accepted management's recommendations regarding compensation for employees (other than members of the Executive Management Committee) and the high end of the range of the Chief Executive Officer's recommendation regarding compensation of the General Counsel and Chief Financial Officer, but made payment of the 2008 bonuses for the General Counsel, the Chief Financial Officer and the Chief Risk Management Officer contingent upon a closing of the sale of the Company to Assured.
2009 Salaries
The named executive officers received salary increases for 2009 of 1.5%, representing 50% of the 3% salary increase provided to other Company employees, primarily representing cost of living adjustments.
Chief Executive Officer. The 2009 salary for the Company's Chief Executive Officer was set at $507,500, compared to a 2008 salary of $500,000, representing a 1.5% salary increase as awarded to other Executive Management Committee members as a cost of living increase. Under his employment agreement with the Company, Mr. Cochran is entitled to a base salary at the annual rate in effect immediately prior to the effective date of the agreement ($490,000), subject to increase at the Board's discretion.
Chief Operating Officer. The 2009 salary for the Company's Chief Operating Officer was set at $355,250 compared to a 2008 salary of $350,000, representing a 1.5% salary increase as awarded to other Executive Management Committee members as a cost of living increase. Under his employment agreement with the Company, Mr. McCarthy is entitled to a base salary at the annual rate in effect immediately prior to the effective date of the agreement ($300,000), subject to increase at the Board's discretion.
254
Chief Risk Management Officer, General Counsel and Chief Financial Officer. The 2009 salaries for the Company's Chief Risk Management Officer, General Counsel and Chief Financial Officer were set at $284,200 compared to 2008 salaries of $280,000, representing a 1.5% salary increase as awarded to other Executive Management Committee members as a cost of living increase.
2008 Cash Bonuses
Based on the Company's 2008 financial performance, under Company's Bonus Pool guideline the Bonus Pool for 2008 was $0. However, the "Rainy Day Fund," which totaled $28 million, was available to fund 2008 bonuses. The Purchase Agreement contemplated distribution of a 2008 bonus pool of up to $28 million absent approval from Assured. Assured consented to the distribution of up to an additional $3 million to fund 2008 bonuses to members of the Company's Executive Management Committee. The $28 million Rainy Day Fund bonus pool was significantly less than the 2007 guideline Bonus Pool of $79.5 million, of which $65.3 million was distributed, and the 2006 guideline Bonus Pool of $61.4 million, of which $57.3 million was distributed.
Chief Executive Officer and Chief Operating Officer. Neither Mr. Cochran nor Mr. McCarthy was awarded a bonus for 2008.
General Counsel, Chief Financial Officer and Chief Risk Management Officer. The 2008 bonus for each of Messrs. Stern and Simon was set at $500,000, a decrease from their 2007 bonuses of $1,000,000 each. The bonuses awarded to Messrs. Stern and Simon are contingent upon the closing of the sale of the Company to Assured, and were considered necessary by the HR Committee for retentive purposes. The 2008 bonus for Mr. Brewer was set at $300,000, a decrease from his 2007 bonus of $1,200,000, and is also contingent upon closing of the sale of the Company to Assured and was considered necessary for retentive purposes.
Performance Share Unit Awards
The HR Committee has not awarded performance share units or performance shares in 2009 to date. Performance share unit awards made in February 2008 are described in the Company's 2007 Annual Report on Form 10-K, including the Grants of Plan-Based Awards table. Because there have been no further awards since the previously reported awards granted in 2008, a Grants of Plan-Based Awards table is not included in this Annual Report.
The following table sets forth a summary of the outstanding unvested equity awards to each of the named executive officers as of December 31, 2008 (excluding awards vesting on such date and payable in February 2009).
255
Outstanding Equity Awards at 2008 Fiscal Year-End
Name
|
Number of
Performance Shares That Have Not Vested(1) |
Market Value of
Performance Shares That Have Not Vested(2) |
Equity Incentive
Plan Awards: Number of Shares of Dexia Restricted Stock That Have Not Vested(3) |
Equity Incentive
Plan Awards: Market Value of Dexia Restricted Stock That Have Not Vested(4) |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Robert P. Cochran |
78,000 | $ | | 46,346 | $ | 207,167 | |||||||
Séan W. McCarthy |
65,400 | | 42,605 | 190,446 | |||||||||
Bruce E. Stern |
21,600 | | 13,960 | 62,403 | |||||||||
Joseph W. Simon |
21,600 | | 13,960 | 62,403 | |||||||||
Russell B. Brewer II |
22,500 | | 14,625 | 65,375 |
Name
|
2009 | 2010 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Robert P. Cochran |
30,600 | 29,400 | 18,000 | |||||||
Séan W. McCarthy |
22,800 | 24,600 | 18,000 | |||||||
Bruce E. Stern |
8,100 | 8,100 | 5,400 | |||||||
Joseph W. Simon |
8,100 | 8,100 | 5,400 | |||||||
Russell B. Brewer II |
8,100 | 8,400 | 6,000 |
Name
|
2009 | 2010 | 2011 | |||||||
---|---|---|---|---|---|---|---|---|---|---|
Robert P. Cochran |
37,690 | 6,756 | 1,900 | |||||||
Séan W. McCarthy |
13,953 | 15,351 | 13,301 | |||||||
Bruce E. Stern |
11,421 | 1,969 | 570 | |||||||
Joseph W. Simon |
4,963 | 5,007 | 3,991 | |||||||
Russell B. Brewer II |
4,963 | 9,029 | 633 |
2006/2007/2008 Performance Share Payout
Performance Shares awarded under the 2004 Equity Plan with respect to the 2006/2007/2008 performance cycle ("2006/2007/2008 performance shares") vested in accordance with their award agreements on December 31, 2008 but there was no payout as they had no value due to the poor financial performance of the Company. The 2006/2007/2008 performance shares held by the named executive officers were awarded in February 2005 and February 2006, and disclosed in the Company's
256
Annual Reports on Form 10-K for the years ended December 31, 2004 and December 31, 2005, respectively.
Dexia Restricted Stock Vested During 2008
The following table sets forth a summary of Dexia Restricted Stock awarded to each of the named executive officers that vested during the year ended December 31, 2008:
Dexia Restricted Stock Vested During 2008
Name
|
Number of Shares
Acquired on Vesting |
Value Realized on
Vesting(1) |
|||||
---|---|---|---|---|---|---|---|
Robert P. Cochran(2) |
9,534 | $ | 152,544 | ||||
Séan W. McCarthy |
14,396 | 230,341 | |||||
Bruce E. Stern |
5,183 | 82,924 | |||||
Joseph W. Simon |
4,797 | 76,758 | |||||
Russell B. Brewer II |
5,183 | 82,924 |
Nonqualified Deferred Compensation
The following table sets forth a summary of information with respect to the Company's Deferred Compensation Plans (DCPs) and Supplemental Executive Retirement Plans (SERPs) as of and for the year ended December 31, 2008:
2008 Nonqualified Deferred Compensation
Name
|
Executive
Contributions in Last FY (DCPs)(1) |
Registrant
Contributions in Last FY (SERPs)(2) |
Aggregate
Earnings in Last FY |
Aggregate
Withdrawals/ Distributions in Last FY |
Aggregate
Balance at Last FYE |
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Robert P. Cochran |
| $ | 69,750 | $ | (5,510,113 | ) | $ | (17,858,232 | ) | $ | 9,900,546 | |||||
Séan W. McCarthy |
| 69,750 | (1,116,611 | ) | | 5,098,719 | ||||||||||
Bruce E. Stern |
| 69,750 | (523,140 | ) | | 2,579,111 | ||||||||||
Joseph W. Simon |
| 69,750 | 7,802 | | 345,164 | |||||||||||
Russell B. Brewer II |
| 69,750 | (1,917,598 | ) | (1,258,391 | ) | 7,962,476 |
257
The SERPs and DCPs are "top hat" plans, which are unfunded and unsecured non-qualified plans restricted under applicable law to a limited number of highly compensated employees. Under the SERPs, the Company makes an annual contribution equal to 9% of prior year salary and bonus in excess of the money purchase plan salary/bonus cap (but disregarding salary/bonus in excess of $1.0 million), with such contributed amounts generally credited with returns on mutual funds or securities selected by the participants and "match funded" by the Company. The mutual funds and securities employed as investment benchmarks under the DCPs and SERPs in 2008 and their respective 2008 rates of return were as follows:
Name of Mutual Fund or Stock Benchmark
|
2008
% Rate of Return |
|||
---|---|---|---|---|
ARTIO International Fund |
(43.7 | ) | ||
Dodge & Cox Income Fund |
(0.3 | ) | ||
Dodge & Cox Stock Fund |
(43.3 | ) | ||
Fidelity Contrafund |
(37.2 | ) | ||
Fidelity Investment Grade Bond Fund |
(7.1 | ) | ||
Fidelity U.S. Government Reserves |
2.5 | |||
Financial Security Assurance Holdings Ltd. common shares (Director Share Purchase Program) |
(12.6 | ) | ||
Harbor Capital Appreciation |
(37.1 | ) | ||
Longleaf Partners Fund |
(50.6 | ) | ||
Longleaf Partners Small Cap Fund |
(43.9 | ) | ||
Montpelier Re common shares |
0.6 | |||
Northern Select Equities Fund |
(40.5 | ) | ||
Olympus Re common shares |
(44.6 | ) | ||
PIMCO Stocks Plus |
(45.4 | ) | ||
White Mountains Insurance Group common shares |
(47.6 | ) |
Amounts contributed by the Company under the SERPs and the earnings thereon are payable upon or after termination of employment in accordance with a schedule elected by the employee. Under the DCPs, participants are entitled to irrevocably defer receipt (generally for a minimum deferral period equal to the earlier of three years or until termination of employment) of bonus and performance share compensation otherwise payable to them by the Company, with such deferred amounts generally credited with returns on mutual funds or securities selected by the participants and "match funded" by the Company. While the SERPs and DCPs are unfunded plans, the plans contemplate that the Company will make available to plan participants "deemed" investment alternatives comprised of mutual funds or securities. Plan participants are generally entitled to select one or more such "deemed" investments for their plan balances (and to change such selections on a quarterly basis) and their plan balances are credited or debited with the performance of such selected investments. Plan participants are entitled to elect to receive SERP and DCP payouts in lump sums at the payout date or in installments (over a period of years elected in advance by the participant) commencing with the payout date. The SERPs and DCPs generally do not permit early withdrawals of funds absent extreme financial hardship, but allow for extensions of deferrals to the extent permitted by the Internal Revenue Code. In connection with amendments made in 2007 and 2008 to the DCPs, participants were entitled, in accordance with applicable Internal Revenue Code requirements, to change deferral elections previously made under those plans.
Potential Payments Upon Termination of Employment, Retirement or Change-in-Control
Set forth below is a description of amounts payable to the named executive officers upon termination of employment with the Company, retirement from the Company or change in control of the Company. Amounts set forth below do not include amounts payable under the Company's Pension Plan, 401(k) plan, DCPs or SERPs described above.
258
Payments Upon Termination of Employment
Chief Executive Officer and Chief Operating Officer
The employment agreements provide for continued participation by Messrs. Cochran and McCarthy in the Company's benefit plans and severance benefits in lieu of the Company's existing severance policy. Specifically, if the Company terminates Mr. Cochran or Mr. McCarthy without "cause" or either of such executive officers terminates his employment for "good reason," the terminated employee will be entitled to:
For purposes of each employment agreement, (a) "cause" means conviction of, or a plea of nolo contendere to, a criminal misdemeanor or felony materially injurious to the Company, willful and continued failure to perform duties after a specific demand to do so or willful misconduct in carrying out duties directly and materially harmful to the Company's business or reputation; and (b) "good reason" means a diminution in the employee's significant duties or responsibilities, breach by the Company of its obligations under the employment agreement, relocation of the executive more than 25 miles from New York City, a material adverse change in total compensation, or, in the case of Mr. McCarthy, not being named Mr. Cochran's successor as Chief Executive Officer of the Company.
If his employment with the Company had been terminated without cause by the Company on December 31, 2008, then pursuant to his employment agreement Mr. Cochran would have been entitled to receive a minimum of up to $15,364,902, comprised of:
259
The amounts provided above represent the Company's understanding of the amount payable under the interpretation of the severance provisions of Mr. Cochran's employment agreement most favorable to the employee.
If his employment with the Company had been terminated without cause by the Company on December 31, 2008, then pursuant to his employment agreement Mr. McCarthy would have been entitled to receive a minimum of $13,033,202, comprised of:
The amounts provided above represent the Company's understanding of the amount payable under the interpretation of the severance provisions of Mr. McCarthy's employment agreement most favorable to the employee.
In the fourth quarter of 2008, Mr. McCarthy provided notice of constructive termination of employment under his employment agreement alleging a diminution of his significant duties and responsibilities. The Company has entered into a "tolling agreement" with Mr. McCarthy with respect to the termination notice period under the employment agreement, pending further discussions.
Both employment agreements provide that payments in respect of salary and bonus are, to the extent otherwise subject to penalty under Section 409A of the Internal Revenue Code, payable six months after termination of employment and are credited with interest at the three-month Treasury bill rate until so paid. Payments in respect of performance shares (a) are subject to forfeiture in the event of a breach by the employee of the covenant not to compete or covenant not to solicit Company clients or employees during a two year restricted period following termination of employment, and (b) are payable in a lump sum following expiration of the restricted period, together with interest accrued at 8% per annum, compounded semi-annually, during the restricted period.
Both employment agreements provide that, if the employee is terminated for cause or terminates his employment without "good reason" during the term, he will be entitled only to be paid his pro rata annual base salary through the date of termination and all unvested performance shares and Dexia restricted stock will be forfeited. If such termination occurs after the term of the agreement, he will also be entitled to his pro-rata annual bonus through the date of termination and his performance shares will vest pro rata in proportion to the percentage of the applicable performance cycle during
260
which he was employed by the Company. Each employment agreement contains a non-compete provision extending through the greater of two years and the term of the agreement.
If Mr. Cochran becomes Non-Executive Chairman of the Company, he will be entitled to his then-current salary and an annual performance share unit award with an estimated economic value at least equal to 50% of normal prior awards, but will not be entitled to a mandatory annual cash bonus. If Mr. McCarthy becomes the Chief Executive Officer of the Company, he will be entitled to compensation equal to 90% or more of Mr. Cochran's latest compensation, including salary, bonus and performance share units.
General Counsel, Chief Risk Management Officer and Chief Financial Officer
Pursuant to the Severance Policy for Senior Management, upon termination of employment (including constructive termination) by the Company other than for cause, each of Messrs. Brewer, Stern and Simon will become entitled to twelve months of pay, as well as a gross-up payment to hold the employee harmless from any excise Golden Parachute Tax. For purposes of the foregoing:
An eligible employee's base salary and bonus shall include amounts deferred under the DCPs and the 401(k), and amounts allocated to the Flex Plan. In addition, severance benefits (applicable to all employees of the Company during their severance period) include:
Payments of severance under the Severance Policy for Senior Management is subject to execution by the employee of a waiver and release agreement, and any unpaid severance amounts are subject to up to a 50% reduction when offset by any employment or consulting income of the employee during the severance period. If any of Mr. Brewer, Mr. Stern or Mr. Simon is terminated for cause or terminates his employment absent "constructive termination", he will be entitled only to be paid his pro rata annual base salary through the date of termination and all unvested performance shares and Dexia restricted stock will be forfeited.
261
If his employment with the Company had been terminated without cause by the Company on December 31, 2008, then pursuant to the Severance Policy for Senior Management, Mr. Stern would have been entitled to receive $1,397,672, comprised of:
If his employment with the Company had been terminated without cause by the Company on December 31, 2008, then pursuant to the Severance Policy for Senior Management, Mr. Simon would have been entitled to receive $1,395,872, comprised of:
If his employment with the Company had been terminated without cause by the Company on December 31, 2008, then pursuant to the Severance Policy for Senior Management, Mr. Brewer would have been entitled to receive $1,606,968, comprised of:
262
Payments Upon Retirement
Their employment agreements provide that Messrs. Cochran and McCarthy may elect to retire at the end of any employment agreement term after age 60, but that retirement is mandatory at age 65. Upon any such retirement, each of Mr. Cochran and Mr. McCarthy will be entitled to his pro-rata annual base salary and annual bonus through the date of retirement and the vesting of his outstanding performance shares over time as if he remained employed. Messrs. Cochran and McCarthy are not entitled to any other on-going retirement compensation except as provided by the Pension Plan and SERPs. Each of Mr. Cochran and Mr. McCarthy is below the minimum retirement age of 60 provided in their employment agreements. Each of Mr. Brewer, Mr. Stern and Mr. Simon is below the minimum retirement age of 55 otherwise applicable to employees of the Company. Accordingly, none of the named executive officers would be entitled to any payments by reason of retirement at December 31, 2008. In addition, under the Company's Optional Retiree Medical Program applicable to all U. S. Company employees, Messrs. Cochran, McCarthy, Brewer, Stern and Simon are entitled to participate in the Company's medical plan following retirement provided that they pay the full cost of coverage plus a 5% administrative fee to the Company. The Company retains the right to terminate the Optional Retiree Medical Program at any time.
Payments Upon Change in Control
The 2004 Equity Plan provides that the plan shall automatically continue if a change in control occurs. Following a "plan continuation," performance shares and Dexia restricted stock are not accelerated, but vest and are payable as if no change in control had occurred, except that performance shares and Dexia restricted stock vest in the case of any employee who is terminated without cause or leaves for "good reason" following the change in control, with the payouts for each completed year prior to termination of employment based on actual results and the payout for each uncompleted year following termination of employment based upon 100% achievement of the performance objectives.
The table below sets forth a summary of all compensation paid to the directors of the Company, in each case for services rendered to the Company for the year ended December 31, 2008. Employees of the Company and Dexia received no additional compensation for their services as directors of the Company.
2008 Director Compensation Table
Name
|
Fees Earned Or
Paid in Cash |
Total | |||||
---|---|---|---|---|---|---|---|
Robert N. Downey |
$ | 79,000 | $ | 79,000 | |||
John W. Everets |
86,000 | 86,000 | |||||
James H. Ozanne |
118,000 | 118,000 | |||||
Roger K. Taylor |
116,250 | 116,250 |
Each director of the Company who is not an officer of the Company or Dexia received a fee of $50,000 per annum for service as a director and an additional annual fee of $20,000 if Chairman of the Underwriting Committee or Audit Committee of the Board of Directors or $5,000 if Chairman of another Committee of the Board of Directors. Each director also received $2,000 for each Board meeting and regular Committee meeting attended and reimbursement for expenses for each such
263
meeting attended. Each director is entitled to defer fees under the Company's DCP and to participate in the Director Share Purchase Program.
Director Share Purchase Program
In the fourth quarter of 2000, the Company entered into an agreement with Dexia Holdings and Dexia Public Finance Bank, now Dexia Crédit Local, to establish the Director Share Purchase Program (the "Director Share Purchase Program"), pursuant to which Company directors could invest in shares of the Company's common stock. Dexia and the Company established the Director Share Purchase Program to encourage directors to have a financial interest in the Company to better align their financial interests with those of the Company's shareholders.
The Director Share Purchase Program entitles each director of the Company to purchase from Dexia (or an affiliate thereof) up to 126,958 restricted shares of the Company's common stock (which represented a $10.0 million investment at the purchase price at inception of the program) at a price determined in accordance with the provisions of the Director Share Purchase Program Agreement:
Directors may purchase such shares either directly or through deemed investments under the DCPs or, in the case of Company employees, the SERPs. Each deemed investment election with respect to these shares is irrevocable.
The Director Share Purchase Program enables the Company to purchase from Dexia Holdings, at the same price, the same number of shares of common stock purchased by directors through phantom investments under the DCPs or SERPs. Upon expiration of any applicable deferral period, the Company is obligated to pay out the phantom investments in shares of common stock, which must be held by the participant as if acquired directly from Dexia Holdings for generally a minimum of six months.
Sales under the program are not registered under the Securities Act of 1933, as amended, in reliance upon an exemption from registration under Section 4(2) of that Act. For more information regarding the directors' share ownership, see "Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersDirectors and Executive Officers."
Since the fourth quarter of 2008, there has been a difference between Dexia and the holders of shares under the Program regarding the proper valuation of such shares, which may lead to arbitration if unresolved.
Compensation Committee Interlocks and Insider Participation
As of January 1, 2008, the HR Committee consisted of Messrs. Downey (chairman), Cochran and Taylor, as well as Bruno Deletré and Axel Miller. Mr. Deletré resigned as a director of the Company in July 2008, and Mr. Miller resigned in October 2008. Alain Delouis served as a director of the Company from August 2008 to December 22, 2008, during which time he served on the HR Committee. Commencing in December 2008, the HR Committee consisted of Messrs. Downey (chairman), Buysschaert, Cochran, Joly, Piret, Poupelle and Taylor.
264
Except for Messrs. Cochran and Taylor, none of such persons is currently or has ever been an officer or employee of the Company or any subsidiary of the Company. Mr. Taylor retired from active employment with the Company in July 2004. Mr. Miller was the Group Chief Executive Officer and Member of the Board of Directors and Chairman of the Management Board of Dexia prior to his termination of employment with Dexia. Mr. Deletré was a Member of the Management Board of Dexia prior to his termination of employment with Dexia. Messrs. Buysschaert, Joly and Poupelle are each executive officers of Dexia.
As described in "Director Share Purchase Program," above, members of the HR Committee are entitled to participate in a share purchase program available to all directors of the Company, either directly or through deemed investments under the Company's DCPs or SERPs.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
5% Shareholders
The following table sets forth certain information regarding beneficial ownership of the Company's equity at March 1, 2009 as to each person known by the Company to beneficially own, within the meaning of the Exchange Act, 5% or more of the outstanding shares of the common stock, par value $.01 per share, of the Company.
Title of class
|
Name and address of beneficial owner |
Amount and nature of
beneficial ownership |
Percent of
class |
|||||
---|---|---|---|---|---|---|---|---|
Common stock, par value $.01 per share |
Dexia S.A.(1) | 33,300,063 shares | (1)(2) | 99.9% | (2) | |||
|
1 passerelle des Reflets | |||||||
|
Tour DexiaLa Défense 2 | |||||||
|
TSA 12203 | |||||||
|
F-92919 La Défense Cedex | |||||||
|
France | |||||||
|
Place Rogier 11 |
|||||||
|
B1210 Brussels, Belgium |
Directors and Executive Officers
Ownership of Company Common Stock
The following table sets forth certain information regarding beneficial and economic ownership of the Company's common stock at March 1, 2009 for (a) each director of the Company, (b) each named executive officer named in the "Summary Compensation Table" in Item 11, and (c) all executive officers and directors of the Company as a group.
265
Beneficial ownership is less than 1% for each executive officer and director listed, individually and as a group.
Name of Beneficial
Owner |
Amount and
Nature of Beneficial Ownership(1) |
Economic
Ownership(1) |
||||||
---|---|---|---|---|---|---|---|---|
Robert P. Cochran(2) |
24,611 | 129,698 | ||||||
Michel Buysschaert(3) |
| | ||||||
Michèle Colin(3) |
| | ||||||
Robert N. Downey(4) |
17,913 | 26,662 | ||||||
John W. Everets |
| | ||||||
Alexandre Joly(3) |
| | ||||||
Rembert von Lowis(3) |
| | ||||||
Séan W. McCarthy |
| 87,706 | ||||||
James H. Ozanne |
| 23,816 | ||||||
Claude Piret(3) |
| | ||||||
Pascal Poupelle(3) |
| | ||||||
Roger K. Taylor(2) |
3,406 | 79,672 | ||||||
Xavier de Walque(3) |
| | ||||||
Bruce E. Stern |
| 21,600 | ||||||
Joseph W. Simon |
| 21,600 | ||||||
Russell B. Brewer II |
| 22,500 | ||||||
All executive officers and directors as a group (16 persons) |
45,930 | 413,254 | ||||||
Officer
|
Performance Shares | |||
---|---|---|---|---|
Robert P. Cochran |
78,000 | |||
Séan W. McCarthy |
65,400 | |||
Bruce E. Stern |
21,600 | |||
Joseph W. Simon |
21,600 | |||
Russell B. Brewer II |
22,500 |
266
Ownership of Dexia Common Stock
The following table sets forth beneficial ownership of common shares of the Company's parent, Dexia, at March 1, 2009, for (a) each director of the Company, (b) each executive officer and (c) all executive officers and directors of the Company as a group. Beneficial ownership is less than 1% for each executive officer and director listed, individually and as a group.
Directors and Executive Officers(1)
|
Amount and Nature of Beneficial Ownership | ||||
---|---|---|---|---|---|
Robert P. Cochran(2) |
476,558 | ||||
Michel Buysschaert |
21,951 | ||||
Michèle Colin |
4,094 | ||||
Robert N. Downey |
| ||||
John W. Everets |
| ||||
Alexandre Joly |
| ||||
Rembert von Lowis |
27,391 | ||||
Séan W. McCarthy(2) |
470,944 | ||||
James H. Ozanne |
4,000 | ||||
Claude Piret |
47,930 | ||||
Pascal Poupelle |
| ||||
Roger K. Taylor |
| ||||
Xavier de Walque |
37,808 | ||||
Bruce E. Stern(2) |
173,483 | ||||
Joseph W. Simon(2) |
71,535 | ||||
Russell B. Brewer II(2) |
165,540 | ||||
All executive officers and directors as a group (16 persons) |
1,501,234 | ||||
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shows the number of leveraged shares beneficially held by each of the named executive officers as of March 1, 2009:
Officer
|
Leveraged Shares | |||
---|---|---|---|---|
Robert P. Cochran |
371,240 | |||
Séan W. McCarthy |
428,290 | |||
Bruce E. Stern |
147,160 | |||
Joseph W. Simon |
55,390 | |||
Russell B. Brewer II |
145,870 |
Change in Control
In November 2008, Dexia and Assured entered into the Purchase Agreement providing for the purchase by Assured of all Company shares owned by Dexia (the "Acquisition"), subject to the satisfaction of specified closing conditions. Purchase Agreement closing conditions include (1) receipt of regulatory and Assured shareholder approvals; (2) confirmation from S&P, Moody's and Fitch that the acquisition of the Company would not result in a downgrade of the financial strength ratings of the insurance company subsidiaries of Assured or of the Company; and (3) segregation or separation of the Company's FP business such that the credit and liquidity risk of the FP business resides with Dexia, with FSA protected against any future Dexia credit impairment.
The Company cannot estimate whether or when the remaining closing conditions will be satisfied or relevant agreements negotiated, whether the Acquisition will be completed and, if completed, whether it will be structured as currently contemplated, or what the effects of the change in control or removal of the FP business will be on the Company and its results of operations. If the Acquisition is not completed, Dexia may explore other options with respect to the Company, including selling the Company or some of its operations to a third party or ceasing to write new business, which may have a material adverse effect on the Company.
Securities Available under Equity Compensation Plans
The following table sets forth information as of December 31, 2008 with respect to each compensation plan of the Company under which equity securities of the Company are authorized for issuance.
268
Equity Compensation Plan Information
Plan Category
|
Number of securities
to be issued upon exercise of outstanding options, warrants and rights(a) |
Weighted average
exercise price of outstanding options, warrants and rights(b) |
Number of securities
remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))(c) |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
Equity compensation plans approved by security holders(1) |
0 | | 2,322,587 | (3) | ||||||
Equity compensation plans not approved by security holders(2) |
Not applicable | | Not applicable | |||||||
Total |
0 | | 2,322,587 | |||||||
Item 13. Certain Relationships and Related Transactions.
Dexia Transactions
Since the Company's merger with a subsidiary of Dexia in July 2000, various affiliates of Dexia, including certain wholly owned bank subsidiaries and/or their U.S. branches, have participated in transactions in which subsidiaries of the Company have provided financial guaranty insurance. For example, Dexia affiliates have provided liquidity facilities and letters of credit in FSA-insured transactions, have acted as the intermediary in CDS transactions and have been the beneficiaries of financial guaranty insurance policies issued by insurance company subsidiaries of the Company. In addition, in its FP segment the Company enters into transactions with various affiliates of Dexia in which Dexia acts as the counterparty in swap contracts. The Company invests short term assets in Dexia accounts and earns interest income on those accounts. In the opinion of management of the Company, the terms of these arrangements are no less favorable to the Company than the terms that could be obtained from unaffiliated parties.
269
During 2008, the Company and its subsidiaries FSA and FSAM entered into transactions with Dexia affiliates to address FP segment liquidity requirements and support the FP business:
In February 2009 the parties entered into several additional agreements, which transfer credit and liquidity risk of the GIC operations to Dexia:
For more information regarding these and related agreements, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital ResourcesFP Segment LiquiditySources of Liquidity."
Certain notes held by FSA Global contain provisions that could extend the stated maturities of those notes. To ensure FSA Global will have sufficient cash flow to repay its own debt issuances that
270
relate to such notes, FSA Global has entered into several liquidity facilities with Dexia for $419.4 million.
For more information regarding the Company's transactions with Dexia and other related parties, see Note 24 to the consolidated financial statements in Item 8.
Director Share Purchase Program
At December 31, 2008, each director was entitled to purchase up to 126,958 actual or phantom shares of the Company's common stock, as described in "Item 11. Executive CompensationCompensation of DirectorsDirector Share Purchase Program."
Other Relationships
Additional information relating to certain relationships and related transactions is set forth in "Item 11. Executive CompensationCompensation Committee Interlocks and Insider Participation."
Review, Approval or Ratification of Transactions with Related Persons
The Company's ability to enter into related party transactions is limited by law. Under the New York Insurance Holding Company Act, the Company is required to obtain the prior approval of the New York Superintendent of the following transactions with related parties in amounts greater than 5% of the Company's admitted assets: sales, purchases, exchanges, loans or extensions of credits or investments. The Company must provide the New York Superintendent with 30 days' prior notice of such transactions with related parties in amounts equal to 0.5%-5% of the Company's admitted assets or involving reinsurance treaties or agreements or the rendering of services on a regular or systematic basis. For these purposes, an entity is presumed to be a "related party" if the direct or indirect voting control is 10% or greater. Absent a determination by the New York Superintendent of non-control, acquisition of a voting interest of 10% or more of Dexia would require prior approval of the New York Superintendent.
The Company provides an annual report to the New York Superintendant and the Board of Directors of the Company of all transactions with Dexia and its affiliates that are not members of the FSA group.
All directors and officers are subject to the Company's Code of Conduct, pursuant to which no director or officer may have, directly or indirectly:
For these purposes, "interest" includes the interest of the spouse or dependents of a director or officer, and "financial interest" does not include ownership of less than 1 / 10 of one percent of the outstanding stock of any corporation listed on a national securities exchange or less than $10,000 of the outstanding stock of any corporation whose stock is regularly sold at least once a week on the over-the-counter market in the U.S. In addition, pursuant to the bylaws of the Company, the Board of Directors must ratify any loans or debt of the Company. The Company does not have any other written policies and procedures for the review, approval or ratification of related party transactions.
As noted above, affiliates of Dexia have participated in transactions in which subsidiaries of the Company have provided financial guaranty insurance, including by providing liquidity facilities and
271
letters of credit in FSA-insured transactions, and have been beneficiaries of financial guaranty insurance policies issued by insurance company subsidiaries of the Company. Such transactions are the principal context in which affiliates of Dexia participate in transactions with the Company, and are subject to the same credit committee reviews as transactions in which no Dexia affiliates participate. In the opinion of management of the Company, the terms of these arrangements are no less favorable to the Company than the terms that could be obtained from unaffiliated parties.
Director Independence
Board members Robert N. Downey, James H. Ozanne, Roger K. Taylor and John W. Everets are independent within the meaning of Rule 10A-3 of the Exchange Act. Messrs. Ozanne (Chairman), Everets and Taylor comprise the Audit Committee of the Board of Directors and Messrs. Downey (Chairman) and Taylor are members of the Human Resources Committee of the Board of Directors.
In determining whether or not a director is independent, the Company uses the standards set out in Rule 10A-3(a)(b)(1) of the Exchange Act. Because the Company has only debt securities listed on the NYSE, it is not subject to the additional independence standards imposed by the NYSE, and is not subject to the NYSE requirement that a majority of the members of a board of directors and all members of a human resources committee be independent.
Item 14. Principal Accounting Fees and Services.
Aggregate fees for professional services by PricewaterhouseCoopers LLP for 2008 and 2007 were:
Professional Services by PricewaterhouseCoopers LLP
|
2008 | 2007 | ||||||
---|---|---|---|---|---|---|---|---|
|
(in thousands)
|
|||||||
Audit |
$ | 1,773.9 | $ | 1,644.4 | ||||
Audit-related |
587.2 | 504.3 | ||||||
Tax |
40.4 | 66.7 | ||||||
Total |
$ | 2,401.5 | $ | 2,215.4 | ||||
Audit fees for the years ended December 31, 2008 and 2007 were for professional services rendered for the audits of the Company's consolidated financial statements, audits of the Subsidiaries, and issuance of consents and in 2008 comfort letter procedures. Included in this amount is $6,000 and $108,000 in fees relating to consents that are reimbursed to the Company by the issuers of FSA-insured deals for the years ended December 31, 2008 and 2007, respectively.
Audit related fees for the years ended December 31, 2008 and 2007 were for assurance and related services related to the Company's retirement plans, actuarial certifications and consultations concerning financial accounting and reporting standards.
Tax fees for the years ended December 31, 2008 and 2007 were related to tax compliance.
Audit Committee Pre-Approval Policies and Procedures
The Audit Committee of the Company's Board of Directors pre-approves all audit and non-audit related fees paid to the Company's auditors.
272
Item 15. Exhibits, Financial Statement Schedules.
1. Consolidated Financial Statements
Item 8 sets forth the following financial statements of Financial Security Assurance Holdings Ltd. and Subsidiaries:
Report of Independent Registered Public Accounting Firm |
138 | |
Consolidated Balance Sheets at December 31, 2008 and 2007 |
139 | |
Consolidated Statements of Operations and Comprehensive Income for the Years Ended December 31, 2008, 2007 and 2006 |
140 | |
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2008, 2007 and 2006 |
141 | |
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006 |
142 | |
Notes to Consolidated Financial Statements |
144 |
2. Financial Statement Schedules
The following financial statement schedule is filed as part of this Report.
Schedule | Title | ||
---|---|---|---|
I | Parent Company Condensed Financial Information at December 31, 2008 and 2007 and for the Years Ended December 31, 2008, 2007 and 2006. | ||
|
|
|
The report of the Independent Registered Public Accounting Firm with respect to the above listed financial statement schedule is set forth under Item 8 of this Report. |
|
|
|
All other schedules are omitted because they are either inapplicable or the required information is presented in the Consolidated Financial Statements of the Company or the notes thereto. |
3. Exhibits
The following are annexed as exhibits to this Report:
Exhibit No. | Exhibit | ||
---|---|---|---|
2.1 | Agreement and Plan of Merger dated as of March 14, 2000 by and among Dexia S.A., Dexia Crédit Local de France S.A., PAJY Inc. and the Company. (Previously filed as Exhibit 2.1 to Current Report on Form 8-K (Commission File No. 1-12644) dated March 14, 2000, and incorporated herein by reference.) | ||
|
3.1 |
|
Restated Certificate of Incorporation of the Company. (Previously filed as Exhibit 3.1 to the Company's Registration Statement on Form S-3 (Reg. No. 333-74165) (the "Form S-3"), and incorporated herein by reference.) |
|
3.2 |
|
Certificate of Merger of PAJY Inc. into the Company under Section 904 of the Business Corporation Law of the State of New York (effective July 5, 2000). (Previously filed as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period ended September 30, 2000 (the "September 30, 2000 10-Q"), and incorporated herein by reference.) |
273
Exhibit No. | Exhibit | ||
---|---|---|---|
3.3 | Certificate of Merger of White Mountains Holdings, Inc. and the Company into the Company under Section 904 of the Business Corporation Law (effective July 5, 2000). (Previously filed as Exhibit 3.2 to the September 30, 2000 10-Q, and incorporated herein by reference.) | ||
|
3.4 |
|
Amended and Restated By-laws of the Company, as amended and restated on May 21, 2008. (Previously filed as Exhibit 3.0 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period ended June 30, 2008 (the "June 30, 2008 10-Q"), and incorporated herein by reference.) |
|
4.1 |
|
Amended and Restated Trust Indenture dated as of February 24, 1999 (the "Amended and Restated Senior Indenture") between the Company and the Senior Debt Trustee. (Previously filed as Exhibit 4.1 to the Form S-3, and incorporated herein by reference.) |
|
4.1A |
|
Form of 6 7 / 8 % Quarterly Interest Bond Securities due December 15, 2101. (Previously filed as Exhibit 2 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated December 12, 2001 (the "December 2001 Form 8-K"), and incorporated herein by reference.) |
|
4.1B |
|
Officers' Certificate pursuant to Sections 2.01 and 2.03 of the Amended and Restated Senior Indenture. (Previously filed as Exhibit 3 to the December 2001 Form 8-K, and incorporated herein by reference.) |
|
4.1C |
|
Form of 6.25% Notes due 2102. (Previously filed as Exhibit 3 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated November 6, 2002 and filed November 25, 2002 (the "November 2002 Form 8-K"), and incorporated herein by reference.) |
|
4.1D |
|
Officers' Certificate pursuant to Sections 2.01 and 2.03 of the Amended and Restated Senior Indenture. (Previously filed as Exhibit 4 to the November 2002 Form 8-K, and incorporated herein by reference.) |
|
4.1E |
|
Form of 5.60% Notes due 2103. (Previously filed as Exhibit 2 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated July 17, 2003 and filed July 30, 2003 (the "July 2003 Form 8-K"), and incorporated herein by reference.) |
|
4.1F |
|
Officers' Certificate pursuant to Sections 2.01 and 2.03 of the Amended and Restated Senior Indenture. (Previously filed as Exhibit 3 to the July 2003 Form 8-K, and incorporated herein by reference.) |
|
4.2 |
|
Indenture, dated as of November 22, 2006, between Financial Security Assurance Holdings Ltd. and The Bank of New York, as Trustee. (Previously filed as Exhibit 4.1 to Current Report on Form 8-K (Commission File No. 1-12644) dated November 22, 2006 (the "November 2006 8-K"), and incorporated herein by reference.) |
|
4.2A |
|
Financial Security Assurance Holdings Ltd., Officer's Certificate Pursuant to Sections 1.02 and 3.01 of the Indenture, dated as of November 22, 2006, between Financial Security Assurance Holdings Ltd. and The Bank of New York, as Trustee. (Previously filed as Exhibit 10.2 to the November 2006 8-K, and incorporated herein by reference.) |
|
4.2B |
|
Form of Junior Subordinated Debenture, Series 2006-1. (Previously filed as Exhibit 10.3 to the November 2006 8-K, and incorporated herein by reference.) |
274
Exhibit No. | Exhibit | ||
---|---|---|---|
10.1 | | 1989 Supplemental Executive Retirement Plan (amended and restated as of December 17, 2004). (Previously filed as Exhibit 10.4 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated December 17, 2004 and filed on December 17, 2004 (the "December 2004 Form 8-K"), and incorporated herein by reference.) | |
|
10.2 |
|
2004 Supplemental Executive Retirement Plan, dated as of December 17, 2004. (Previously filed as Exhibit 10.3 to the December 2004 Form 8-K, and incorporated herein by reference. |
|
10.2A |
|
2004 Supplemental Executive Retirement Plan, as amended on May 18, 2006. (Previously filed as Exhibit 10.1 to the Current Report on Form 8-K (Commission File No. 1-12644) dated May 18, 2006 (the "May 2006 8-K"), and incorporated herein by reference.) |
|
10.2B |
|
2004 Supplemental Executive Retirement Plan, as amended on February 14, 2008. (Previously filed as Exhibit 10.3 to the Current Report on Form 8-K (Commission File No. 1-12644) dated February 14, 2008 (the "February 2008 8-K"), and incorporated herein by reference.) |
|
10.3 |
|
Amended and Restated 1993 Equity Participation Plan (amended and restated as of May 17, 2001). (Previously filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period ended June 30, 2001, and incorporated herein by reference.) |
|
10.4 |
|
2004 Equity Participation Plan (Previously filed as Exhibit 10.1 to the Company's current report on Form 8-K (Commission File No. 1-12644) dated November 18, 2004 and filed on November 23, 2004 and incorporated herein by reference.) |
|
10.4A |
|
2004 Equity Participation Plan, as amended on September 15, 2005. (Previously filed as Exhibit 10.1 to Current Report on Form 8-K (Commission File No. 1-12644) dated September 16, 2005, and incorporated herein by reference.) |
|
10.4B |
|
2004 Equity Participation Plan, as amended on February 16, 2006. (Previously filed as Exhibit 10.1 to Current Report on Form 8-K (Commission File No. 1-12644) dated February 16, 2006 (the "February 2006 8-K"), and incorporated herein by reference.) |
|
10.4C |
|
2004 Equity Participation Plan, as amended on February 14, 2008. (Previously filed as Exhibit 10.1 to the February 2008 8-K, and incorporated herein by reference.) |
|
10.4D |
|
2004 Equity Participation Plan, as amended and restated on May 21, 2008. (Previously filed as Exhibit 10.3 to the June 30, 2008 10-Q, and incorporated herein by reference.) |
|
10.5A |
|
Form of Financial Security Assurance Holdings Ltd. Agreement Evidencing an Award of Dexia Restricted Stock. (Previously filed as Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period ended March 31, 2005 (the "March 31, 2005 10-Q"), and incorporated herein by reference.) |
|
10.5B |
|
Form of Financial Security Assurance Holdings Ltd. Agreement Evidencing an Award of Dexia Restricted Stock, as amended on February 16, 2006. (Previously filed as Exhibit 10.2 to the February 2006 8-K, and incorporated herein by reference.) |
|
10.5C |
|
Form of Financial Security Assurance Holdings Ltd. Agreement Evidencing an Award of Dexia Restricted Stock, as amended on February 14, 2008. (Previously filed as Exhibit 10.6F to the Company's Annual Report on Form 10-K (Commission File No. 1-12644) for the fiscal year ended December 31, 2007 (the "December 31, 2007 10-K"), and incorporated herein by reference.) |
275
Exhibit No. | Exhibit | ||
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10.5D | | Form of Financial Security Assurance Holdings Ltd. Agreement Evidencing an Award of Dexia Restricted Stock, as amended on February 14, 2007. (Previously filed as Exhibit 10.6E to the Company's Annual Report on Form 10-K (Commission File No. 1-12644) for the fiscal year ended December 31, 2006 (the "December 31, 2006 10-K"), and incorporated herein by reference.) | |
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10.5E |
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Amendment to Financial Security Assurance Holdings Ltd. Agreement Evidencing an Award of Dexia Restricted Stock to Robert P. Cochran, dated as of February 14, 2007 (Previously filed as exhibit 10.6F to the December 31, 2006 10-K, and incorporated herein by reference.) |
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10.5F |
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Form of Financial Security Assurance Holdings Ltd. Agreement Evidencing an Award of Performance Shares. (Previously filed as Exhibit 99.1 to the Current Report on Form 8-K (Commission File No. 1-12644) dated February 16, 2005, and incorporated herein by reference.) |
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10.5G |
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Form of Financial Security Assurance Holdings Ltd. Agreement Evidencing an Award of Performance Shares, as amended on February 16, 2006. (Previously filed as Exhibit 10.3 to the February 2006 8-K, and incorporated herein by reference.) |
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10.5H |
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Form of Financial Security Assurance Holdings Ltd. Agreement Evidencing an Award of Performance Shares, as amended on February 14, 2008. (Previously filed as Exhibit 10.6 to the February 2008 8-K, and incorporated herein by reference.) |
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10.6 |
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Financial Security Assurance Inc. Overseas Pension Plan. (Previously filed as Exhibit 10.3 to the February 2006 8-K, and incorporated herein by reference.) |
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10.7 |
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1995 Deferred Compensation Plan (amended and restated as of December 17, 2004). (Previously filed as Exhibit 10.2 to the December 2004 8-K, and incorporated herein by reference.) |
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10.7A |
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1995 Deferred Compensation Plan (amended and restated as of September 15, 2008). (Previously filed as Exhibit 10.2 to the December 2004 8-K, and incorporated herein by reference.) |
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10.7B |
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1995 Deferred Compensation Plan, as amended and restated as of September 15, 2008. (Previously filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period ended September 30, 2008 (the "September 30, 2008 10-Q"), and incorporated herein by reference.) |
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10.8 |
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2004 Deferred Compensation Plan, dated December 17, 2004. (Previously filed as Exhibit 10.1 to the December 2004 8-K, and incorporated herein by reference.) |
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10.8A |
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2004 Deferred Compensation Plan, as amended on May 18, 2006. (Previously filed as Exhibit 10.2 to the May 2006 8-K, and incorporated herein by reference.) |
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10.8B |
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2004 Deferred Compensation Plan, as amended on February 14, 2008. (Previously filed as Exhibit 10.2 to the February 2008 8-K, and incorporated herein by reference.) |
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10.9 |
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Severance Policy for Senior Management (amended and restated as of November 13, 2003). (Previously filed as Exhibit 10.7 to the Company's Annual Report on Form 10-K (Commission File No. 1-12644) for the fiscal year ended December 31, 2003, and incorporated herein by reference.) |
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10.9A |
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Severance Policy for Senior Management, as amended on May 18, 2006. (Previously filed as Exhibit 10.3 to the May 2006 8-K, and incorporated herein by reference.) |
276
277
278
Exhibit No. | Exhibit | ||
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23 | * | Consent of PricewaterhouseCoopers LLP. | |
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24.1 |
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Powers of Attorney. (Previously filed as (i) Exhibit 24 to the Company's Annual Report on Form 10-K (Commission File No. 1-12644) for the fiscal year ended December 31, 2002, (ii) Exhibit 24.2 to the Company's Annual Report on Form 10-K (Commission File No. 1-12644) for the fiscal year ended December 31, 2004, (iii) Exhibit 24.2 to the Company's Annual Report on Form 10-K (Commission File No. 1-12644) for the fiscal year ended December 31, 2005, (iv) Exhibit 24.2 to the December 31, 2006 10-K, and (v) Exhibit 24.2 to the December 31, 2007 10-K, and incorporated herein by reference.) |
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24.2 |
* |
Powers of Attorney with respect to Messrs Buysschaert, Joly, Piret and Poupelle. |
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31.1 |
* |
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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31.2 |
* |
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
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32.1 |
** |
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2 |
** |
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
|
99.1 |
* |
Financial Security Assurance Inc. and Subsidiaries 2008 Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm. |
279
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. |
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By: |
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/s/ ROBERT P. COCHRAN |
Name: Robert P. Cochran Title: Chairman and Chief Executive Officer Dated: March 19, 2009 |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
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Title
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Date
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/s/ ROBERT P. COCHRAN
Robert P. Cochran |
Chairman, Chief Executive Officer and
Director (Principal Executive Officer) |
March 19, 2009 | ||
/s/ SÉAN W. MCCARTHY Séan W. McCarthy* |
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President, Chief Operating Officer and Director |
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March 19, 2009 |
/s/ JOSEPH W. SIMON Joseph W. Simon* |
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Managing Director and Chief Financial Officer (Principal Financial Officer) |
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March 19, 2009 |
/s/ LAURA A. BIELING Laura A. Bieling* |
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Managing Director and Controller (Principal Accounting Officer) |
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March 19, 2009 |
/s/ MICHEL BUYSSCHAERT Michel Buysschaert* |
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Director |
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March 19, 2009 |
/s/ MICHÈLE COLIN Michèle Colin* |
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Director |
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March 19, 2009 |
/s/ ROBERT N. DOWNEY Robert N. Downey* |
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Director |
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March 19, 2009 |
/s/ JOHN W. EVERETS John W. Everets* |
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Director |
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March 19, 2009 |
/s/ ALEXANDRE JOLY Alexandre Joly* |
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Director |
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March 19, 2009 |
280
Signature
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Title
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Date
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/s/ REMBERT VON LOWIS
Rembert Von Lowis* |
Director | March 19, 2009 | ||
/s/ JAMES H. OZANNE James H. Ozanne* |
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Director |
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March 19, 2009 |
/s/ CLAUDE PIRET Claude Piret* |
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Director |
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March 19, 2009 |
/s/ PASCAL POUPELLE Pascal Poupelle* |
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Director |
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March 19, 2009 |
/s/ ROGER K. TAYLOR Roger K. Taylor* |
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Director |
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March 19, 2009 |
/s/ XAVIER DE WALQUE Xavier de Walque* |
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Director |
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March 19, 2009 |
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By: |
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/s/ ROBERT P. COCHRAN |
Robert P. Cochran Attorney in fact |
281
Schedule I
Financial Security Assurance Holdings Ltd. (Parent Company)
Condensed Financial Information
Condensed Balance Sheets
(in thousands)
|
As of December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
ASSETS: |
||||||||
Bonds at fair value (amortized cost of $18,299 and $33,935) |
$ | 18,710 | $ | 34,292 | ||||
Short-term investments |
32,976 | 350 | ||||||
Cash |
1,863 | 1,099 | ||||||
Investment in subsidiaries |
(4,922,057 | ) | 1,741,084 | |||||
Deferred compensation plans ("DCP") and supplemental executive retirement plans ("SERP") |
90,704 | 142,642 | ||||||
Deferred tax asset |
379,982 | 530,440 | ||||||
Taxes receivable |
20,757 | | ||||||
Other assets |
16,360 | 16,713 | ||||||
TOTAL ASSETS |
$ | (4,360,705 | ) | $ | 2,466,620 | |||
LIABILITIES AND SHAREHOLDERS' EQUITY: |
||||||||
Notes payable |
$ | 730,000 | $ | 730,000 | ||||
Other liabilities |
3,065 | 6,512 | ||||||
DCP and SERP |
90,704 | 142,653 | ||||||
Taxes payable |
| 9,641 | ||||||
Shareholders' equity (deficit) |
(5,184,474 | ) | 1,577,814 | |||||
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY |
$ | (4,360,705 | ) | $ | 2,466,620 | |||
Condensed Statements of Income
(in thousands)
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||
Net investment income |
$ | 1,661 | $ | 1,743 | $ | 3,018 | ||||
Net realized gains (losses) |
532 | 210 | (108 | ) | ||||||
Net realized and unrealized gains (losses) on derivative instruments |
| 324 | 761 | |||||||
DCP and SERP |
(37,491 | ) | 6,079 | 14,413 | ||||||
Other income |
| 539 | 418 | |||||||
TOTAL REVENUES |
(35,298 | ) | 8,895 | 18,502 | ||||||
Interest and amortization expense |
(46,335 | ) | (46,336 | ) | (29,096 | ) | ||||
DCP and SERP |
37,244 | (6,079 | ) | (14,413 | ) | |||||
Other operating expenses |
(13,730 | ) | (7,593 | ) | (5,990 | ) | ||||
TOTAL EXPENSES |
(22,821 | ) | (60,008 | ) | (49,499 | ) | ||||
INCOME (LOSS) BEFORE EQUITY IN INCOME (LOSS) OF SUBSIDIARIES AND INCOME TAXES |
(58,119 | ) | (51,113 | ) | (30,997 | ) | ||||
Equity in income (loss) of subsidiaries |
(8,771,135 | ) | (31,170 | ) | 473,652 | |||||
Income (loss) before income taxes |
(8,829,254 | ) | (82,283 | ) | 442,655 | |||||
Income tax (provision) benefit |
386,084 | 16,629 | (18,501 | ) | ||||||
NET INCOME (LOSS) |
$ | (8,443,170 | ) | $ | (65,654 | ) | $ | 424,154 | ||
The Parent Company Condensed Financial Information should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in Item 8.
282
Condensed Statements of Cash Flows
(in thousands)
|
Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||
Cash flows from operating activities: |
||||||||||||
Other operating expenses paid, net |
$ | (16,256 | ) | $ | (8,282 | ) | $ | (3,758 | ) | |||
Net investment income received |
1,435 | 5,965 | 7,520 | |||||||||
Federal income taxes received |
24,186 | 6,762 | 1,991 | |||||||||
Interest paid |
(46,050 | ) | (47,277 | ) | (26,878 | ) | ||||||
Dividend from subsidiary |
30,000 | | 140,000 | |||||||||
Other |
| 997 | (1,057 | ) | ||||||||
Net cash provided by (used for) operating activities |
(6,685 | ) | (41,835 | ) | 117,818 | |||||||
Cash flows from investing activities: |
||||||||||||
Proceeds from sales of bonds |
29,235 | 46,328 | 55,650 | |||||||||
Proceeds from maturities of bonds |
2,340 | 4,726 | 2,410 | |||||||||
Purchases of bonds |
(15,495 | ) | (44,995 | ) | (87,098 | ) | ||||||
Capital contribution to subsidiaries |
(724,927 | ) | (132,478 | ) | (1,500 | ) | ||||||
Repurchase of stock by subsidiary |
70,000 | 180,000 | 100,000 | |||||||||
Purchase of surplus notes |
(300,000 | ) | | | ||||||||
Surplus notes redeemed |
| 108,850 | | |||||||||
Net change in short-term investments |
(32,209 | ) | 1,664 | 45,931 | ||||||||
Net cash provided by (used for) investing activities |
(971,056 | ) | 164,095 | 115,393 | ||||||||
Cash flows from financing activities: |
||||||||||||
Capital contribution from parent |
1,012,111 | | | |||||||||
Issuance of notes payable |
| | 295,788 | |||||||||
Dividends paid |
(33,606 | ) | (122,005 | ) | (530,050 | ) | ||||||
Net cash provided by (used for) financing activities |
978,505 | (122,005 | ) | (234,262 | ) | |||||||
Effects of foreign exchange rates |
| | | |||||||||
Net (decrease) increase in cash |
764 | 255 | (1,051 | ) | ||||||||
Cash at beginning of year |
1,099 | 844 | 1,895 | |||||||||
Cash at end of year |
$ | 1,863 | $ | 1,099 | $ | 844 | ||||||
In 2006, the Company's subsidiaries received a tax benefit of $1,200 by utilizing the Company's losses. These balances were recorded as capital contributions.
The Parent Company Condensed Financial Information should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in Item 8.
283
Condensed Statement of Cash Flows (continued)
(in thousands)
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
Reconciliation of net income (loss) to net cash provided by operating activities: |
|||||||||||
Net income (loss) |
$ | (8,443,170 | ) | $ | (65,654 | ) | $ | 424,154 | |||
Equity in undistributed net income (loss) of subsidiary |
8,801,131 | 35,486 | (329,566 | ) | |||||||
Change in accrued investment income |
108 | 200 | (269 | ) | |||||||
Change in accrued income taxes |
(32,192 | ) | (568 | ) | 2,191 | ||||||
Provision (benefit) for deferred income taxes |
(329,706 | ) | (9,299 | ) | 20,775 | ||||||
Net realized losses (gains) on investments |
(532 | ) | (177 | ) | 108 | ||||||
Accretion of bond discount |
(329 | ) | (60 | ) | (509 | ) | |||||
Change in other assets and liabilities |
(1,995 | ) | (1,763 | ) | 934 | ||||||
Cash provided by (used for) operating activities |
$ | (6,685 | ) | $ | (41,835 | ) | $ | 117,818 | |||
The Parent Company Condensed Financial Information should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in Item 8.
284
Financial Security Assurance Holdings Ltd. (Parent Company)
Notes to Condensed Financial Statements
1. Condensed Financial Statements
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These condensed financial statements should be read in conjunction with the Company's Consolidated Financial Statements and the notes thereto. Certain reclassifications have been made to conform to the current year presentation.
2. Significant Accounting Policies
The Parent Company accounts for its investments in subsidiaries under the equity method.
3. Organization and Ownership
At December 31, 2008, Dexia Holdings Inc. ("Dexia Holdings") owned over 99% of outstanding Parent Company shares; the only other holders of Parent Company common stock were directors of Parent Company who owned shares of Parent Company common stock or economic interests therein under the Company's Director Share Purchase Program.
The Company is a subsidiary of 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 primarily engaged in the business of public finance, banking and investment management in France, Belgium, Luxembourg and other European countries, as well as in the United States. Dexia Crédit Local is a wholly owned subsidiary of Dexia.
Expected Sale of the Company
Purchase Agreement with Assured Guaranty Ltd.
In November 2008, Dexia Holdings entered into a purchase agreement (the "Purchase Agreement") providing for the sale of all the Company shares owned by Dexia to Assured (the "Acquisition"), subject to the consummation of specified closing conditions, including regulatory approvals, absence of rating impairment and segregation or separation of the Company's FP operations from the Company's financial guaranty operations.
Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act") and the rules promulgated thereunder by the Federal Trade Commission (the "FTC"), the Acquisition may not be consummated until notifications have been given and certain information has been furnished to the FTC and the Department of Justice (the "DOJ") and specified waiting period requirements have been satisfied. The HSR Act waiting period expired on January 21, 2009. In addition, under the insurance holding company laws and regulations applicable to the insurance subsidiaries of the Company and Assured, before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance commissioner of the state where the insurer is domiciled. Assured has informed the Company that Assured filed applications with the insurance departments of the States of New York and Oklahoma and the U.K. Financial Services Authority; that the applications to the New York Insurance Department and U.K. Financial Services Authority have been approved; and that it has made pre-acquisition filings regarding the potential competitive impact of the acquisition, which are deemed to have been approved. Dexia has informed the Company that it has filed an application with the U.K. Financial Services Authority in connection with its acquisition of Assured common shares pursuant to the Purchase Agreement, which has been approved, and that it has filed disclaimers of control with the insurance departments of the states of Maryland, New York, and Oklahoma.
285
Satisfying all three rating agencies that the necessary steps have or will be taken to transfer the FP segment credit and liquidity risk to Dexia is one of the last conditions to the Purchase Agreement closing. Rating agency confirmation that the Acquisition will not have a negative impact on the financial strength ratings of Assured's insurance company subsidiaries or the Company's insurance company subsidiaries is a condition for closing, and is beyond the Company's control.
The Company cannot estimate whether or when the remaining closing conditions will be satisfied or relevant agreements negotiated, whether the Acquisition will be completed and, if completed, whether it will be structured as currently contemplated, or what the effects of the change in control or removal of the FP business will be on the Company and its results of operations. If the Acquisition is not carried out, Dexia may explore other options with respect to the Company, including selling the Company or some of its operations to a third party or ceasing to write new business, which may have a material adverse effect on the Company.
Dexia's Retention of the FP Business
Under the Purchase Agreement, Dexia is expected to retain the Company's FP business after the Acquisition. The Purchase Agreement provides that Dexia will provide guarantees with respect to the FP business' assets and liabilities, including derivative contracts and anticipates that some of its guarantees will benefit from guarantees provided by the French and Belgian states. Dexia Holdings, the Company's parent, agreed that if such sovereign guarantees are provided, it will cause FSA Holdings to transfer the ownership interests of certain of the subsidiaries that conduct the FP business, or all the assets and liabilities of such subsidiaries, to Dexia Holdings or one of its affiliates in form reasonably acceptable to Assured.
Transfer of Credit and Liquidity Risk of the GIC Business
When the GIC Subsidiaries sold a GIC, they loaned the proceeds to FSAM. The terms governing FSAM's repayment of those proceeds to the GIC Subsidiaries match the payment terms under the related GIC. FSAM invests the proceeds in securities and enters into derivative transactions to convert any fixed-rate assets and liabilities into London Interbank Offered Rate ("LIBOR")-based floating rate assets and liabilities. Most of FSAM's assets consist of residential mortgage-backed securities ("RMBS") that have suffered significant market value declines and, in more limited cases, credit deterioration resulting in a shareholders' deficit for FSAM as of December 31, 2008. The market value declines of FSAM's assets subject FSAM to significant liquidity risk insofar as the GICs are in most cases subject to redemption or collateralization upon the downgrade of FSA below certain thresholds, with a significant number of GICs subject to redemption or collateralization should FSA be downgraded below Aa3 by Moody's (FSA's current Moody's rating) or below AA- by S&P. Dexia had previously announced its intention to assume the credit and liquidity risk associated with the Company's FP business, and provided significant support to the FP business in the course of 2008.
As a result of the significant decline in asset value and the November 2008 cessation of issuing GICs, the GIC business changed from a business model managed by the Company focused on attaining positive net interest margin, to a run-off business managed by Dexia seeking to minimize liquidity risk and optimize asset recovery values.
Subsequent Event
In February 2009, Dexia entered into several agreements that transfer credit and liquidity risk of the GIC operations to Dexia, (the "FSAM Risk Transfer Transaction"). Each of the agreements executed under the FSAM Risk Transfer Transaction directly affect (1) FSAM and (2) the entities that absorb the risks created by FSAM. These agreements provide for the (i) elimination of FSA's guaranty of repayment of FSAM's borrowings under the credit facilities provided by Dexia's bank subsidiaries;
286
(ii) elimination of FSA's guaranty of certain of FSAM's investments; and (iii) increase in the credit facilities provided to FSAM by Dexia's bank subsidiaries from $5 billion to $8 billion.
As a result, the FSAM Risk Transfer Transaction was deemed a reconsideration event for FSAM under FASB Interpretation 46 (R), "Consolidation of Variable Interest Entities" ("FIN 46"). There was no reconsideration event for any of the GIC Subsidiaries. Upon the reconsideration event, management determined that Dexia is now absorbing the majority of the variability of expected losses of FSAM, which resulted in deconsolidation of FSAM as of February 24, 2009, the effective date of the FSAM Risk Transfer Transaction.
The GIC subsidiaries, unlike FSAM, remain part of the Company's consolidated financial statements notwithstanding the FSAM Risk Transfer Transaction, which means that the GICs issued to third parties and the note receivable from FSAM will represent the primary liabilities and assets of the FP business in the Company's consolidated financial statements. Since some of the GICs were designated as fair value option, they will continue to be marked to market; however, derivatives are maintained within FSAM, so contracts meant to hedge the interest rate risk of those GICs will no longer be included in the Company's consolidated financial statements, increasing the volatility of the Company's net income (loss).
See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital ResourcesFP Segment LiquiditySources of Liquidity" for more information on the FSAM Risk Transfer Transaction.
4. Long-Term Debt
On November 22, 2006, FSA Holdings issued $300.0 million principal amount of Junior Subordinated Debentures with a scheduled maturity date of December 15, 2036 and a final repayment date of December 5, 2066. The final repayment date of December 5, 2066 may be automatically extended up to four times in five-year increments provided certain conditions are met. The debentures are redeemable, in whole or in part, at any time prior to December 15, 2036 at their principal amount plus accrued and unpaid interest to the date of redemption or, if greater, the make-whole redemption price. Interest on the debentures will accrue from November 22, 2006 to December 15, 2036 at the annual rate of 6.40%. If any amount of the debentures remains outstanding after December 15, 2036, then the principal amount of the outstanding debentures will bear interest at a floating interest rate equal to one-month LIBOR plus 2.215% until repaid. FSA Holdings may elect at one or more times to defer payment of interest on the debentures for one or more consecutive interest periods that do not exceed ten years. The proceeds from this offering were used to pay a dividend to the shareholders of FSA Holdings.
On July 31, 2003, FSA Holdings issued $100.0 million principal amount of 5.60% Notes due July 15, 2103, which are callable without premium or penalty in whole or in part at any time on or after July 31, 2008. Debt issuance costs of $3.3 million are being amortized over the life of the Notes.
On November 26, 2002, FSA Holdings issued $230.0 million principal amount of 6.25% Notes due November 1, 2102, which are callable without premium or penalty in whole or in part at any time on or after November 26, 2007. Debt issuance costs of $7.4 million are being amortized over the life of the debt. The Company used a portion of the proceeds of this issuance to redeem in whole the Company's $130.0 million principal amount of 7.375% Senior QUIDS due September 30, 2097.
On December 19, 2001, FSA Holdings issued $100.0 million of 6 7 / 8 % notes due December 15, 2101, which are callable without premium or penalty on or after December 19, 2006. Debt issuance costs of $3.3 million are being amortized over the life of the debt.
287
5. Taxes
In connection with Dexia's acquisition of the Company in July 2000, the Company became the successor, for tax purposes, to White Mountains Holdings, Inc. ("WMH"). WMH had previously sold an insurance subsidiary to a third party that was indemnified by White Mountains Insurance Group, Ltd. ("White Mountains") for certain future adverse loss development up to $50.0 million. In 2004, the Company made an indemnity payment of $47.0 million to the third party with funds provided for such purpose by White Mountains. While the Company had no legal liability in connection with the indemnity payment, the payment was treated for tax purposes as a $47.0 million loss deduction to the Company, as successor to WMH. The Company therefore recorded a tax benefit of $16.5 million. In addition, the Company shared 50% of the tax benefit with White Mountains when the required circumstances were satisfied in the third quarter of 2008.
6. Investment in subsidiaries
At December 31, 2008, FSA issued a surplus note to FSA Holdings in exchange for $300.0 million. At December 31, 2007, FSA Holdings held no FSA surplus notes. FSA repaid the balance of its surplus notes held by FSA Holdings in December 2007. Payments of principal or interest on such notes may be made only with the approval of the Superintendent of Insurance of the State of New York. FSA Holdings previously employed surplus note purchases in lieu of capital contributions in order to allow it to withdraw funds from FSA through surplus note payments without reducing earned surplus, thereby preserving dividend capacity of FSA.
FSA may repurchase shares of its common stock from FSA Holdings subject to the New York Superintendent's approval. The New York Superintendent has approved the repurchase by FSA of up to $500.0 million of its shares from FSA Holdings through December 31, 2008. In 2007 and 2006, the Company repurchased $180.0 million and $100.0 million, respectively, of shares of its common stock from FSA Holdings and retired such shares.
7. Legal proceedings
In November 2006, (i) the Company received a subpoena from the Antitrust Division of the U.S. Department of Justice issued in connection with an ongoing criminal investigation of bid rigging of awards of municipal GICs and other municipal derivatives and (ii) FSA received a subpoena from the SEC related to an ongoing industry-wide investigation concerning the bidding of municipal GICs and other municipal derivatives. Pursuant to the subpoenas the Company has furnished to the DOJ and SEC records and other information with respect to the Company's municipal GIC business. On February 4, 2008, the Company received a "Wells Notice" from the staff of the Philadelphia Regional Office of the SEC relating to the foregoing matter. The Wells Notice indicates that the SEC staff is considering recommending that the SEC authorize the staff to bring a civil injunctive action and/or institute administrative proceedings against the Company, alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 17(a) of the Securities Act. The Company has had ongoing discussions with the DOJ and the SEC. The ultimate loss that may arise from these investigations remains uncertain.
During 2008 nine putative class action lawsuits were filed in federal court alleging federal antitrust violations in the municipal derivatives industry, seeking damages and alleging, among other things, a conspiracy to fix the pricing of, and manipulate bids for, municipal derivatives, including GICs. These cases have been coordinated and consolidated for pretrial proceedings in the U.S. District Court for the Southern District of New York as MDL 1950, In re Municipal Derivatives Antitrust Litigation, Case No. 1:08-cv-2516 ("MDL 1950").
Five of these cases name both the Company and FSA: (a) Hinds County, Mississippi v. Wachovia Bank, N.A. (filed on or about March 13, 2008); (b) Fairfax County, Virginia v. Wachovia Bank, N.A.
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(filed on or about March 12, 2008); (c) Central Bucks School District, Pennsylvania v. Wachovia Bank N.A. (filed on or about June 4, 2008); (d) Mayor & City Counsel of Baltimore, Maryland v. Wachovia Bank N.A. (filed on or about July 3, 2008); and (e) Washington County, Tennessee v. Wachovia Bank N.A. (filed on or about July 14, 2008). Four of the cases name only the Company and also allege that the defendants violated state antitrust law and common law by engaging in illegal bid-rigging and market allocation, thereby depriving the cities of competition in the awarding of GICs and ultimately resulting in the cities paying higher fees for these products: (a) City of Oakland, California, v. AIG Financial Products Corp. (filed on or about April 23, 2008); (b) County of Alameda, California v. AIG Financial Products Corp. (filed on or about July 8, 2008); (c) City of Fresno, California v. AIG Financial Products Corp. (filed on or about July 17, 2008); and (d) Fresno County Financing Authority v. AIG Financial Products Corp. (filed on or about December 24, 2008).
Interim lead counsel for the MDL 1950 plaintiffs filed a Consolidated Class Action Complaint ("Consolidated Complaint") in August 2008 alleging violations of the federal antitrust laws. Defendants filed motions to dismiss the Consolidated Complaint. The MDL 1950 court has determined that it will handle federal claims alleged in the Consolidated Complaint before addressing state claims. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
The Company and FSA also are named in five non-class actions originally filed in the California Superior Courts alleging violations of California law related to the municipal derivatives industry:
These cases have been transferred to the S.D.N.Y. and consolidated with MDL 1950 for pretrial proceedings. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
The Company has received various regulatory inquiries and requests for information regarding a variety of subjects. These include subpoenas duces tecum and interrogatories from the State of
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Connecticut Attorney General and the Attorney General of the State of California related to antitrust concerns associated with the methodologies used by rating agencies for determining the credit rating of municipal debt, including a proposal by Moody's to assign corporate equivalent ratings to municipal obligations, and the Company's communications with rating agencies. The Company is in the process of satisfying such requests. The Company may receive additional inquiries from these or other regulators and expects to provide additional information to such regulators regarding their inquiries in the future.
In December 2008 and January 2009, FSA and various other financial guarantors were named in three complaints filed in the Superior Court, San Francisco County: (a) City of Los Angeles Department of Water and Power v. Ambac Financial Group et. al (filed on or about December 31, 2008), Case No. CG-08-483689; Sacramento Municipal Utility District v. Ambac Financial Group et. al (filed on or about December 31, 2008), Case No. CGC-08-483691; and (c) City of Sacramento v. Ambac Financial Group Inc. et. al (filed on or about January 6, 2009), Case No. CGC-09-483862. These complaints alleged participation in a conspiracy in violation of California's antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and created market demand for municipal bond insurance and participation in risky financial transactions in other lines of business that damaged each bond insurer's financial condition (thereby undermining the value of each of their guaranties), and a failure to adequately disclose the impact of those transactions on their financial condition. These latter allegations form the predicate for five separate causes of action against each of the Insurers: breach of contract, breach of the covenant of good faith and fair dealing, fraud, negligence, and negligent misrepresentation. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
In August 2008 a number of financial institutions and other parties, including FSA, were named as defendants in a civil action brought in the circuit court of Jefferson County, Alabama relating to the County's problems meeting its debt obligations on its $3.2 billion sewer debt: Charles E. Wilson vs. JPMorgan Chase & Co et al (filed on or about August 8, 2008 in the Circuit Court of Jefferson County, Alabama), Case No. 01-CV-2008-901907.00, a putative class action. The action was brought on behalf of rate payers, tax payers and citizens residing in Jefferson County, and alleges conspiracy and fraud in connection with the issuance of the County's debt. The complaint in this lawsuit seeks unspecified monetary damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss or range of loss that may arise from this lawsuit. FSA was also named as a defendant in a second civil action regarding Jefferson County, Alabama, but was dismissed from such action in January 2009.
The entitlements of the Chief Executive Officer and the President of the Company under their employment agreements with the Company are in dispute. In addition, holders of shares under the Director Share Purchase Program are in discussions with Dexia regarding the proper valuation of such shares, which may lead to mediation or arbitration of the dispute.
There are no other material legal proceedings pending to which the Company is subject.
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EXHIBIT 10.16
***TEXT OMITTED AND SUBMITTED SEPARATELY PURSUANT TO CONFIDENTIAL TREATMENT REQUEST UNDER 17 C.F.R. SECTION 200.80(B)(4)
SECOND REVOLVING CREDIT AGREEMENT dated as of February 20, 2009 between FSA Asset Management LLC, a Delaware limited liability company (with its successors, the Company); and Dexia Crédit Local, a French share Company licensed as a bank under French law, acting through its head office located at 1, Passerelle des Reflets, Tour Dexia La Défense 2, 92913 La Défense Cedex, France (with its successors, the Bank).
ARTICLE I
DEFINITIONS
Section 1.01. Definitions. The following terms, as used herein, have the following meanings:
Authorized Account means the account of the Company designated in writing by two Authorized Signatories.
Authorized Signatory means any person designated by the Company on Exhibit B. Changes to the list of Authorized Signatories require the signature of two Authorized Signatories.
Base Rate means, for any day, the Federal Funds Rate for such day.
Business Day means, in respect of any date, a day that is not a Saturday or Sunday or a day on which commercial banks and foreign exchange markets settle payments and are open for general business (including dealings in foreign exchange) in the Cities of New York, London and Paris.
Commitment means $3,000,000,000 (Three Billion United States Dollars) or such lesser amount to which the Commitment shall be reduced from time to time in accordance with the terms of this Agreement.
Dollars or $ means the lawful currency of the United States of America.
Event of Default means any of the events specified as such in Section 5.01.
Federal Funds Rate means, for any period, a fluctuating interest rate equal for each day during such period to the weighted average of the rates on overnight Federal Funds transactions with members of the Federal Reserve System arranged by
Federal Funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average rate quoted to the Bank at approximately 11:00 a.m. (New York City time) on such day (or, if such day is not a Business Day, on the next preceding Business Day) for overnight Federal Funds transactions arranged by New York Federal Funds brokers of recognized standing selected by the Bank.
First Revolving Credit Agreement means the Revolving Credit Agreement, dated June 30, 2008, among Dexia Crédit Local, Dexia Bank Belgium SA and the Company, as amended as of the date hereof.
FSA means Financial Security Assurance Inc. and its successors.
Interest Period means, with respect to any LIBO Rate Loan, the one-, two-, three- or six-month maturity applicable to such Loan, as specified by the Company at the time of its request for such Loan in accordance with Section 2.01(b).
LIBO Rate shall have the meaning specified in Section 2.01(b).
LIBO Rate Loan shall have the meaning specified in Section 2.01(b).
Loan means any loan made by the Bank to the Company pursuant to Section 2.01.
Maturity Date means, as of any date, the date six months following the Termination Date in effect on such date; provided that, if the Maturity Date would otherwise occur on a date that is not a Business Day, the Maturity Date shall instead occur on the first day following such date that is a Business Day.
Note shall have the meaning specified in Section 2.01(d).
Notice of Termination means any notice, substantially in the form of Exhibit C, duly completed, executed and delivered by the Bank to the Company in accordance with Section 2.08.
Termination Date means (i) on the date of this Agreement, the fifth (5 th ) anniversary of June 30, 2008; (ii) on any date thereafter prior to the earlier of the Companys receipt of a Notice of Termination from the Bank under the First Revolving Credit Agreement or this Agreement, the fifth (5 th ) anniversary of such date; and (iii) on any date on or after the Companys receipt of a Notice of Termination from the Bank under the First Revolving Credit Agreement or this Agreement, the fifth (5 th ) anniversary of the date of such receipt; provided that, if the Termination Date would otherwise occur on a date that is not a Business Day, the Termination Date shall instead occur on the first day following such date that is a Business Day .
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ARTICLE II
THE LOANS
Section 2.01. Loans.
(a) At the request of the Company, the Bank shall, subject to the terms and conditions of this Agreement, from time to time on Business Days during the period from and including the date hereof to but excluding the Termination Date, make one or more Loans to the Company such that, at the time of the making of any such Loan, the aggregate principal amount of all Loans outstanding hereunder at such time (including such Loan) shall not exceed the Commitment.
(b) The Company may request a Loan only by written notice to the Bank signed by an Authorized Signatory of the Company specifying the amount to be borrowed (which must be in a minimum principal amount of $5,000,000 or any larger amount in increments of $1,000,000) and the Interest Period to be applicable to the proposed Loan. Such notice must be delivered to the Bank at or before 4:30 p.m. (Paris time) on the Business Day immediately preceding the date of the proposed borrowing. The Bank shall send the proceeds of any Loan by wire transfer of immediately available funds to the Companys Authorized Account.
Loans will be only LIBO Rate Loans, each of which shall be denominated in Dollars and have an Interest Period as selected by the Company, subject to standard market conventions as to adjustments for non-Business Days and month-ends (but in no event extending beyond the Maturity Date), and shall bear a per annum interest rate equal to [ *** ]% over the applicable LIBO Rate. For purposes hereof, the applicable LIBO Rate shall be the Dollar LIBO Rate for the applicable Interest Period determined by reference to Page 3750 or page 3740, as applicable (or any replacement pages), by Telerate The Financial Information Network published by Telerate Systems, Inc. (the Telerate Service) as of 11:00 a.m. (London time) two Business Days prior to the first day of such Interest Period or (if such rate does not so appear on the Telerate Service) such other publicly available service for displaying LIBO rates as may be agreed upon by the Bank and the Company.
(c) Each Loan will bear interest from its date until maturity on the basis specified to the Company by the Bank (subject to subsection (b) above) contemporaneously with the making of such Loan, payable at maturity. Overdue payments of principal, interest and other amounts payable hereunder shall bear interest, payable on demand, at a rate for each day equal to the Base Rate for such day plus 1% per annum.
No partial or total prepayment of any Loan shall be allowed, except with the prior written consent of the Bank.
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(d) All Loans shall be evidenced by a promissory note appropriately completed, executed and delivered by the Company in the form of Exhibit A hereto (the Note). The Bank will endorse on the Note or otherwise record in its internal records the amount of each Loan, the interest rate applicable thereto and each payment of principal or interest made in respect thereof; provided that neither the failure of the Bank to do so nor any error by the Bank in doing so shall affect the obligations of the Company hereunder or under the Note.
Section 2.02. Conditions. The obligation of the Bank to make a Loan on any proposed borrowing date shall be subject to the satisfaction of the following conditions:
(i) The representations and warranties of the Company herein shall be true and correct in all material respects on the date of such borrowing as though made on and as of such date; and
(ii) No Event of Default shall have occurred and be continuing on the date of such borrowing (either before or after giving effect to such borrowing); and
(iii) The Company shall have borrowed the entire Commitment (as defined in the First Revolving Credit Agreement) under the First Revolving Credit Agreement, which amount remains outstanding, and no Event of Default under the First Revolving Credit Agreement shall have occurred and be continuing ; and
(iv) The Bank shall have received the properly completed and executed Note and such corporate resolutions, certificates, opinions of counsel and other documents in connection herewith as the Bank may, in its reasonable discretion, have required.
The Company shall be deemed to have made a representation and warranty on the date of each borrowing that the conditions specified in clauses (i) through (iii) above have been satisfied.
Section 2.03. Commitment Fees. The Company agrees to pay to the Bank a commitment fee at the rate of [ *** ]% per annum on the unused amount of the Commitment from time to time outstanding. Such fee shall be payable quarterly in arrears on each three-month anniversary of the date hereof and on the date on which the Commitment terminates.
Section 2.04. Taxes; Increased Costs.
(a) All payments under this Agreement (including, without limitation, payments of interest and principal) will be payable to the Bank free and clear of any and
*** Confidential treatment requested
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all present and future taxes, levies, imposts, duties, deductions, withholdings, fees, liabilities and similar charges other than those imposed on the overall net income of the Bank (Taxes). If any Taxes are required to be withheld or deducted from any amount payable under this Agreement, then the amount payable under this Agreement will be increased to the amount which, after deduction from such increased amount of all Taxes required to be withheld or deducted therefrom, will yield to the Bank the amount stated to be payable under this Agreement, and the Company will promptly provide to the Bank tax receipts evidencing the payment of such Taxes. If any of the Taxes specified in this subsection (a) are paid by the Bank, the Company will, upon demand of the Bank, reimburse the Bank for such payments, together with any interest and penalties which may be imposed by the governmental agency or taxing authority in respect thereof.
(b) If, after the date hereof, the adoption of any law, rule or regulation, or any change therein, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof or compliance by the Bank with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency (i) subjects the Bank to any charge with respect to any Loan or the Commitment or changes the basis of taxation of payments to the Bank hereunder or under the Note (except for changes in the rate of tax on the overall net income of the Bank or (ii) imposes, modifies or makes applicable any reserve, special deposit, deposit insurance assessment or similar requirement against loans made by the Bank, and the result of any of the foregoing is to increase the cost to the Bank of making or maintaining such Loan or to reduce any amount received or receivable by the Bank hereunder or under the Note, then, upon demand by the Bank, the Company shall pay to the Bank such additional amount or amounts as will compensate the Bank for such increased cost or reduction; provided that the Bank shall have provided to the Company thirty days prior written advice of any such additional amounts (and the basis for calculation thereof). In determining such additional amounts, the Bank will act reasonably and in good faith. A certificate of the Bank as to the additional amount or amounts payable to the Bank under this subsection (b) shall be conclusive absent manifest error.
Section 2.05. Capital Adequacy. If the adoption after the date hereof of any applicable law, rule or regulation regarding capital adequacy, or any change therein, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by the Bank with any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or other agency, has or would have the effect of reducing the rate of return on the Banks capital as a consequence of the Banks obligations hereunder or under any Loan to a level below that which the Bank could have achieved but for such adoption, change or compliance by an amount deemed by the Bank to be material, the Company shall pay to the Bank, on demand, such additional amount or amounts as will compensate the Bank for such reduction; provided that the Bank shall have provided to the Company thirty days prior written advice of any such additional amounts (and the basis for calculation thereof). In determining such additional amounts, the Bank will act reasonably and in
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good faith. A certificate of the Bank as to the additional amount or amounts payable to the Bank under this Section 2.05 shall be conclusive absent manifest error.
Section 2.06. Payments and Computations.
(a) Subject to the terms and provisions of this Agreement, all amounts of principal, interest, fees and other obligations payable by the Company hereunder or under the Note shall be made by 12:00 noon (Paris time) on the date when due to the Bank by wire transfer of immediately available funds to the account of the Bank in accordance with the wire instructions provided by the Company , or as otherwise from time to time notified to the Company by the Bank in writing.
(b) All computations of interest and fees shall be made on the basis of a year of 360 days, for the actual number of days elapsed (including the first day but excluding the last day). Notwithstanding anything to the contrary set forth herein or in the Note, interest shall in no event accrue hereunder or under the Note at a rate in excess of the maximum rate permitted under applicable law.
(c) Whenever any payment to be made hereunder shall be stated to be due on a day which is not a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall be included in the computation of payment of interest or fees, as the case may be.
(d) If for any reason due to acceleration following the occurrence of an Event of Default, the principal of any LIBO Rate Loan, or any portion thereof, is paid prior to the scheduled maturity date therefor, or if any LIBO Rate Loan is not borrowed after notice thereof shall have been received by the Bank, the Company will reimburse the Bank, on demand, for any resulting loss or expense incurred by the Bank, including without limitation any loss or expense incurred in obtaining, liquidating or employing deposits from third parties.
(e) The Bank is hereby authorized to charge the account, if any, of the Company maintained with the Bank for each payment of principal, interest and fees due from the Company as it becomes due hereunder.
Section 2.07. Optional Reduction of Commitment by the Company. With the mutual consent of the Bank and the Company, not to be unreasonably withheld, the Company may reduce the unused portion of the Commitment at any time in whole, or from time to time in part by an amount equal to $5,000,000 or any larger amount in increments of $1,000,000, by delivering to the Bank written notice specifying the amount of such reduction and the date on which such reduction is to become effective (which date may not be earlier than the date of delivery of such notice). Any such reduction shall be irrevocable.
Section 2.08. Termination of Commitment by the Bank. The Bank may, at any time, in its sole and absolute discretion, terminate its commitment to make Loans
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hereunder by delivering a Notice of Termination to the Company in accordance with the notice provisions set forth in Section 6.02. Any such termination shall be effective on the fifth (5 th ) anniversary of the date of the Companys receipt of such Notice (or, if such fifth (5 th ) anniversary is not a Business Day, the first Business Day immediately succeeding such fifth (5 th ) anniversary).
ARTICLE III
REPRESENTATIONS AND WARRANTIES
Section 3.01. Representations and Warranties. The Company represents and warrants to the Bank as follows:
(a) The Company is a limited liability company duly organized, validly existing and in good standing under the laws of the State of Delaware, and has all requisite power and authority, corporate and otherwise, to conduct its business as now conducted and to own its properties. The Company has full power and authority to enter into this Agreement and the Note and to incur its obligations provided for herein and therein, all of which have been duly authorized by all proper and necessary corporate action on the part of the Company. This Agreement has been duly executed and delivered by the Company and constitutes the valid and legally binding agreement of the Company, enforceable against the Company in accordance with its terms, except as enforceability may be affected by bankruptcy, insolvency and other laws relating to or affecting creditors rights generally and by general principles of equity. Upon execution and delivery thereof, the Note will constitute a valid and legally binding obligation of the Company, enforceable in accordance with its terms, except as enforceability may be affected by bankruptcy, insolvency and other laws relating to or affecting creditors rights generally and by general principles of equity.
(b) All consents and approvals of, and all notices to and filings with, any governmental entities or regulatory bodies required as a condition to the valid execution, delivery or performance by the Company of this Agreement and the Note have been obtained or made. Neither the execution and delivery of this Agreement and the Note nor compliance with the terms and provisions hereof and thereof will conflict with, result in a breach of or constitute a default under (i) any of the terms, conditions or provisions of the limited liability company agreement of the Company, (ii) any law, regulation or order, writ, judgment, injunction, decree, determination or award of any court or governmental instrumentality or (iii) any agreement or instrument to which the Company is a party or by which it is bound.
(c) The consolidated financial statements of FSA and its consolidated subsidiaries heretofore furnished or made available to the Bank are complete and correct and fairly present the consolidated financial condition of FSA and its consolidated subsidiaries as at the dates thereof and the results of operations for the periods covered thereby (subject, in the case of quarterly statements, to normal, year-end audit
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adjustments). Such financial statements were prepared in accordance with U.S. generally accepted accounting principles consistently applied.
(d) As of June 30, 2008, other than as may have been disclosed in the Annual Report on Form 10-K for the year ending December 31, 2007, or the Quarterly Report on Form 10-Q for the quarter ending March 31, 2008, in each case as filed by Financial Security Assurance Holdings Ltd. with the U.S. Securities and Exchange Commission, there is no action, suit or proceeding pending against, or to the Companys knowledge threatened against or affecting, the Company before any court or arbitrator or any governmental body, agency or official which, if adversely determined, would have a material adverse effect (actual or prospective) on the Companys business, properties or financial position or which seeks to terminate or calls into question the validity or enforceability of this Agreement or the Note.
(e) The Company is not (i) a holding company, or a subsidiary company of a holding company, or of a subsidiary company of a holding company, within the meaning of the Public Utility Holding Company Act of 1935, or (ii) required to be registered as an investment company as defined in (or subject to regulation under) the Investment Company Act of 1940. Neither the making of the Loans, or the application of the proceeds or repayment thereof by the Company, nor the consummation of other transactions contemplated hereunder, will violate any provision of the Public Utility Holding Company Act of 1935, the Investment Company Act of 1940 or any rule, regulation or order of the SEC.
ARTICLE IV
COVENANTS
Section 4.01. Covenants of the Company. The Company covenants and agrees that until the later to occur of (i) the Termination Date and (ii) the performance of all obligations of the Company hereunder and under the Note:
(a) General Affirmative Covenants. The Company will maintain its corporate existence in good standing, will comply in all material respects with all applicable laws, rules, regulations and orders of any governmental authority noncompliance with which would have a material adverse effect on its financial condition or operations or on its ability to meet its obligations hereunder, and will continue to engage in business of the same general type as that engaged in by the Company on the date hereof. The Company will pay and discharge, at or before maturity, all its obligations and liabilities, including, without limitation, tax liabilities, where failure to satisfy such obligations or liabilities in the aggregate would have a material adverse effect on its financial condition, operations or ability to meet its obligations hereunder. The Companys obligations hereunder and under the Note will rank pari passu with all other unsecured and unsubordinated obligations of the Company.
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(b) Financial Statements. The Company will furnish to the Bank or make available on FSAs website, www.fsa.com:
(1) as soon as available and in any event within 90 days after the end of each fiscal year of FSA, a consolidated balance sheet of FSA and its consolidated subsidiaries as at the close of such fiscal year and the related consolidated statements of income and changes in financial position for such year, certified by independent public accountants of recognized standing;
(2) as soon as available and in any event within 45 days after the end of each of the first three quarters of each fiscal year of FSA, a consolidated balance sheet of FSA and its consolidated subsidiaries as at the close of such quarter and the related consolidated statements of income and changes in financial position for such quarter and for the portion of such fiscal year then ended, certified by FSAs chief financial officer as having been prepared on a basis consistent with the most recent audited consolidated financial statements of FSA and its consolidated subsidiaries, it being understood that the required certifications on Form 10-Q and Form 10-K shall suffice for such purpose; and
(3) from time to time, such further information regarding the business, affairs and financial condition of the Company and its subsidiaries as the Bank shall reasonably request.
(c) Use of Proceeds. None of the proceeds of the Loans will be used directly or indirectly for the purpose (whether immediate, incidental or ultimate) of buying or carrying any margin stock within the meaning of Regulation U of the Board of Governors of the Federal Reserve System.
(d) Maintenance of Properties. The Company shall (a) maintain, preserve and protect all of its material properties and equipment necessary in the operation of its business in good working order and condition, ordinary wear and tear excepted; and (b) use the standard of care typical in the industry in the operation and maintenance of its facilities, except where the failure to do so could not reasonably be expected to have a material adverse effect on the Company.
(e) Maintenance of Insurance. The Company shall maintain with financially sound and reputable insurance companies or with a captive insurance company that is an affiliate of the Company as to which the Bank may request reasonable evidence of financial responsibility, insurance with respect to its properties in such amounts with such deductibles and covering such risks as are customarily carried by companies engaged in similar businesses and owning similar properties in localities where the Company or any of its subsidiaries operates.
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ARTICLE V
EVENTS OF DEFAULT
Section 5.01. Events of Default.
(a) The following events constitute Events of Default hereunder:
(i) The principal amount of any Loan shall not be paid when due; or
(ii) Any other amount payable under this Agreement or under the Note (including interest or fees) shall not be paid when due and such default shall continue unremedied for a period of five (5) days after written notice thereof to the Company by the Bank; or
(iii) Default shall be made in the due observance or performance by the Company of any other term, covenant or agreement contained in this Agreement or in the Note and such default shall continue unremedied for a period of five (5) Business Days after written notice thereof to the Company by the Bank; or
(iv) Any representation or warranty of the Company herein or any statement or representation made in any application, certificate, report or opinion delivered in connection herewith shall prove to have been incorrect or misleading in any material respect when made or deemed made; or
(v) The Company shall commence a voluntary case or other proceeding seeking liquidation, reorganization or other relief with respect to itself or its debts under any bankruptcy, insolvency or other similar law now or hereafter in effect or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property; or an involuntary case or other proceeding shall be commenced against the Company seeking any such relief or appointment and the Company shall consent thereto, an order for relief shall be granted or such case or proceeding shall remain undismissed and unstayed for a period of 90 days; or the Company shall make a general assignment for the benefit of creditors, shall fail generally to pay its debts as they become due, or shall take any action to authorize any of the foregoing.
(b) If an Event of Default occurs and is continuing, (A) the Bank may by notice to the Company declare the Commitment terminated and the Loans (together with accrued interest thereon) to be, and they shall thereupon become, immediately due without presentment, demand or other notice, all of which are hereby waived by the Company ( provided that, in the case of an Event of Default referred to in clause (v) of subsection (a) above with respect to the Company, the same shall occur with respect to the Commitment and all Loans automatically without any notice or any other act by the Bank or any other person) and/or (B) the Bank may exercise any other rights or remedies it may have under this Agreement or under the Note and take such other action as is permitted at law or in equity.
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ARTICLE VI
MISCELLANEOUS
Section 6.01. Amendments and Waivers. No failure or delay on the part of the Bank in exercising any power or right hereunder or under the Note shall operate as a waiver thereof, nor shall any single or partial exercise of any such right or power preclude any other or further exercise thereof or the exercise of any other right or power hereunder. No amendment or waiver of any provision of this Agreement or the Note nor consent to any departure by the Company herefrom or therefrom shall in any event be effective unless the same shall be in writing and signed by the Bank and the Company. Any such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. No notice to or demand on the Company in any case shall, of itself, entitle the Company to any other or further notice or demand in similar or other circumstances.
Section 6.02. Notices. Any communication, demand, or notice to be given to a party hereunder will be duly given and deemed to have been received when actually delivered (or 72 hours after having been deposited in the mails with first class postage prepaid) to such party at the address specified on the signature pages hereof (or at such other address as such party shall specify to the other party in writing), including delivery by telex, telecopier, e-mail or other telecommunication device capable of transmitting or creating a written record. The Bank may (but shall not be required to) accept and act upon oral, telephonic or other forms of notices or instructions hereunder that the Bank reasonably believes in good faith to have been given by a person authorized to do so on behalf of the Company. The Bank shall be fully protected and held harmless by the Company, and shall have no liability, for acting on any such notice or instruction that the Bank reasonably believes in good faith to have been given by a person authorized to do so on behalf of the Company. The Bank shall send a copy of any notice to the Company to Financial Security Assurance Inc., 31 West 52 nd Street, New York, New York 10019; Attention: General Counsel; Re: Dexia FP Liquidity; Email: generalcounsel@fsa.com.
Section 6.03. Set-off. The Company hereby grants to the Bank a right of set-off against any amounts standing to the credit of the Company (including any of its offices or divisions) on the books of any office of the Bank in any demand deposit or other account maintained with such office.
Section 6.04. Successors and Assigns. This Agreement shall inure to the benefit of, and shall be enforceable by, the parties hereto and their respective successors and permitted assigns. The Bank may assign any of its rights or obligations hereunder or under the Note to any office or affiliate of the Bank or, with the prior written consent of the Company (which consent shall not unreasonably be withheld), to any third party; provided that, from and after the occurrence of an Event of Default, the Bank may assign any of its rights or obligations hereunder without the consent of the Company. The Company may not assign or otherwise transfer any of its rights or obligations under this
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Agreement or the Note without the prior written consent of the Bank, and any purported assignment without such consent shall be void.
Section 6.05. Costs, Expenses and Taxes. The Company agrees to pay on demand all costs and expenses of the Bank, including reasonable fees and expenses of counsel, in connection with the enforcement against it of this Agreement and the Note and the protection of the Banks rights hereunder and thereunder, including any bankruptcy, insolvency, enforcement proceedings or restructuring with respect to the Company. In addition, the Company shall pay any and all stamp and other taxes and fees payable or determined to be payable in connection with the execution, delivery, filing and recording of this Agreement and the Note, and agrees to save the Bank harmless from and against any and all liabilities with respect to or resulting from any delay in paying or omission to pay such taxes and fees.
Section 6.06. Governing Law. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK (WITHOUT REGARD TO CONFLICT OF LAWS PRINCIPLES). Each of the Company and the Bank hereby irrevocably submits to the non-exclusive jurisdiction of any U.S. federal or state court in The City of New York for the purpose of any suit, action, proceeding or judgment relating to or arising out of this Agreement or the Note. Each of the Company and the Bank hereby consents to the laying of venue in any such suit, action or proceeding in New York County, New York, and hereby irrevocably waives any claim that any such suit, action or proceeding brought in such a court has been brought in an inconvenient forum. Any process in any such action shall be duly served if mailed by registered mail, postage prepaid, to the Company or the Bank, as the case may be, at its address designated pursuant to Section 6.02.
Section 6.07. Counterparts; Integration. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if all signatures thereon were upon the same instrument. This Agreement and the Note constitute the entire agreement and understanding between the Company and the Bank with respect to the subject matter hereof, and supersede any prior agreements and understandings with respect thereto.
Section 6.08. WAIVER OF JURY TRIAL. EACH OF THE COMPANY AND THE BANK HEREBY IRREVOCABLY WAIVES ANY RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY.
Section 6.09. PATRIOT ACT. The Bank hereby notifies the Company that, pursuant to the requirements of the USA PATRIOT Act (Title III of Pub. L. 107-56 (signed into law October 26, 2001)) (the Act), it is required to obtain, verify and record information that identifies the Company, which information includes the name and address of the Company and other information that will allow the Bank to identify the Company in accordance with the Act.
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IN WITNESS WHEREOF , the parties hereto have caused this Agreement to be duly executed and delivered by their respective officers thereunto duly authorized as of the date first above written.
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FSA Asset Management LLC |
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31 West 52 nd Street |
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New York, N.Y. 10019 |
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Attn.: |
FP Operations |
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Telephone: |
212.893.2700 |
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Telecopy: |
212.893.2727 |
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Email: |
gicops@fsa.com |
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By: |
/s/ Guy Cools |
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Name: |
Guy Cools |
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Title: |
Managing Director |
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Dexia Cr é dit Local |
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1, Passerelle des Reflets |
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Tour Dexia La Défense 2 |
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92913 La Défense Cedex |
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France |
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Attn.: |
Back Office Operations |
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Telephone: |
33 1 58 58 72 09 |
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33 1 58 58 68 92 |
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Telecopy: |
33 1 58 58 72 90 |
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Email: |
laurent.fritsch@dexia.com |
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By: |
/s/ Pascal Poupelle |
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Name: |
Pascal Poupelle |
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Title: |
Chief Executive Officer |
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Exhibit A
Promissory Note |
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$3,000,000,000 |
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February [ · ], 2009 |
FSA Asset Management LLC, a Delaware limited liability company (the Company), for value received, hereby promises to pay to the order of Dexia Cr é dit Local, acting through its head office (including its successors and permitted assigns, the Bank), located at 1, Passerelle des Reflets, Tour Dexia La Défense 2, 92913 La Défense Cedex, France , in lawful money of the United States, the principal sum of Three Billion Dollars or, if less, the aggregate unpaid principal amount of all loans (Loans) made by the Bank to the Company pursuant to the Second Revolving Credit Agreement dated as of February 20, 2009 (as amended from time to time, the Agreement) between the Company and the Bank. Each Loan shall mature on the date specified in or pursuant to the Agreement, and such maturity shall be subject to acceleration in the circumstances specified therein. Each Loan shall bear interest at the rate or rates and such interest shall be payable on the date or dates specified in or pursuant to the Agreement.
Loan and related information may be endorsed by the Bank hereon or upon a schedule that may be attached hereto and made a part hereof; provided that the failure of the Bank to make any such endorsement or any error in doing so shall not affect the obligations of the Company hereunder or under the Agreement.
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FSA Asset Management LLC |
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By: |
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Name: |
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Title: |
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Exhibit B
Name |
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Signature |
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Robert P. Cochran |
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Séan W. McCarthy |
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Guy Cools |
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Joseph W. Simon |
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Russell B. Brewer II |
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Edsel C. Langley, Jr. |
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M. Douglas Watson, Jr. |
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Bruce E. Stern |
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Hongfei Zhang |
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Dennis H. Kim |
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15
Exhibit C
[Form of Notice of Termination]
[Letterhead of]
DEXIA CRÉDIT LOCAL, Head Office
[Date]
FSA Asset Management LLC
31 West 52 nd Street
New York, N.Y. 10019
Attention: |
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FP Operations |
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Re: |
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Termination of Second Revolving Credit Agreement |
Dear Sirs:
Reference is hereby made to that certain Second Revolving Credit Agreement, dated as of February 20, 2009, by and between you and the undersigned (such Agreement, as the same may have been heretofore amended, the Agreement). Capitalized terms used herein without definition are used herein as defined in the Agreement.
In accordance with Section 2.08 of the Agreement, the undersigned hereby notifies you that the commitment of the undersigned to make Loans to you under the Agreement is hereby terminated effective as of, and from and after, the fifth (5 th ) anniversary of the date of your receipt of this notice.
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Very truly yours, |
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Dexia Crédit Local, |
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By: |
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Name: |
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Title: |
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cc: |
FSA Asset Management LLC |
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31 West 52 nd Street |
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New York, N.Y. 10019 |
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Attention: |
General Counsel |
16
EXHIBIT 10.19
AMENDED AND RESTATED PLEDGE AND INTERCREDITOR AGREEMENT
THIS AMENDED AND RESTATED PLEDGE AND INTERCREDITOR AGREEMENT (as further amended, supplemented, or otherwise modified from time to time, this Agreement ), dated as of February 20, 2009, is entered into among Dexia Crédit Local ( DCL ), Dexia Bank Belgium S.A. ( DBB ), Financial Security Assurance Inc. ( FSA ), FSA Asset Management LLC ( FSAM ), FSA Capital Markets Services LLC ( FSA Capital Markets ) and FSA Capital Management Services LLC ( FSA Capital Management ).
W I T N E S S E T H :
WHEREAS, pursuant to the Amended and Restated Insurance and Indemnity Agreement dated as of October 21, 2008 between FSA and FSAM (the FSAM Insurance Agreement ), a copy of which is attached hereto as Annex A, FSAM has granted FSA a security interest in the collateral identified therein (as defined in the FSAM Insurance Agreement the Collateral ) to secure the obligations of FSAM under the FSAM Insurance Agreement, including the reimbursement of amounts paid by FSA under the Derivative Policies (as defined in the FSAM Insurance Agreement);
WHEREAS, pursuant to a Pledge and Intercreditor Agreement dated November 13, 2008, FSAM granted a security interest over the Collateral to DBB and DCL (together, the Lenders ) in connection with their agreement to provide financing under the terms of a Revolving Credit Agreement dated June 30, 2008, as amended (the First Credit Agreement ), which security interest is junior in priority to the security interest granted to FSA;
WHEREAS, in connection with the execution of the Release and Termination Agreement dated February 20, 2009, FSA Capital Markets and FSA Capital Management (the GIC Issuers ) wish to obtain and FSAM wishes to grant a security interest over the Collateral that is pari passu with the security interest granted to FSA and senior to the security interest granted to the Lenders in connection with the First Credit Agreement and FSA, DBB and DCL wish to consent to the foregoing grant of security;
WHEREAS, pursuant to a Second Revolving Credit Agreement dated February 20, 2009 between FSAM and DCL (the Second Credit Agreement , and each of the First Credit Agreement and the Second Credit Agreement, a Credit Agreement ), DCL has agreed to provide additional financing to FSAM which is to be secured by a lien that is junior to the lien provided to the Lenders in connection with the First Credit Agreement and FSAM, FSA, the GIC Issuers, DBB and DCL wish to consent to the foregoing grant of security;
WHEREAS, the parties wish to set forth the priorities of their respective liens in the Collateral and the circumstances that will determine such relative priorities in an amended and restated pledge and intercreditor agreement; and
WHEREAS, DCL and DBB have agreed that DCL will act as Security Agent under this Agreement on behalf of itself and DBB with respect to the First Credit Agreement and on behalf of itself with respect to the Second Credit Agreement;
NOW THEREFORE, for good and valuable consideration the receipt of which is hereby acknowledged, DBB, DCL, FSA, the GIC Issuers and FSAM each agree as follows:
ARTICLE
I
DEFINITIONS
SECTION 1.1. Certain Terms . Capitalized terms used but not defined herein have the meanings set forth in each Credit Agreement or, if not defined therein, in the FSAM Insurance Agreement. The following terms (whether or not underscored) when used in this Agreement, including its preamble and recitals, shall have the following meanings (such definitions to be equally applicable to the singular and plural forms thereof):
Account Bank Lien means any Lien for the benefit of the Accoun t Bank, as securities intermediary (as defined in the UCC), as required or permitted under the UCC or under the Securities Account Control Agreement.
Collateral Posting Lien means, in the event that the Master Agreements are recharacterized as secured financings, the Lien for the benefit of FSA Capital Management and/or FSA Capital Markets pursuant to a pledge or advance of Collateral by FSAM for the purpose of enabling FSA Capital Management and FSA Capital Markets to satisfy their respective Collateral Posting Requirements.
Collateral Posting Requirements means any requirement for FSA Capital Management or FSA Capital Markets to post specified collateral either (i) pursuant to the terms of the relevant GIC irrespective of the rating of the financial strength of FSA or (ii) during such time as the financial strength of FSA is not rated at least the required rating specified under the relevant GIC. For the avoidance of doubt, a requirement to post collateral includes a provision in a GIC that upon a relevant downgrade of FSA, the GIC Issuers have the option to post collateral (or effect one or more other cures), failing which the GIC would become subject to termination (either automatically or at the election of the relevant GIC holder).
Excluded Collateral means any (i) Collateral specifically granted or sold by FSAM, in each case subject to the consent of FSA and the GIC Issuers (and the GIC Issuers shall be deemed to have consented to the same extent as FSA under Section 6.06 of the FSAM Insurance Agreement), to secure its payment obligations under (A) any Master Agreement, Related Derivative Agreement or other similar financing arrangements or posted by FSAM as collateral to satisfy margin requirements with one or more brokers or dealers, (B) any repurchase agreement between FSAM and DCL, DBB, FSA or FSA Insurance Company, (C) any securities lending agreement between FSAM and DCL, DBB, FSA or FSA Insurance Company, or (D) any repurchase agreement between FSAM and any third party, where (I) the right to act as purchaser under such repurchase agreement has first been offered to DCL or DBB in the same amount and on substantially the same terms as those subsequently agreed by FSAM with the relevant purchaser, pursuant to the Offer Procedures, and (II) DCL or DBB, as applicable, has not accepted such offer to enter into such repurchase agreement with FSAM on such terms in accordance with the Offer Procedures and (ii) any other Collateral consented to by FSA, the GIC Issuers and the Lenders (such consents not to be unreasonably withheld). For the avoidance of doubt, Excluded Collateral does not include, and the security interest of (i) the Lenders, with respect to the First Credit Agreement (ii) DCL, with respect to the Second Credit Agreement, and (iii) the GIC Issuers, with respect to the Master Notes and the Master Agreements, shall extend to, all rights of FSAM to repurchase or to receive the return of Collateral (or equivalent
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securities or payments) under the Master Agreements or any Related Derivative Agreement or other similar financing arrangements pursuant to which Collateral may become Excluded Collateral.
FSA Capital Management Insurance Agreement means the Insurance and Indemnity Agreement dated as of October 29, 2001 between FSA and FSA Capital Management.
FSA Capital Markets Insurance Agreement means the Insurance and Indemnity Agreement dated as of October 29, 2001 between FSA and FSA Capital Markets.
FSA Liens means the security interest(s) in favor of FSA in relation to any or all of the Collateral under the FSAM Insurance Agreement.
GIC Issuer Obligations means all payment obligations of FSAM under the Master Notes and the Master Agreements.
Grant means, as to any asset or property, to mortgage, pledge, assign and grant a security interest in such asset or property. A Grant of the Collateral or any assigned document, instrument or agreement shall include all rights, powers and options (but none of the obligations, except to the extent required by law), of the Granting party thereunder or with respect thereto, including the immediate and continuing right to claim, collect, receive and give receipt for all moneys payable thereunder and all income, proceeds, products, rents and profits thereof, to give and receive notices and other communications, to make waivers or other agreements, to exercise all rights and options, to bring proceedings in the name of the Granting party or otherwise, and generally to do and receive anything which the Granting party is or may be entitled to do or receive thereunder or with respect thereto.
Intended Uses means FSAMs application of funds to (i) make payments in respect of the Master Notes or Master Agreements, (ii) make payments in respect of Related Derivatives and any other hedging transactions (such as futures transactions) entered into by FSAM to hedge exposures relating to the Assets, the Master Notes and the Master Agreements, (iii) make advances to FSA Capital Management and FSA Capital Markets for the purpose of enabling FSA Capital Management and FSA Capital Markets to satisfy their respective Collateral Posting Requirements under the guaranteed investment contracts ( GICs ) issued by FSA Capital Management and FSA Capital Markets, (iv) make reimbursement payments to FSA in respect of any payments by FSA under the Derivative Policies, (v) make payments in respect of financing obtained under the Master Agreements for the purpose of meeting Collateral Posting Requirements or otherwise for the payments described in (i) through (iv), (vi) make payment of other sums payable by the Issuer under the foregoing documents and any of the other Issuer Documents as defined in the FSAM Insurance Agreement, in connection with the transactions contemplated thereby, (vii) make payments under agreements or transactions ancillary or incidental to the items described in (i) through (vi), (viii) make payments of fees, charges, costs and expenses in respect of banking, custodial and other services to FSAM incurred in connection with the transactions contemplated by the agreements in (i) through (vii) and (ix) make transfers of securities under FSAMs other repurchase agreements or securities lending agreements.
Lender Agreements means each Credit Agreement, the Note(s) issued thereunder and this Agreement.
Lender Obligations means all payment obligations of FSAM under the Lender Agreements.
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Lenders Liens has the meaning provided in Section 2.1(c).
Lenders means DCL and DBB.
Lien means, with respect to any property, any mortgage, lien, pledge, charge, security interest or encumbrance of any kind in respect of such property.
Master Agreements means the Master Repurchase Agreement I dated as of October 29, 2001 between FSAM and FSA Capital Management and the Master Repurchase Agreement II dated as of October 29, 2001 between FSAM and FSA Capital Markets.
Master Notes means the Master Note, Series A dated October 29, 2001 issued by FSAM to FSA Capital Management and the Master Note, Series B dated October 29, 2001 issued by FSAM to FSA Capital Markets.
Offer Procedures means the following procedures for giving DBB or DCL a right to match the terms of any additional repurchase agreement financing obtained by FSAM: (1) if FSAM intends to solicit one or more quotations for repurchase agreement financing, FSAM shall give notice (which may be oral notice) of such intention to DBB or DCL, with FSAM giving as much advance notice of its solicitation of quotations as is reasonably practicable and in any event contacting DBB or DCL substantially at the same time as FSAM contacts other potential providers of financing, with such notice to (x) be given at such notice details as DBB and DCL, as applicable, shall specify from time to time to FSAM for this purpose and (y) describe the expected purchased securities, purchase date, repurchase date, purchase price, and approximate time at which FSAM intends to obtain quotations; (2) at the time at which one or more quotations are obtained, FSAM shall contact DBB or DCL by telephone, at the contact number(s) of such individuals at DBB or DCL, as applicable, as DBB or DCL shall specify from time to time to FSAM for such purpose (it being understood that FSAM shall not be responsible if the relevant persons are unavailable at such number(s)), of the terms (including the final purchased securities, purchase date, repurchase date, purchase price, pricing rate, and margin percentage) of the proposed repurchase agreement for which FSAM has obtained one or more quotations from a third party; and (3) DBB or DCL, as applicable, shall have 15 minutes from receipt of such notice of such terms in which to accept an offer (which may be by telephone) to act as purchaser under such a repurchase agreement with FSAM. The Offer Procedures will be satisfied in relation to DBB only if all relevant notices given to DBB are given during business hours in Brussels. In the case of notices given to DCL, the Offer Procedures may be satisfied by notices given to personnel of DCLs New York Branch during business hours in New York; provided that if DCL ceases to conduct U.S. dollar repurchase agreement financing activity in New York, FSAM and DCL shall cooperate in good faith to specify an alternative set of procedures for giving DCL a commercially reasonable notice and opportunity to exercise its option to provide repurchase agreement financing arranged by FSAM from time to time. For the avoidance of doubt, the Offer Procedures are required to be satisfied with respect to any proposed repurchase agreement only in relation to either DBB or DCL, not both DBB and DCL.
Permitted Lien means (i) any Collateral Posting Lien and (ii) any Account Bank Lien.
Person Any individual, corporation, partnership, joint venture, association, company, trust, unincorporated organization or government or any agency or political subdivision thereof.
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Security Agent means the DCL acting as agent for itself and, as applicable, DBB for purposes of the Lender Agreements.
Senior Secured Obligations means all payment obligations of FSAM under the FSAM Insurance Agreement, the Master Notes and the Master Agreements.
Subordinated Liens means the Lenders Liens.
UCC or Uniform Commercial Code means the Uniform Commercial Code as in effect from time to time in the State of New York and, with respect to security interests perfected through the possession of the Security Agent, the Uniform Commercial Code as in effect from time to time in the State of New York. Unless otherwise stated, all references herein to statutory sections or articles are to sections and articles of the UCC.
ARTICLE II
SECURITY INTEREST PROVISIONS
SECTION 2.1. GIC Issuers and Lenders Liens
(a) In order to secure, as provided herein, the performance and observance of each term, covenant, agreement and condition of FSAM contained in the Master Notes and the Master Agreements (whether in respect of existing or future obligations thereunder), FSAM hereby Grants a security interest in and collaterally assigns, transfers, sets over, pledges and conveys to each GIC Issuer, all the right, title, interest and estate of FSAM, whether now or hereafter acquired, in, to and under the Collateral (as defined in the FSAM Insurance Agreement) that secures the FSA Liens and such security interest shall be pari passu with the FSA Liens (the GIC Issuers Lien ).
(b) In order to secure, as provided herein, the performance and observance of each term, covenant, agreement and condition of FSAM contained in the First Credit Agreement or the Notes issued thereunder (whether in respect of existing or future advances under the First Credit Agreement), FSAM hereby Grants a security interest in and collaterally assigns, transfers, sets over, pledges and conveys to the Security Agent, on behalf of and for the benefit of each Lender, all the right, title, interest and estate of FSAM, whether now or hereafter acquired, in, to and under the Collateral as defined in the FSAM Insurance Agreement; provided, however, that the Collateral shall not include any Excluded Collateral; and provided, further, that such security interest shall be subordinated to the security interest granted pursuant to Section 2.1(a) (the First Credit Agreement Lien ).
(c) In order to secure, as provided herein, the performance and observance of each term, covenant, agreement and condition of FSAM contained in the Second Credit Agreement or the Notes issued thereunder (whether in respect of existing or future advances under the Second Credit Agreement), FSAM hereby Grants a security interest in and collaterally assigns, transfers, sets over, pledges and conveys to the Security Agent, on behalf of and for the benefit of DCL, all the right, title, interest and estate of FSAM, whether now or hereafter acquired, in, to and under the Collateral as defined in the FSAM Insurance Agreement; provided, however, that the Collateral shall not include any Excluded Collateral; and provided, further, that such security interest shall be subordinated to the security interests granted pursuant to Section 2.1(a)
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and Section 2.1(b) (the Second Credit Agreement Lien , and, together with the First Credit Agreement Lien, the Lenders Liens ).
SECTION 2.2. Notices .
In the event that DCL, in the case of either Credit Agreement, or DBB, in the case of the First Credit Agreement, shall give notice of an Event of Default under such Credit Agreement or notify FSAM of the termination of the commitment of the Lenders and acceleration of the amounts owed under the relevant Credit Agreement pursuant to Section 5.01(b) of such Credit Agreement, the Security Agent shall promptly give a copy of such notice to FSA. In the event that a GIC Issuer shall give notice of an Event of Default under the Master Notes or Master Agreements, such GIC Issuer shall promptly give a copy of such notice to FSA.
SECTION 2.3 Timing and Manner of Enforcement .
Notwithstanding the Lenders Liens, neither FSA nor the GIC Issuers shall have any duty to the Security Agent, (i) on behalf of the Lenders with respect to the First Credit Agreement or (ii) on behalf of DCL with respect to the Second Credit Agreement, as holders of Subordinated Liens as to the timing or manner of FSAs exercise of its remedies under the FSAM Insurance Agreement or the GIC Issuers exercise of their remedies under the Master Notes, the Master Agreements or this Agreement, which shall in each case be in the discretion of FSA or the GIC Issuers, as applicable, and pursuant to the terms of the FSAM Insurance Agreement, the Master Notes, the Master Agreements and this Agreement, as the case may be, and the failure by FSA or the GIC Issuers to take any action shall not be deemed a waiver by FSA or the GIC Issuers of any rights thereunder or hereunder.
Furthermore, neither FSA nor the GIC Issuers shall be liable to the Security Agent, (i) on behalf of the Lenders with respect to the First Credit Agreement or (ii) on behalf of DCL with respect to the Second Credit Agreement, as holders of Subordinated Liens with respect to any action taken or omitted to be taken by FSA or the GIC Issuers with respect to the Collateral or any property distributable on or by reason thereof, other than a failure to deliver any remaining Collateral after all of the obligations of FSAM under the FSAM Insurance Agreement, the Master Notes and the Master Agreements, have been satisfied in full and the Liens of FSA and the GIC Issuers have been discharged (the Senior Lien Release Date ).
The Security Agent, (i) on behalf of the Lenders with respect to the First Credit Agreement and (ii) on behalf of DCL with respect to the Second Credit Agreement, shall have no right to take action to enforce the Subordinated Liens or exercise any creditors remedies in respect thereof, notwithstanding occurrence of an Event of Default under either Credit Agreement, unless the Senior Lien Release Date has occurred or FSA and the GIC Issuers have each given their written consent with respect thereto.
The parties acknowledge that the GIC Issuers have, pursuant to the FSA Capital Management Insurance Agreement and the FSA Capital Markets Insurance Agreement, collaterally assigned their rights hereunder to FSA to secure their obligations to FSA thereunder and that FSA may exercise all rights of the GIC Issuers hereunder and in relation to the GIC Issuers Lien.
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SECTION 2.4 Amendments .
With respect to the First Credit Agreement, the Lenders agree with FSA and the GIC Issuers that the Lenders shall not enter into any amendment, modification or supplement to the First Credit Agreement or the Letter Agreement dated August 5, 2008 between DCL, FSA and FSAM without the prior written consent of FSA and the GIC Issuers, which consent shall not be unreasonably withheld or delayed. With respect to the Second Credit Agreement, DCL agrees with FSA and the GIC Issuers that DCL shall not enter into any amendment, modification or supplement to the Second Credit Agreement or the Letter Agreement dated February 20, 2009 between DCL and FSAM without the prior written consent of FSA and the GIC Issuers, which consent shall not be unreasonably withheld or delayed. FSA and the GIC Issuers each agree with the Lenders that they shall not enter into any amendment, modification or supplement to the FSAM Insurance Agreement, the FSA Capital Markets Insurance Agreement, the FSA Capital Management Insurance Agreement, the Master Notes or the Master Agreements without the prior written consent of the Lenders, which consent shall not be unreasonably withheld or delayed.
The parties agree that the FSAM Insurance Agreement, the FSA Capital Markets Insurance Agreement, the FSA Capital Management Insurance Agreement, the Master Notes and the Master Agreements shall be amended as and to the extent deemed necessary or advisable to reflect the terms of this Agreement and the cancellation of the FSA policies under the Release and Termination Agreement dated February 20, 2009 among FSA, FSAM, FSA Capital Markets and FSA Capital Management.
ARTICLE III
REPRESENTATIONS AND WARRANTIES
Each of the Lenders, the GIC Issuers, FSA and FSAM represents and warrants as to itself as of the date hereof that:
SECTION 3.1. Due Organization and Qualification . Such party is duly organized and validly existing under the jurisdiction of its organization, and is duly qualified to do business, is in good standing and has obtained all necessary licenses, permits, charters, registrations and approvals necessary for the performance of its obligations under this Agreement.
SECTION 3.2. Due Authorization . The execution, delivery and performance of this Agreement have been duly authorized by such party and do not require any additional approvals or consents or other action by or any notice to or filing with any Person, including, without limitation, any governmental entity.
SECTION 3.3. Noncontravention . Neither the execution and delivery of this Agreement by such party, the consummation of the transactions contemplated thereby nor the satisfaction of the terms and conditions of this Agreement,
(a) conflicts with or results in any breach or violation of any provision of such partys organization or constitutional documents or any law, rule, regulation, order, writ, judgment, injunction, decree, determination or award currently in effect having applicability to such party or any of its properties, including regulations issued by an administrative agency or other governmental authority having supervisory powers over such party; or
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(b) constitutes a default by such party under or a breach of any provision of any loan agreement, mortgage, indenture or other agreement or instrument to which such party is a party or by which it or any of its properties is or may be bound or affected.
SECTION 3.4. Valid and Binding Obligations . This Agreement, when executed and delivered by such party, will constitute the legal, valid and binding obligation of such party, enforceable in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting creditors rights generally.
ARTICLE IV
SECURITY INTEREST PROVISIONS
SECTION 4.1. Financing Statement . FSAM shall do all such acts, and shall execute and deliver to the GIC Issuers and the Security Agent all such financing statements, certificates, instruments and other documents and shall do and perform or cause to be done all matters and such other things necessary or expedient to be done as the GIC Issuers and the Security Agent may reasonably request from time to time in order to give full effect to this Agreement and for the purpose of effectively perfecting, maintaining, preserving and enforcing the GIC Issuers and the Security Agents security interests in the Collateral and the benefits intended to be granted to the GIC Issuers and the Security Agent hereunder. To the extent permitted by applicable law, FSAM hereby authorizes the GIC Issuers and the Security Agent to file, in the name of FSAM or otherwise, Uniform Commercial Code financing statements, including continuation statements, which the GIC Issuers or the Security Agent in its sole discretion may deem necessary or appropriate.
SECTION 4.2. Account Control Agreement .
(a) The Bank of New York Mellon (f/k/a The Bank of New York) (the Account Bank ) has established an account in the name FSA Asset Management LLC (such account and any successor account, the Securities Account ). The Account Bank, FSAM and FSA are parties to a securities account control agreement dated as of July 31, 2003 (the Existing Control Agreement ) that among other things evidences FSAs control (within the meaning of Section 8-106(d)(2) of the UCC) with respect to the security entitlements (within the meaning of the UCC) in the Securities Account.
(b) FSA hereby acknowledges that, to the extent that it holds, or a third party holds on its behalf, physical possession of or control or as bailee over the Securities Account, the security entitlements therein or any other Collateral, such possession, control or bailment is also for the benefit of the GIC Issuers, the Security Agent, and the Lenders solely to the extent required to perfect their security interests in the Securities Account, the security entitlements therein and such other Collateral. Nothing in the preceding sentence shall be construed to impose any duty on FSA (or any third party acting on its behalf) with respect to the Securities Account, security entitlements and other Collateral. The provisions of this Agreement are intended solely to govern the respective priorities as between the FSA Liens, the GIC Issuers Lien, the First Credit Agreement Lien and the Second Credit Agreement Lien and shall not impose on FSA any obligations in respect of the disposition of any assets in the Securities Account, any security entitlements therein or any other Collateral.
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(c) FSAM, FSA, the GIC Issuers and the Security Agent, on behalf of the Lenders with respect to the First Credit Agreement and on behalf of DCL with respect to the Second Credit Agreement, each agree to use their commercially reasonable efforts, as soon as practicable after the date of this Agreement, either to (i) enter into a custodial and securities account control arrangement with the Account Bank or any successor thereto as FSAMs regular custodian, or (ii) amend and restate the Existing Control Agreement with the Account Bank to reflect the agreements among such parties set forth herein and the respective priorities as between the FSA Liens, the GIC Issuers Lien, the First Credit Agreement Lien and the Second Credit Agreement Lien. The Existing Control Agreement prior to any amendment thereto, any such new custodial and securities account control arrangement, or any such amendment and restatement of the Existing Control Agreement shall hereafter be referred to as the Securities Account Control Agreement . The Securities Account Control Agreement shall include, without limitation, a covenant that in the event that the Senior Lien Release Date has occurred but any of the Lender Obligations remain outstanding, that FSA shall assign control (within the meaning of Section 8-106(d)(2) of the UCC) over the Securities Account to the Security Agent, on behalf of the Lenders.
(d) For the avoidance of doubt, unless the Senior Lien Release Date has occurred and an Event of Default under either Credit Agreement has occurred and is continuing, the Security Agent agrees that FSAM shall be entitled to instruct the sale or transfer from the Securities Account of such Collateral as FSAM may determine necessary for any of the Intended Uses.
SECTION 4.3. Security Interest Representations and Warranties . FSAM represents, warrants and agrees that:
(a) This Agreement creates a valid and continuing security interest (as defined in the UCC) in the Collateral in favor of (i) with respect to the Master Notes and the Master Agreements, the GIC Issuers, which security interest is prior to all other Liens except for any Collateral Posting Lien and any Account Bank Lien, to which it is subordinate, and the FSA Liens, with which it is pari passu, (ii) with respect to the First Credit Agreement, the Security Agent, on behalf of the Lenders, which security interest is prior to all other Liens (except for any Collateral Posting Lien, any Account Bank Lien, the FSA Liens and the GIC Issuers Lien) and (iii) with respect to the Second Credit Agreement, the Security Agent, on behalf of DCL, which security interest is prior to all other Liens (except for any Collateral Posting Lien, any Account Bank Lien, the FSA Liens, the GIC Issuers Lien and the First Credit Agreement Lien), and is enforceable as such as against creditors of and purchasers from FSAM. The security interest of the GIC Issuers in the Collateral shall, until payment in full of the obligations and indebtedness secured thereby hereunder and termination of this Agreement with respect thereto, be a perfected security interest in the Collateral, senior to all other security interests in the Collateral, except for any Collateral Posting Lien and any Account Bank Lien, to which it is subordinate, and the FSA Liens, with which it is pari passu . The security interest of the Security Agent, (i) on behalf of the Lenders with respect to the First Credit Agreement and (ii) on behalf of DCL, with respect to the Second Credit Agreement, in the Collateral shall, until payment in full of the obligations and indebtedness secured thereby hereunder and termination of this Agreement with respect thereto, be a perfected
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security interest in the Collateral, senior to all other security interests in the Collateral, except for (i) in the case of the First Credit Agreement, any Collateral Posting Lien, Account Bank Lien, the FSA Liens and the GIC Issuers Lien, and (ii) in the case of Second Credit Agreement, any Collateral Posting Lien, Account Bank Lien, the FSA Liens, the GIC Issuers Lien and the First Credit Agreement Lien.
(b) FSAM owns the Collateral free and clear of any lien, claim or encumbrance of any Person other than the FSA Liens, the GIC Issuers Lien, the Lenders Liens or any Permitted Lien.
(c) FSAM has caused or will have caused, as soon as reasonably practicable but in any event within 10 days of this Agreement, the filing of all appropriate financing statements in the proper filing office in the appropriate jurisdictions under applicable law in order to perfect the security interest in the Collateral granted hereunder to the GIC Issuers and to the Security Agent (on behalf of the Lenders in the case of the First Credit Agreement, or DCL in the case of the Second Credit Agreement). In each case, FSAM shall provide a copy of each such financing statement, with filing numbers noted thereon, to the GIC Issuers and the Security Agent, as applicable.
(d) Other than the FSA Liens, the GIC Issuers Lien, any Permitted Lien and the Lenders Liens, FSAM has not pledged, assigned, sold, granted a security interest in, or otherwise conveyed any of the Collateral. FSAM has not authorized the filing of and is not aware of any financing statements against FSAM that include a description of the Collateral, including those financing statements that have been terminated, other than any financing statement relating to the FSA Liens, the GIC Issuers Lien, any Permitted Lien and the Lenders Liens.
(e) None of the instruments (as defined in the UCC) that constitute or evidence the Collateral has any marks or notations indicating that they have been pledged, assigned or otherwise conveyed to any Person other than to FSA, the GIC Issuers, the Security Agent (on behalf of the Lenders in the case of the First Credit Agreement, or DCL in the case of the Second Credit Agreement), or in connection with any Permitted Lien.
(f) FSAM has received all consents and approvals required by the terms of the Collateral to the transfer to the GIC Issuers and the Security Agent (on behalf of the Lenders in the case of the First Credit Agreement, or DCL in the case of the Second Credit Agreement), its interest and rights in the Collateral hereunder.
(g) FSAM has not consented to the Account Banks complying with the entitlement orders or other instructions of any Person other than FSA, the GIC Issuers and the Security Agent (i) on behalf of the Lenders with respect to the First Credit Agreement and (ii) on behalf of DCL with respect to the Second Credit Agreement, as applicable, in connection with the Securities Account. All of the Collateral consisting of security entitlements (within the meaning of the UCC) and financial assets (within the meaning of the UCC) has been credited to the Securities Account. The securities intermediary for the Securities Account has agreed to treat all Collateral (for this purpose as such term is defined in the Existing Control Agreement) credited to the Securities Account as financial assets (within the meaning of the UCC). The Securities
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Account is a securities account (within the meaning of the UCC). FSAM acknowledges that the Account Bank as securities intermediary has agreed, or will agree, upon execution of the Securities Account Control Agreement pursuant to Section 4.2, to comply with all instructions originated by either FSA or the GIC Issuers or (in the event the Senior Lien Release Date has occurred) the Security Agent, (i) on behalf of the Lenders with respect to the First Credit Agreement and (ii) on behalf of DCL with respect to the Second Credit Agreement, as applicable, relating to the Securities Account, without further consent by FSAM.
(h) The Collateral consists of (1) instruments (within the meaning of the UCC), (2) accounts (within the meaning of the UCC), (3) general intangibles (within the meaning of the UCC), (4) security entitlements (within the meaning of the UCC), (5) securities accounts (within the meaning of the UCC), (6) deposit accounts (within the meaning of the UCC) or (7) financial assets (within the meaning of the UCC).
(i) With respect to any sale of Collateral by FSAM from time to time, the amount of consideration being received by FSAM from the purchaser of such Collateral constitutes reasonably equivalent value and fair consideration for FSAMs interest in the Collateral.
(j) Each of the foregoing representations: (i) shall also be deemed made and repeated by FSAM, as applicable, for purposes of Sections 2.02(a) and 3.01 of each Credit Agreement as of the date of the relevant loan and (ii) shall, as applicable, be deemed repeated each time new assets become part of the Collateral.
SECTION 4.4. Further Assurances . At any time and from time to time, upon the written request of FSA, a GIC Issuer or a Lender, and at the sole expense of FSAM, FSAM will promptly and duly execute and deliver, or will promptly cause to be executed and delivered, such further instruments and documents and take such further action as FSA, a GIC Issuer or Lender may reasonably request for the purpose of obtaining or preserving the full benefits of this Article IV and of the rights and powers herein granted, including, without limitation, the execution and delivery of deposit account control agreements and the filing of any financing or continuation statements under the Uniform Commercial Code in effect in any jurisdiction with respect to the Liens created hereby. FSAM also hereby authorizes FSA, each GIC Issuer and the Security Agent to file any such financing or continuation statement without the signature of FSAM to the extent permitted by applicable law. A carbon, photographic or other reproduction of this Agreement shall be sufficient as a financing statement for filing in any jurisdiction. The Security Agent, (i) on behalf of the Lenders with respect to the First Credit Agreement and (ii) on behalf of DCL with respect to the Second Credit Agreement, and each Lender covenants with FSA and the GIC Issuers that such party will not file any such financing statement until after FSA and the GIC Issuers confirm the filing of a financing statement perfecting FSAs and the GIC Issuers pari passu security interests in the Collateral not previously perfected under the Existing Control Agreement.
SECTION 4.5. Release of Security Interest .
(a) Upon termination of the Master Notes and Master Agreements and repayment to the GIC Issuers of all amounts owed by FSAM thereunder and the performance by FSAM of all obligations thereunder, the GIC Issuers shall release their security interest in any
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remaining Collateral; provided that if any payment, or any part thereof, of any of the GIC Issuer Obligations is rescinded or must otherwise be restored or returned by a GIC Issuer upon the insolvency, bankruptcy, dissolution, liquidation or reorganization of FSAM, or upon or as a result of the appointment of a receiver, intervenor or conservator of, or a trustee or similar officer for FSAM or any substantial part of its property, or otherwise, the Master Notes and Master Agreements, all rights thereunder and the GIC Issuers Lien created hereby shall continue to be effective, or be reinstated, as though such payments had not been made. The GIC Issuers shall be authorized to take any action and make any filings necessary or desirable to continue or reinstate such GIC Issuers Lien.
(b) Upon termination of the Lender Agreements and repayment to the Lenders of all amounts owed by FSAM under the Credit Agreements and the performance of all obligations under the Lender Agreements, the Security Agent, on behalf of the Lenders with respect to the First Credit Agreement and on behalf of DCL with respect to the Second Credit Agreement, shall release its security interest in any remaining Collateral; provided that if any payment, or any part thereof, of any of the Lender Obligations is rescinded or must otherwise be restored or returned by a Lender upon the insolvency, bankruptcy, dissolution, liquidation or reorganization of FSAM, or upon or as a result of the appointment of a receiver, intervenor or conservator of, or a trustee or similar officer for FSAM or any substantial part of its property, or otherwise, the Lender Agreements, all rights thereunder and the Lenders Liens created hereby shall continue to be effective, or be reinstated, as though such payments had not been made. The Security Agent shall be authorized to take any action and make any filings necessary or desirable to continue or reinstate such Lenders Liens.
(c) So long as no Event of Default under either Credit Agreement has occurred and is continuing, no Senior Lien Release Date has occurred and no Notice of Sole Control (as such term is defined in the Securities Account Control Agreement) has been delivered by the Security Agent, the Lenders Liens in any Collateral sold by FSAM from time to time in accordance with the Lender Agreements, the Master Notes and the Master Agreements, and the FSAM Insurance Agreement for one or more of the Intended Uses shall be deemed released without the need for further action or consent by the Security Agent at the same time as the FSA Liens and the GIC Issuers Lien in such Collateral are released in connection with such sale by FSAM (provided that the existence of a Permitted Lien shall result in the subordination of the Lenders Liens, the FSA Liens and the GIC Issuers Lien in accordance with Section 5.1 but not the release of such Liens).
SECTION 4.6. Changes in Locations, Name, etc . FSAM shall not (i) change the location of its chief executive office/chief place of business from that specified in the Lender Agreements, (ii) change its name, identity or corporate structure (or the equivalent) or change the location where it maintains its records with respect to the Collateral or (iii) reorganize or reincorporate under the laws of any other jurisdiction, unless it shall have given FSA, the GIC Issuers and the Security Agent at least 30 days prior written notice thereof and shall have delivered to FSA, the GIC Issuers and the Security Agent all Uniform Commercial Code financing statements and amendments thereto as FSA, the GIC Issuers and the Security Agent shall request and taken all other reasonable actions deemed necessary or desirable by FSA, the GIC Issuers and the Security Agent to continue FSA, the GIC Issuers and the Security Agents perfected statuses in the Collateral with the same or better priorities.
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ARTICLE V
SUBORDINATION; REMEDIES
SECTION 5.1. Subordination to Permitted Liens .
The Lenders, FSA, the GIC Issuers and FSAM agree that the Lenders Liens, the GIC Issuers Lien and the FSA Liens, including any right or security of any party arising in connection with a Collateral Posting Lien, shall be expressly made subordinate and junior in priority and right of enforcement to any Permitted Lien.
SECTION 5.2 Subordination of Lenders Liens .
(a) Irrespective of anything contained in any Lender Agreement, the Master Notes, the Master Agreements, the FSAM Insurance Agreement, the FSA Capital Management Insurance Agreement or the FSA Capital Markets Insurance Agreement, so long as any Senior Secured Obligations are outstanding, the Lenders agree that the security interest created in favor of the Security Agent, (i) on behalf of the Lenders with respect to the First Credit Agreement and (ii) on behalf of DCL with respect to the Second Credit Agreement, under this Agreement, is hereby expressly made subordinate and junior in priority and right of enforcement to the security interest in the Collateral to the extent for the benefit of FSA and the GIC Issuers now existing and arising in the future securing the Senior Secured Obligations.
(b) Following receipt of notice of an Event of Default (as defined in the FSAM Insurance Agreement) from FSA or of notice of an Event of Default (as defined in the Master Notes or Master Agreements) from either of the GIC Issuers and prior to the Senior Lien Release Date, each of the Lenders agrees that it shall not exercise any rights, remedies or powers with respect to the Collateral granted to it under this Agreement, as a secured party or otherwise, without the prior written consent of FSA and the GIC Issuers.
(c) From and after any Event of Default under the FSAM Insurance Agreement or the Master Notes or Master Agreements, all collections, payments, sale proceeds realized on disposition or other proceeds of the Collateral shall be applied in the following order: (i) to the payment of due and unpaid fees and expenses of the Account Bank, (ii) pro rata to (a) the payment of all obligations of FSAM to FSA under the FSAM Insurance Agreement, and (b) the payment of all unpaid principal or interest in respect of the Master Notes or repurchase price in respect of the Master Agreements, provided that such payment is applied on the same Business Day to the payment of a corresponding amount of unpaid principal and interest in respect of the GICs, (iii) following the final payment of all amounts owed under the FSAM Insurance Agreement and the Master Notes and the Master Agreements, to the payment of any and all unpaid principal or interest, commitment fees, or other amounts due and payable in respect of the First Credit Agreement, (iv) following the final payment of all amounts owed under the First Credit Agreement, to the payment of any and all unpaid principal or interest, commitment fees, or other amounts due and payable in respect of the Second Credit Agreement, and (v) after occurrence of the dates referred to in (i), (ii), (iii) and (iv), to FSAM; provided , that the provisions of this Section 5.2(c) shall not limit the right of FSAM to use any such proceeds of the Collateral or any borrowings made under either Credit Agreement for any of the Intended Uses.
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(d) If at any time following notice of an Event of Default under the FSAM Insurance Agreement, the Master Notes or the Master Agreements, the Lenders shall have received any payment or distribution (whether voluntary, involuntary, through the exercise of any rights of set-off, or otherwise, and whether in cash, property or securities) in excess of the payments or distributions the Lenders would have received through the operation of 5.2(c) (such excess payments or distributions being referred to as Excess Payments ), then the Lenders shall hold such Excess Payments in trust for the benefit of FSA and the GIC Issuers, and shall promptly pay over such Excess Payments in the form received (duly endorsed, if necessary, to FSA) to FSA, for distribution by FSA pursuant to Section 5.2(c).
(e) Upon release by FSA of the security interest in all Collateral pursuant to the terms of the FSAM Insurance Agreement and by the GIC Issuers of the GIC Issuers Lien, either (i) FSA shall transfer and assign control (as defined under the UCC) of the Securities Account under the Securities Account Control Agreement to the Security Agent or (ii) FSA shall terminate the Securities Account Control Agreement in accordance with the terms thereunder and the Security Agent and the Account Bank may enter into a new securities account control agreement giving the Security Agent control (as defined under the UCC) of the Securities Account.
SECTION 5.3 Effectiveness of Subordination . The subordinations, agreements and priorities set forth in this Agreement shall remain in full force and effect, regardless of whether any Person in the future seeks to rescind, amend, terminate or reform, by litigation or otherwise, its respective agreements with FSAM.
SECTION 5.4 Obligations Absolute . Nothing herein shall impair, as between FSAM, on the one hand, and FSA, on the other hand, the obligations of FSAM, which are irrevocable, unconditional and absolute, to pay to FSA the amounts due under the FSAM Insurance Agreement from time to time. Nothing herein shall impair, as between FSAM, on the one hand, and the GIC Issuers, on the other hand, the obligations of FSAM, which are irrevocable, unconditional and absolute, to pay to the GIC Issuers the amounts due under the Master Notes and Master Agreements from time to time.
SECTION 5.5 Lender Remedies . The provisions of this Section 5.5 are subject to the provisions of Section 2.3 hereof. If any Event of Default under either Credit Agreement shall occur and be continuing, the Security Agent may exercise, in addition to all other rights and remedies granted to it under this Agreement and each Credit Agreement and in any other instrument or agreement securing, evidencing or relating to the Lender Obligations, all rights and remedies of a secured party under the Uniform Commercial Code. Without limiting the generality of the foregoing, the Security Agent may without demand of performance or other demand, presentment, protest, advertisement or notice of any kind (except any notice required by law referred to below) to or upon FSAM or any other Person (each and all of which demands, presentments, protests, advertisements and notices are hereby waived), in such circumstances forthwith collect, receive, appropriate and realize upon the Collateral, or any part thereof, and/or may forthwith sell (on a servicing released basis, at the Security Agents option), lease, assign, give option or options to purchase, or otherwise dispose of and deliver the Collateral or any part thereof (or contract to do any of the foregoing), in one or more parcels or as an entirety at public or private sale or sales, at any exchange, brokers board or office of the Security Agent or elsewhere upon such terms and conditions as it may deem advisable and at such prices as it may
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deem best, for cash or on credit or for future delivery without assumption of any credit risk. The Security Agent shall have the right upon any such public sale or sales, and, to the extent permitted by law, upon any such private sale or sales, to purchase the whole or any part of the Collateral so sold, free of any right or equity of redemption in FSAM, which right or equity is hereby waived or released. The Security Agent may, on one or more occasions, postpone or adjourn any such sale by public announcement at the time of such sale. The Security Agent shall give FSAM prior or concurrent notice of any such postponement or adjournment. FSAM further agrees, at the Security Agents request, to assemble the Collateral and make it available to the Security Agent at places which the Security Agent shall reasonably select, whether at FSAMs premises or elsewhere. The Security Agent shall apply the net proceeds of any such collection, recovery, receipt, appropriation, realization or sale, after deducting all reasonable costs and expenses of every kind incurred therein or incidental to the care or safekeeping of any of the Collateral or in any way relating to the Collateral or the rights of the Security Agent hereunder, including without limitation reasonable attorneys fees and disbursements, to the payment in whole or in part of the Lender Obligations, in such order as the Security Agent may elect, and only after such application and after the payment by the Lenders of any other amount required or permitted by any provision of law, including without limitation the Uniform Commercial Code, need the Security Agent account for the surplus, if any, to FSA, the GIC Issuers or FSAM. If any notice of a proposed sale or other disposition of Collateral shall be required by law, such notice shall be deemed reasonable and proper if given at least 10 days before such sale or other disposition. FSAM shall remain liable for any deficiency (plus accrued interest thereon in accordance with the terms of the Lender Agreements) if the proceeds of any sale or other disposition of the Collateral are insufficient to pay the Lender Obligations and the fees and disbursements of any attorneys employed by the Security Agent to collect such deficiency.
SECTION 5.6 GIC Issuer Remedies . The provisions of this Section 5.6 are subject to the provisions of Section 2.3 hereof. If any Event of Default under the Master Notes or the Master Agreements shall occur and be continuing, the GIC Issuers may exercise, in addition to all other rights and remedies granted to it under this Agreement, the Master Notes, the Master Agreements and in any other instrument or agreement securing, evidencing or relating to the Master Notes or the Master Agreements, all rights and remedies of a secured party under the Uniform Commercial Code. Without limiting the generality of the foregoing, the GIC Issuers may without demand of performance or other demand, presentment, protest, advertisement or notice of any kind (except any notice required by law referred to below) to or upon FSAM or any other Person (each and all of which demands, presentments, protests, advertisements and notices are hereby waived), in such circumstances forthwith collect, receive, appropriate and realize upon the Collateral, or any part thereof, and/or may forthwith sell (on a servicing released basis, at the GIC Issuers option), lease, assign, give option or options to purchase, or otherwise dispose of and deliver the Collateral or any part thereof (or contract to do any of the foregoing), in one or more parcels or as an entirety at public or private sale or sales, at any exchange, brokers board or office of the GIC Issuers or elsewhere upon such terms and conditions as they may deem advisable and at such prices as they may deem best, for cash or on credit or for future delivery without assumption of any credit risk. The GIC Issuers shall have the right upon any such public sale or sales, and, to the extent permitted by law, upon any such private sale or sales, to purchase the whole or any part of the Collateral so sold, free of any right or equity of redemption in FSAM, which right or equity is hereby waived or released. The GIC Issuers may, on one or more occasions, postpone or adjourn any such sale by public announcement at the time of such sale. The GIC Issuers shall give FSAM prior or concurrent notice of any such
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postponement or adjournment. FSAM further agrees, at the GIC Issuers request, to assemble the Collateral and make it available to the GIC Issuers at places which the GIC Issuers shall reasonably select, whether at FSAMs premises or elsewhere. The GIC Issuers shall apply the net proceeds of any such collection, recovery, receipt, appropriation, realization or sale, after deducting all reasonable costs and expenses of every kind incurred therein or incidental to the care or safekeeping of any of the Collateral or in any way relating to the Collateral or the rights of the GIC Issuers hereunder, including without limitation reasonable attorneys fees and disbursements, to the payment in whole or in part of the GIC Issuer Obligations, in such order as the GIC Issuers may elect, and only after such application and after the payment by the GIC Issuers of any other amount required or permitted by any provision of law, including without limitation the Uniform Commercial Code, need the GIC Issuers account for the surplus, if any, to FSA or FSAM. If any notice of a proposed sale or other disposition of Collateral shall be required by law, such notice shall be deemed reasonable and proper if given at least 10 days before such sale or other disposition. FSAM shall remain liable for any deficiency (plus accrued interest thereon in accordance with the terms of the Master Notes and the Master Agreements) if the proceeds of any sale or other disposition of the Collateral are insufficient to pay the GIC Issuer Obligations and the fees and disbursements of any attorneys employed by the GIC Issuers to collect such deficiency.
SECTION 5.7 Right to Initiate Judicial Proceedings, etc . The provisions of this Section 5.7 are subject to the provisions of Section 2.3 hereof. The GIC Issuers and the Security Agent shall have the right and power to institute and maintain such suits and proceedings as they may deem appropriate to protect and enforce the rights vested in (i) the GIC Issuers, in the case of the Master Notes and Master Agreements, and (ii) the Lenders under the Lender Agreements. From and after the occurrence of an Event of Default (as defined under a Master Note or Master Agreement) the GIC Issuers may, either after entry or without entry, proceed by suit or suits at law or in equity to enforce such rights and to foreclose upon the Collateral and to sell all, or from time to time any, of the Collateral under the judgment or decree of a court of competent jurisdiction. From and after the occurrence of an Event of Default (as defined under a Credit Agreement) the Security Agent may, either after entry or without entry, proceed by suit or suits at law or in equity to enforce such rights and to foreclose upon the Collateral and to sell all, or from time to time any, of the Collateral under the judgment or decree of a court of competent jurisdiction.
SECTION 5.8 Remedies Not Exclusive . The provisions of this Section 5.8 are subject to the provisions of Section 2.3 hereof. (a) No remedy conferred upon or reserved to the GIC Issuers, the Security Agent or the Lenders herein is intended to be exclusive of any other remedy or remedies, but every such remedy shall be cumulative and shall be in addition to every other remedy conferred herein or now or hereafter existing at law or in equity or by statute.
(b) No delay by or omission of the GIC Issuers, the Security Agent or the Lenders to exercise any right, remedy or power accruing upon the occurrence and continuance of any Event of Default under the Master Notes or Master Agreements or under the Lender Agreements, as applicable, shall impair any such right, remedy or power or shall be construed to be a waiver of any such Event of Default or an acquiescence therein; and every right, power and remedy given by this Agreement to the GIC Issuers or the Security Agent may be exercised from time to time and as often as may be deemed expedient by the GIC Issuers subject to the provisions of the Master Notes and the Master Agreements or the
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Security Agent subject to the provisions of the Lender Agreements.
(c) In case the GIC Issuers or the Security Agent shall have proceeded to enforce any right, remedy or power under this Agreement, the Master Notes, the Master Agreements, or any Lender Agreement and the proceeding for the enforcement thereof shall have been discontinued or abandoned for any reason or shall have been determined adversely to the GIC Issuers, the Security Agent or the Lenders, as applicable, then and in every such case FSAM, the GIC Issuers, the Security Agent, and the Lenders shall, subject to any effect of or determination in such proceeding, severally and respectively be restored to their former positions and rights hereunder with respect to the Collateral and in all other respects, and thereafter all rights, remedies and powers of the GIC Issuers and the Security Agent shall continue as though no such proceeding had been taken.
(d) All rights of action and rights to assert claims upon or under this Agreement may be enforced by the GIC Issuers or the Security Agent without the possession of this Agreement, the Master Notes, the Master Agreements, the Credit Agreements or any Note issued thereunder, or any other document or instrument (within the meaning of the UCC) evidencing any of the GIC Issuer Obligations or Lender Obligations or the production thereof in any trial or other proceeding relative thereto, and any such suit or proceeding instituted by the GIC Issuers or the Security Agent shall, in the case of the GIC Issuers, be brought in the names of the GIC Issuers, or in the case of the Security Agent, in its name, and any recovery of judgment shall be held as part of the Collateral.
SECTION 5.9 Security Agents Appointment as Attorney-in-Fac t
(a) FSAM hereby irrevocably constitutes and appoints the Security Agent, (i) on behalf of the Lenders with respect to the First Credit Agreement and (ii) on behalf of DCL with respect to the Second Credit Agreement, and any officer or agent thereof, with full power of substitution, as its true and lawful attorney-in-fact with full irrevocable power and authority in the place and stead of FSAM, and in the name of FSAM or in its own name, from time to time in their discretion, for the purpose of, carrying out the terms of each Credit Agreement and this Agreement, to take any and all appropriate action and to execute any and all documents and instruments which may be necessary or desirable to accomplish the purposes of such agreements; provided, that the Security Agent hereby agrees that it shall not exercise its rights under this Section 5.9(a) until (i) the occurrence of the Senior Lien Release Date and (ii) the occurrence and continuation of any Event of Default under either Credit Agreement. Without limiting the generality of the foregoing, FSAM hereby gives the Security Agent the power and right, on behalf of FSAM, without assent by, but with notice to, FSAM, if the Senior Lien Release Date has occurred and an Event of Default has occurred and is continuing with respect to either Credit Agreement, to do the following:
(i) in the name of FSAM, or its own name, or otherwise, to take possession of and endorse and collect any checks, drafts, notes, acceptances or other instruments for the payment of moneys due with respect to any other Collateral and to file any claim or to take any other action or proceeding in any court of law or equity or otherwise deemed appropriate by the Security Agent for the purpose of collecting any and all such moneys due under any such insurance or with respect to any other Collateral whenever payable;
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(b) FSAM hereby ratifies all that said attorneys shall lawfully do or cause to be done by virtue hereof.
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SECTION 5.10 GIC Issuers Appointment as Attorney-in-Fac t
(a) FSAM hereby irrevocably constitutes and appoints the GIC Issuers and any officer or agent thereof, with full power of substitution, as its true and lawful attorney-in-fact with full irrevocable power and authority in the place and stead of FSAM, and in the name of FSAM or in their own names, from time to time in their discretion, for the purpose of, carrying out the terms of the Master Notes, Master Agreements and this Agreement, to take any and all appropriate action and to execute any and all documents and instruments which may be necessary or desirable to accomplish the purposes of such agreements; provided, that the GIC Issuers hereby agree that they shall not exercise their rights under this Section 5.10(a) until the occurrence and continuation of any Event of Default under either a Master Note or Master Agreement. Without limiting the generality of the foregoing, FSAM hereby gives the GIC Issuers the power and right, on behalf of FSAM, without assent by, but with notice to, FSAM, if an Event of Default has occurred and is continuing with respect to any Master Note or Master Agreement, to do the following:
(i) in the name of FSAM, or its own name, or otherwise, to take possession of and endorse and collect any checks, drafts, notes, acceptances or other instruments for the payment of moneys due with respect to any other Collateral and to file any claim or to take any other action or proceeding in any court of law or equity or otherwise deemed appropriate by the GIC Issuers for the purpose of collecting any and all such moneys due under any such insurance or with respect to any other Collateral whenever payable;
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(b) FSAM hereby ratifies all that said attorneys shall lawfully do or cause to be done by virtue hereof.
(e) All powers, authorizations and agencies herein contained with respect to the Collateral are irrevocable and powers coupled with an interest.
SECTION 5.11 Waiver of Certain Rights . FSAM, to the extent it may lawfully do so, on behalf of itself and all who may claim through or under it, including any and all subsequent creditors, vendees, assignees and lienors, expressly waives and releases any, every and all rights to presentment, demand, protest or any notice (to the extent permitted by applicable law and except as specifically provided in this Agreement) of any kind in connection with this Agreement or any Collateral or to have any marshalling of the Collateral upon any sale, whether made under any power of sale granted hereunder or any other agreement or instrument, or pursuant to judicial proceedings or upon any foreclosure or any enforcement of this Agreement, any other Lender Agreement or any Master Note or Master Agreement and consents and agrees that all the Collateral may at any such sale be offered and sold as an entirety or in lots or otherwise as the GIC Issuers or the Security Agent may determine or be directed hereunder, as applicable.
SECTION 5.12 Limitation by Law . All the provisions of this Article V are intended to be subject to all applicable mandatory provisions of law which may be controlling in the premises and to be limited to the extent necessary so that they will not render this Agreement invalid, unenforceable in whole or in part or not entitled to be recorded, registered, or filed under the provisions of any applicable law.
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ARTICLE VI
MISCELLANEOUS PROVISIONS
SECTION 6.1. Binding on Successors, Transferees and Assigns . This Agreement shall be binding upon and shall inure to the benefit of and be enforceable by each party, and their respective successors, transferees and assigns.
SECTION 6.2. Amendments, etc. No amendment to, waiver of or consent to departure from the terms of any provision of this Agreement shall be effective unless the same shall be in writing signed by all of the parties hereto and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given.
SECTION 6.3. Notices . All notices and other communications provided for hereunder shall be in writing (including facsimile communication) and mailed or telecopied or delivered by electronic transmission or delivered to it at the address and in the manner set forth in the applicable Lender Agreement, FSAM Insurance Agreement, Master Note or Master Agreement, as applicable.
SECTION 6.4. No Waiver; Remedies . No failure on the part of a party to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise of any right hereunder preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law.
SECTION 6.5. Captions . Section captions used in this Agreement are for convenience of reference only, and shall not affect the construction of this Agreement.
SECTION 6.6. Severability . Wherever possible each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement shall be prohibited by or invalid under such law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Agreement.
SECTION 6.7. Governing Law, Entire Agreement, etc. THIS AGREEMENT SHALL BE DEEMED TO BE A CONTRACT MADE UNDER AND GOVERNED BY THE INTERNAL LAWS OF THE STATE OF NEW YORK (INCLUDING FOR SUCH PURPOSE SECTIONS 5-1401 AND 5-1402 OF THE GENERAL OBLIGATIONS LAW OF THE STATE OF NEW YORK). THIS AGREEMENT CONSTITUTES THE ENTIRE UNDERSTANDING AMONG THE PARTIES HERETO WITH RESPECT TO THE SUBJECT MATTER HEREOF AND SUPERSEDES ANY PRIOR AGREEMENTS, WRITTEN OR ORAL, WITH RESPECT THERETO. THE SECURITIES INTERMEDIARYS JURISDICTION AND THE BANKS JURISDICTION UNDER THE SECURITIES ACCOUNT CONTROL AGREEMENT SHALL BE THE STATE OF NEW YORK, AND, ACCORDINGLY, THE PARTIES RIGHTS AND OBLIGATIONS CONCERNING THE SECURITIES ACCOUNT AND ALL FINANCIAL ASSETS CREDITED THERETO AND CASH THEREIN SHALL BE GOVERNED BY THE LAWS OF THE STATE OF NEW YORK.
SECTION 6.8. Forum Selection and Consent to Jurisdiction . ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER OR IN CONNECTION WITH, THIS AGREEMENT OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER ORAL OR WRITTEN) OR ACTIONS OF THE PARTIES
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SHALL BE BROUGHT AND MAINTAINED IN THE COURTS OF THE STATE OF NEW YORK, NEW YORK COUNTY OR IN THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK. EACH PARTY HEREBY EXPRESSLY AND IRREVOCABLY SUBMITS TO THE JURISDICTION OF THE COURTS OF THE STATE OF NEW YORK, NEW YORK COUNTY AND OF THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK FOR THE PURPOSE OF ANY SUCH LITIGATION AND IRREVOCABLY AGREES TO BE BOUND BY ANY JUDGMENT RENDERED THEREBY IN CONNECTION WITH SUCH LITIGATION. EACH PARTY HERETO IRREVOCABLY CONSENTS TO THE SERVICE OF PROCESS BY REGISTERED MAIL, POSTAGE PREPAID, OR BY PERSONAL SERVICE WITHIN OR OUTSIDE OF THE STATE OF NEW YORK. EACH PARTY HEREBY IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, ANY OBJECTION WHICH IT MAY HAVE OR HEREAFTER MAY HAVE TO THE LAYING OF VENUE OF ANY SUCH LITIGATION BROUGHT IN ANY SUCH COURT REFERRED TO ABOVE AND ANY CLAIM THAT SUCH LITIGATION HAS BEEN BROUGHT IN AN INCONVENIENT FORUM. TO THE EXTENT THAT ANY PARTY HAS OR HEREAFTER MAY ACQUIRE ANY IMMUNITY FROM JURISDICTION OF ANY COURT OR FROM ANY LEGAL PROCESS (WHETHER THROUGH SERVICE OR NOTICE, ATTACHMENT PRIOR TO JUDGMENT, ATTACHMENT IN AID OF EXECUTION OR OTHERWISE) WITH RESPECT TO ITSELF OR ITS PROPERTY, SUCH PARTY HEREBY IRREVOCABLY WAIVES SUCH IMMUNITY IN RESPECT OF ITS OBLIGATIONS UNDER THIS AGREEMENT.
SECTION 6.9. Waiver of Jury Trial . EACH PARTY HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES ANY RIGHTS IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS AGREEMENT OR ANY COURSE OF CONDUCT, COURSE OF DEALING, STATEMENTS (WHETHER ORAL OR WRITTEN) OR ACTIONS OF EITHER PARTY. EACH PARTY ACKNOWLEDGES AND AGREES THAT IT HAS RECEIVED FULL AND SUFFICIENT CONSIDERATION FOR THIS PROVISION.
SECTION 6.10. Counterparts . This Agreement may be executed by the parties hereto in several counterparts, each of which shall be deemed to be an original and all of which shall constitute together but one and the same agreement.
SECTION 6.11. Third Party Beneficiaries . Nothing in this Agreement shall confer any right, remedy or claim, express or implied, upon any person other than the parties hereto, and all the terms, covenants, conditions, promises and agreements contained herein shall be for the sole and exclusive benefit of the parties hereto and their successors and permitted assigns
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IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed and delivered by its officer thereunto as of the date first written above.
DEXIA CR É DIT LOCAL |
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FINANCIAL SECURITY ASSURANCE INC. |
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/s/ Pascal Poupelle |
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/s/ Robert P. Cochran |
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Chief Executive Officer |
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Chairman & CEO |
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DEXIA BANK BELGIUM S.A. |
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FSA ASSET MANAGEMENT LLC |
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/s/ Ann De Roeck |
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Ann De Roeck |
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Managing Director |
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Secretary General, Member of the
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/s/ Christine Vanderveeren |
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Director, Legal Department |
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Managing Director |
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Managing Director |
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EXHIBIT 10.21
GUARANTEE RELEASE AGREEMENT
Dexia Crédit Local
Dexia Bank Belgium SA
FSA Asset Management LLC
and
Financial Security Assurance Inc.
February 20, 2009
GUARANTEE RELEASE AGREEMENT
This guarantee release agreement (the Agreement ) is dated as of February 20, 2009, and entered into by and among Dexia Crédit Local ( DCL ), Dexia Bank Belgium SA ( DBB , together with DCL, the Banks ), FSA Asset Management LLC (the Company ), and Financial Security Assurance Inc. (the Guarantor ). Each of the Banks, the Company and the Guarantor are sometimes referred to herein individually as a Party and collectively as the Parties .
WHEREAS , on June 30, 2008, DCL entered into a Revolving Credit Agreement (the Credit Agreement ) providing for loans to the Company of up to US$5 billion at any one time outstanding;
WHEREAS , effective August 22, 2008, DCL assigned part of its interest in the Credit Agreement to DBB, as a result of which assignment DBB became a Bank as defined under the Credit Agreement;
WHEREAS , the Guarantor guarantees the repayment of borrowings by the Company under the Credit Agreement pursuant to a Financial Guaranty Insurance Policy (Policy No.: 90908-N) issued on June 30, 2008 (the Policy ); and
WHEREAS , in connection with the reorganization of the business of Financial Security Assurance Holdings Ltd. and certain of its affiliates (including the Company), the Banks have each deemed it to be in their best interests to release the Guarantor from any and all obligations that it may have under the Policy, and to make appropriate amendments to the Credit Agreement reflecting such release and eliminating any requirement on the part of the Company to provide or maintain the Policy (or any substitution therefor or replacement thereof);
NOW, THEREFORE , in consideration of the premises and the representations, warranties, covenants and agreements herein contained, and intending to be legally bound hereby, the Parties hereby agree as follows:
Article I
Surrender of Policy and Release of Guarantor
Section 1.1 Surrender of Policy . Each of the Banks, in their capacity as Holders as defined under the Policy, hereby surrender the Policy to the Guarantor, irrevocably release and waive any and all rights they may have under the Policy, and agree to hold the Guarantor harmless against any claims they (or any third party claiming rights through such Party) may make under the Policy. DCL agrees to return the original Policy to the Guarantor on behalf of the Holders as soon as reasonably practicable following the execution of this Agreement.
Article II
Amendments to Revolving Credit Agreement
Section 2.1. Amendments to Credit Agreement . Each of the Banks and the Company agree that the Credit Agreement is hereby amended as follows:
1. The term FSA Policy is deleted in its entirety from Section 1.01.
2. Section 2.02(iii) is deleted in its entirety and the remaining provisions in Section 2.02 are renumbered accordingly. In the last sentence in Section 2.02, (iii) is replaced with (ii).
3. Section 3.01(e) is deleted in its entirety and the remaining provisions in Section 3.01 are relabeled accordingly.
4. Each instance of FSA or appearing in Section 5.01(a)(v) shall be deleted.
5. Section 5.01(a)(vi) is deleted in its entirety and, for the avoidance of doubt, the surrender of the Policy shall not constitute an Event of Default (as defined in the Credit Agreement).
Section 2.2. Reference to and Effect on the Credit Agreement . On and after the date of this Agreement, each reference in the Credit Agreement to this Agreement, hereunder, hereof or words of like import referring to the Credit Agreement, and each reference in the notes to the Revolving Credit Agreement, Agreement, therein, or words of like import referring to the Credit Agreement, shall mean and be a reference to the Credit Agreement, as amended by this Agreement. The Credit Agreement and the notes, as specifically amended by this Agreement, are and shall continue to be in full force and effect and are hereby in all respects ratified and confirmed. The execution, delivery and effectiveness of this Agreement shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of any Bank under the Credit Agreement, nor constitute a waiver of any provision of the Credit Agreement.
Article III
Other Provisions
Section 3.1. Entire Agreement . This Agreement contains, and is intended as, a complete statement of all of the terms of the agreement among the Parties with respect to the matters provided for herein.
Section 3.2 Further Assurances . The Parties will from time to time and at all times hereafter make, do, execute, or cause or procure to be made, done and executed such further acts, deeds, conveyances, consents and assurances without further consideration, which may reasonably be required to effect the transactions contemplated by this Agreement.
Section 3.3 Counterparts . This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so
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executed shall be deemed to be an original and all of which taken together shall constitute but one and the same agreement. Delivery of an executed counterpart of a signature page to this Agreement by email or facsimile shall be effective as delivery of a manually executed counterpart of this Agreement.
Section 3.4 Governing Law . The provisions of Section 6.06 of the Credit Agreement shall apply to this Agreement ( mutatis mutandis ).
[Remainder of Page Intentionally Left Blank]
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IN WITNESS WHEREOF, the Parties hereto have caused this Agreement to be executed by their respective authorized signatories as of the date first written above.
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DEXIA CREDIT LOCAL |
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By: |
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/s/ Pascal Poupelle |
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Name: |
Pascal Poupelle |
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Title: |
Chief Executive Officer |
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DEXIA BANK BELGIUM SA |
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/s/ Jean-François Martin |
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Jean-François Martin |
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Member of the Management Board |
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/s/ Luc van Thielen |
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Luc van Thielen |
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Member of the Management Board |
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FSA ASSET MANAGEMENT LLC |
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/s/ Guy Cools |
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Guy Cools |
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Title: |
Managing Director |
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FINANCIAL SECURITY ASSURANCE INC. |
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Robert P. Cochran |
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Chairman & CEO |
7
EXHIBIT 10.22
RELEASE AND TERMINATION AGREEMENT
by and among
FSA Asset Management LLC
FSA Capital Management Services LLC
FSA Capital Markets Services LLC
and
Financial Security Assurance Inc.
February 20, 2009
RELEASE AND TERMINATION AGREEMENT
This release and termination agreement (the Agreement ) is dated as of February 20, 2009, and entered into between FSA Asset Management LLC (the FSAM ), FSA Capital Management Services LLC ( FSA Capital Management ), FSA Capital Markets Services LLC ( FSA Capital Markets ) and Financial Security Assurance Inc. (the Guarantor ). Each of FSAM, FSA Capital Management, FSA Capital Markets and the Guarantor are sometimes referred to herein individually as a Party and collectively as the Parties .
WHEREAS , the Guarantor has issued the Financial Guaranty Insurance Policies (collectively, the Policies ) listed in Schedule A;
WHEREAS , in connection with the issuance of the Policies and certain amendments to those policies, certain of the Parties have entered into the agreements listed in Schedule A (collectively, the Related Agreements ); and
WHEREAS , in connection with the reorganization of the business of Financial Security Assurance Holdings Ltd. and certain of its affiliates, the Parties have each deemed it to be in their best interests that the Policies and the Related Agreements be terminated;
NOW, THEREFORE , in consideration of the premises and the representations, warranties, covenants and agreements herein contained, and intending to be legally bound hereby, the Parties hereby agree as follows:
Article I
Release and Termination
Section 1.1 Surrender of Policy . The Parties agree that each of the Policies are terminated, effective immediately. Each Party that it is a Holder or Policyholder under any of the Policies hereby surrenders such Policies to the Guarantor, irrevocably releases and waives any and all rights it may have under such Policies, and agrees to hold the Guarantor harmless against any claims it (or any third party claiming rights through such Party) may make under such Policies. Each Party that it is a Holder or Policyholder under any of the Policies agrees to return any original Policies provided to it to the Guarantor promptly following the execution of this Agreement.
Section 1.2. Termination of Related Agreements . The Parties hereby agree that each of the Related Agreements to which they are party are terminated, effective immediately, and each Party irrevocably releases and waives any and all rights it may have under the Related Agreements and agrees to hold each other Party harmless against any claims it (or any third party claiming rights through such Party) may make thereunder.
Section 1.3 Payment of Premiums . FSAM agrees to pay to the Guarantor the premium owed to the Guarantor under the Reimbursement Agreement and the Premium Letter (as defined in Schedule A) in accordance with the terms of such agreements for the portion of the
Payment Period (as defined therein) during which the relevant Policies were outstanding. The Guarantor agrees that (a) FSAM shall not owe any premium to the Guarantor with respect to any period from and after the date of this Agreement under (i) the Reimbursement Agreement, (ii) the Premium Letter, or (iii) the Amended and Restated Insurance and Indemnity Agreement dated as of October 21, 2008 between FSAM and the Guarantor; (b) FSA Capital Management shall not owe any premium to the Guarantor with respect to any period from and after the date of this Agreement under (i) the Reimbursement Agreement, (ii) the Premium Letter, or (iii) the Insurance and Indemnity Agreement dated as of October 29, 2001, as amended, between FSA Capital Management and the Guarantor; and (c) FSA Capital Markets shall not owe any premium to the Guarantor with respect to any period from and after the date of this Agreement under (i) the Reimbursement Agreement, (ii) the Premium Letter, or (iii) the Insurance and Indemnity Agreement dated as of October 29, 2001, as amended, between FSA Capital Markets and the Guarantor.
Article II
Other Provisions
Section 3.1. Entire Agreement . This Agreement contains, and is intended as, a complete statement of all of the terms of the agreement among the Parties with respect to the matters provided for herein.
Section 3.2 Further Assurances . The Parties will from time to time and at all times hereafter make, do, execute, or cause or procure to be made, done and executed such further acts, deeds, conveyances, consents and assurances without further consideration, which may reasonably be required to effect the transactions contemplated by this Agreement.
Section 3.3 Counterparts . This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute but one and the same agreement. Delivery of an executed counterpart of a signature page to this Agreement by email or facsimile shall be effective as delivery of a manually executed counterpart of this Agreement.
Section 3.4 Governing Law . This Agreement will be governed by and construed in accordance with the laws of the State of New York applicable to contracts made and to be performed within the State of New York.
[Remainder of Page Intentionally Left Blank]
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IN WITNESS WHEREOF, the Parties hereto have caused this Agreement to be executed by their respective authorized signatories as of the date first written above.
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FSA ASSET MANAGEMENT LLC |
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/s/ Guy Cools |
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Guy Cools |
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Managing Director |
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FSA CAPITAL MANAGEMENT SERVICES LLC |
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/s/ Guy Cools |
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Guy Cools |
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Title |
Managing Director |
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FSA CAPITAL MARKETS SERVICES LLC |
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/s/ Guy Cools |
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Name: |
Guy Cools |
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Title: |
Managing Director |
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FINANCIAL SECURITY ASSURANCE INC. |
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/s/ Robert P. Cochran |
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Robert P. Cochran |
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Title: |
Chairman & CEO |
3
SCHEDULE A
Policies
1. Policy No. 90002-A, dated October 29, 2001.
2. Policy No. 90002-B, dated October 29, 2001.
3. Policy No. 90002-C, dated October 29, 2001.
4. Policy No. 90002-D, dated October 29, 2001.
5. Policy No. 91001-N et seq. as described in Schedule A to Endorsement No. 1 thereto, dated December 31, 2007, as amended on September 30, 2008 through the issuance by the Guarantor of Endorsement No. 2 thereto.
Related Agreements
1. Reimbursement Agreement dated December 31, 2007 (the Reimbursement Agreement ).
2. Agreement on Additional Obligations For Policy No.91001-N et seq. dated September 30, 2008.
3. Premium Letter dated December 31, 2007 between FSAM and the Guarantor (the Premium Letter ).
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SUBSIDIARIES OF
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (File No. 33-78784) (1993 Equity Participation Plan) and Form S-8 (File No. 33-92648) (Deferred Compensation Plan) of Financial Security Assurance Holdings Ltd. of our report dated March 18, 2009, relating to the financial statements and financial statement schedule, which appears in this Form 10-K.
/s/ PRICEWATERHOUSECOOPERS LLP
New York, New York March 18, 2009 |
Exhibit 24.2
POWER-OF-ATTORNEY
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
The undersigned, as a director of Financial Security Assurance Holdings Ltd., a New York corporation (the Company), and/or, as applicable, as an officer of the Company, does hereby constitute and appoint each of Robert P. Cochran, Séan W. McCarthy and Bruce E. Stern to be his agent and attorney-in-fact, with the power to act fully hereunder and with full power of substitution to act in the name and on behalf of the undersigned, (i) to sign in the name and on behalf of the undersigned, as a director and/or officer of the Company, as applicable, and file with the Securities and Exchange Commission, an Annual Report on Form 10-K for each fiscal year for which the Company is required to file such an Annual Report, and any amendments or supplements thereto, and (ii) to execute and deliver any instruments, certificates or other documents which he shall deem necessary or proper in connection with the filing of each such Annual Report on Form 10-K, and any such amendment or supplement thereto, and generally to act for and in the name of the undersigned with respect to each such filing as fully as could the undersigned if then personally present and acting. The foregoing Power-of-Attorney shall be in full force and effect for so long as the undersigned shall be a director or officer of the Company, as applicable, unless and until revoked as to the undersigned by written instrument delivered by him to the Secretary of the Company.
IN WITNESS WHEREOF, the undersigned has duly executed this Power-of-Attorney on March 10, 2009.
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/s/ Michel Buysschaert |
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Michel Buysschaert |
POWER-OF-ATTORNEY
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
The undersigned, as a director of Financial Security Assurance Holdings Ltd., a New York corporation (the Company), and/or, as applicable, as an officer of the Company, does hereby constitute and appoint each of Robert P. Cochran, Séan W. McCarthy and Bruce E. Stern to be his agent and attorney-in-fact, with the power to act fully hereunder and with full power of substitution to act in the name and on behalf of the undersigned, (i) to sign in the name and on behalf of the undersigned, as a director and/or officer of the Company, as applicable, and file with the Securities and Exchange Commission, an Annual Report on Form 10-K for each fiscal year for which the Company is required to file such an Annual Report, and any amendments or supplements thereto, and (ii) to execute and deliver any instruments, certificates or other documents which he shall deem necessary or proper in connection with the filing of each such Annual Report on Form 10-K, and any such amendment or supplement thereto, and generally to act for and in the name of the undersigned with respect to each such filing as fully as could the undersigned if then personally present and acting. The foregoing Power-of-Attorney shall be in full force and effect for so long as the undersigned shall be a director or officer of the Company, as applicable, unless and until revoked as to the undersigned by written instrument delivered by him to the Secretary of the Company.
IN WITNESS WHEREOF, the undersigned has duly executed this Power-of-Attorney on October 31, 2008.
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/s/ Alexandre Joly |
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Alexandre Joly |
POWER-OF-ATTORNEY
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
The undersigned, as a director of Financial Security Assurance Holdings Ltd., a New York corporation (the Company), and/or, as applicable, as an officer of the Company, does hereby constitute and appoint each of Robert P. Cochran, Séan W. McCarthy and Bruce E. Stern to be his agent and attorney-in-fact, with the power to act fully hereunder and with full power of substitution to act in the name and on behalf of the undersigned, (i) to sign in the name and on behalf of the undersigned, as a director and/or officer of the Company, as applicable, and file with the Securities and Exchange Commission, an Annual Report on Form 10-K for each fiscal year for which the Company is required to file such an Annual Report, and any amendments or supplements thereto, and (ii) to execute and deliver any instruments, certificates or other documents which he shall deem necessary or proper in connection with the filing of each such Annual Report on Form 10-K, and any such amendment or supplement thereto, and generally to act for and in the name of the undersigned with respect to each such filing as fully as could the undersigned if then personally present and acting. The foregoing Power-of-Attorney shall be in full force and effect for so long as the undersigned shall be a director or officer of the Company, as applicable, unless and until revoked as to the undersigned by written instrument delivered by him to the Secretary of the Company.
IN WITNESS WHEREOF, the undersigned has duly executed this Power-of-Attorney on 8/27/2008.
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/s/ Claude Piret |
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Claude Piret |
POWER-OF-ATTORNEY
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
The undersigned, as a director of Financial Security Assurance Holdings Ltd., a New York corporation (the Company), and/or, as applicable, as an officer of the Company, does hereby constitute and appoint each of Robert P. Cochran, Séan W. McCarthy and Bruce E. Stern to be his agent and attorney-in-fact, with the power to act fully hereunder and with full power of substitution to act in the name and on behalf of the undersigned, (i) to sign in the name and on behalf of the undersigned, as a director and/or officer of the Company, as applicable, and file with the Securities and Exchange Commission, an Annual Report on Form 10-K for each fiscal year for which the Company is required to file such an Annual Report, and any amendments or supplements thereto, and (ii) to execute and deliver any instruments, certificates or other documents which he shall deem necessary or proper in connection with the filing of each such Annual Report on Form 10-K, and any such amendment or supplement thereto, and generally to act for and in the name of the undersigned with respect to each such filing as fully as could the undersigned if then personally present and acting. The foregoing Power-of-Attorney shall be in full force and effect for so long as the undersigned shall be a director or officer of the Company, as applicable, unless and until revoked as to the undersigned by written instrument delivered by him to the Secretary of the Company.
IN WITNESS WHEREOF, the undersigned has duly executed this Power-of-Attorney on January 28, 2009.
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/s/ Pascal Poupelle |
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Pascal Poupelle |
I, Robert P. Cochran, Chief Executive Officer of Financial Security Assurance Holdings Ltd., certify that:
Date:
March 19, 2009
|
|
/s/ ROBERT P. COCHRAN |
Name: Robert P. Cochran Title: Chief Executive Officer |
I, Joseph W. Simon, Chief Financial Officer of Financial Security Assurance Holdings Ltd., certify that:
Date:
March 19, 2009
|
|
/s/ JOSEPH W. SIMON |
Name: Joseph W. Simon Title: Chief Financial Officer |
Certification of Chief Executive Officer
In connection with the Annual Report on Form 10-K for the fiscal year ending December 31, 2008 of Financial Security Assurance Holdings Ltd. (the "Company"), as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Robert P. Cochran, Chief Executive Officer of the Company, hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
|
|
By: |
|
/s/ ROBERT P. COCHRAN |
Chief Executive Officer March 19, 2009 |
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.
Certification of Chief Financial Officer
In connection with the Annual Report on Form 10-K for the fiscal year ending December 31, 2008 of Financial Security Assurance Holdings Ltd. (the "Company"), as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Joseph W. Simon, Chief Financial Officer of the Company, hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
|
|
By: |
|
/s/ JOSEPH W. SIMON |
Chief Financial Officer March 19, 2009 |
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm
December 31, 2008
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM |
1 | |
CONSOLIDATED FINANCIAL STATEMENTS: |
||
Consolidated Balance Sheets |
2 |
|
Consolidated Statements of Operations and Comprehensive Income |
3 |
|
Consolidated Statements of Changes in Shareholder's Equity |
4 |
|
Consolidated Statements of Cash Flows |
5 |
|
Notes to Consolidated Financial Statements |
7 |
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, 2008 and December 31, 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 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.
As discussed in Note 1 to the consolidated financial statements, in November 2008, Dexia S.A. ("Dexia"), the Company's ultimate parent, entered into an agreement to sell the Company. As discussed in Notes 3 and 4 to the consolidated financial statements, the Company has adopted SFAS No. 157, "Fair Value Measurements" and SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" in 2008.
/s/ PRICEWATERHOUSECOOPERS LLP
New York, New York March 18, 2009 |
1
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
|
At December 31, | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||||
ASSETS |
|||||||||
General investment portfolio, available for sale: |
|||||||||
Bonds at fair value (amortized cost of $5,380,542 and $4,857,295) |
$ | 5,264,538 | $ | 5,019,961 | |||||
Equity securities at fair value (cost of $1,434 and $40,020) |
374 | 39,869 | |||||||
Short-term investments (cost of $615,299 and $88,972) |
616,065 | 90,075 | |||||||
Variable interest entities segment investment portfolio, available for sale: |
|||||||||
Bonds at fair value (amortized cost of $923,093 and $1,119,359) |
923,332 | 1,139,568 | |||||||
Guaranteed investment contracts from GIC Affiliates at fair value (amortized cost of $695,898 and $621,054) |
801,547 | 639,950 | |||||||
Short-term investments (at cost which approximates fair value) |
8,221 | 8,618 | |||||||
Assets acquired in refinancing transactions (includes $152,527 and $22,433 at fair value) |
166,600 | 229,264 | |||||||
Total investment portfolio |
7,780,677 | 7,167,305 | |||||||
Cash |
101,151 | 21,770 | |||||||
Deferred acquisition costs |
299,321 | 347,870 | |||||||
Prepaid reinsurance premiums |
1,011,950 | 1,119,565 | |||||||
Reinsurance recoverable on unpaid losses |
302,124 | 76,478 | |||||||
Deferred tax asset |
796,257 | | |||||||
Variable interest entities segment derivatives |
378,741 | 634,458 | |||||||
Credit derivatives |
287,449 | 126,749 | |||||||
Other assets (includes $100,000 at fair value at December 31, 2008) (See Notes 19) |
642,465 | 682,592 | |||||||
TOTAL ASSETS |
$ | 11,600,135 | $ | 10,176,787 | |||||
LIABILITIES, MINORITY INTEREST AND SHAREHOLDER'S EQUITY |
|||||||||
Deferred premium revenue |
3,052,879 | 2,879,378 | |||||||
Losses and loss adjustment expenses |
1,992,178 | 274,556 | |||||||
Variable interest entities segment debt (includes $799,086 at fair value at December 31, 2008) |
1,243,640 | 2,584,800 | |||||||
Deferred tax liability |
| 110,156 | |||||||
Notes payable to affiliate |
172,499 | 210,143 | |||||||
Credit derivatives |
1,543,809 | 689,746 | |||||||
Minority interest |
1,111,240 | 138,233 | |||||||
Other liabilities (includes $(112) and $173 at fair value) |
232,900 | 327,474 | |||||||
TOTAL LIABILITIES AND MINORITY INTEREST |
9,349,145 | 7,214,486 | |||||||
COMMITMENTS AND CONTINGENCIES (See Note 20) |
|||||||||
Preferred stock (5,000.1 shares authorized; 0 shared issued and outstanding; par value of $1,000 per share) |
| | |||||||
Common stock (330 and 344 shares authorized; issued and outstanding; par value of $45,455 and $43,605 per share) |
15,000 | 15,000 | |||||||
Additional paid-in capital |
1,410,202 | 679,692 | |||||||
Accumulated other comprehensive income (loss), net of deferred tax (benefit) provision of $(40,696) and $58,530 |
(75,585 | ) | 108,669 | ||||||
Accumulated earnings |
901,373 | 2,158,940 | |||||||
TOTAL SHAREHOLDER'S EQUITY |
2,250,990 | 2,962,301 | |||||||
TOTAL LIABILITIES, MINORITY INTEREST AND SHAREHOLDER'S EQUITY |
$ | 11,600,135 | $ | 10,176,787 | |||||
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
2
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands)
|
Year Ended December 31, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||||
REVENUES |
|||||||||||||
Net premiums written |
$ | 701,593 | $ | 494,463 | $ | 476,926 | |||||||
Net premiums earned |
$ | 420,339 | $ | 361,622 | $ | 336,878 | |||||||
Net investment income from general investment portfolio |
261,784 | 234,786 | 215,595 | ||||||||||
Net realized gains (losses) from general investment portfolio |
(6,790 | ) | (2,096 | ) | (5,212 | ) | |||||||
Net change in fair value of credit derivatives: |
|||||||||||||
Realized gains (losses) and other settlements |
126,891 | 102,800 | 87,200 | ||||||||||
Net unrealized gains (losses) |
(744,963 | ) | (642,609 | ) | 31,823 | ||||||||
Net change in fair value of credit derivatives |
(618,072 | ) | (539,809 | ) | 119,023 | ||||||||
Net interest income from variable interest entities segment |
76,450 | 136,041 | 137,844 | ||||||||||
Net realized gains (losses) from variable interest entities segment |
(236,220 | ) | | | |||||||||
Net realized and unrealized gains (losses) on derivative instruments |
256,602 | 96,314 | 99,296 | ||||||||||
Net unrealized gains (losses) on financial instruments at fair value |
1,101,807 | | | ||||||||||
Income from assets acquired in refinancing transactions |
11,154 | 20,907 | 24,661 | ||||||||||
Net realized gains (losses) from assets acquired in refinancing transactions |
(4,260 | ) | 4,660 | 12,729 | |||||||||
Other income |
22,172 | 34,417 | 23,806 | ||||||||||
TOTAL REVENUES |
1,284,966 | 346,842 | 964,620 | ||||||||||
EXPENSES |
|||||||||||||
Losses and loss adjustment expenses |
2,090,883 | 31,567 | 23,303 | ||||||||||
Interest expense |
12,120 | 21,358 | 25,497 | ||||||||||
Amortization of deferred acquisition costs |
65,700 | 63,442 | 63,012 | ||||||||||
Foreign exchange (gains) losses from variable interest entities segment |
1,652 | 134,707 | 146,097 | ||||||||||
Interest expense from variable interest entities segment |
129,864 | 138,220 | 147,621 | ||||||||||
Other operating expenses |
80,631 | 113,104 | 91,510 | ||||||||||
TOTAL EXPENSES |
2,380,850 | 502,398 | 497,040 | ||||||||||
INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST |
(1,095,884 | ) | (155,556 | ) | 467,580 | ||||||||
Provision (benefit) for income taxes: |
|||||||||||||
Current |
(398 | ) | 78,393 | 77,024 | |||||||||
Deferred |
(821,903 | ) | (178,216 | ) | 49,715 | ||||||||
Total provision (benefit) |
(822,301 | ) | (99,823 | ) | 126,739 | ||||||||
NET INCOME (LOSS) BEFORE MINORITY INTEREST |
(273,583 | ) | (55,733 | ) | 340,841 | ||||||||
Less: Minority interest |
982,260 | (27,656 | ) | (48,660 | ) | ||||||||
NET INCOME (LOSS) |
(1,255,843 | ) | (28,077 | ) | 389,501 | ||||||||
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX |
|||||||||||||
Unrealized gains (losses) on available-for-sale securities arising during the period, net of deferred income tax provision (benefit) of $(100,514), $400 and $8,307 |
(186,645 | ) | 743 | 15,398 | |||||||||
Less: reclassification adjustment for gains (losses) included in net income, net of deferred income tax provision (benefit) of $(1,288), $4,933 and $3,442 |
(2,391 | ) | 9,161 | 6,393 | |||||||||
Other comprehensive income (loss) |
(184,254 | ) | (8,418 | ) | 9,005 | ||||||||
COMPREHENSIVE INCOME (LOSS) |
$ | (1,440,097 | ) | $ | (36,495 | ) | $ | 398,506 | |||||
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
3
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
(in thousands, except share data)
|
Common Stock |
|
Accumulated
Other Comprehensive Income (Loss) |
|
|
||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Additional
Paid-In Capital |
Accumulated
Earnings |
Total
Shareholders' Equity |
||||||||||||||||
|
Shares | Amount | |||||||||||||||||
BALANCE, December 31, 2005 |
400 | $ | 15,000 | $ | 841,828 | $ | 108,082 | $ | 1,937,516 | $ | 2,902,426 | ||||||||
Net income for the year |
389,501 | 389,501 | |||||||||||||||||
Other comprehensive income (loss), net of deferred income tax provision (benefit) of $4,865 |
9,005 | 9,005 | |||||||||||||||||
Capital contributions |
2,637 | 2,637 | |||||||||||||||||
Repurchase of stock |
(20 | ) | (100,000 | ) | (100,000 | ) | |||||||||||||
Dividends paid |
(140,000 | ) | (140,000 | ) | |||||||||||||||
Capital issuance costs |
(961 | ) | | (961 | ) | ||||||||||||||
BALANCE, December 31, 2006 |
380 | 15,000 | 743,504 | 117,087 | 2,187,017 | 3,062,608 | |||||||||||||
Net income (loss) for the year |
(28,077 | ) | (28,077 | ) | |||||||||||||||
Other comprehensive income (loss), net of deferred income tax provision (benefit) of $(4,533) |
(8,418 | ) | (8,418 | ) | |||||||||||||||
Capital contributions |
113,839 | 113,839 | |||||||||||||||||
Repurchase of stock |
(36 | ) | (180,000 | ) | (180,000 | ) | |||||||||||||
Capital issuance costs |
(764 | ) | (764 | ) | |||||||||||||||
Other |
3,113 | 3,113 | |||||||||||||||||
BALANCE, December 31, 2007 |
344 | 15,000 | 679,692 | 108,669 | 2,158,940 | 2,962,301 | |||||||||||||
Cumulative effect of change in accounting principle, net of deferred income tax provision (benefit) of $15,225 |
28,276 | 28,276 | |||||||||||||||||
Balance at beginning of the year, adjusted |
344 | 15,000 | 679,692 | 108,669 | 2,187,216 | 2,990,577 | |||||||||||||
Net income (loss) for the year |
(1,255,843 | ) | (1,255,843 | ) | |||||||||||||||
Other comprehensive income (loss), net of deferred income tax provision (benefit) of $(99,226) |
(184,254 | ) | (184,254 | ) | |||||||||||||||
Capital contributions |
500,000 | 500,000 | |||||||||||||||||
Repurchase of stock |
(14 | ) | (70,000 | ) | (70,000 | ) | |||||||||||||
Dividends paid on common stock |
(30,000 | ) | (30,000 | ) | |||||||||||||||
Surplus note |
300,000 | 300,000 | |||||||||||||||||
Other |
510 | 510 | |||||||||||||||||
BALANCE, December 31, 2008 |
330 | $ | 15,000 | $ | 1,410,202 | $ | (75,585 | ) | $ | 901,373 | $ | 2,250,990 | |||||||
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
4
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
|
Year Ended December 31, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||||
Cash flows from operating activities: |
|||||||||||||
Premiums received, net |
$ | 662,170 | $ | 467,626 | $ | 483,399 | |||||||
Credit derivative fees received, net |
113,292 | 108,710 | 82,860 | ||||||||||
Other operating expenses paid, net |
(213,790 | ) | (138,048 | ) | (167,280 | ) | |||||||
Salvage and subrogation received (paid) |
(527 | ) | 292 | 1,745 | |||||||||
Losses and loss adjustment expenses paid, net |
(602,870 | ) | (68,634 | ) | (405 | ) | |||||||
Net investment income received from general investment portfolio |
254,243 | 231,322 | 213,341 | ||||||||||
Federal income taxes paid |
143,102 | (108,907 | ) | (82,800 | ) | ||||||||
Interest paid |
(12,247 | ) | (20,925 | ) | (25,877 | ) | |||||||
Interest paid on variable interest entities segment |
(6,709 | ) | (8,776 | ) | (5,956 | ) | |||||||
Net investment income received from variable interest entities segment |
27,896 | 45,510 | 37,400 | ||||||||||
Net derivative payments in variable interest entities segment |
(10,809 | ) | (29,913 | ) | (23,960 | ) | |||||||
Income received from assets acquired in refinancing transactions |
12,001 | 19,979 | 41,622 | ||||||||||
Other |
45,028 | 5,000 | 8,543 | ||||||||||
Net cash provided by (used for) operating activities |
410,780 | 503,236 | 562,632 | ||||||||||
Cash flows from investing activities: |
|||||||||||||
General investment portfolio: |
|||||||||||||
Proceeds from sales of bonds |
3,982,212 | 3,521,879 | 1,581,689 | ||||||||||
Proceeds from maturities of bonds |
516,865 | 184,469 | 160,846 | ||||||||||
Purchases of bonds |
(4,998,300 | ) | (4,054,958 | ) | (2,074,463 | ) | |||||||
Net (increase) decrease in short-term investments |
(521,902 | ) | 1,076 | 18,700 | |||||||||
Variable interest entities segment investment portfolio: |
|||||||||||||
Proceeds from maturities of bonds |
119,500 | 265,400 | 103,662 | ||||||||||
Net (increase) decrease in short-term |
397 | 10,860 | (16,802 | ) | |||||||||
Other: |
|||||||||||||
Paydowns of assets acquired in refinancing transactions |
36,727 | 110,581 | 88,477 | ||||||||||
Proceeds from sales of assets acquired in refinancing transactions |
5,193 | 7,956 | 13,643 | ||||||||||
Purchases of property, plant and equipment |
(2,595 | ) | (1,152 | ) | (2,263 | ) | |||||||
Other investments |
989 | 7,257 | 24,109 | ||||||||||
Net cash provided by (used for) investing activities |
(860,914 | ) | 53,368 | (102,402 | ) | ||||||||
Cash flows from financing activities: |
|||||||||||||
Capital contribution |
500,000 | 112,478 | | ||||||||||
Surplus Notes |
300,000 | | | ||||||||||
Dividends paid |
(30,000 | ) | | (140,000 | ) | ||||||||
Repayment of surplus notes |
| (108,850 | ) | | |||||||||
Repayment of notes payable to affiliate |
(37,644 | ) | (111,228 | ) | (142,207 | ) | |||||||
Repayment of variable interest entities segment debt |
(123,730 | ) | (276,900 | ) | (87,500 | ) | |||||||
Capital issuance costs |
(4,920 | ) | (1,829 | ) | (961 | ) | |||||||
Repurchase of shares |
(70,000 | ) | (180,000 | ) | (100,000 | ) | |||||||
Net cash provided by (used for) financing activities |
533,706 | (566,329 | ) | (470,668 | ) | ||||||||
Effect of changes in foreign exchange rates on cash balances |
(4,191 | ) | 1,835 | 592 | |||||||||
Net increase (decrease) in cash |
79,381 | (7,890 | ) | (9,846 | ) | ||||||||
Cash at beginning of year |
21,770 | 29,660 | 39,506 | ||||||||||
Cash at end of year |
$ | 101,151 | $ | 21,770 | $ | 29,660 | |||||||
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
5
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(in thousands)
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
Reconciliation of net income (loss) to net cash flows from operating
|
|||||||||||
Net income (loss) |
(1,255,843 | ) | $ | (28,077 | ) | $ | 389,501 | ||||
Change accrued investment income |
(1,995 | ) | 19,929 | (10,798 | ) | ||||||
Change deferred premium revenue net of prepaid reinsurance premiums |
281,116 | 143,378 | 138,199 | ||||||||
Change deferred acquisition costs |
48,549 | (7,197 | ) | (5,544 | ) | ||||||
Change in current federal income taxes payable |
142,704 | (30,515 | ) | (5,776 | ) | ||||||
Change in unpaid losses and loss adjustment expenses, net of reinsurance recoverable |
1,491,976 | 7,298 | 21,401 | ||||||||
Provision (benefit) for deferred income taxes |
(821,903 | ) | (178,216 | ) | 49,715 | ||||||
Net realized (gains) losses on investments |
251,166 | (15,948 | ) | (10,578 | ) | ||||||
Depreciation and accretion of discount |
2,409 | (26,643 | ) | 31,927 | |||||||
Minority interest |
982,259 | (106,136 | ) | (48,660 | ) | ||||||
Change in other assets and liabilities |
(709,658 | ) | 725,363 | 13,245 | |||||||
Cash provided by operating activities |
$ | 410,780 | $ | 503,236 | $ | 562,632 | |||||
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
6
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006
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 engages in providing financial guaranty insurance on public finance obligations in domestic and international markets. Historically, the Company also provided financial guaranty insurance on asset-backed obligations. In August 2008, the Company announced that it would cease insuring asset-backed obligations and instead participate exclusively in the global public finance financial guaranty business. The Company operates in two business segments: a financial guaranty segment and a variable interest entities ("VIE") segment.
Within the financial guaranty segment, 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. In November 2008, the GIC Affiliates ceased issuing GICs. While the Company has ceased new originations of asset-backed financial guaranty business and the GIC Affiliates have ceased issuing GICs, a substantial portfolio of such obligations remains outstanding.
The Parent is 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 primarily engaged in the business of public finance, banking and investment management in France, Belgium, Luxemburg and other European countries, as well as in the United States. Dexia Crédit Local is a wholly owned subsidiary of Dexia. At December 31, 2008, Dexia Holdings owned over 99% of outstanding shares of the Parent.
Expected Sale of the Company
Purchase Agreement with Assured Guaranty Ltd.
In November 2008, Dexia Holdings entered into a purchase agreement (the "Purchase Agreement") providing for the sale of all Parent shares owned by Dexia to Assured (the "Acquisition"), subject to the consummation of specified closing conditions, including regulatory approvals, absence of rating impairment and segregation or separation of the Parent's financial products ("FP") operations from the Parent's financial guaranty operations.
Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act") and the rules promulgated thereunder by the Federal Trade Commission (the "FTC"), the Acquisition may not be consummated until notifications have been given and certain information has been furnished to the FTC and the Department of Justice (the "DOJ") and specified waiting period requirements have been satisfied. The HSR Act waiting period expired on January 21, 2009. In addition, under the insurance holding company laws and regulations applicable to the Parent and its insurance subsidiaries and Assured's insurance company subsidiaries, before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance commissioner of the state where the insurer is domiciled. Assured has informed the Parent that Assured filed applications with the insurance departments of the States of New York and Oklahoma and the U.K. Financial Services Authority; that the applications to the New York Insurance Department and the U.K. Financial Services Authority have been approved; and that it has made pre-acquisition filings regarding the
7
potential competitive impact of the acquisition, which are deemed to have been approved. Dexia has informed Parent that it has filed an application with the U.K. Financial Services Authority in connection with its acquisition of Assured common shares pursuant to the Purchase Agreement, which has been approved, and that it has filed disclaimers of control with the insurance departments of the states of Maryland, New York, and Oklahoma.
Satisfying all three rating agencies that the necessary steps have or will be taken to transfer the Parent's FP segment credit and liquidity risk to Dexia is one of the last conditions to the Purchase Agreement closing. Rating agency confirmation that the Acquisition will not have a negative impact on the financial strength ratings of Assured's insurance company subsidiaries or FSA and its insurance company subsidiaries is a condition for closing, and is beyond the Parent's control.
The Company cannot estimate whether or when the remaining closing conditions will be satisfied or relevant agreements negotiated, whether the Acquisition will be completed and, if completed, whether it will be structured as currently contemplated, or what the effects of the change in control or removal of the Parent's FP business will be on the Company and its results of operations. If the Acquisition is not carried out, Dexia may explore other options with respect to the Parent and its subsidiaries, including selling the Parent or some of its operations to a third party or ceasing to write new business, which may have a material adverse effect on the Company.
Dexia's Retention of the Parent's FP Business
Under the Purchase Agreement, Dexia is expected to retain the Parent's FP business after the Acquisition. The Parent's FP business includes the Company's VIE Segment. The Purchase Agreement provides that Dexia will provide guarantees with respect to the FP business' assets and liabilities, including derivative contracts and anticipates that some of its guarantees will benefit from guarantees provided by the French and Belgian states. Dexia Holdings, the Company's ultimate parent, agreed that if such sovereign guarantees are provided, it will cause Parent to transfer the ownership interests of certain of the subsidiaries that conduct the FP business, or all the assets and liabilities of such subsidiaries, to Dexia Holdings or one of its affiliates in form reasonably acceptable to Assured.
Subsequent Event
In February 2009, Dexia entered into several agreements that transfer credit and liquidity risk of the GIC operations to Dexia, (the "FSAM Risk Transfer Transaction"). Each of the agreements executed under the FSAM Risk Transfer Transaction directly affect (1) FSA Asset Management LLC ("FSAM"), an affiliate of the Company, and (2) the entities that absorb the risks created by FSAM. These agreements provide for the (i) elimination of FSA's guaranty of repayment of FSAM's borrowings under the credit facilities provided by Dexia's bank subsidiaries; (ii) elimination of FSA's guaranty of certain of FSAM's investments; and (iii) increase in the credit facilities provided to FSAM by Dexia's bank subsidiaries from $5 billion to $8 billion.
Financial Guaranty
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 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.
Obligations insured by the Company are generally awarded ratings on the basis of the financial strength ratings given to the Company's insurance company subsidiaries by the major securities rating agencies. On December 31, 2008, the Company was rated Triple-A (negative credit watch) by Standard & Poor's Ratings Services ("S&P") and Fitch Ratings ("Fitch") and Aa3 (developing outlook)
8
by Moody's Investors Service, Inc. ("Moody's"). Prior to the third quarter of 2008, the Company's insurance company subsidiaries, as well as the obligations they insured, had been awarded Triple-A ratings by the three major rating agencies.
During 2007 and 2008, the global financial crisis that began in the U.S. subprime residential mortgage market transformed the financial guaranty industry. By the end of November 2008, all of the monoline guarantors that had been rated Triple-A at the beginning of the year had been downgraded in varying degrees by Moody's, and all but one had been either downgraded or placed on negative outlook or negative credit watch by S&P and Fitch. FSA and its insurance company subsidiaries were among the last companies to be affected, and were rated "Triple-A/stable" by all three rating agencies until July 2008. Rating agencies raised concerns about the stability of FSA's rating during the second half of 2008, and Moody's lowered FSA's and its insurance company subsidiaries' Aaa rating to Aa3 (developing outlook) in November. These developments, combined with illiquidity in the capital markets, led to a marked reduction in the Company's production in the second half of 2008.
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 were 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 insured synthetic asset-backed obligations that generally took the form of credit default swap ("CDS") obligations or credit-linked notes that reference asset-backed securities ("ABS") or pools of securities or other obligations, with a defined deductible to cover credit risks associated with the referenced securities or loans.
The Company has refinanced certain poorly performing transactions by employing refinancing vehicles to raise funds, prepay the claim obligations and take control of the assets. These refinancing vehicles are consolidated with the Company and considered part of the financial guaranty segment.
Variable Interest Entities
The Company consolidated the results of VIEs where it is the primary beneficiary. These VIEs include FSA Global Funding Limited ("FSA Global") and Premier International Funding Co. ("Premier"). The Company does not own an equity interest in the VIEs.
FSA Global is a special purpose funding vehicle partially owned by a subsidiary of the Parent. FSA Global issues FSA-insured medium term notes and generally invests the proceeds from the sale 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 note proceeds. Premier is principally engaged in leveraged lease transactions.
The Company's management believes that the assets held by FSA Global and Premier, including those that are eliminated in consolidation, are beyond the reach of the Company's creditors, even in bankruptcy or other receivership. Substantially all the assets of FSA Global are pledged to secure the repayment, on a pro rata basis, of FSA Global's notes and its other obligations.
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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 accounting practices prescribed or permitted by insurance regulatory authorities (see Note 26). 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, 2008 and 2007, the reported amounts of revenues and expenses in the consolidated statements of operations and comprehensive income during the years ended December 31, 2008, 2007 and 2006 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 determination of other-than-temporary impairment ("OTTI"), 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:
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's presentation.
Significant accounting policies under GAAP are described below. To the extent the accounting policy calls for fair value measurement, see Note 3 for a discussion of how fair value is measured for each financial instrument.
Investments
The Company segregates its investments into the following portfolios:
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, unless deemed to be OTTI. OTTI is reflected in earnings as a realized loss. 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 variable interest entities segment". Realized and unrealized gain or loss on the VIE Segment Investment Portfolio has no effect on equity or net income after giving effect to minority interest.
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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. 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. Auction Rate Securities are long-term securities with interest rate reset features and are traded in the marketplace through a bidding process. 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.
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. 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.
Effective January 1, 2009, the Company's recognition of premium revenue will change due to the adoption of Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standard ("SFAS") No. 163, "Accounting for Financial Guarantee Insurance Contracts" ("SFAS 163"), as described in "Recently Issued Accounting Standards that are Not Yet Effective."
Losses and Loss Adjustment Expenses
The Company establishes loss 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 loss 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
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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 automobile 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 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 statistically estimated using 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. Management's best estimate of inherent losses associated with providing credit protection at each balance sheet date is evaluated by applying the Moody's expected loss algorithm as an estimate of the reserve required for non-investment grade risks not requiring a core reserve. If such amount is greater than 10% of the statistical product then an additional contribution to the non-specific reserve is made.
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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 1970-2007, 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.
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.
In order to determine any adjustment to the non-specific reserve, management uses a methodology that references a calculation of expected loss for risks that are below-investment-grade according to the Company's ratings. The calculation of expected loss relies on the following assumptions and parameters:
In 2008, management recorded additional non-specific reserves as a result of such analysis.
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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 accounting literature in effect for 2008 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 FAS No. 60, "Accounting and Reporting by Insurance Enterprises: ("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 No. 5, "Accounting for Contingencies" ("SFAS 5"), which requires the establishment of liabilities when a loss is both probable and reasonably estimable. The Company also relies by analogy on Emerging Issues Task Force Issue 85-20, "Recognition of fees for guaranteeing a loan," 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.
Effective January 1, 2009, the Company's measurement and recognition of claims liabilities will change due to the adoption of SFAS 163, as described in "Recently Issued Accounting Standards."
Deferred Costs
Financial Guaranty
Deferred acquisition costs comprise expenses primarily related to the production of business, including commissions paid on reinsurance assumed, compensation and related costs of underwriting, 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.
Derivatives
Derivative contracts are entered into to manage interest rate and foreign currency risks associated with the 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
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debt into U.S.-dollar floating rate assets and liabilities. Cash collateral received from derivative counterparties is netted with derivative receivables from the same counterparties when the right of offset exists under master netting agreements.
The 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 from variable interest entities segment" or "net interest expense from variable interest entities segment," as appropriate, along with the offsetting change in the fair value of the risk being hedged. Hedge accounting is applied to fair value hedges provided certain criteria are met. See Note 16 for more information. All cash flows from derivative instruments are classified as "net derivative payments in variable interest entities segment" on the statement of cash flows, regardless of their designation as fair-value hedges.
The Company also has a portfolio of insured derivatives (primarily CDS). 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. Changes in fair value are recorded in "net change in fair value of credit derivatives."
In consultation with the Securities and Exchange Commission (the "SEC"), members of the financial guaranty industry have collaborated to develop a presentation of credit derivatives issued by financial guaranty insurers that is more consistent with that of non-insurers. Prior-period balances have been reclassified to conform to the current presentation. The reclassifications do not affect net income or equity, although they do affect various revenue, asset and liability line items. Changes in fair value are recorded in "net change in fair value of credit derivatives" in the consolidated statements of operations and comprehensive income. The "realized gains (losses) and other settlements" component of this income statement line includes premiums received and receivable on written CDS contracts and premiums paid and payable on purchased contracts. If a credit event occurred that required a payment under the contract terms, this line item would also include losses paid and payable to CDS contract counterparties due to the credit event and losses recovered and recoverable on purchased contracts.
Variable Interest Entities Segment Debt
VIE segment debt is recorded at amortized cost or fair value, if the fair value option was elected. Certain VIE liabilities include embedded derivatives. Prior to the adoption of SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159") on January 1, 2008, changes in fair value of embedded derivatives in VIE debt were recorded in "net realized and unrealized gains (losses) on derivative instruments." In 2008, the fair value option was elected for all VIE liabilities containing embedded derivatives and the change in fair value of the entire debt instrument is recorded in "net unrealized gains (losses) on financial instruments at fair value."
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 recorded 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 resulting from translating investments denominated in foreign currencies are recorded in accumulated other comprehensive income unless the security is deemed OTTI. Gains and losses from transactions in foreign currencies are recorded in "other income."
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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 amounts reported in the financial statements. 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. Deferred tax assets are evaluated for recoverability and a valuation allowance is established if a deferred tax asset is determined to be non-recoverable.
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 recognizes tax benefits only if a tax position is "more likely than not" to prevail.
Special Purpose Entities
Asset-backed and, to a lesser extent, public finance transactions insured by the Company may employ special purpose entities ("SPEs") for a variety of purposes. A typical asset-backed transaction, for example, employs an SPE as the purchaser of the securitized assets and as the issuer of the insured obligations. SPEs are typically owned by transaction sponsors or charitable trusts, although the Company may have an ownership interest in some cases. The Company generally maintains certain contractual rights and exercises varying degrees of influence over SPE issuers of FSA-insured obligations.
The Company also bears some of the "risks and rewards" associated with the performance of those SPE's assets. Specifically, as issuer of the financial guaranty insurance policy insuring a given SPE's obligations, the Company bears the risk of asset performance (typically, but not always, after a significant depletion of overcollateralization, excess spread, a deductible or other credit protection).
The Company's underwriting guidelines for public finance obligations generally require that a transaction be rated investment grade when FSA's insurance is applied. The Company's underwriting guidelines for asset-backed obligations, which it followed prior to its August 2008 decision to cease insuring such obligations, varied by obligation type in order to reflect different structures and types of credit support. The Company sought to insure asset-backed obligations that generally provided for one or more forms of overcollateralization or third-party protection. In addition, the SPE typically pays a periodic premium to the Company in consideration of the issuance by the Company of its insurance policy, with the SPE's assets typically serving as the source of payment of such premium, thereby providing some of the "rewards" of the SPE's assets to the Company. SPEs are also employed by the Company in connection with secondary market transactions and with refinancing underperforming, non-investment-grade transactions insured by FSA. See Note 7 for more information.
The degree of influence exercised by the Company over these SPEs varies from transaction to transaction, as does the degree to which "risks and rewards" associated with asset performance are assumed by the Company. 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 outstanding exposure amounts reported.
The Company is required to consolidate SPEs that are considered VIEs where the Company is considered the primary beneficiary.
In determining whether the Company is the Primary Beneficiary of a particular VIE, a number of factors are considered. The significant factors considered are: the design of the entity and the risks it was created to pass-along to variable interest holders; the extent of credit risk absorbed by the
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Company through its insurance contract and the extent to which credit protection provided by other variable interest holders reduces this exposure; the exposure that the Company cedes to third party reinsurers, to reduce the extent of expected loss which the Company absorbs; and the portion of the VIE's total notional exposure covered by the Company's insurance policy. The Company's accounting policy is to first conduct a qualitative analysis based on the design of the VIE in order to identify whether it is the primary beneficiary. Should the qualitative analysis not provide a basis for conclusion, the Company will perform a quantitative analysis in order to determine if it is the primary beneficiary of the VIE under review.
In considering the significance of its interest in a particular VIE, the Company considers the extent to which both the variability it absorbs from the VIE and the Company's exposure to that VIE are material to the Company's own financial statements. The Company believes that its surveillance categories are an appropriate measure to use for identification of VIEs in which the Company absorbs other than insignificant variability. VIEs selected for this purpose are related to risks classified as surveillance Category IV, defined as "demonstrating sufficient deterioration to indicate that material credit losses are possible even though not yet probable" or risks classified as surveillance Category V, defined as "transactions where losses are probable." The Company believes that VIE-related risks classified as surveillance Categories IV and V are VIEs in which the Company absorbs a significant portion of the variability created by the particular VIE. For a more detailed description of the surveillance categories used by the Company, see Note 9.
VIEs in which the Company holds a significant variable interest, but which are not consolidated, have been aggregated according to principle line of business for the purpose of disclosing the nature and extent of the Company's exposure to such VIEs. The Company considers such VIEs according to principle line of business to appropriately reflect the VIE risk and reward characteristics in an aggregated manner. The table below displays the Company's exposure to these VIEs at December 31, 2008.
|
At December 31, 2008 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Liability |
|
|
|||||||||||||||
|
Net Case Reserve |
Net Non-
Specific Reserve |
Fair Value of
Credit Derivatives |
Net Par
Outstanding(1) |
Number of VIEs | |||||||||||||
|
(dollars in thousands)
|
|||||||||||||||||
Asset-backed: |
||||||||||||||||||
Domestic |
||||||||||||||||||
Residential mortgages |
$ | 1,221,410 | $ | 36,422 | $ | 11,263 | $ | 9,130,637 | 59 | |||||||||
Consumer receivables |
| 9,163 | | 88,438 | 1 | |||||||||||||
Pooled corporate |
25,866 | | 110,488 | 797,835 | 10 | |||||||||||||
Other |
| | 34,981 | 125,710 | 1 | |||||||||||||
Total asset-backed |
1,247,276 | 45,585 | 156,732 | 10,142,620 | 71 | |||||||||||||
Public finance: |
||||||||||||||||||
Domestic |
263 | | | 239 | 1 | |||||||||||||
International |
10,960 | | | 509,520 | 7 | |||||||||||||
Total public finance |
11,223 | | | 509,759 | 8 | |||||||||||||
Total |
$ | 1,258,499 | $ | 45,585 | $ | 156,732 | $ | 10,652,379 | 79 | |||||||||
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The Company's interest in these non-consolidated VIEs is included in "losses and loss adjustment expenses" and "credit derivatives" in the Company's balance sheet.
The Company has consolidated certain VIEs for which it has determined that it is the primary beneficiary. The table below shows the carrying value and classification of the consolidated VIE assets and liabilities in the Company's financial statements:
|
At December 31, 2008 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
Total Assets | Total Liabilities | Minority Interest | |||||||
|
(in thousands)
|
|||||||||
VIE segment VIEs |
$ | 2,427,640 | $ | 1,316,400 | $ | 1,111,240 |
FSA has provided financial guarantee insurance contracts on the assets held and the notes issued by FSA Global Funding and, as such, FSA is exposed to the risk of non-payment of the assets held by FSA Global Funding. In addition, aside from the financial guarantee insurance contracts provided by FSA, there are no arrangements, either explicit or implicit, which could require the Company to provide financial support to the VIEs.
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 14.
Under SFAS No. 123, "Share-Based Payment" (revised 2004), the Company recorded $1.2 million and $1.0 million in additional after-tax expense related to the Dexia Employee Share Plans in 2007 and 2006, respectively. There was no expense recorded in 2008.
Recently Issued Accounting Standards
In October 2008, the FASB issued FSP No. FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active" ("FSP 157"). FSP 157 clarifies the application of SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), in an inactive market, without changing its existing principles. The FSP was effective immediately upon issuance. The adoption of FSP No. FAS 157-3 did not have an effect on the Company's financial position or results of operations or cash flows.
Recently Issued Accounting Standards that are Not Yet Effective
In May 2008, the FASB issued SFAS 163. This statement addresses accounting standards applicable to existing and future financial guaranty insurance and reinsurance contracts issued by insurance companies, including accounting for claims liability measurement and recognition and premium recognition and related disclosures. SFAS 163 requires 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 net cash flows. The premium earnings methodology under SFAS 163 will be based on a constant rate methodology. SFAS 163 does not apply to financial guarantee insurance contracts accounted for as derivatives within the scope of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 163 also requires
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the Company to provide expanded disclosures relating to factors affecting the recognition and measurement of financial guaranty contracts. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, except for the presentation and disclosure requirements related to claim liabilities which were effective for financial statements prepared as of September 30, 2008. The cumulative effect of initially applying SFAS 163 is required to be recognized as an adjustment to the opening balance of retained earnings. The Company is currently assessing the impact of SFAS 163 on the Company's consolidated financial position and results of operations.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS 133" ("SFAS 161"). This statement amends and expands the disclosure requirements for derivative instruments and hedging activities by requiring companies to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. This statement is effective for fiscal years and interim periods beginning after November 15, 2008. Since SFAS 161 only requires additional disclosures concerning derivatives and hedging activities, adoption of SFAS 161 will not affect the Company's consolidated financial position and results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements" ("SFAS 160"). SFAS 160 will change the accounting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This statement is effective for fiscal years beginning on or after December 15, 2008, with early adoption prohibited. Upon adoption, SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests and prospective adoption for all other requirements. The Company is currently assessing the impact of SFAS 160 on the Company's consolidated financial position, results of operations and cash flows.
3. FAIR VALUE MEASUREMENT
The Company adopted SFAS 157, effective January 1, 2008. SFAS 157 addresses how companies should measure fair value when required to use fair value measures under GAAP. SFAS 157:
In February 2007 the FASB issued SFAS 159. SFAS 159 provides an option to elect fair value as an alternative measurement for selected financial assets and financial liabilities not previously recorded at fair value. The Company adopted SFAS 159 on January 1, 2008 and elected fair value accounting for certain VIE segment debt and certain assets acquired in refinancing Company insured transactions not previously carried at fair value. For more information regarding the fair value option, see Note 4.
19
The Company applied its valuation methodologies for its assets and liabilities measured at fair value to all of the assets and liabilities carried at fair value effective January 1, 2008, whether those instruments are carried at fair value as a result of the adoption of SFAS 159 or in compliance with other authoritative accounting guidance. The Company has fair value committees to review and approve valuations and assumptions used in its models. These committees meet quarterly prior to the Company issuing its financial statements.
Fair value is based upon pricing received from dealer quotes or alternative pricing sources with reasonable levels of price transparency, internally developed estimates that employ credit-spread algorithms or models that use market-based or independently sourced market data inputs, including yield curves, interest rates, volatilities, debt prices, foreign exchange rates and credit curves. In addition to market information, models also incorporate instrument- specific data, such as maturity date.
Considerable judgment is necessary to interpret the data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company would realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair-value amounts.
The transition adjustment in connection with the adoption of SFAS 157 was an increase of $26.6 million after-tax to beginning retained earnings, which relates to day one gains that had been deferred under EITF 02-03.
20
The following table summarizes the components of the fair-value adjustments included in the consolidated statements of operations and comprehensive income:
|
Year Ended December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||||||
|
(in thousands)
|
|||||||||||||||
REVENUES GAINS/(LOSSES): |
||||||||||||||||
Net realized gains (losses) from general investment portfolio: |
||||||||||||||||
Fair-value adjustments attributable to impairment charges in general investment portfolio |
$ | (5,977 | ) | $ | | $ | (284 | ) | ||||||||
Net change in fair value of credit derivatives (See Note 15) |
$ | (618,072 | ) | $ | (539,809 | ) | $ | 119,023 | ||||||||
Net interest income from variable interest entities segment(1): |
||||||||||||||||
Fair-value adjustments on VIE segment investment portfolio |
$ | 33,448 | $ | | $ | | ||||||||||
Fair-value adjustments on VIE segment derivatives |
(34,844 | ) | | | ||||||||||||
Net interest income from variable interest entities segment |
$ | (1,396 | ) | $ | | $ | | |||||||||
Net realized gains (losses) from variable interest entities segment: |
||||||||||||||||
Fair-value adjustments attributable to impairment charges in VIE segment investment portfolio |
$ | (236,220 | ) | $ | | $ | | |||||||||
Net realized and unrealized gains (losses) on derivative instruments: |
||||||||||||||||
VIE segment derivatives(2) (See Note 16) |
$ | 256,317 | $ | 95,895 | $ | 98,827 | ||||||||||
Other financial guaranty segment derivatives |
285 | 419 | 469 | |||||||||||||
Net realized and unrealized gains (losses) on derivative instruments |
$ | 256,602 | $ | 96,314 | $ | 99,296 | ||||||||||
Net unrealized gains (losses) on financial instruments at fair value |
||||||||||||||||
Financial guaranty segment: |
||||||||||||||||
Assets acquired in refinancing transactions |
$ | (17,200 | ) | $ | | $ | | |||||||||
Committed preferred trust put options |
100,000 | | | |||||||||||||
Net unrealized gains (losses) on financial instruments at fair value in the financial guaranty segment |
82,800 | | | |||||||||||||
VIE segment: |
||||||||||||||||
Fixed-rate VIE segment debt: |
||||||||||||||||
Fair-value adjustments other than the Company's own credit risk |
(203,735 | ) | | | ||||||||||||
Fair-value adjustments attributable to the Company's own credit risk |
1,222,742 | | | |||||||||||||
Net unrealized gains (losses) on financial instruments at fair value in the VIE segment |
1,019,007 | | | |||||||||||||
Net unrealized gains (losses) on financial instruments at fair value |
$ | 1,101,807 | $ | | $ | | ||||||||||
Net realized gains (losses) from assets acquired in refinancing transactions: |
||||||||||||||||
Fair-value adjustments attributable to assets acquired in refinancing transactions portfolio |
$ | (7,723 | ) | $ | | $ | (2,523 | ) | ||||||||
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Valuation Hierarchy
SFAS 157 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
A financial instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Inputs to Valuation Techniques
Inputs refer broadly to the assumptions that market participants use in pricing assets or liabilities, including assumptions about risk. Inputs may be observable or unobservable.
Valuation Techniques
Valuation techniques used for assets and liabilities accounted for at fair value are generally categorized into three types:
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The Company uses valuation techniques that it concludes are appropriate in the specific circumstances and for which sufficient data are available. In selecting the valuation technique to apply, management considers the definition of an exit price and considers the nature of the asset or liability being valued.
The following is a description of the valuation methodologies the Company uses for financial instruments including the general classification of such instruments within the valuation hierarchy.
General Investment Portfolio
The fair value of bonds in the General Investment Portfolio is generally based on quoted market prices received from dealer quotes or alternative pricing sources with reasonable levels of price transparency. Such quotes generally consider a variety of factors, including recent trades of the same and similar securities. If quoted market prices are not available, the valuation is based on pricing models that use dealer price quotations, price activity for traded securities with similar attributes and other relevant market factors as inputs, including security type, rating, vintage, tenor and its position in the capital structure of the issuer. Assets in this category are primarily categorized as Level 2.
At December 31, 2008, the Company's equity securities were comprised of common stock of Dexia. The fair value of the common stock is based upon quoted prices and is categorized as Level 1. At December 31, 2007, the fair value of the Company's equity investment in Syncora Guaranty Re Ltd. ("SGR"), was based on redemption value and other inputs.
For short-term investments in the General Investment Portfolio, which are those investments with a maturity of less than one year at time of purchase, the carrying amount approximates fair value. These short-term investments include money-market funds and other highly liquid short-term investments, which are categorized as Level 1 on the valuation hierarchy, and foreign government and agency securities, which are categorized as Level 2.
VIE Segment Investment Portfolio
The "VIE Segment Investment Portfolio" is comprised of investments supporting the VIE liabilities, which are primarily designated as available-for-sale, but in some cases are classified as held-to-maturity. See "Other Assets and Other Liabilities." The fair value of bonds in the VIE Segment Investment Portfolio is generally based on quoted market prices received from dealer quotes or alternative pricing sources with reasonable levels of price transparency. Such quotes generally consider a variety of factors, including recent trades of the same and similar securities. For assets not valued by quoted market prices received from dealer quotes or alternative pricing sources, fair value is based on either internally developed models using market-based inputs or based on broker quotes for identical or similar assets. Valuation results, particularly those derived from valuation models and quotes on certain mortgage and asset-backed securities, could differ materially from amounts that would actually be realized in the market. Assets in the VIE Segment Investment Portfolio are generally categorized as Level 3 on the valuation hierarchy.
The fair value of the GICs in the VIE Segment Investment Portfolio is determined using cash flow models which include assumptions for interest rate curves based on selected benchmark securities and weighted average expected lives. These are categorized as Level 3 on the valuation hierarchy.
For short-term investments in the VIE Segment Investment Portfolio, which are those investments with a maturity of less than one year at time of purchase, the carrying amount is fair value. These short-term investments include overnight money market funds, which are categorized as Level 1 on the valuation hierarchy.
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Cash
For cash, the carrying amount equals fair value.
Assets Acquired in Refinancing Transactions
For certain assets acquired in refinancing transactions, fair value is either the present value of expected cash flows or a quoted market price as of the reporting date. This portfolio is comprised primarily of bonds, securitized loans, common stock, mortgage loans, real estate and short term investments, of which bonds, common stocks and certain securitized loans are carried at fair value. Mortgage loans are accounted for at fair value when lower than cost. The majority of the assets in this portfolio are categorized as Level 3 in the valuation hierarchy, except for the short-term investments, which are categorized as Level 2.
Credit Derivatives in the Insured Portfolio
The Company's insured portfolio includes contracts accounted for as derivatives, namely,
The Company considers all such agreements to be a normal part of its financial guaranty insurance business but, for accounting purposes, these contracts are deemed to be derivative instruments and therefore must be recorded at fair value, with changes in fair value recorded in the consolidated statements of operations and comprehensive income in "net change in fair value of credit derivatives."
Credit Default Swap Contracts
In the case of CDS contracts, a trust that is consolidated by the Company writes a derivative contract that provides for payments to be made if certain credit events occur related to certain specified reference obligations, in exchange for a fee. The need to interpose a trust is a regulatory requirement imposed by the New York State Insurance Department as an exception to its general rule, in order to allow the financial guarantors to sell credit protection by entering into credit derivative contracts (albeit indirectly by guaranteeing the trust), while other types of insurance enterprises may neither directly enter into such credit derivative contracts, nor provide such guarantees to a trust. The trust's obligation on the CDS contracts it writes are guaranteed by a financial guaranty contract written by FSA that provides payments to the insured if the trust defaults on its payments under the derivative contract. In these transactions, FSA is considered the counterparty to a financial guaranty contract that is defined as a derivative. The credit event is typically based upon failure to pay or the insolvency of a referenced obligation. In such cases, the claim represents payment for the shortfall amount.
The Company's accounting policy regarding CDS contract valuations requires management to make numerous complex and subjective judgments relating to amounts that are inherently uncertain. CDS contracts are valued using proprietary models because such instruments are unique, complex and are typically highly customized transactions. Valuation models and the related assumptions are continuously reevaluated by management and enhanced, as appropriate, based on market developments
24
and improvements in modeling techniques and the availability of market observable data. Due to the significance of unobservable inputs required to value CDS contracts, they are considered to be Level 3 under the SFAS 157 fair value hierarchy.
Significant assumptions that, if changed, could result in materially different fair values include:
Market perceptions of credit deterioration of the underlying referenced obligation would result in an increase in the expected exit value (the amount required to be paid to exit the transaction due to wider credit spreads).
Fair Value of CDS Contracts in which the Company Sells Protection
Determination of Current Exit Value Premium: The estimation of the current exit value premium is derived using a unique credit-spread algorithm for each defined CDS category that utilizes various publicly available credit indices, depending on the types of assets referenced by the CDS contract and the duration of the contract. The "exit price" derived is technically an "entry price" and not an "exit price" (i.e., the price that would be received to sell an asset or paid to transfer a liability that is required under SFAS 157). This is because a monoline insurer cannot observe "exit prices" for the CDS contract that it writes in a principal market since these contracts are not transferable. While SFAS 157 provides that the transaction (entry) price and the exit price may not be equal if the transaction price includes transaction costs, the Company believes those transaction costs would be the same in an "entry" market and a hypothetical "exit" market and thus it would be inappropriate to record a day one gain when using the estimated "entry price" to determine the exit value premium.
Management applies judgment when developing these estimates and considers factors such as current prices charged for similar agreements, if available, performance of underlying assets, changes in internal credit assessments or rating agency-based shadow ratings, and 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.
In a financial guaranty insurance policy, a deductible is the portion of a loss under that policy that is not covered by the policy, or in other words, the amount of the loss for which the insurer is not responsible. In a CDS contract, the deductible is quoted as a percentage of the contract's notional amount, and is also referred to as the contract's attachment point. For example, for a CDS with a $1 billion notional amount and a 15% deductible, the Company would only be obligated to make a claim payment after the insured incurred more than $150 million (15% of $1 billion) of losses (net of recoveries). The attachment points for each of the Company's CDS contracts vary, as the deductibles are negotiated on a contract-by-contract basis.
In the ordinary course, the Company does not post collateral to the counterparty as security for the Company's obligation under CDS contracts. As a result, the Company receives a smaller fee than it would for a CDS contract that required the posting of collateral. In order to calculate the exit value premium for CDS that do not require collateral to be posted, the Company applies a factor (the "non-collateral posting factor") to the indicated market premium for CDS contracts that require collateral to be posted. The non-collateral posting factor was 70% for the year ended December 31, 2008.
25
The Company calculates the non-collateral posting factor quarterly based in part on observable market inputs. In the market where transactions are executed, the Company has observed since the beginning of 2008 that when a collateral posting counterparty executes a CDS contract purchasing protection from a non-collateral posting counterparty, it will hold back a minimum of 20% of the CDS premium it charged to provide the CDS protection. The Company believes that the non-collateral posting factor has the effect of adjusting the fair value of these contracts for the Company's credit quality in addition to adjusting the contract to a collateral posting basis. Accordingly, the Company adds to the 20% minimum an additional amount to reflect the market price of CDS protection on FSA. The Company estimated the additional amount at December 31, 2008 to be 50% using an algorithm that uses as an input FSA's current annual five-year CDS credit spread, which was approximately 1,421 basis points at December 31, 2008. The Company uses the current five-year CDS credit spread based on its observation that the five-year instrument is the standard term for CDS contracts used to hedge counterparty credit risk. Quoted prices for shorter or longer terms are typically not available and, when available, are less reliable.
The underlying securities of the Company's CDS contracts are predominantly corporate obligations, specifically investment grade pooled corporate CDS, high yield pooled corporate CDS and collateralized loan obligations ("CLOs"). The Company's exposure to underlying securities such as those backed by domestic residential mortgage-backed securities ("RMBS") and CDOs of ABS was less than one percent of the total CDS par outstanding at December 31, 2008.
Below is an explanation of how the Company determines the current exit value for each of the following types of CDS contracts:
For each of these types of CDS contracts, the price the Company charges when entering into such contract sometimes differs from the fair value determined by the Company's fair value model at the time when the Company enters into the CDS contract. The Company refers to this difference as the "initial model adjustment," and is not an indicator of a day one gain. The initial model adjustment is needed because of differences between the CDS contract being valued and the reference index. The initial model adjustment is calculated at the inception of a CDS contract in order to calibrate the indicated model fair value of the CDS contract to the contractual premium rate on the trade date.
Pooled Corporate CDS Contracts : A pooled corporate CDS contract insures the default risk of a pool of referenced 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 the mid-point of the bid and ask prices (the "mid-market price") of dealer quotes on specific indexes as inputs to its pricing model, principally the Dow Jones CDX for domestic corporate CDS ("DJ CDX") and iTraxx for European corporate CDS ("iTraxx"). The mid-market price is a practical expedient for the fair-value measurement within a bid-ask spread. For those pooled corporate CDS contracts that include both domestic and foreign reference entities, the Company applies the iTraxx price in proportion to the pool of applicable foreign reference entities comprising the pool by calculating a weighted average of the DJ CDX and iTraxx quoted prices.
The Company's valuation process for pooled corporate CDS involves stratifying the pools into either investment grade credits or high-yield credits and then by remaining term to maturity, consistent with the reference indexes. Within maturity bands, further distinction is made for contracts that have higher attachment points. Both the DJ CDX and iTraxx indices provide quoted prices for standard
26
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.
Investment-Grade Pooled Corporate CDS Contracts: The Company applies quoted prices to its investment-grade pooled corporate CDS contracts ("IG CDS") by stratifying its IG CDS contracts into four maturity bands: less than 3.5 years; 3.5 to 5.5 years; 5.5 to 7.5 years; and 7.5 to 10 years. Within the maturity bands, further distinction is made for contracts that have a significantly higher starting attachment point (usually 30% or higher).
The CDX North America IG Index ("CDX IG Index") is comprised of prices sourced from 125 North American investment grade CDS quoted (each, an "Index CDS") and is supported by at least 10 of the largest CDS dealers. In addition to the full capital structure, the CDX IG Index also provides price quotes for various tranches delineated by attachment and detachment points: 0 to 3%; 3 to 7%; 7 to10%; 10 to 15%; 15 to 30% and 30 to 100%. Approximately every six months, a new "series" of the CDX IG Index is published ("on-the-run") based on a new grouping of 125 Index CDS, which changes the composition of the 125 Index CDS of older ("off-the-run") series. Each quarter, the Company compares the composition of the 125 Index CDS in both the on-the-run and off-the run series of the CDX IG Index to the CDS pool referenced by the Company's IG CDS contracts (the "reference CDS pool") and uses the average of the series of the CDX IG Index and the comparable iTraxx Index that most closely relates to the credit characteristics of the Company's IG CDS contracts, mainly the Weighted-Average Rating Factor ("WARF"), of the Company's IG CDS contracts. The Company also remodels each of its contracts to determine if the credit quality remains Super Triple-A and compares the WARF of the index to the WARF of each of the Company's IG CDS contracts. A "Super Triple-A" credit rating indicates a level of first-loss protection generally exceeding 1.3 times the level required by a rating agency for a Triple-A rating. WARF is a 10,000 point scale developed by Moody's that is used as an indicator of collateral pool risk. A higher WARF indicates a lower average collateral rating.
The Company calibrates the quoted index price to the approximate attachment points for its IG CDS contracts by calculating the weighted average of the given quoted tranche prices for IG CDS of a given maturity using the CDX IG Index and iTraxx quoted tranche widths. The relevant widths of the quoted tranches used by the two indices differ. DJ CDX uses tranches of 10 to 15%, 15 to 30%, and 30 to 100%, resulting in tranche widths of five, 15 and 70 percentage points, whereas iTraxx uses tranches of 9 to 12%, 12 to 22% and 22 to 100%, resulting in tranche widths of three, 10 and 78 percentage points.
27
The Company's IG CDS contracts typically attach at 10% or higher. The following table indicates FSA's typical attachment points and total tranche widths:
Portfolio Classification
|
Index Quoted
Duration |
FSA's Typical
Attachment Point |
FSA's Total
Tranche Width |
||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
(in years)
|
|
|
||||||||
Less than 3.5 Yrs |
3 | 10 | % | 90 | % | ||||||
3.5 to 5.5 Yrs |
5 | 10 | 90 | ||||||||
5.5 to 7.5 Yrs: |
|||||||||||
Lower attachment |
7 | 15 | 85 | ||||||||
Higher attachment |
7 | 30 | 70 | ||||||||
7.5 to 10 Yrs: |
|||||||||||
Lower attachment |
10 | 15 | 82.5 | ||||||||
Higher attachment |
10 | 30 | 70 |
To calculate the weighted average price for the entire tranche width of the Company's IG CDS (the "total tranche width"), a price is obtained for each quoted tranche comprising the total tranche width, and the sum of the weighted average prices is divided by the total tranche width. The price for each quoted tranche is the mid-market of the quoted price for that tranche, weighted by the width of that tranche. The following table illustrates the calculation of the weighted-average price of the Company's IG CDS contracts with a maturity of up to 3.5 years, given quoted CDX IG tranche prices of 332 basis points, 83.5 basis points and 68.4 basis points for the 10 to 15%, 15 to 30%, and 30 to 100% tranches, respectively.
FSA Portfolio
Classification |
|
|
|
|
|
|
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
CDX IG Mid-Market Price Multiplied by the Tranche Width |
|
|
|||||||||||||||||
Total
Tranche Width |
Weighted
Average Price |
||||||||||||||||||
Attachment/
Detachment |
10 to 15% | 15 to 30% | 30 to 100% | Total | |||||||||||||||
Less than 3.5 Yrs |
332 bps × 5 =
1,660.0 |
83.5 bps × 15 =
1,252.5 |
68.4 bps × 70 =
4,788.0 |
7,700.5 | 90 | 85.6 bps |
The Company applies a factor to the quoted prices (the "IG calibration factor"). The calibration factor is intended to calibrate the index price to each of the Company's pooled corporate investment grade CDS contracts, which reference pools of entities that are typically of lower average credit quality than those reflected in the CDX IG Index. The IG calibration factor is determined for each IG CDS contract by calibrating the WARF of the index so that it approximately equals the WARF of each IG CDS contract. To do so, the Company recalculates the index price after removing from the index the reference obligations that have the highest ratings. This recalculated index price is then divided by the unadjusted index to arrive at the IG calibration factor. As of December 31, 2008, the IG calibration factor applied to the Company's IG CDS contracts ranged from 112% to 530% of the WARF of the index.
The Company's Transaction Oversight Department reviews the pooled corporate CDS portfolio regularly and no less than quarterly and factors in any rating changes. Any new reported credit events under a given CDS contract are factored into the contract's deductible level. As such credit events occur, the contract's attachment point is recalculated based on the revised deductible amount to determine if the attachment point for each contract in the portfolio continues to be at a "Super Triple-A" credit rating.
To arrive at the exit value premium applied to each of the Company's IG CDS contracts, the Company:
28
the total amount derived by the total tranche width, using CDX IG and iTraxx quoted prices; and then
Below is an example of the pricing algorithm that is applied to the Company's domestic IG CDS contracts with durations of 3.5 to 5.5 years, assuming an average IG calibration factor of 296%, to determine the exit premium value as of December 31, 2008:
Index
Duration |
Unadjusted Quoted
Price |
After IG Calibration
Factor |
Adjusted to Non-Collateral
Posting Contract Value |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
5 yrs |
85.1 bps | 251.9 bps | 75.6 bps |
High-Yield Pooled Corporate CDS Contracts: In order to estimate the market price for high-yield pooled corporate CDS contracts ("HY CDS"), the Company uses the average of the dealer mid-market prices obtained for the most senior quoted of the respective three-year, five-year and seven-year tranches of the CDX North America High Yield Index ("CDX HY Index"). The CDX HY Index is comprised of prices sourced from 100 of the most liquid North American high yield CDS quoted (each, an "Index CDS") and is supported by more than 10 of the largest CDS dealers. In addition to the full capital structure, the CDX HY Index also provides price quotes for various tranches delineated by attachment and detachment points: 0 to 10%; 10 to 15%; 15 to 25%; 25 to 35%; and 35 to 100%. The Company uses an average of the dealer mid-market quotes of the index because the Company believes that dealer price quotes have historically been indicative of where trades have been executed in the high-yield market.
The Company applies a factor to the quoted prices (the "HY calibration factor"). The HY calibration factor is intended to calibrate the index price to each of the Company's pooled corporate high-yield CDS contracts, which reference pools of entities that are typically of higher average credit quality than those reflected in the CDX HY Index. The HY calibration factor is determined for each HY CDS contract by calibrating the WARF of the index so that it approximately equals the WARF of each HY CDS contract. To do so, the Company recalculates the index price after removing from the index the reference obligations that have the lowest ratings. This recalculated index price is then divided by the unadjusted index to arrive at the HY calibration factor. At December 31, 2008, the HY calibration factor applied to the Company's HY CDS contracts ranged from 28% to 100% of the WARF of the index.
Approximately every six months, a new "series" of the CDX HY Index is published ("on-the-run") based on a new grouping of 100 single name CDS, which changes the composition of the Index of older ("off-the-run") series. The Company compares the composition of the Index in both the on-the-run and off-the run series of the HY index to each CDS pool (i.e., "reference entities" or companies included in each contract) referenced by the Company's contracts (the "reference CDS pool"). Based on that comparison, the Company determines which of the actively quoted series most closely relates to the credit characteristics, mainly with reference to the WARF, of the Company's HY CDS contracts, and then uses the average of dealer quotes of that series. The Company also remodels each of its contracts to determine if the credit quality remains Super Triple-A and compares the WARF of the index to the WARF of each of the Company's HY CDS contracts.
To arrive at the exit value premium that is applied to each of the Company's CDS contracts in a given maturity band, the non-collateral posting factor is applied to the weighted-average market price determined for that maturity band.
29
Below is an example of the pricing algorithm that is applied to the Company's domestic HY CDS contracts with durations of 3.5 to 5.5 years, assuming an average HY calibration factor of 100% to determine the exit premium value as of December 31, 2008:
Index
Duration |
Unadjusted Quoted Price |
After HY
Calibration Factor |
Adjusted to Non-Collateral Posting
Contract Value |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
5 yrs |
266.3 bps | 266.3 bps | 79.9 bps |
CDS of Funded CDOs and CLOs : Prior to August 2008, the Company sold protection to financial institutions in a principal-to-principal market in which transactions are highly customized and negotiated independently. The Company therefore cannot observe "exit" prices for the CDS contracts it writes in this market since these contracts are not transferable. In the absence of a principal exit market, the Company determines the fair value of a CDS contract it writes by using an internally-developed estimate of an "exit price" that a hypothetical market participant (i.e., a similarly rated monoline financial guarantee insurer, or "monoline insurer") would accept to assume the risk from the CDS writer on the measurement date, on terms identical to the contract written by the CDS writer. The Company believes this approach is reasonable because the hypothetical exit market has been defined as other monoline insurers. In essence, the exit market participants are the same as the monoline participants competing in the entry market.
As with pooled corporate CDS, there is no observable exchange trading of CDS of funded CDOs and CLOs. The price of protection charged by a CDS writer is based on the "credit spread component" of the "all-in credit spread" of funded CLOs, as quoted by underwriter participants. As the all-in credit spread for a given CLO may not always be observable in the market, the CDS writer often utilizes an index, published by an underwriter participant, such as the "all-in" London Interbank Offered Rate ("LIBOR") spread for Triple-A rated cash-funded CLOs (the "Triple-A CLO Funded Rate") as published by J.P. Morgan Chase & Co. The Triple-A CLO Rate is an all-in credit spread that includes both a funding and credit spread component.
The CDS protection of a CLO provided by the Company is priced to capture only the credit spread component, as the CDS writer is not providing funding for the CLO, only credit protection. The contracts on which the Company has provided credit protection are regularly evaluated to ascertain whether or not the original Triple-A credit rating is still considered appropriate. The Company determines the exit value premium for all these CDS of CLO contracts in its portfolio that are rated Triple-A with reference to the Triple-A CLO Funded Rate, which is currently the only regularly and frequently quoted rate observable in the market. The Triple-A CLO Funded Rate was 500 bps as of December 31, 2008. The Company applies a credit component factor to the Triple-A CLO Funded Rate as a means of estimating the fair value of its Triple-A rated contract, which only refers to the credit component. The credit and funding components were 50% each as of December 31, 2008. The components are determined judgmentally and can vary based on estimates provided to the Company by external market participants, specifically purchasers of CDS protection on Triple-A CLO risk and investors in Triple-A CLO bonds.
30
To arrive at the exit value premium that is applied to each of the Company' CDO and CLO CDS contracts, the non-collateral posting factor is applied to the weighted-average market price determined for each maturity band.
The determination of the exit value premium is summarized as follows:
|
Triple-A CLO
Funded Rate |
After Credit Component
Factor |
After Non-Collateral Posting
Factor |
|||||
---|---|---|---|---|---|---|---|---|
Rate |
500 bps | 250 bps | 75 bps |
Other Structured Obligations Valuation: For CDS for which observable market value information is not available, management applies its best judgment to estimate the appropriate current exit value premium, and takes into consideration the Company's estimation of the price at which the Company would currently charge to provide similar protection, and other factors such as the nature of the underlying reference credit, the Company's attachment point, and the tenor of the CDS contract.
Fair Value of CDS Contracts in which the Company Purchases Protection
The Company generally utilizes reinsurance to purchase protection for CDS contracts it writes in the same way that it employs reinsurance in respect of other financial guaranty insurance policies. The Company's uses of reinsurance to mitigate risk exposures for CDS contracts and financial guaranty insurance policies are nearly identical as they involve the same reinsurers, the same underwriting process evaluating the reinsurers and the same credit risk management and surveillance processes supporting the reinsurance function. The Company enters into reinsurance agreements on CDS contracts primarily on a quota share basis. Under a quota share reinsurance agreement with a reinsurer, the Company cedes to the assuming reinsurer a proportionate share of the risk and premium.
The determination of the hypothetical exit market is a key factor in determining the fair value of protection purchased (the "ceded" or "reinsurance" contract) with respect to a CDS contract written by a financial guarantor (the "direct contract"). SFAS 157 requires that the valuation premise, used to measure the fair value of an asset, must consider the asset's "highest and best use" from the perspective of market participants. Generally, the valuation premise used for a financial asset is "in-exchange" since this type of asset provides maximum value to market participants on a stand-alone basis. The maximum value of a ceded contract to the CDS writer's exit market participants is in combination with the CDS writer's direct contract. Therefore the appropriate valuation premise to use for a ceded contract is the "in-use" premise.
The Company determines the fair value of a CDS contract in which it purchases protection from a reinsurer (the "ceded CDS contract") as the proportionate percentage of the fair value of the related written CDS contracts, adjusted for any ceding commission and consideration of counterparty risk. In quota share reinsurance agreements, the assuming reinsurer typically pays a ceding commission periodically over the life of the CDS contract to the ceding company that is intended to defray the ceding company's costs for the services it provides to the reinsurer, such as risk selection, underwriting activities and ongoing servicing and reporting. As an element of the fair value of the ceded CDS contract, the ceding commission paid to the ceding company represents the ceding company's profit on the ceded CDS contract after considering counterparty credit risk, (i.e., the difference between (a) the price of the protection the ceding company purchased from the reinsurer, which is net of the ceding commission, and (b) the price that the ceding company would receive to exit the ceded CDS contract in its principal market, which is comprised of other ceding insurers of comparable credit standing). The Company applies a credit valuation adjustment to the fair value of a ceded CDS contract due from a reinsurer if the reinsurer's credit quality (as determined by CDS price if available, or if not, its credit rating) is less than that of the Company's based upon the premise that the exit market for these contracts would be another monoline financial guarantee insurer that has similar credit rating or spread as the Company.
31
Insured Interest Rate Swaps and Financial Guarantee Contracts Deemed to be Derivatives
The Company insures interest rate swaps entered into in connection with the issuance of certain public finance obligations. Because the financial guaranty contract insures a derivative, the financial guaranty contract is deemed to be a derivative. Therefore, the contract is required to be carried at fair value, with the change in fair value being recorded in the determination of net income (loss). As there is no observable market for these policies, the fair value of these contracts is determined by using an internally-developed model and, therefore, they are classified as Level 3 in the valuation hierarchy.
Insured NIM securitizations issued in connection with certain mortgage-backed security financings and financial guaranty contracts with embedded derivatives are deemed to be hybrid instruments that contain an embedded derivative if they were issued after January 1, 2007. The Company elected to record these financial instruments at fair value under SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments." Changes in the fair value of these contracts are recorded in the consolidated statements of operations and comprehensive income. As there is no observable market for these policies, the fair value of these contracts is based on internally-derived estimates and they are, therefore, classified as Level 3 in the valuation hierarchy.
VIE Segment Derivatives
On the date of adoption, all derivatives used to hedge VIE debt were valued by obtaining prices from brokers or counterparties, and accordingly were classified as Level 3 in the valuation hierarchy. At December 31, 2008, the majority of these derivatives were valued using a pricing model that uses observable market inputs such as interest rate curves, foreign exchange rates and inflation indices. Therefore, these derivatives are classified as Level 2 in the valuation hierarchy at December 31, 2008. If a significant model input had been used that was not observable in the market, the derivative would have been classified as a Level 3 in the valuation hierarchy.
Other Assets and Other Liabilities
Other assets primarily include held-to-maturity investments in VIE Segment Investment Portfolio, receivables for securities sold and the fair value of the committed preferred trust securities ("CPS"). As there is no observable market for the Company's CPS, fair value of the CPS is based on internally-derived estimates and, therefore, these put options are categorized as Level 3 in the fair value hierarchy.
The Company determined the fair value of the CPS by estimating the fair value of a floating rate security with an estimated market yield reflective of the underlying committed preferred security structure and the relevant coupon based on the capped auction rate.
Other liabilities include payables for securities purchased and derivative obligations. For receivable for securities sold and payable for securities purchased, the carrying amount is cost, which approximates fair value because of the short maturity.
VIE Segment Debt
The fair value of the VIE segment debt is determined based on a discounted cash flow model. Fair value calculated by these models includes assumptions for interest rate curves based on selected benchmark securities and weighted average expected lives. In addition, the valuation of the fair-valued liabilities includes an adjustment to reflect the credit quality of the Company that represents the impact of changes in market credit spreads on these liabilities. The fair-valued liabilities are categorized as Level 3 in the valuation hierarchy. See Note 4 for a description of the VIE segment debt for which the Company elected fair value option.
32
Net Financial Guarantee Contracts Written
The fair value of net financial guarantees written is based on the estimated cost to the Company of transferring the outstanding insured portfolio to another financial guarantor of comparable credit standing, under current market conditions. The fair value of net financial guarantees written incorporates (i) deferred premium revenue, (ii) amounts recoverable from reinsurers on unpaid losses, (iii) estimated future installment premiums receivable, and (iv) losses and loss adjustment expenses. These fair values are based on inputs observable in the market, where available, as well as inputs which are not readily observable in the market. SFAS 157 requires the risk of nonperformance to be included in the estimation of fair value of financial liabilities. The Company's credit risk as measured by the credit spread on its CDS, has been factored into the fair value of the financial guarantees written in order to account for the risk of nonperformance.
Notes Payable to Affiliate
For notes payable, the carrying amount represents the principal amount due at maturity. The fair value is based on a discounted cash flow model that includes assumptions for interest rate curves based on selected benchmark securities and weighted average expected lives.
The following table presents the financial instruments carried at fair value at December 31, 2008, by caption on the consolidated balance sheet and SFAS 157 valuation hierarchy.
33
Assets and Liabilities Measured at Fair Value on a Recurring Basis
|
At December 31, 2008 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Level 1 | Level 2 | Level 3 |
FIN 39
Netting(1) |
Total | |||||||||||||
|
(in thousands)
|
|||||||||||||||||
Assets: |
||||||||||||||||||
General investment portfolio, available for sale: |
||||||||||||||||||
Bonds |
$ | | $ | 5,219,789 | $ | 44,749 | $ | | $ | 5,264,538 | ||||||||
Equity securities |
374 | | | | 374 | |||||||||||||
Short-term investments |
9,687 | 606,378 | | | 616,065 | |||||||||||||
VIE segment investment portfolio, available for sale: |
||||||||||||||||||
Bonds |
| 22,470 | 900,862 | | 923,332 | |||||||||||||
GICs |
| | 801,547 | | 801,547 | |||||||||||||
Short-term investments |
8,221 | | | | 8,221 | |||||||||||||
Assets acquired in refinancing transactions |
| 20,962 | 117,814 | | 138,776 | |||||||||||||
VIE segment derivatives |
| 754,328 | 59,268 | (434,855 | ) | 378,741 | ||||||||||||
Credit derivatives(2) |
| | 287,449 | | 287,449 | |||||||||||||
Other assets: |
||||||||||||||||||
CPS |
| | 100,000 | | 100,000 | |||||||||||||
Total assets at fair value |
$ | 18,282 | $ | 6,623,927 | $ | 2,311,689 | $ | (434,855 | ) | $ | 8,519,043 | |||||||
Liabilities: |
||||||||||||||||||
VIE segment debt |
$ | | $ | | $ | 799,086 | $ | | $ | 799,086 | ||||||||
Credit derivatives |
| | 1,543,809 | | 1,543,809 | |||||||||||||
Other liabilities: |
||||||||||||||||||
Other financial guarantee segment derivatives |
| (112 | ) | | | (112 | ) | |||||||||||
Total liabilities at fair value |
$ | | $ | (112 | ) | $ | 2,342,895 | $ | | $ | 2,342,783 | |||||||
Non-Recurring Fair Value Measurements
Mortgage loans in the portfolio of assets acquired in refinancing transactions are carried at the lower of cost or market on an aggregate basis. At December 31, 2008, such investments were carried at their market value of $13.8 million. The mortgage loans are classified as Level 3 of the fair value
34
hierarchy as there are significant unobservable inputs used in the valuation of such loans. An indicative dealer quote is used to price the non-performing portion of these mortgage loans. The performing loans are valued using management's determination of future cash flows arising from these loans, discounted at the rate of return that would be required by a market participant. This rate of return is based on indicative dealer quotes.
Changes in Level 3 Recurring Fair Value Measurements
The table below includes a rollforward of the balance sheet amounts for financial instruments classified by the Company within Level 3 of the valuation hierarchy for the year ended December 31, 2008. When a determination is made to classify a financial instrument within Level 3, the determination is based upon the significance of the unobservable data to the overall fair value measurement. However, Level 3 financial instruments may include, in addition to the unobservable or Level 3 components, observable components. Accordingly, the gains and losses in the table below include changes in fair value due in part to observable factors that are part of the valuation methodology. Level 3 assets were 19.9% of total assets at December 31, 2008. Level 3 liabilities were 24.7% of total liabilities at December 31, 2008.
|
|
Year Ended December 31, 2008 | |||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
|
|
|
|
Change in
Unrealized Gains/(Losses) Related to Financial Instruments Held at December 31, 2008 |
||||||||||||||||
|
|
Total Pre-tax Realized/Unrealized
Gains/(Losses)(1) Recorded in: |
|
|
|
||||||||||||||||||
|
Fair Value
at January 1, 2008 |
Net
Income (Loss) |
Other
Comprehensive Income (Loss) |
Purchases,
Issuances, Settlements, net |
Transfers
in and/or out of Level 3(2) |
Fair
Value at December 31, 2008 |
|||||||||||||||||
|
(in thousands)
|
||||||||||||||||||||||
General investment portfolio, available for sale: |
|||||||||||||||||||||||
Bonds |
$ | 59,840 | $ | (720 | )(3) | $ | (10,953 | ) | $ | (3,418 | ) | $ | | $ | 44,749 | $ | | ||||||
Equity securities |
39,000 | (36,075 | )(3) | | (2,925 | ) | | | | ||||||||||||||
VIE segment investment portfolio, available for sale(4): |
|||||||||||||||||||||||
Bonds |
1,120,533 | (200,622 | )(5) | (19,049 | ) | | | 900,862 | (200,139 | ) | |||||||||||||
GICs |
639,950 | | 86,753 | 74,844 | | 801,547 | | ||||||||||||||||
Assets acquired in refinancing transactions |
170,492 | (17,200 | )(6) | (3,564 | ) | (31,914 | ) | | 117,814 | (17,200 | ) | ||||||||||||
VIE segment debt(4) |
(1,852,759 | ) | 994,239 | (7) | | 59,434 | | (799,086 | ) | 1,000,302 | |||||||||||||
VIE segment derivatives(4) |
634,458 | (3,593 | )(8) | | | (571,597 | ) | 59,268 | 11,957 | ||||||||||||||
CPS |
| 100,000 | (6) | | | | 100,000 | 100,000 | |||||||||||||||
Net credit derivatives(9) |
(522,033 | ) | (618,072 | )(10) | | (116,255 | ) | | (1,256,360 | ) | (632,678 | ) |
35
The table below shows the carrying amount and fair value of the Company's other financial instruments:
|
At December 31, 2008 | At December 31, 2007 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Carrying
Amount |
Fair Value |
Carrying
Amount |
Fair Value | |||||||||
|
(in thousands)
|
||||||||||||
Assets acquired in refinancing transactions | $ | 14,073 | $ | 14,073 | $ | 229,264 | $ | 231,801 | |||||
Other assets | 542,465 | 542,465 | 682,592 | 682,592 | |||||||||
Net financial guarantee contracts written | (3,730,984 | ) | (3,256,605 | ) | (1,957,891 | ) | (1,748,668 | ) | |||||
VIE segment debt(1) | (444,554 | ) | (249,895 | ) | (2,584,800 | ) | (2,630,139 | ) | |||||
Notes payable to affiliate | (172,499 | ) | (189,964 | ) | (210,143 | ) | (211,998 | ) | |||||
Other liabilities | (233,012 | ) | (233,012 | ) | (327,301 | ) | (327,301 | ) |
4. FAIR VALUE OPTION
The Company adopted SFAS 159 effective January 1, 2008. SFAS 159 provides an option to elect fair value as an alternative measurement for selected financial assets and financial liabilities not previously carried at fair value. The fair-value option may be applied to single eligible instruments, is irrevocable and is applied only to entire instruments and not to portions of instruments. For a discussion of the Company's valuation methodologies, see Note 3.
The Company's fair value elections were intended to mitigate the volatility in earnings that had been created by recording financial instruments and the related risk management instruments on a different basis of accounting, to eliminate the operational complexities of applying hedge accounting or to conform to the fair value elections made by the Company in 2006 under its International Financial Reporting Standards reporting to Dexia. The requirement, under SFAS 157, to incorporate a reporting entity's own credit risk in the valuation of liabilities which are carried at fair value, has created some additional volatility in earnings as credit risk is not hedged. The following table provides detail regarding the Company's elections by consolidated balance sheet line at January 1, 2008.
36
|
Carrying Value of
Financial Instruments |
Transition
Gain/(Loss) Recorded in Retained Earnings |
Adjusted Carrying
Value of Financial Instruments |
||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
(in thousands)
|
||||||||||
Assets acquired in refinancing transactions |
$ | 163,285 | $ | 2,537 | (1) | $ | 165,822 | ||||
VIE segment debt |
(1,824,676 | ) | (28,083 | ) | (1,852,759 | ) | |||||
Subtotal |
(25,546 | ) | |||||||||
Minority interest |
28,083 | ||||||||||
Deferred income taxes |
(888 | ) | |||||||||
Cumulative effect of adoption of SFAS 159 |
$ | 1,649 | |||||||||
Elections
On January 1, 2008, the Company elected to record the following at fair value:
Changes in Fair Value under the Fair Value Option Election
The following table presents the pre-tax changes in fair value included in the consolidated statements of operations and comprehensive income for the year ended December 31, 2008, for items for which the SFAS 159 fair value election was made.
Net Unrealized Gains (Losses) on Financial Instruments at Fair Value
|
Year Ended December 31,
2008 |
|||
---|---|---|---|---|
|
(in thousands)
|
|||
Assets acquired in refinancing transactions |
$ | (17,200 | ) | |
VIE segment debt(1) |
1,019,007 |
The table above includes gains of approximately $1.2 billion for the year ended December 31, 2008, that are attributable to changes in the Company's own credit spread.
37
Aggregate Fair Value and Aggregate Remaining Contractual Principal Balance Outstanding
The following table reflects the aggregate fair value and the aggregate remaining contractual principal balance outstanding at December 31, 2008, for certain assets acquired in refinancing transactions and VIE segment debt for which the SFAS 159 fair value option has been elected.
|
At December 31, 2008 | ||||||
---|---|---|---|---|---|---|---|
|
Remaining
Aggregate Contractual Principal Amount Outstanding |
Fair Value | |||||
|
(in thousands)
|
||||||
Assets acquired in refinancing transactions |
$ | 133,124 | (1) | $ | 117,796 | ||
VIE segment debt(2) |
1,681,855 | 799,086 |
5. GENERAL INVESTMENT PORTFOLIO
The following table summarizes the components of the net investment income generated by the General Investment Portfolio:
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in thousands)
|
||||||||||
Bonds and short-term investments |
$ | 263,559 | $ | 234,495 | $ | 213,959 | |||||
Equity securities |
1,609 | 3,483 | 4,523 | ||||||||
Investment expenses |
(3,384 | ) | (3,192 | ) | (2,887 | ) | |||||
Net investment income from general investment portfolio |
$ | 261,784 | $ | 234,786 | $ | 215,595 | |||||
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
Rating(1)
|
At
December 31, 2008 Percent of Bonds |
||||
---|---|---|---|---|---|
AAA(2) |
42.9 | % | |||
AA |
36.3 | ||||
A |
19.2 | ||||
BBB |
1.5 | ||||
Not Rated |
0.1 | ||||
Total |
100.0 | % | |||
38
The General Investment Portfolio includes bonds insured by FSA ("FSA-Insured Investments") that were acquired in the ordinary course of business. Of the bonds included in the General Investment Portfolio at December 31, 2008, 6.6% were insured by FSA and 28.8% were insured by other monolines. All of the FSA-Insured Investments were investment grade without giving effect to the FSA insurance. The average shadow rating of the FSA-insured investments, which is the rating without giving effect to the FSA guaranty, was the Single-A range. These assets are included in the Company's surveillance process and, at December 31, 2008, no loss reserves were anticipated on any of these assets. See Note 27 for more information.
The amortized cost and fair value of the securities in the General Investment Portfolio were as follows:
General Investment Portfolio by Security Type
|
At December 31, 2008 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Investment Category
|
Amortized
Cost |
Gross
Unrealized Gains |
Gross
Unrealized Losses |
Fair Value | ||||||||||
|
(in thousands)
|
|||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 103,725 | $ | 9,127 | $ | (23 | ) | $ | 112,829 | |||||
Obligations of U.S. states and political subdivisions |
4,321,118 | 87,081 | (168,414 | ) | 4,239,785 | |||||||||
Mortgage-backed securities |
393,001 | 13,365 | (9,492 | ) | 396,874 | |||||||||
Corporate securities |
203,396 | 7,650 | (3,492 | ) | 207,554 | |||||||||
Foreign securities(1) |
333,646 | 334 | (50,271 | ) | 283,709 | |||||||||
Asset-backed securities |
25,656 | | (1,869 | ) | 23,787 | |||||||||
Total bonds |
5,380,542 | 117,557 | (233,561 | ) | 5,264,538 | |||||||||
Short-term investments |
615,299 | 825 | (59 | ) | 616,065 | |||||||||
Total fixed-income securities |
5,995,841 | 118,382 | (233,620 | ) | 5,880,603 | |||||||||
Equity securities |
1,434 | | (1,060 | ) | 374 | |||||||||
Total General Investment Portfolio |
$ | 5,997,275 | $ | 118,382 | $ | (234,680 | ) | $ | 5,880,977 | |||||
|
At December 31, 2007 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Investment Category
|
Amortized
Cost |
Gross
Unrealized Gains |
Gross
Unrealized Losses |
Fair Value | ||||||||||
|
(in thousands)
|
|||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 85,088 | $ | 4,046 | $ | (87 | ) | $ | 89,047 | |||||
Obligations of U.S. states and political subdivisions |
3,920,509 | 149,893 | (5,837 | ) | 4,064,565 | |||||||||
Mortgage-backed securities |
390,992 | 5,032 | (1,698 | ) | 394,326 | |||||||||
Corporate securities |
190,048 | 3,866 | (1,123 | ) | 192,791 | |||||||||
Foreign securities(1) |
248,006 | 8,584 | (285 | ) | 256,305 | |||||||||
Asset-backed securities |
22,652 | 279 | (4 | ) | 22,927 | |||||||||
Total bonds |
4,857,295 | 171,700 | (9,034 | ) | 5,019,961 | |||||||||
Short-term investments |
88,972 | 2,260 | (1,157 | ) | 90,075 | |||||||||
Total fixed-income securities |
4,946,267 | 173,960 | (10,191 | ) | 5,110,036 | |||||||||
Equity securities |
40,020 | 4 | (155 | ) | 39,869 | |||||||||
Total General Investment Portfolio |
$ | 4,986,287 | $ | 173,964 | $ | (10,346 | ) | $ | 5,149,905 | |||||
39
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
|
At December 31, 2008 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Aging Categories
|
Number of
Securities |
Amortized
Cost |
Unrealized
Losses |
Fair Value |
Unrealized
Loss as a Percentage of Amortized Cost |
|||||||||||||
|
(dollars in thousands)
|
|||||||||||||||||
Less than Six Months(1) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 137 | $ | (1 | ) | $ | 136 | (0.7 | )% | |||||||||
Obligations of U.S. states and political subdivisions |
993,745 | (58,846 | ) | 934,899 | (5.9 | ) | ||||||||||||
Mortgage-backed securities |
8,684 | (118 | ) | 8,566 | (1.4 | ) | ||||||||||||
Corporate securities |
20,654 | (1,459 | ) | 19,195 | (7.1 | ) | ||||||||||||
Foreign securities |
220,257 | (30,425 | ) | 189,832 | (13.8 | ) | ||||||||||||
Asset-backed securities |
23,288 | (1,469 | ) | 21,819 | (6.3 | ) | ||||||||||||
Total |
310 | 1,266,765 | (92,318 | ) | 1,174,447 | (7.3 | ) | |||||||||||
More than Six Months but Less than 12 Months(2) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
37 | (1 | ) | 36 | (2.7 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
587,069 | (53,447 | ) | 533,622 | (9.1 | ) | ||||||||||||
Mortgage-backed securities |
31,793 | (8,310 | ) | 23,483 | (26.1 | ) | ||||||||||||
Corporate securities |
24,441 | (1,389 | ) | 23,052 | (5.7 | ) | ||||||||||||
Foreign securities |
95,887 | (18,890 | ) | 76,997 | (19.7 | ) | ||||||||||||
Asset-backed securities |
1,456 | (117 | ) | 1,339 | (8.0 | ) | ||||||||||||
Total |
230 | 740,683 | (82,154 | ) | 658,529 | (11.1 | ) | |||||||||||
12 Months or More(3) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
331 | (21 | ) | 310 | (6.3 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
407,344 | (56,121 | ) | 351,223 | (13.8 | ) | ||||||||||||
Mortgage-backed securities |
10,157 | (1,064 | ) | 9,093 | (10.5 | ) | ||||||||||||
Corporate securities |
8,179 | (644 | ) | 7,535 | (7.9 | ) | ||||||||||||
Foreign securities |
4,072 | (956 | ) | 3,116 | (23.5 | ) | ||||||||||||
Asset-backed securities |
912 | (283 | ) | 629 | (31.0 | ) | ||||||||||||
Total |
184 | 430,995 | (59,089 | ) | 371,906 | (13.7 | ) | |||||||||||
Total |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
505 | (23 | ) | 482 | (4.6 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
1,988,158 | (168,414 | ) | 1,819,744 | (8.5 | ) | ||||||||||||
Mortgage-backed securities |
50,634 | (9,492 | ) | 41,142 | (18.7 | ) | ||||||||||||
Corporate securities |
53,274 | (3,492 | ) | 49,782 | (6.6 | ) | ||||||||||||
Foreign securities |
320,216 | (50,271 | ) | 269,945 | (15.7 | ) | ||||||||||||
Asset-backed securities |
25,656 | (1,869 | ) | 23,787 | (7.3 | ) | ||||||||||||
Total |
724 | $ | 2,438,443 | $ | (233,561 | ) | $ | 2,204,882 | (9.6 | ) | ||||||||
40
|
At December 31, 2007 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Aging Categories
|
Number of
Securities |
Amortized
Cost |
Unrealized
Losses |
Fair Value |
Unrealized
Loss as a Percentage of Amortized Cost |
|||||||||||||
|
(dollars in thousands)
|
|||||||||||||||||
Less than Six Months(1) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
$ | 17,043 | $ | (17 | ) | $ | 17,026 | (0.1 | )% | |||||||||
Obligations of U.S. states and political subdivisions |
87,782 | (1,247 | ) | 86,535 | (1.4 | ) | ||||||||||||
Mortgage-backed securities |
220 | (0 | ) | 220 | (0.0 | ) | ||||||||||||
Corporate securities |
4,527 | (22 | ) | 4,505 | (0.5 | ) | ||||||||||||
Foreign securities |
37,836 | (285 | ) | 37,551 | (0.8 | ) | ||||||||||||
Asset-backed securities |
| | | | ||||||||||||||
Total |
53 | 147,408 | (1,571 | ) | 145,837 | (1.1 | ) | |||||||||||
More than Six Months but Less than 12 Months(2) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
| | | | ||||||||||||||
Obligations of U.S. states and political subdivisions |
326,960 | (4,132 | ) | 322,828 | (1.3 | ) | ||||||||||||
Mortgage-backed securities |
158 | (6 | ) | 152 | (3.8 | ) | ||||||||||||
Corporate securities |
12,297 | (433 | ) | 11,864 | (3.5 | ) | ||||||||||||
Foreign securities |
| | | | ||||||||||||||
Asset-backed securities |
| | | | ||||||||||||||
Total |
121 | 339,415 | (4,571 | ) | 334,844 | (1.3 | ) | |||||||||||
12 Months or More(3) |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
2,099 | (70 | ) | 2,029 | (3.3 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
11,324 | (458 | ) | 10,866 | (4.0 | ) | ||||||||||||
Mortgage-backed securities |
110,896 | (1,692 | ) | 109,204 | (1.5 | ) | ||||||||||||
Corporate securities |
28,226 | (668 | ) | 27,558 | (2.4 | ) | ||||||||||||
Foreign securities |
| | | | ||||||||||||||
Asset-backed securities |
2,985 | (4 | ) | 2,981 | (0.1 | ) | ||||||||||||
Total |
180 | 155,530 | (2,892 | ) | 152,638 | (1.9 | ) | |||||||||||
Total |
||||||||||||||||||
U.S. Treasury securities and obligations of U.S. government corporations and agencies |
19,142 | (87 | ) | 19,055 | (0.5 | ) | ||||||||||||
Obligations of U.S. states and political subdivisions |
426,066 | (5,837 | ) | 420,229 | (1.4 | ) | ||||||||||||
Mortgage-backed securities |
111,274 | (1,698 | ) | 109,576 | (1.5 | ) | ||||||||||||
Corporate securities |
45,050 | (1,123 | ) | 43,927 | (2.5 | ) | ||||||||||||
Foreign securities |
37,836 | (285 | ) | 37,551 | (0.8 | ) | ||||||||||||
Asset-backed securities |
2,985 | (4 | ) | 2,981 | (0.1 | ) | ||||||||||||
Total |
354 | $ | 642,353 | $ | (9,034 | ) | $ | 633,319 | (1.4 | )% | ||||||||
41
In 2008, the Company had realized gains for sales of bonds, offset in part by an OTTI charge of $6.0 million for several municipal bonds. There were no OTTI charges in the General Investment Portfolio in 2007 and 2006.
Management has determined that the remaining unrealized losses in fixed-income securities at December 31, 2008 are primarily attributable to the current interest rate environment and has concluded that these unrealized losses are temporary in nature based upon (a) the lack of principal or interest payment defaults on these securities, (b) the creditworthiness of the issuers, and (c) the Company's ability and current intent to hold these securities until a recovery in fair value or maturity. As of December 31, 2008 and 2007, 100% of the securities that were in a gross unrealized loss position were rated investment grade. Management has based its conclusions on current facts and circumstances. Events could occur in the future that could change management conclusions about its ability and intent to hold such securities.
The amortized cost and fair value of fixed-income securities in the General Investment Portfolio at December 31, 2008 and 2007, 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.
Distribution of Fixed-Income Securities in General Investment Portfolio
by Contractual Maturity
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Amortized
Cost |
Fair Value |
Amortized
Cost |
Fair Value | ||||||||||
|
(in thousands)
|
|||||||||||||
Due in one year or less |
$ | 797,372 | $ | 801,867 | $ | 148,286 | $ | 150,306 | ||||||
Due after one year through five years |
1,034,999 | 1,044,285 | 1,353,006 | 1,423,378 | ||||||||||
Due after five years through ten years |
823,258 | 827,436 | 816,987 | 852,469 | ||||||||||
Due after ten years |
2,921,555 | 2,786,354 | 2,214,344 | 2,266,630 | ||||||||||
Mortgage-backed securities(1) |
393,001 | 396,874 | 390,992 | 394,326 | ||||||||||
Asset-backed securities(2) |
25,656 | 23,787 | 22,652 | 22,927 | ||||||||||
Total fixed-income securities in General Investment Portfolio |
$ | 5,995,841 | $ | 5,880,603 | $ | 4,946,267 | $ | 5,110,036 | ||||||
Proceeds from sales of long-term bonds from the General Investment Portfolio during 2008, 2007 and 2006 were $3,982.2 million, $3,521.9 million and $1,581.7 million, respectively. Proceeds from maturities of bonds for the General Investment Portfolio during 2008, 2007 and 2006 were $516.9 million, $184.5 million and $160.8 million, respectively. Gross gains of $51.1 million, $5.2 million and $0.8 million and gross losses of $52.0 million, $7.3 million and $5.7 million were realized on sales in 2008, 2007 and 2006, respectively.
Bonds and short-term investments at an amortized cost of $10.0 million and cash of $1.8 million at December 31, 2008 and bonds and short-term investments at an amortized cost of $10.1 million and cash of $1.8 million at December 31, 2007, were on deposit with regulatory authorities as required by insurance regulations.
42
Equity Investments
In 2008, the Company sold its investment in SGR Redeemable Preferred Shares. Amounts recorded by the Company in connection with SGR are as follows:
|
As of and for the Year Ended
December 31, |
|||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||
|
(in thousands)
|
|||||||||
Equity securities |
$ | | $ | 39,000 | $ | 54,016 | ||||
Dividends earned from SGR |
1,609 | 3,465 | 4,518 | |||||||
Realized gain (loss) on sale |
(36,100 | ) | | |
6. 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
Rating(1)
|
At December 31, 2008
Percent of Bonds |
||||
---|---|---|---|---|---|
AAA |
0.9 | % | |||
A |
80.0 | ||||
BBB |
19.1 | ||||
Total |
100.0 | % | |||
The following tables present the amortized cost and fair value of available-for-sale securities and short-term investments held in the VIE Segment Investment Portfolio:
Available-for-Sale Securities in the VIE Segment Investment Portfolio by Security Type
|
At December 31, 2008 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Investment Category
|
Amortized
Cost |
Gross
Unrealized Gains |
Fair Value | ||||||||
|
(in thousands)
|
||||||||||
Obligations of U.S. states and political subdivisions |
$ | 12,931 | $ | | $ | 12,931 | |||||
Foreign securities |
9,300 | 239 | 9,539 | ||||||||
Asset-backed securities |
900,862 | | 900,862 | ||||||||
Total available-for-sale bonds |
923,093 | 239 | 923,332 | ||||||||
Available-for-sale GICs |
695,898 | 105,649 | 801,547 | ||||||||
Short-term investments |
8,221 | | 8,221 | ||||||||
Total available-for-sale securities |
$ | 1,627,212 | $ | 105,888 | $ | 1,733,100 | |||||
43
|
At December 31, 2007 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
Investment Category
|
Amortized
Cost |
Gross
Unrealized Gains |
Fair Value | ||||||||
|
(in thousands)
|
||||||||||
Obligations of U.S. states and political subdivisions |
$ | 15,443 | $ | 729 | $ | 16,172 | |||||
Foreign securities |
9,177 | 430 | 9,607 | ||||||||
Asset-backed securities |
1,094,739 | 19,050 | 1,113,789 | ||||||||
Total available-for-sale bonds |
1,119,359 | 20,209 | 1,139,568 | ||||||||
Available-for-sale GICs |
621,054 | 18,896 | 639,950 | ||||||||
Short-term investments |
8,618 | | 8,618 | ||||||||
Total available-for-sale securities |
$ | 1,749,031 | $ | 39,105 | $ | 1,788,136 | |||||
Historically, the Company had the ability and intent to hold the VIE Segment Investment Portfolio to maturity. However, the Company no longer has the intent to hold such securities to maturity, due to Dexia's agreement under the Purchase Agreement to retain the VIE operations and segregate or separate the Company's VIE operations from the Company's financial guaranty operations. As a result, the Company was required to record an OTTI charge for all assets in the portfolio in an unrealized loss position at December 31, 2008.
OTTI of $236.2 million was recorded in "net realized gains (losses) from variable interest entities segment" on the VIE Segment Investment Portfolio in 2008. At December 31, 2007, there were no securities in an unrealized loss position.
The amortized cost and fair value of available-for-sale bonds and short-term investments in the VIE Segment Investment Portfolio 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.
Distribution of Available-for-Sale Bonds
in the VIE Segment Investment Portfolio by Contractual Maturity
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Amortized
Cost |
Fair Value |
Amortized
Cost |
Fair Value | ||||||||||
|
(in thousands)
|
|||||||||||||
Due in one year or less |
$ | 17,521 | $ | 17,760 | $ | 8,618 | $ | 8,618 | ||||||
Due after one year through five years |
| | 9,177 | 9,607 | ||||||||||
Due after ten years |
12,931 | 12,931 | 15,443 | 16,172 | ||||||||||
Asset-backed securities(1) |
900,862 | 900,862 | 1,094,739 | 1,113,789 | ||||||||||
Total available-for-sale bonds and short-term investments |
$ | 931,314 | $ | 931,553 | $ | 1,127,977 | $ | 1,148,186 | ||||||
Proceeds from maturities of bonds for the VIE Segment Investment Portfolio during 2008, 2007 and 2006 were $119.5 million, $265.4 million and $103.7 million, respectively.
The amortized cost and fair value of the GICs in the VIE Segment Investment Portfolio 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.
44
Distribution of Available-for-sale GICs
in the VIE Segment Investment Portfolio by Contractual Maturity
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Amortized
Cost |
Fair
Value |
Amortized
Cost |
Fair
Value |
||||||||||
|
(in thousands)
|
|||||||||||||
Due in one year or less |
$ | 15,000 | $ | 15,000 | $ | 168,039 | $ | 168,039 | ||||||
Due after one year through five years |
88,751 | 88,751 | 103,751 | 103,751 | ||||||||||
Due after five years through ten years |
210,914 | 234,541 | 27,744 | 27,744 | ||||||||||
Due after ten years |
381,233 | 463,255 | 321,520 | 340,416 | ||||||||||
Total available-for-sale GICs |
$ | 695,898 | $ | 801,547 | $ | 621,054 | $ | 639,950 | ||||||
At December 31, 2008 and 2007, there were two held-to-maturity GICs in the VIE Segment Investment Portfolio with carrying value of $279.2 million and $277.5 million, respectively, with maturity dates of October 3, 2012 and November 12, 2013. These GICs are recorded in "other assets."
The Company pledges and receives collateral related to certain business lines or transactions. The following is a description of those arrangements by transaction type.
Securities Pledged to Note Holders and Derivative Counterparties
Substantially all the assets of FSA Global are pledged to secure the repayment, on a pro rata basis, of FSA Global's notes and its other obligations. FSA Global, under the terms of its derivative agreements, is not required to pledge collateral. Its counterparties, however, may be required to pledge collateral or transfer assets to FSA Global.
At December 31, 2008, the Company had received $434.9 million of collateral from counterparties to reduce its net derivative exposure to such parties.
7. ASSETS ACQUIRED IN REFINANCING TRANSACTIONS
The Company has rights under certain of its financial guaranty insurance policies and indentures that allow it to accelerate the insured notes and pay claims under its insurance policies upon the occurrence of predefined events of default. To mitigate financial guaranty insurance losses, the Company may elect to purchase the outstanding insured obligation or its underlying collateral. Generally, refinancing vehicles reimburse FSA in whole for its claims payments in exchange for assignments of certain of FSA's rights against the trusts. The refinancing vehicles obtain their funds from the proceeds of FSA-insured GICs issued in the ordinary course of business by the GIC Affiliates. The refinancing vehicles are consolidated into the Company's financial statements.
The following table presents the balance sheet components of the assets acquired in refinancing transactions:
Summary of Assets Acquired in Refinanced Transactions
|
At December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in thousands)
|
|||||||
Bonds |
$ | 886 | $ | 5,949 | ||||
Securitized loans |
130,056 | 177,810 | ||||||
Other assets |
35,658 | 45,505 | ||||||
Total |
$ | 166,600 | $ | 229,264 | ||||
45
The accretable yield on the securitized loans at December 31, 2008, 2007 and 2006 was $7.5 million, $148.8 million and $157.3 million, respectively.
The bonds within the refinanced asset portfolio all have contractual maturities of less than five years. 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.
8. DEFERRED ACQUISITION COSTS
Acquisition costs deferred and the related amortization charged to expense are as follows:
Rollforward of Deferred Acquisition Costs
|
Year Ended December 31, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||
|
(in thousands)
|
|||||||||||
Balance, beginning of period |
$ | 347,870 | $ | 340,673 | $ | 335,129 | ||||||
Costs deferred during the period: |
||||||||||||
Ceded and assumed commissions |
(10,526 | ) | (83,252 | ) | (79,713 | ) | ||||||
Premium taxes |
13,856 | 13,182 | 14,032 | |||||||||
Compensation and other acquisition costs |
13,821 | 140,709 | 134,237 | |||||||||
Total |
17,151 | 70,639 | 68,556 | |||||||||
Costs amortized during the period |
(65,700 | ) | (63,442 | ) | (63,012 | ) | ||||||
Balance, end of period |
$ | 299,321 | $ | 347,870 | $ | 340,673 | ||||||
9. LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for losses and loss adjustment expenses, which consist of the case and non-specific reserves, is summarized below. Adjustments to reserves represent management's estimate of the amount required to cover the present value of the net cost of claims based on statistical provisions for new originations.
Reconciliation of Net Loss and Loss Adjustment Expenses
|
Year Ended December 31, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||||
|
(in thousands)
|
||||||||||||
Case Reserve Activity: |
|||||||||||||
Gross balance at January 1 |
$ | 174,557 | $ | 90,306 | $ | 89,984 | |||||||
Less reinsurance recoverable |
76,478 | 37,342 | 36,339 | ||||||||||
Net balance at January 1 |
98,079 | 52,964 | 53,645 | ||||||||||
Transfer from non-specific reserve |
2,036,437 | 69,384 | 1,221 | ||||||||||
Paid (net of recoveries) related to: |
|||||||||||||
Current year recovery (paid) |
16,682 | (8,248 | ) | | |||||||||
Prior year |
(615,589 | ) | (16,021 | ) | (1,902 | ) | |||||||
Total paid |
(598,907 | ) | (24,269 | ) | (1,902 | ) | |||||||
Net balance at December 31 |
1,535,609 | 98,079 | 52,964 | ||||||||||
Plus reinsurance recoverable |
283,973 | 76,478 | 37,342 | ||||||||||
Gross balance at December 31 |
1,819,582 | 174,557 | 90,306 | ||||||||||
46
|
Year Ended December 31, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||||
|
(in thousands)
|
||||||||||||
Non-Specific Reserve Activity: |
|||||||||||||
Gross balance at January 1 |
99,999 | 137,816 | 115,734 | ||||||||||
Provision for losses |
|||||||||||||
Current year |
1,338 | 25,797 | 17,837 | ||||||||||
Prior year |
2,089,545 | 5,770 | 5,466 | ||||||||||
Transfers to case reserves |
(2,036,437 | ) | (69,384 | ) | (1,221 | ) | |||||||
Net balance at December 31 |
154,445 | 99,999 | 137,816 | ||||||||||
Plus reinsurance recoverable |
18,151 | | | ||||||||||
Gross balance at January 1 |
172,596 | 99,999 | 137,816 | ||||||||||
Total gross case and non-specific reserves |
$ | 1,992,178 | $ | 274,556 | $ | 228,122 | |||||||
The following table shows the gross and net par outstanding on transactions with case reserves, the gross and net case reserves recorded and the number of transactions comprising case reserves.
|
At December 31, 2008 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Par
Outstanding |
Net Par
Outstanding |
Gross Case
Reserve |
Net Case
Reserve |
Number
of Risks |
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
Asset-backedHELOCs |
$ | 4,833,059 | $ | 3,853,788 | $ | 745,790 | $ | 593,752 | 10 | ||||||||
Asset-backedAlt-A CES |
999,475 | 954,296 | 245,702 | 234,158 | 5 | ||||||||||||
Asset-backedOption ARM |
1,674,743 | 1,587,145 | 282,131 | 260,599 | 9 | ||||||||||||
Asset-backedAlt-A first-lien |
1,226,480 | 1,122,333 | 106,545 | 96,327 | 10 | ||||||||||||
Asset-backedNIMs |
90,070 | 85,341 | 15,961 | 15,817 | 3 | ||||||||||||
Asset-backedSubprime |
298,457 | 280,128 | 24,521 | 20,757 | 5 | ||||||||||||
Asset-backedother |
54,491 | 50,969 | 13,685 | 12,933 | 3 | ||||||||||||
Public finance |
1,238,816 | 698,708 | 172,063 | 88,082 | 6 | ||||||||||||
Financial products portfolio |
1,672,616 | 1,672,616 | 213,184 | 213,184 | 73 | ||||||||||||
Total |
$ | 12,088,207 | $ | 10,305,324 | $ | 1,819,582 | $ | 1,535,609 | 124 | ||||||||
|
At December 31, 2007 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Par
Outstanding |
Net Par
Outstanding |
Gross Case
Reserve(1) |
Net Case
Reserve(1) |
Number
of Risks |
||||||||||||
|
(dollars in thousands)
|
||||||||||||||||
Asset-backedHELOCs |
$ | 1,803,340 | $ | 1,442,657 | $ | 69,633 | $ | 56,913 | 5 | ||||||||
Asset-backedSubprime |
22,280 | 18,335 | 3,399 | 1,583 | 2 | ||||||||||||
Asset-backedother |
24,905 | 22,219 | 4,890 | 4,684 | 2 | ||||||||||||
Public finance |
1,164,248 | 560,610 | 96,635 | 34,899 | 4 | ||||||||||||
Total |
$ | 3,014,773 | $ | 2,043,821 | $ | 174,557 | $ | 98,079 | 13 | ||||||||
The table below presents certain assumptions inherent in the calculations of the case and non-specific reserves:
Assumptions for Case and Non-Specific Reserves
|
At December 31, | |||
---|---|---|---|---|
|
2008 | 2007 | ||
Case reserve discount rate |
1.90%5.90% | 3.13%5.90% | ||
Non-specific reserve discount rate |
6.00% | 1.20%7.95% | ||
Current experience factor |
20.4 | 2.0 |
47
During 2008, loss and loss adjustment expenses was $2,090.9 million. The increase for the year was driven primarily by deteriorating credit performance in home equity lines of credit ("HELOCs"), financial products portfolio, Alt-A closed end second lien mortgage securities ("CES"), Option adjustable rate mortgage loan ("Option ARMs"), Alt-A first lien and public finance transactions. "Alt-A" refers to borrowers whose credit falls between prime and subprime. In addition, the net non-specific reserves increased by $54.5 million for the year. Management's current reserve estimates assume loss levels for transactions backed by second-lien mortgage products will remain at their peaks until mid-2009 and slowly recover to more normal rates by mid-2010. For first-lien mortgage transactions, where losses take longer to develop than in second-lien mortgage transactions, peak conditional default rates are assumed to continue until mid-2010 and then decline linearly over 12 months to 25% of the peak, remain there for three years and then taper down to 5% of peak rates over several years.
The increase in losses paid is driven by payments on HELOC transactions. Generally, once the overcollateralization is exhausted on an insured HELOC transaction, the Company pays a claim if losses in a period exceed spread for the period, and, to the extent excess spread exceeds losses, the Company is reimbursed for any losses paid to date. In 2008, the Company paid net HELOC claims of $577.7 million. This brought the inception to date net claim payments on HELOC transactions to $625.3 million. There were no claims paid on most other classes of insured transactions through December 31, 2008. Most claim payments on Alt-A CES are not payable until 2037 or later. Option ARM claim payments are expected to occur between 2010 and 2012.
During 2007, the Company charged $31.6 million to loss expense, consisting of $25.8 million for originations of new business and $5.8 million related to accretion on the reserve for in-force business. Net case reserves increased $45.1 million in 2007 due primarily to the establishment of new case reserves for HELOC and public finance transactions, offset in part by the settlement of several pooled corporate collateralized bond obligations ("CBOs"), which were accrued for in prior years. As of December 31, 2007, an estimated ultimate loss (discounted to present value) of $65.0 million on HELOC transactions had been transferred from the non-specific reserve to case reserves, which increased the experience factor. Such estimate of loss is net of reinsurance and anticipated recoveries and is reevaluated on a quarterly basis. In the second half of 2007, the Company paid a total of $47.6 million in HELOC claims, of which $39.5 million represented what the Company deemed to be recoverable and was recorded as salvage and subrogation ("S&S") recoverable as of December 31, 2007.
During 2006, the Company charged $23.3 million to loss expense, consisting of $17.8 million for originations of new business and $5.5 million related to accretion on the reserve for in-force business. Net case reserves decreased $0.7 million due primarily to loss payments and some improvement in CBO transactions, offset in part by the establishment of a new case reserve for a municipal health care transaction.
The Company assigns each insured credit to one of five designated surveillance categories to facilitate the appropriate allocation of resources to monitoring, loss mitigation efforts and rating the credit condition of each risk exposure. Such categorization is determined in part by the risk of loss and in part by the level of routine involvement required. The surveillance categories are organized as follows:
48
The tables below present the gross and net par and interest outstanding and deferred premium revenue in the insured portfolio for risks classified as described above:
Par and Interest Outstanding
Excluding Credit Derivatives
|
At December 31, 2008 | |||||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross
Par |
Gross
Interest |
Net
Par |
Net
Interest |
No. of
risks |
Weighted Avg Life |
Gross
Deferred Premium Revenue |
Net
Deferred Premium Revenue |
||||||||||||||||||
|
(dollars in millions)
|
|||||||||||||||||||||||||
Categories I and II |
$ | 433,542 | $ | 273,907 | $ | 330,811 | $ | 196,976 | 11,194 | 13.5 | $ | 2,899 | $ | 1,964 | ||||||||||||
Category III |
13,487 | 5,902 | 9,845 | 3,427 | 117 | 8.0 | 109 | 50 | ||||||||||||||||||
Category IV |
1,260 | 321 | 1,181 | 289 | 8 | 4.5 | 0 | 0 | ||||||||||||||||||
Category V with no claim payments |
7,033 | 2,226 | 6,374 | 1,866 | 34 | 8.0 | 41 | 25 | ||||||||||||||||||
Category V with claim payments |
5,153 | 899 | 4,023 | 661 | 20 | 3.9 | 4 | 2 | ||||||||||||||||||
Total |
$ | 460,475 | $ | 283,255 | $ | 352,234 | $ | 203,219 | 11,373 | 12.9 | $ | 3,053 | $ | 2,041 | ||||||||||||
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
|
Gross | Net | Gross | Net | ||||||||||
|
(in thousands)
|
|||||||||||||
Category V no claim payments |
$ | 1,031,656 | $ | 921,214 | $ | 112,629 | $ | 64,430 | ||||||
Category V with claim payments |
787,926 | 614,395 | 61,928 | 33,649 | ||||||||||
Total |
$ | 1,819,582 | $ | 1,535,609 | $ | 174,557 | $ | 98,079 | ||||||
|
At
December 31, 2008 Category V |
||||
---|---|---|---|---|---|
|
(in thousands)
|
||||
Gross undiscounted cash outflows expected in future |
$ | 3,745,709 | |||
Less: Gross estimated recoveries (S&S) in future |
1,515,903 | ||||
Subtotal |
2,229,806 | ||||
Less: Discount taken on subtotal |
410,224 | ||||
Gross case reserve |
1,819,582 | ||||
Less: Reinsurance recoverable on unpaid losses (net of discount of $35.3 million) |
283,973 | ||||
Net case reserve |
$ | 1,535,609 | |||
Management periodically evaluates its estimates for losses and LAE and establishes reserves that management believes are adequate to cover the present value of the ultimate net cost of claims. The Company will continue, on an ongoing basis, to monitor these reserves and may periodically adjust such
49
reserves, upward or downward, based on the Company's actual loss experience, its mix of business and economic conditions. However, because of the uncertainty involved in developing these estimates, the ultimate liability may differ materially from current estimates.
10. VARIABLE INTEREST ENTITIES SEGMENT DEBT
At December 31, 2008, interest rates on VIE segment debt were between 1.98% and 6.22% per annum. Payments due under the VIE segment debt included $692.2 million of future interest accretion on zero coupon obligations. The following table presents the combined principal amounts due under VIE Segment debt for 2009 and each of the next four years ending December 31 and thereafter:
Expected Maturity Schedule of VIE Segment Debt
Year
|
Principal
Amount |
||||
---|---|---|---|---|---|
|
(in thousands)
|
||||
2009 |
$ | 359,441 | |||
2010 |
94,428 | ||||
2011 |
18,504 | ||||
2012 |
144,528 | ||||
2013 |
145,338 | ||||
Thereafter |
2,056,395 | ||||
Total |
$ | 2,818,634 | |||
11. OUTSTANDING EXPOSURE
The Company's insurance policies typically guarantee the scheduled payments of principal and interest on public finance and asset-backed (including credit derivatives in the insured portfolio) obligations. The gross amount of financial guaranties in force (principal and interest) was $833.9 billion at December 31, 2008 and $857.9 billion at December 31, 2007. The net amount of financial guaranties in force was $631.5 billion at December 31, 2008 and $622.9 billion at December 31, 2007.
The Company seeks to limit its exposure to losses from writing financial guarantees by underwriting investment-grade obligations, diversifying its portfolio and maintaining rigorous collateral requirements on asset-backed obligations, as well as through reinsurance.
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. The expected maturities for asset-backed obligations are, in general, considerably shorter than the contractual maturities for such
50
obligations. For asset-backed obligations, the full par outstanding for each insured risk is shown in the maturity category that corresponds to the legal final maturity of such risk:
Contractual Terms to Maturity of Net Par Outstanding of Insured Obligations(1)
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
Terms to Maturity
|
Public Finance | Asset-Backed | Public Finance | Asset-Backed | ||||||||||
|
(in millions)
|
|||||||||||||
0 to 5 years |
$ | 59,743 | $ | 36,803 | $ | 54,037 | $ | 42,714 | ||||||
5 to 10 years |
64,224 | 29,186 | 58,719 | 34,858 | ||||||||||
10 to 15 years |
59,443 | 17,818 | 53,738 | 19,332 | ||||||||||
15 to 20 years |
46,735 | 737 | 44,446 | 2,644 | ||||||||||
20 years and above |
76,274 | 33,131 | 71,767 | 44,087 | ||||||||||
Total |
$ | 306,419 | $ | 117,675 | $ | 282,707 | $ | 143,635 | ||||||
Contractual Terms to Maturity of Ceded Par Outstanding of Insured Obligations
|
At December 31, | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||||||
Terms to Maturity
|
Public Finance | Asset-Backed | Public Finance | Asset-Backed | ||||||||||
|
(in millions)
|
|||||||||||||
0 to 5 years |
$ | 15,407 | $ | 6,224 | $ | 16,500 | $ | 7,211 | ||||||
5 to 10 years |
17,555 | 6,829 | 17,895 | 7,808 | ||||||||||
10 to 15 years |
18,270 | 2,722 | 19,617 | 1,664 | ||||||||||
15 to 20 years |
16,810 | 119 | 19,143 | 1,857 | ||||||||||
20 years and above |
34,721 | 2,432 | 42,635 | 3,420 | ||||||||||
Total |
$ | 102,763 | $ | 18,326 | $ | 115,790 | $ | 21,960 | ||||||
The par outstanding of insured obligations in the public finance insured portfolio includes the following amounts by type of issue:
Summary of Public Finance Insured Portfolio(1)
|
At December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Par Outstanding | Ceded Par Outstanding | Net Par Outstanding | ||||||||||||||||||
Types of Issues
|
2008 | 2007 | 2008 | 2007 | 2008 | 2007 | |||||||||||||||
|
(in millions)
|
||||||||||||||||||||
Domestic obligations |
|||||||||||||||||||||
General obligation |
$ | 155,249 | $ | 146,883 | $ | 30,186 | $ | 32,427 | $ | 125,063 | $ | 114,456 | |||||||||
Tax-supported |
73,718 | 69,534 | 18,272 | 19,453 | 55,446 | 50,081 | |||||||||||||||
Municipal utility revenue |
63,516 | 57,975 | 13,175 | 13,610 | 50,341 | 44,365 | |||||||||||||||
Health care revenue |
21,841 | 25,843 | 9,656 | 11,796 | 12,185 | 14,047 | |||||||||||||||
Housing revenue |
9,310 | 9,898 | 1,876 | 2,187 | 7,434 | 7,711 | |||||||||||||||
Transportation revenue |
32,493 | 29,189 | 11,189 | 11,782 | 21,304 | 17,407 | |||||||||||||||
Education/University |
9,560 | 7,178 | 1,658 | 1,710 | 7,902 | 5,468 | |||||||||||||||
Other domestic public finance |
2,858 | 2,773 | 677 | 900 | 2,181 | 1,873 | |||||||||||||||
Subtotal |
368,545 | 349,273 | 86,689 | 93,865 | 281,856 | 255,408 | |||||||||||||||
International obligations |
40,637 | 49,224 | 16,074 | 21,925 | 24,563 | 27,299 | |||||||||||||||
Total public finance obligations |
$ | 409,182 | $ | 398,497 | $ | 102,763 | $ | 115,790 | $ | 306,419 | $ | 282,707 | |||||||||
51
The par outstanding of insured obligations in the asset-backed insured portfolio includes the following amounts by type of collateral:
Summary of Asset-Backed Insured Portfolio
|
At December 31, | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Gross Par Outstanding | Ceded Par Outstanding | Net Par Outstanding | ||||||||||||||||||
Types of Collateral
|
2008 | 2007 | 2008 | 2007 | 2008 | 2007 | |||||||||||||||
|
(in millions)
|
||||||||||||||||||||
Domestic obligations |
|||||||||||||||||||||
Residential mortgages |
$ | 19,453 | $ | 22,882 | $ | 2,401 | $ | 3,108 | $ | 17,052 | $ | 19,774 | |||||||||
Consumer receivables(1) |
6,946 | 12,647 | 907 | 1,076 | 6,039 | 11,571 | |||||||||||||||
Pooled corporate |
63,764 | 69,317 | 8,861 | 10,110 | 54,903 | 59,207 | |||||||||||||||
Financial products(2) |
15,253 | 19,468 | | | 15,253 | 19,468 | |||||||||||||||
Other domestic asset-backed |
3,194 | 4,000 | 1,626 | 2,024 | 1,568 | 1,976 | |||||||||||||||
Subtotal |
108,610 | 128,314 | 13,795 | 16,318 | 94,815 | 111,996 | |||||||||||||||
International obligations |
27,391 | 37,281 | 4,531 | 5,642 | 22,860 | 31,639 | |||||||||||||||
Total asset-backed obligations |
$ | 136,001 | $ | 165,595 | $ | 18,326 | $ | 21,960 | $ | 117,675 | $ | 143,635 | |||||||||
In its asset-backed business, the Company considers geographic concentration as a factor in underwriting insurance covering securitizations of pools of such assets as residential mortgages or consumer receivables. However, after the initial issuance of an insurance policy relating to such securitizations, the geographic concentration of the underlying assets may not remain fixed over the life of the policy. In addition, in writing insurance for other types of asset- backed obligations, such as securities primarily backed by government or corporate debt, geographic concentration is not deemed by the Company to be significant, given other more relevant measures of diversification, such as issuer or industry diversification.
The Company seeks to maintain a diversified portfolio of insured public finance obligations designed to spread its risk across a number of geographic areas. The following table sets forth those
52
states in which municipalities located therein issued an aggregate of 2% or more of the Company's net par amount outstanding of insured public finance securities:
Public Finance Insured Portfolio by Location of Exposure
|
At December 31, 2008 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Number of
Risks |
Net Par
Amount Outstanding(1) |
Percent of Total
Net Par Amount Outstanding |
Ceded Par
Amount Outstanding |
||||||||||||
|
(dollars in millions)
|
|||||||||||||||
Domestic obligations |
||||||||||||||||
California |
1,121 | $ | 40,868 | 13.3 | % | $ | 12,864 | |||||||||
New York |
775 | 23,158 | 7.5 | 10,220 | ||||||||||||
Pennsylvania |
894 | 20,537 | 6.7 | 4,488 | ||||||||||||
Texas |
826 | 19,525 | 6.4 | 4,604 | ||||||||||||
Illinois |
756 | 16,612 | 5.4 | 6,083 | ||||||||||||
Florida |
291 | 15,585 | 5.1 | 4,620 | ||||||||||||
Michigan |
639 | 13,093 | 4.3 | 2,157 | ||||||||||||
New Jersey |
659 | 12,509 | 4.1 | 6,063 | ||||||||||||
Washington |
344 | 10,225 | 3.3 | 3,754 | ||||||||||||
Massachusetts |
241 | 7,896 | 2.6 | 4,289 | ||||||||||||
Ohio |
452 | 7,242 | 2.4 | 1,678 | ||||||||||||
Georgia |
129 | 7,000 | 2.3 | 1,482 | ||||||||||||
Indiana |
300 | 6,674 | 2.2 | 1,199 | ||||||||||||
All other U.S. locations |
3,405 | 80,932 | 26.4 | 23,188 | ||||||||||||
Subtotal |
10,832 | 281,856 | 92.0 | 86,689 | ||||||||||||
International obligations |
173 | 24,563 | 8.0 | 16,074 | ||||||||||||
Total |
11,005 | $ | 306,419 | 100.0 | % | $ | 102,763 | |||||||||
12. FEDERAL INCOME TAXES
The Company adopted FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxesan 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 it is "more likely than not" to prevail. There was no effect on the Company's statements of operations and comprehensive income from adopting FIN 48.
Dexia Holdings, the Parent and the Company and its subsidiaries, except FSA International, file a consolidated federal income tax return. Under the terms of a tax-sharing agreement, each company pays taxes on a separate return basis.
In addition, the Company and its subsidiaries or branches file separate tax returns in various states and local and foreign jurisdictions, including the United Kingdom, Japan, Mexico and Australia. With limited exceptions, the Company and its Subsidiaries are no longer subject to income tax examinations for its 2004 and prior tax years for U.S. federal, state and local, or non-U.S. jurisdictions.
53
The cumulative balance sheet effects of deferred federal tax consequences are as follows:
Components of Deferred Tax Assets and Liabilities
|
December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in thousands)
|
|||||||
Loss and loss adjustment expense reserves |
$ | 367,632 | $ | 37,650 | ||||
Deferred compensation |
41,786 | 70,709 | ||||||
Unrealized capital losses |
25,470 | | ||||||
Derivative fair-value adjustments |
710,954 | 109,817 | ||||||
Foreign currency transaction loss |
73,538 | 72,960 | ||||||
Minority interest |
| 2,257 | ||||||
Tax credits |
15,731 | | ||||||
Undistributed earnings |
37,830 | | ||||||
Other |
5,294 | 3,109 | ||||||
Total deferred federal income tax assets |
1,278,235 | 296,502 | ||||||
Deferred acquisition costs |
(90,249 | ) | (109,237 | ) | ||||
Deferred premium revenue adjustments |
(44,502 | ) | (67,562 | ) | ||||
Unrealized capital gains |
| (58,530 | ) | |||||
Contingency reserves |
| (162,686 | ) | |||||
Undistributed earnings |
| (5,340 | ) | |||||
Minority interest |
(341,534 | ) | | |||||
Other |
(5,693 | ) | (3,303 | ) | ||||
Total deferred federal income tax liabilities |
(481,978 | ) | (406,658 | ) | ||||
Net deferred federal income tax asset (liability) |
$ | 796,257 | $ | (110,156 | ) | |||
A valuation allowance is required when it is more likely than not that a portion or all of a deferred tax asset will not be realized. All evidence, both positive and negative, needs to be identified and considered in making the determination. Future realization of the existing deferred tax asset will depend on the Company's ability to generate sufficient taxable income of appropriate character (i.e. ordinary income versus capital gains) within the carryback and carryforward periods available under the tax law.
The net deferred tax asset of $796 million at December 31, 2008 consists primarily of $368 million related to loss reserves, and $453 million related to mark to market on CDS, offset by other net liabilities. The Company's management has concluded that no valuation allowance is necessary based on the following analysis: The $368 million tax benefit from loss reserves and $453 million from CDS would be realizable against future ordinary income. Negative evidence includes the uncertainty of selling financial guaranty policies in the future as well as the stability of the Company's credit rating by the three principal rating agencies. However, the Company has substantial streams of future premium earnings from its in force insured portfolio, with the total aggregating to approximately $3.5 billion at December 31, 2008. Even with the uncertainty of future business and the stability of the Company's credit rating, future premium revenues, coupled with investment income less expenses, are expected to be more than sufficient to offset current incurred losses, including credit derivatives losses. The Company's loss reserves represent the discounted value of future claims. Therefore, the accretion of losses to the undiscounted future value has also been taken into consideration, and the Company does not anticipate any significant additional loss trends. The Company expects future accretion on loss reserves of about $410.2 million. In addition, except for true credit losses, mark-to-market losses from
54
CDS contracts will reverse over time. As the mark-to-market losses reverse, the deferred tax asset will also reverse. To the extent that true credit losses increase, the related mark-to-market losses will not fully reverse and the Company may not be able to offset such future losses against future ordinary income.
The Company treats its CDS contracts as insurance contracts for U.S. tax purposes. The current federal tax treatment of CDS contracts is an unsettled area of tax law. Market participants are generally treating CDS contracts for tax purposes as either: (1) notional principal contract ("NPC") derivative instruments, (2) guarantees, (3) insurance contracts, or (4) capital assets. The Company believes that it is more likely than not that its CDS contracts are either NPC or insurance contracts. Both receipts and payments arising from NPC and insurance contracts are characterized as ordinary income (although a termination of a CDS contract as an NPC may be treated as a capital transaction). Although the Company believes it is properly treating potential losses on its CDS contracts as ordinary, there are no assurances that the Internal Revenue Service ("IRS") will agree with the Company. Should the IRS disagree with the Company and characterize such losses, if any, as capital losses, the Company's ability to realize a related tax asset would be more limited, possibly leading to a reduction or elimination of the related deferred tax asset.
The Company recognized tax benefits of $3.7 million and $3.0 million for 2008 and 2007, respectively, from the expiration of the statute of limitations for the 2004 and 2003 tax years. Of the tax benefits, $0.6 million and $0.5 million were related benefits from the release of accrued interest for 2008 and 2007, respectively.
A reconciliation of the effective tax rate (before minority interest and equity in earnings of unconsolidated affiliates) with the federal statutory rate follows:
Effective Tax Rate Reconciliation
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
Tax provision (benefit) at statutory rate |
(35.0 | )% | (35.0 | )% | 35.0 | % | |||||
Tax-exempt investments |
(5.4 | ) | (34.3 | ) | (11.6 | ) | |||||
Minority interest |
(31.4 | ) | 6.2 | 3.6 | |||||||
Fair-value adjustment for CPS |
(3.2 | ) | | | |||||||
Other |
0.0 | (1.1 | ) | 0.1 | |||||||
Provision (benefit) for income taxes |
(75.0 | )% | (64.2 | )% | 27.1 | % | |||||
The current-year effective tax rate reflects significant mark to market income in FSA Global Funding debt that was not tax-effected. The prior-year effective tax rate reflects the lower ratio of tax-exempt interest income to year-to-date pre-tax loss due to the significant negative fair value adjustments.
The total amount of unrecognized tax benefits at December 31, 2008 and December 31, 2007 was $14.5 million and $17.7 million, respectively. If recognized, the entire amount would favorably affect the effective tax rate. The Company recognizes interest and penalties related to unrecognized tax benefits as part of income taxes. For the years ended December 31, 2008 and 2007, the Company accrued $0.1 million benefit and $0.4 of expenses, respectively, related to interest and penalties. Cumulative interest and penalties of $1.4 and $1.5 million were accrued on the Company's balance sheet at
55
December 31, 2008 and December 31, 2007, respectively. A reconciliation of the beginning to ending unrecognized tax benefits follows:
Reconciliation of Unrecognized Tax Benefit
|
Year Ended December 31, | ||||||
---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||
|
(in thousands)
|
||||||
Balance at January 1, 2008 |
$ | 17,680 | $ | 20,208 | |||
Reductions as a result of a lapse in the statute of limitations |
(3,143 | ) | (2,528 | ) | |||
Balance at December 31, 2008 |
$ | 14,537 | $ | 17,680 | |||
The Company believes that within the next 12 months, it is reasonably possible that unrecognized tax benefits for positions taken on previously filed tax returns will become recognized as a result of the expiration of statute of limitations for the 2005 tax year, which absent any extension, will close in September 2009.
13. NOTES PAYABLE TO AFFILIATE
The Company had $172.5 million of notes payable to GIC Affiliates at December 31, 2008 and $210.1 million at December 31, 2007. For the years ended December 31, 2008, 2007 and 2006 the Company recorded $12.1 million, $16.4 million and $20.1 million, respectively, of interest expense on the notes payable.
Principal payments due under these notes for each of the next five years ending December 31 and thereafter are as follows:
Expected Maturity Schedule of Notes Payable
Expected Withdrawal Date
|
Principal Amount | ||||
---|---|---|---|---|---|
|
(in thousands)
|
||||
2009 |
$ | 13,479 | |||
2010 |
6,975 | ||||
2011 |
18,262 | ||||
2012 |
23,879 | ||||
2013 |
31,179 | ||||
Thereafter |
78,725 | ||||
Total |
$ | 172,499 | |||
14. EMPLOYEE BENEFIT PLANS
Defined Contribution Plans
The Company maintains both qualified and non-qualified, non-contributory defined contribution pension plans for the benefit of eligible employees. Contributions are based on a fixed percentage of employee compensation. Pension expense, which is funded annually, amounted to $5.9 million, $6.8 million and $6.6 million for the years ended December 31, 2008, 2007 and 2006, respectively.
The Company has an employee retirement savings plan for the benefit of eligible employees. The plan permits employees to contribute a percentage of their salaries up to limits prescribed by Internal
56
Revenue Code Section 401(k). Contributions by the Company are discretionary, and none have been made.
Equity Participation Plans
Through 2004, performance shares were awarded under the Parent's 1993 Equity Participation Plan (the "1993 Equity Plan"). The 1993 Equity Plan authorized the discretionary grant of performance shares by the Human Resources Committee to key employees. The amount earned for each performance share depends on the attainment of certain growth rates of adjusted book value as defined by the 1993 Equity Plan, and book value per outstanding share over specified three-year performance cycles.
Performance shares issued prior to January 1, 2005 permitted the participant to elect, at the time of award, growth rates including or excluding realized and unrealized gains and losses on the Parent's consolidated investment portfolios. Performance shares issued after January 1, 2005 do not offer the option to include the impact of unrealized gains and losses on the investment portfolio. No payout occurs if the compound annual growth rate of the Parent's consolidated adjusted book value and book value per outstanding share over specified three-year performance cycles is less than 7%, and a 200% payout occurs if the compound annual growth rate is 19% or greater. Payout percentages are interpolated for compound annual growth rates between 7% and 19%.
In 2004, the Company adopted the 2004 Equity Participation Plan (the "2004 Equity Plan"), which continues the incentive compensation program formerly provided under the Company's 1993 Equity Participation Plan. The 2004 Equity Plan provides for performance share units comprised 90% of performance shares (which provide for payment based upon the Parent's consolidated performance over two specified three-year performance cycles as described above) and 10% of shares of Dexia restricted stock. Performance shares have generally been awarded on the basis of two sequential three-year performance cycles, with one third of each award allocated to the first cycle, which commences on the date of grant, and two thirds of each award allocated to the second cycle, which commences one year after the date of grant. The Company recognizes expense ratably over the course of each three-year performance cycle. The total number of performance shares authorized under this plan was 3.3 million. At December 31, 2008, 2.3 million performance shares remained available for distribution.
The Dexia restricted stock component is a fixed plan, where the Company purchases Dexia shares and establishes a prepaid expense for the amount paid, which is amortized over 2.5-year and 3.5-year vesting periods. In 2008 and 2007, FSA purchased shares that economically defeased its liability for $3.8 million and $4.7 million, respectively. These amounts are being amortized to expense over the employees' vesting periods. For the years ended December 31, 2008, 2007 and 2006, the after-tax amounts amortized into income were $2.7 million, $2.5 million and $1.7 million, respectively.
57
Performance shares granted under the 1993 Equity Plan and 2004 Equity Plan are as follows:
|
Outstanding
at Beginning of Year |
Granted
During the Year |
Paid out
During the Year |
Forfeited
During the Year |
Outstanding
at End of Year |
Price per
Share at Grant Date |
Paid During
the Year |
|||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
|
|
|
|
(in thousands)
|
|||||||||||||||
2006 |
1,195,978 | 370,441 | 340,429 | 15,696 | 1,210,294 | $ | 139.22 | $ | 60,993 | |||||||||||||
2007 |
1,210,294 | 306,368 | 364,510 | 37,550 | 1,114,602 | 145.61 | 61,872 | |||||||||||||||
2008 |
1,114,602 | 313,245 | 349,533 | 100,901 | 977,413 | 156.99 | 46,590 |
At December 31, 2008, 276,842 outstanding performance shares were fully vested, with a value of $0. At December 31, 2008, the total compensation cost related to non-vested performance shares not yet recognized was $0.
At December 31, 2007, 349,533 outstanding performance shares were fully vested, with a value of $46.6 million. These amounts were paid in the first quarter of 2008. At December 31, 2007, the total compensation cost related to non-vested performance shares not yet recognized was $130.2 million.
The estimated final cost of these performance shares is accrued over the performance period. The after-tax benefit of $35.9 million for the year ended December 31, 2008 and expense of $35.7 million and $34.3 million, for the years ended December 31, 2008, 2007 and 2006, respectively, was recorded for the performance shares. In 2008, the accrual for performance shares was completely written off to reflect the Company's performance, resulting in a benefit to income.
Awards of Dexia restricted stock remain restricted for an additional six months after the end of each vesting period. Shares of Dexia restricted stock purchased under the 2004 Equity Plan are as follows:
|
Outstanding
at Beginning of Year |
Purchased
During the Year |
Vested
During the Year |
Forfeited
During the Year |
Outstanding
at End of Year |
Price per
Share at Purchase Date |
|||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
2006 |
180,296 | 190,572 | 22,146 | 4,574 | 344,148 | $ | 24.17 | ||||||||||||
2007 |
344,148 | 158,096 | 65,524 | 17,607 | 419,113 | 29.80 | |||||||||||||
2008 |
419,113 | 248,886 | 178,449 | 50,170 | 439,380 | 23.61 |
58
15. CREDIT DERIVATIVES IN THE INSURED PORTFOLIO
The components of the net change in the fair value of credit derivatives are shown in the table below:
Summary of the Net Change in the Fair Value of Credit Derivatives
|
Year Ended December 31, | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||||||||
|
(in thousands)
|
|||||||||||||||
Net change in fair value of credit derivatives: |
||||||||||||||||
Realized gains (losses) and other settlements(1) |
$ | 126,891 | $ | 102,800 | $ | 87,200 | ||||||||||
Net unrealized gains (losses): |
||||||||||||||||
CDS: |
||||||||||||||||
Pooled corporate CDS: |
||||||||||||||||
Investment grade |
(165,295 | ) | (159,748 | ) | 21,034 | |||||||||||
High yield |
(242,294 | ) | (151,779 | ) | 8,057 | |||||||||||
Total pooled corporate CDS |
(407,589 | ) | (311,527 | ) | 29,091 | |||||||||||
Funded CLOs and CDOs |
(226,530 | ) | (288,762 | ) | 0 | |||||||||||
Other structured obligations |
(77,939 | ) | (35,474 | ) | 1,900 | |||||||||||
Total CDS |
(712,058 | ) | (635,763 | ) | 30,991 | |||||||||||
IR swaps and FG contracts with embedded derivatives |
(32,905 | ) | (6,846 | ) | 832 | |||||||||||
Subtotal |
(744,963 | ) | (642,609 | ) | 31,823 | |||||||||||
Net change in fair value of credit derivatives |
$ | (618,072 | ) | $ | (539,809 | ) | $ | 119,023 | ||||||||
The fair value of credit derivatives is reported in the balance sheet as "other assets" or "other liabilities" based on the net gain or loss position with each counterparty. The unrealized component includes the market appreciation or depreciation of the derivative contracts, as discussed in Note 3.
Unrealized Gains (Losses) of the Credit Derivative Portfolio(1)
|
At December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||||
|
(in thousands)
|
|||||||||
Pooled corporate CDS: |
||||||||||
Investment grade |
$ | (255,980 | ) | $ | (116,175 | ) | ||||
High yield(2) |
(374,249 | ) | (144,419 | ) | ||||||
Total pooled corporate CDS |
(630,229 | ) | (260,594 | ) | ||||||
Funded CLOs and CDOs |
(478,904 | ) | (263,422 | ) | ||||||
Other structured obligations(2) |
(108,841 | ) | (32,954 | ) | ||||||
Total CDS |
(1,217,974 | ) | (556,970 | ) | ||||||
IR swaps and FG contracts with embedded derivatives(2) |
(38,386 | ) | (6,027 | ) | ||||||
Total net credit derivatives |
$ | (1,256,360 | ) | $ | (562,997 | ) | ||||
59
Prior to the adoption of SFAS 157 on January 1, 2008 (the "Adoption Date"), the Company followed EITF 02-03. Under EITF 02-03, the Company was prohibited from recognizing a profit at the inception of its CDS contracts (referred to as "day one" gains) because the fair value of those derivatives is based on a valuation technique that incorporated unobservable inputs. Accordingly, the Company deferred approximately $40.9 million pre-tax of day one gains related to the fair value of CDS contracts purchased that were not permitted to be recognized under EITF 02-03. As SFAS 157 nullified the guidance in EITF 02-03, the Company recognized a transition adjustment totaling $40.9 million of previously deferred day one gains (pre-tax) in beginning retained earnings on the Adoption Date. See Note 3 for further discussion of the Company's adoption of SFAS 157.
The negative fair-value adjustments for the year ended December 31, 2008 were a result of continued widening of credit spreads in the insured CDS portfolio, offset in part by the positive income effects of the Company's own credit spread widening. Despite the structural protections associated with CDS contracts written by FSA, the significant widening of credit spreads on pooled corporate CDS and funded CDOs and CLOs, as with other structured credit products, resulted in a decline in the fair value of these contracts compared with December 31, 2007.
As the fair value of a CDS contract incorporates all the remaining future payments to be received over the life of the CDS contract, the fair value of that contract will change, in part, solely from the passage of time as fees are received.
The Company's typical CDS contract is different from CDS contracts entered into by parties that are not financial guarantors because:
CDS contracts in the asset-backed portfolio represent 71.2% of total asset-backed par outstanding. The Company has grouped CDS contracts by major category of underlying instrument for purposes of internal risk management and external reporting. The tables below summarize the credit rating, net par outstanding and remaining weighted average lives for the primary components of the Company's CDS portfolio. Net par outstanding in the table below is also included in the tables in Note 11.
60
Selected Information for CDS Portfolio
|
At December 31, 2008 | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Credit Ratings |
|
|
|||||||||||||||||||||
|
|
Remaining
Weighted Average Life |
||||||||||||||||||||||
|
Triple-A*(1) | Triple-A | Double-A |
Other
Investment Grades(2) |
Below
Investment Grade(3) |
Net Par
Outstanding(4) |
||||||||||||||||||
|
|
|
|
|
|
(in millions)
|
(in years)
|
|||||||||||||||||
Pooled Corporate CDS: |
||||||||||||||||||||||||
Investment grade |
100 | % | | % | | % | | % | | % | $ | 17,464 | 4.1 | |||||||||||
High yield |
41 | 54 | | | 5 | 15,467 | 2.4 | |||||||||||||||||
Funded CDOs and CLOs |
27 | 65 | (5) | 7 | 1 | | 31,681 | 2.6 | ||||||||||||||||
Other structured obligations(6) |
53 | 11 | (5) | 8 | 27 | 1 | 8,272 | 2.6 | ||||||||||||||||
Total |
50 | 41 | 4 | 4 | 1 | $ | 72,884 | 2.9 | ||||||||||||||||
|
At December 31, 2007 | |||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Credit Ratings |
|
|
|||||||||||||||||||||
|
|
Remaining
Weighted Average Life |
||||||||||||||||||||||
|
Triple-A*(1) | Triple-A | Double-A |
Other
Investment Grades(2) |
Below
Investment Grade |
Net Par
Outstanding(4) |
||||||||||||||||||
|
|
|
|
|
|
(in millions)
|
(in years)
|
|||||||||||||||||
Pooled Corporate CDS: |
||||||||||||||||||||||||
Investment grade |
91 | % | 1 | % | 8 | % | | % | | % | $ | 22,883 | 4.1 | |||||||||||
High yield |
95 | | | 5 | | 14,765 | 3.3 | |||||||||||||||||
Funded CDOs and CLOs |
28 | 72 | (5) | | | | 33,000 | 3.4 | ||||||||||||||||
Other structured obligations(6) |
62 | 36 | (5) | 1 | 1 | | 13,529 | 2.1 | ||||||||||||||||
Total |
62 | 34 | 3 | 1 | | $ | 84,177 | 3.4 | ||||||||||||||||
16. VARIABLE INTEREST ENTITIES SEGMENT DERIVATIVE INSTRUMENTS
The Company enters into derivative contracts to manage interest rate and foreign currency exposure in its VIE segment debt and VIE Segment Investment Portfolio.
As a result of market interest rate fluctuations, fixed-rate assets and liabilities appreciate or depreciate in market value. Gains or losses on the derivative instruments that are linked to the
61
fixed-rate assets and liabilities being hedged are expected to substantially offset this unrealized appreciation or depreciation relating to the risk being hedged.
The Company uses foreign currency contracts to manage the foreign exchange risk associated with certain foreign currency-denominated assets and liabilities. Gains or losses on the derivative instruments that are linked to the foreign currency denominated assets or liabilities being hedged are expected to substantially offset this variability.
In order for a derivative to qualify for hedge accounting, it must be highly effective at reducing the risk associated with the exposure being hedged. In order for a derivative to be designated as a hedge, there must be documentation of the risk management objective and strategy, including identification of the hedging instrument, the hedged item and the risk exposure, and how effectiveness is to be assessed prospectively and retrospectively. To assess effectiveness, the Company uses analysis of the sensitivity of fair values to changes in the risk being hedged, as well as dollar value comparisons of the change in the fair value of the derivative to the change in the fair value of the hedged item that is attributable to the risk being hedged. The extent to which a hedging instrument has been and is expected to continue to be effective at achieving offsetting changes in fair value must be assessed and documented at least quarterly. Any ineffectiveness must be reported in current-period earnings. If it is determined that a derivative is not highly effective at hedging the designated exposure, hedge accounting is discontinued.
An effective fair-value hedge is defined as one whose periodic change in fair value is 80% to 125% correlated with the change in fair value of the hedged item. The difference between a perfect hedge (i.e., the change in fair value of the hedge and hedged item offset one another so that there is zero effect on the consolidated statements of operations and comprehensive income, referred to as being "100% correlated") and the actual correlation within the 80% to 125% effectiveness range is the ineffective portion of the hedge. A failed hedge is one whose correlation falls outside of the 80% to 125% effectiveness range.
The net loss related to the ineffective portion of the Company's fair-value hedges including changes in fair value of hedging instruments related to the passage of time, which was excluded from the assessment of hedge ineffectiveness, was $49 thousand in 2007. For 2008, this measure is not meaningful as substantially all assets in fair value hedging relationships have been recorded in the statement of operations and comprehensive income as OTTI.
The inception-to-date net unrealized gain on derivatives (excluding accrued interest and collateral) in the VIE segment of $206.2 million and $474.4 million at December 31, 2008 and 2007, respectively, is recorded in "other assets" or "other liabilities," as applicable.
Changes in Hedge Accounting Designations
As of January 1, 2008, the Company adopted SFAS 159 and elected the fair value option for certain fixed-rate liabilities in the VIE segment debt portfolio, as described in Note 4. The fair value option allows the fair value adjustment on these liabilities to be recorded in earnings without hedge documentation and effectiveness testing requirements prescribed under SFAS 133. However, when the fair value option is elected, the fair value adjustment of liabilities must incorporate all components of fair value, including valuation adjustments related to the reporting entity's own credit risk. Under hedge accounting, only the component of fair value attributable to the hedged risk (i.e. interest rate risk) was recorded in earnings.
As of January 1, 2008, fixed-rate assets in the available-for-sale VIE Segment Investment Portfolio that were economically hedged with interest rate swaps were designated in fair value hedging relationships. Prior to January 1, 2008, changes in the fair value of these economically hedged assets were recorded in "accumulated other comprehensive income," whereas the corresponding changes in fair value of the related hedging instrument were recorded in earnings. Under fair value hedge
62
accounting, the fair value adjustments related to the hedged risk are recorded in earnings and adjust the amortized cost basis of the related assets. The interest and fair value adjustments on the derivatives and the interest income and fair value adjustment on the assets attributable to the hedged interest rate risk are recorded in "net interest income from variable interest entities segment" in the consolidated statements of operations and comprehensive income, thereby offsetting each other and reflecting economic inefficiency on the hedging relationship in earnings. The Company does not seek to apply hedge accounting to all of its economic hedges.
17. MINORITY INTEREST IN FSA GLOBAL
All equity and net income of the VIEs are shown as minority interest. The VIEs are consolidated into all applicable captions of the consolidated financial statements under FASB Interpretation 46(R), "Consolidation of Variable Interest Entities."
18. REINSURANCE
The Company obtains reinsurance to increase its policy-writing capacity on both an aggregate-risk and a single-risk basis; to meet rating agency, internal and state insurance regulatory limits; to diversify risk; to reduce the need for additional capital; and to strengthen financial ratios. The Company reinsures portions of its risks with affiliated (see Note 25 for more information) and unaffiliated reinsurers under quota share, first-loss and excess-of-loss treaties and on a facultative basis.
Reinsurance does not relieve the Company of its obligations to policyholders. In the event that any or all of the reinsuring companies are unable to meet their obligations, or contest such obligations, the Company may be unable to recover amounts due. A number of FSA's reinsurers are required to pledge collateral to secure their reinsurance obligations to FSA in an amount equal to their statutory unearned premium, loss and contingency reserves associated with the ceded business. FSA requires collateral from reinsurers primarily to (a) receive statutory credit for the reinsurance, (b) provide liquidity to FSA in the event of claims on the reinsured exposures, and (c) enhance rating agency credit for the reinsurance.
Amounts of ceded and assumed business were as follows:
|
Year Ended December 31, | |||||||||
---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | |||||||
|
(in thousands)
|
|||||||||
Written premiums ceded |
$ | 32,176 | $ | 273,255 | $ | 275,175 | ||||
Written premiums assumed |
1,848 | 5,015 | 10,793 | |||||||
Earned premiums ceded |
139,625 | 146,900 | 141,232 | |||||||
Earned premiums assumed |
14,331 | 5,226 | 3,356 | |||||||
Losses and loss adjustment expense payments ceded |
214,833 | 5,052 | 3,486 | |||||||
Losses and loss adjustment expense payments assumed |
694 | 13 | 8 |
|
At December 31, | ||||||
---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||
|
(in thousands)
|
||||||
Principal outstanding ceded |
$ | 121,089,257 | $ | 137,749,095 | |||
Principal outstanding assumed |
6,152,541 | 4,433,549 | |||||
Deferred premium revenue assumed |
17,604 | 30,087 | |||||
Losses and loss adjustment expense reserves assumed |
| 579 |
63
The Company cedes approximately 23% of its gross par insured to a diversified group of reinsurers, including other monolines. Based on ceded par outstanding at December 31, 2008, 56.1% of FSA's reinsurers were rated Double-A- or higher at March 13, 2009. Some are still under review by rating agencies. The Company's reinsurance contracts generally allow the Company to recapture ceded business after certain triggering events, such as reinsurer downgrades. Included in the table below is $12,099 million in ceded par outstanding related to insured CDS.
Reinsurance Recoverable and Ceded Par Outstanding by Reinsurer and Ratings
|
Ratings at March 13, 2009 | At December 31, 2008 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Reinsurer
|
Moody's
Reinsurer Rating |
S&P
Reinsurer Rating |
Reinsurance
Recoverable |
Ceded
Par Outstanding |
Ceded Par
Outstanding as a % of Total |
||||||||||||
|
(dollars in millions)
|
||||||||||||||||
Assured Guaranty Re Ltd. |
Aa3 | AA | $ | 82.5 | $ | 32,843 | 27 | % | |||||||||
Tokio Marine and Nichido Fire Insurance Co., Ltd. |
Aa2 | (1) | AA | (1) | 133.6 | 31,481 | 26 | ||||||||||
Radian Asset Assurance Inc. |
Ba1 | BBB+ | 37.2 | 24,449 | 20 | ||||||||||||
RAM Reinsurance Co. Ltd. |
Baa3 | A+ | 22.3 | 11,930 | 10 | ||||||||||||
Syncora Guarantee Inc. |
Ca | CC | | 4,135 | 4 | ||||||||||||
Swiss Reinsurance Company |
A1 | A+ | 11.0 | 4,098 | 3 | ||||||||||||
R.V.I. Guaranty Co., Ltd. |
Baa3 | A- | | 4,109 | 3 | ||||||||||||
Mitsui Sumitomo Insurance Co. Ltd. |
Aa3 | AA | (1) | 8.9 | 2,658 | 2 | |||||||||||
CIFG Assurance North America Inc. |
Ba3 | BB | 17.9 | 1,901 | 2 | ||||||||||||
Ambac Assurance Corporation |
Baa1 | A | 0.2 | 1,075 | 1 | ||||||||||||
Other(2) |
Various | Various | 1.0 | 2,410 | 2 | ||||||||||||
Valuation allowance |
N/A | N/A | (12.5 | ) | | | |||||||||||
Total |
$ | 302.1 | $ | 121,089 | 100 | % | |||||||||||
In 2008, $28.5 million of net premiums earned resulted from commutations or cancellations of reinsurance contracts. The largest such transactions were with SGR and Bluepoint Re. Limited ("Bluepoint").
In July 2008, the Company agreed to re-assume all reinsurance ceded to SGR, which consisted of $8.4 billion in outstanding par, in exchange for the June 30, 2008 statutory basis ceded unearned premium, net of its applicable ceding commission, any case basis reserves established at that date and a $35.0 million commutation premium. The Company agreed to cede a portion of this business, approximately $6.4 billion of outstanding par with no outstanding case basis reserves, to Syncora Guarantee Inc. ("SGI") (formerly XL Capital Assurance), an affiliate of SGR, as of the re-assumption date. Ceded net unearned premiums and future ceded case reserves are secured by collateral then held in a trust. Since SGI was an affiliate of SGR, the Company did not consider the portion of the business bought back from SGR and subsequently ceded to SGI as commuted and as a result did not record any commutation gain on that portion of the business. The Company recorded a commutation gain of $10.0 million on the business it retained, which was recorded in "other income" in the statement of operations and comprehensive income. In 2008, $14.8 million of earned premium related to this commutation.
64
In September 2008, FSA agreed to re-assume a portion of the business it ceded to SGI in July for the statutory basis ceded unearned premium, net of its applicable ceding commissions. This resulted in a commutation gain of $10 million, which was recorded in other income in the statement of operations and comprehensive income. In 2008, $1.5 million of earned premium related to this commutation.
Due to a liquidation order against Bluepoint, the Company is treating all reinsurance ceded to Bluepoint as cancelled as of the August 29, 2008 date of the liquidation order. Subsequent to September 30, 2008, in accordance with guidance obtained from the New York Insurance Department, the Company drew down from collateral maintained in trust by Bluepoint an amount equal to the net statutory basis unearned premium and case basis reserves and, as a result, the Company was able to take credit for such balances. In 2008, $9.4 million of earned premium related to this commutation.
19. OTHER ASSETS
The detailed balances that comprise other assets at December 31, 2008 and 2007 are as follows:
|
At December 31, | |||||||
---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | ||||||
|
(in thousands)
|
|||||||
Other assets: |
||||||||
VIE other invested assets |
$ | 304,598 | $ | 301,599 | ||||
Tax and loss bonds |
| 153,844 | ||||||
Accrued interest in VIE segment investment portfolio |
10,443 | 14,333 | ||||||
Accrued interest income on general investment portfolio |
70,465 | 63,317 | ||||||
Salvage and subrogation recoverable |
10,431 | 39,669 | ||||||
CPS at fair value |
100,000 | | ||||||
Other assets |
146,528 | 109,830 | ||||||
Total other assets |
$ | 642,465 | $ | 682,592 | ||||
20. COMMITMENTS AND CONTINGENCIES
Leases
Effective June 2004, the Company entered into a 21-year sublease agreement with Deutsche Bank AG for office space at 31 West 52 nd Street, New York, New York to be used as the Company's headquarters. The Company moved to this space in June 2005. The lease contains scheduled rent increases every five years after a 19-month rent-free period, as well as lease incentives for initial construction costs of up to $6.0 million, as defined in the sublease. The lease contains provisions for rent increases related to increases in the building's operating expenses. The lease also contains a renewal option for an additional ten-year period, and an option to rent additional office space at various points in the future, in each case at then-current market rents. In addition, the Company and its Subsidiaries lease additional office space under non-cancelable operating leases, which expire at various dates through 2013.
65
Future Minimum Rental Payments
Year
|
At
December 31, 2008 |
||||
---|---|---|---|---|---|
|
(in thousands)
|
||||
2009 |
$ | 9,076 | |||
2010 |
8,720 | ||||
2011 |
8,439 | ||||
2012 |
8,444 | ||||
2013 |
8,144 | ||||
Thereafter |
96,009 | ||||
Total |
$ | 138,832 | |||
Rent expense was $9.5 million in 2008, $8.9 million in 2007 and $9.4 million in 2006.
Insured Portfolio
In connection with its financial guaranty business, the Company had outstanding commitments to provide guarantees of $4,639.4 million at December 31, 2008. These commitments are typically short term and principally relate to primary and secondary public finance debt issuances. Commitments are contingent on the satisfaction of all conditions set forth in the contract. These commitments may expire unused or be cancelled at the counterparty's request. Therefore, the total commitment amount does not necessarily reflect actual future guaranteed amounts.
Legal Proceedings
The entitlements of the Chief Executive Officer and the President of the Company under their employment agreements with the Parent are in dispute.
In November 2006, (i) the Parent received a subpoena from the Antitrust Division of the U.S. Department of Justice issued in connection with an ongoing criminal investigation of bid rigging of awards of municipal GICs and other municipal derivatives and (ii) the Company received a subpoena from the SEC related to an ongoing industry-wide investigation concerning the bidding of municipal GICs and other municipal derivatives. Pursuant to the subpoenas the Parent has furnished to the DOJ and SEC records and other information with respect to the Parent's municipal GIC business. On February 4, 2008, the Parent received a "Wells Notice" from the staff of the Philadelphia Regional Office of the SEC relating to the foregoing matter. The Wells Notice indicates that the SEC staff is considering recommending that the SEC authorize the staff to bring a civil injunctive action and/or institute administrative proceedings against the Parent, alleging violations of Section 10(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and Rule 10b-5 thereunder and Section 17(a) of the Securities Act of 1933, as amended. The Parent has had ongoing discussions with the DOJ and the SEC. The ultimate loss that may arise from these investigations is uncertain.
66
During 2008 nine putative class action lawsuits were filed in federal court alleging federal antitrust violations in the municipal derivatives industry, seeking damages and alleging, among other things, a conspiracy to fix the pricing of, and manipulate bids for, municipal derivatives, including GICs. These cases have been coordinated and consolidated for pretrial proceedings in the U.S. District Court for the Southern District of New York as MDL 1950, In re Municipal Derivatives Antitrust Litigation, Case No. 1:08-cv-2516 ("MDL 1950").
Five of these cases name both the Parent and the Company: (a) Hinds County, Mississippi v. Wachovia Bank, N.A. (filed on or about March 13, 2008); (b) Fairfax County, Virginia v. Wachovia Bank, N.A. (filed on or about March 12, 2008); (c) Central Bucks School District, Pennsylvania v. Wachovia Bank N.A. (filed on or about June 4, 2008); (d) Mayor & City Counsel of Baltimore, Maryland v. Wachovia Bank N.A. (filed on or about July 3, 2008); and (e) Washington County, Tennessee v. Wachovia Bank N.A. (filed on or about July 14, 2008). Four of the cases name only the Parent and also allege that the defendants violated state antitrust law and common law by engaging in illegal bid-rigging and market allocation, thereby depriving the cities of competition in the awarding of GICs and ultimately resulting in the cities paying higher fees for these products: (a) City of Oakland, California v. AIG Financial Products Corp. (filed on or about April 23, 2008); (b) County of Alameda, California v. AIG Financial Products Corp. (filed on or about July 8, 2008); (c) City of Fresno, California v. AIG Financial Products Corp. (filed on or about July 17, 2008); and (d) Fresno County Financing Authority v. AIG Financial Products Corp . (filed on or about December 24, 2008).
Interim lead counsel for the MDL 1950 plaintiffs filed a Consolidated Class Action Complaint ("Consolidated Complaint") in August 2008 alleging violations of the federal antitrust laws. Defendants filed motions to dismiss the Consolidated Complaint. The MDL 1950 court has determined that it will handle federal claims alleged in the Consolidated Complaint before addressing state claims. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
The Parent and the Company also are named in five non-class actions originally filed in the California Superior Courts alleging violations of California law related to the municipal derivatives industry:
67
CGC-08-480733, removed to N.D. Cal. as Case No. 4:08-cv-4752, transferred to S.D.N.Y. as Case No. 1:09-cv-1197).
These cases have been transferred to the S.D.N.Y. and consolidated with MDL 1950 for pretrial proceedings. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
The Parent and the Company have received various regulatory inquiries and requests for information regarding a variety of subjects. These include subpoenas duces tecum and interrogatories from the State of Connecticut Attorney General and the Attorney General of the State of California related to antitrust concerns associated with the methodologies used by rating agencies for determining the credit rating of municipal debt, including a proposal by Moody's to assign corporate equivalent ratings to municipal obligations, and communications with rating agencies. The Parent and the Company are in the process of satisfying such requests. The Company may receive additional inquiries from these or other regulators and expects to provide additional information to such regulators regarding their inquiries in the future.
In December 2008 and January 2009, the Comapny and various other financial guarantors were named in three complaints filed in the Superior Court, San Francisco County: (a) City of Los Angeles Department of Water and Power v. Ambac Financial Group et. al (filed on or about December 31, 2008), Case No. CG-08-483689; Sacramento Municipal Utility District v. Ambac Financial Group et. al (filed on or about December 31, 2008), Case No. CGC-08-483691; and (c) City of Sacramento v. Ambac Financial Group Inc. et. al (filed on or about January 6, 2009), Case No. CGC-09-483862. These complaints alleged participation in a conspiracy in violation of California's antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and created market demand for municipal bond insurance and participation in risky financial transactions in other lines of business that damaged each bond insurer's financial condition (thereby undermining the value of each of their guaranties), and a failure to adequately disclose the impact of those transactions on their financial condition. These latter allegations form the predicate for five separate causes of action against each of the Insurers: breach of contract, breach of the covenant of good faith and fair dealing, fraud, negligence, and negligent misrepresentation. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.
In August 2008 a number of financial institutions and other parties, including FSA, were named as defendants in a civil action brought in the circuit court of Jefferson County, Alabama relating to the County's problems meeting its debt obligations on its $3.2 billion sewer debt: Charles E. Wilson vs. JPMorgan Chase & Co et al (filed on or about August 8, 2008 in the Circuit Court of Jefferson County, Alabama), Case No. 01-CV-2008-901907.00, a putative class action. The action was brought on behalf of rate payers, tax payers and citizens residing in Jefferson County, and alleges conspiracy and fraud in connection with the issuance of the County's debt. The complaint in this lawsuit seeks unspecified monetary damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss or range of loss that may arise from this lawsuit. The Company was also named as a defendant in a second civil action regarding Jefferson County, Alabama, but was dismissed from such action in January 2009.
There are no other material legal proceedings pending to which the Company is subject.
21. DIVIDENDS AND CAPITAL REQUIREMENTS
FSA's ability to pay dividends depends on FSA's financial condition, results of operations, cash requirements, rating agency capital adequacy and other related factors, and is also subject to restrictions contained in the insurance laws and related regulations of New York and other states.
68
Under the insurance laws of the State of New York, FSA may pay dividends out of earned surplus, provided that, together with all dividends declared or distributed by FSA during the preceding 12 months, the dividends do not exceed the lesser of (a) 10% of policyholders' surplus as of its last statement filed with the Superintendent of Insurance of the State of New York (the "New York Superintendent") or (b) adjusted net investment income during this period. FSA paid dividends of $30.0 million in 2008, no dividends in 2007 and $140.0 million in 2006. Based upon FSA's statutory statements for December 31, 2008, the maximum amount normally available for payment of dividends by FSA without regulatory approval over the following 12 months would be approximately $62.0 million, subject to certain limitations.
In lieu of dividends, FSA may repurchase shares of its common stock from shareholders, subject to the New York Superintendent's approval. The New York Superintendent has approved the repurchase by the Company of up to $500.0 million of its shares from the Parent through December 31, 2008. The Company repurchased $70.0 million of its common stock during the first six months of 2008, and retired the shares. As the amounts paid for repurchases may not exceed cumulative statutory earnings from January 1, 2006 through the end of the quarter prior to the repurchase, the Company was unable to make repurchases during the third and fourth quarter of 2008. In 2007 and 2006, the Company repurchased $180.0 million and $100.0 million of shares of its common stock, respectively, from FSA Holdings and retired such shares.
At December 31, 2007, the Company repaid its entire surplus note obligation of $108.9 million to its Parent. In addition, the Parent forgave all interest expense for 2007, which totaled $5.0 million, including $3.6 million already paid by the Company and $1.4 million of accrued interest. The Parent recontributed to the Company the proceeds from the repayment of the surplus note plus the amount of interest expense already paid. All surplus note transactions were approved by the New York Superintendent. The Company paid interest of $5.4 million in 2006.
In 2008, Dexia Holdings contributed $1,012.1 million of capital to the Parent, which included $4.3 million contributed by a liquidation of program shares and phantom shares held by directors. In the first quarter of 2008, the Parent contributed capital to FSA of $500 million. In the third quarter of 2008, FSA issued a non-interest bearing surplus note with no term to its Parent in exchange for $300 million, which due to the terms of the agreement is recorded as capital.
22. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES
The Company has a credit arrangement aggregating $150.0 million provided by commercial banks and intended for general application to insured transactions. If the Company is downgraded below Aa3 by Moody's and AA- by S&P, the lenders may terminate the commitment, and the commitment commission becomes due and payable. If the Company is downgraded below Baa3 by Moody's and BBB- by S&P, any outstanding loans become due and payable. At December 31, 2008, there were no borrowings under this arrangement, which expires on April 21, 2011.
The Company has a standby line of credit in the amount of $350.0 million with a group of international banks to provide loans to the Company after it has incurred, during the term of the facility, cumulative municipal losses (net of any recoveries) in excess of the greater of $350.0 million or the average annual debt service of the covered portfolio multiplied by 5.00%, which amounted to $1,612.0 million at December 31, 2008. The obligation to repay loans made under this agreement is a limited recourse obligation payable solely from, and collateralized by, a pledge of recoveries realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. This commitment has a term expiring on April 30, 2015. The rating downgrade of FSA by Moody's to Aa3 in November 2008 resulted in an increase to the commitment fee. No amounts have been utilized under this commitment at December 31, 2008.
69
In June 2003, $200.0 million of CPS, money market committed preferred trust securities, were issued by trusts created for the primary purpose of issuing the CPS, investing the proceeds in high-quality commercial paper and providing the Company with put options for issuing to the trusts non-cumulative redeemable perpetual preferred stock (the "Preferred Stock") of the Company. There are four trusts, each with an initial aggregate face amount of $50 million. These trusts hold auctions every 28 days at which time investors submit bid orders to purchase CPS. If the Company were to exercise a put option, the applicable trust would transfer the portion of the proceeds attributable to principal received upon maturity of its assets, net of expenses, to the Company in exchange for Preferred Stock of the Company. The Company pays a floating put premium to the trusts, which represents the difference between the commercial paper yield and the winning auction rate (plus all fees and expenses of the trust). If an auction does not attract sufficient clearing bids, however, the auction rate will be subject to a maximum rate of 200 basis points above LIBOR for the next succeeding distribution period. Beginning in August 2007, the CPS required the maximum rate for each of the relevant trusts. The Company continues to have the ability to exercise its put option and cause the related trusts to purchase the Company Preferred Stock. The cost of the facility was $4.9 million, $1.8 million and $1.0 million for 2008, 2007 and 2006, respectively, and was recorded within other operating expenses. The trusts are vehicles for providing the Company access to new capital at its sole discretion through the exercise of the put options. The Company does not consider itself to be the primary beneficiary of the trusts because it does not retain the majority of the residual benefits or expected losses.
Certain notes held by FSA Global contain provisions that could extend the stated maturities of those notes. To ensure FSA Global will have sufficient cash flow to repay its own debt issuances that relate to such notes, it entered into several liquidity facilities with Dexia for $419.4 million. Certain notes held by FSA Global benefit from a liquidity facility with XL Insurance Ltd. for $341.5 million.
23. SEGMENT REPORTING
The Company operates in two business segments: financial guaranty and variable interest entities. The financial guaranty segment is primarily in the business of providing financial guaranty insurance on public finance obligations. Historically it also provided financial guaranty insurance on asset-backed obligations. The VIE segment includes the VIEs' operations. See Note 1 for a description of each segment's business. The following tables summarize the financial information by segment as of and for the years ended December 31, 2008, 2007 and 2006:
Financial Information Summary by Segment
|
For the Year Ended December 31, 2008 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Variable
Interest Entities |
Intersegment
Eliminations |
Total | ||||||||||
|
(in thousands)
|
|||||||||||||
Revenues: |
||||||||||||||
External |
$ | 167,648 | $ | 1,117,318 | $ | | $ | 1,284,966 | ||||||
Intersegment |
2,663 | | (2,663 | ) | | |||||||||
Expenses: |
||||||||||||||
External |
(2,248,455 | ) | (132,395 | ) | | (2,380,850 | ) | |||||||
Intersegment |
| (2,663 | ) | 2,663 | | |||||||||
Income (loss) before income taxes |
(2,078,144 | ) | 982,260 | | (1,095,884 | ) | ||||||||
Minority interest |
| (982,260 | ) | | (982,260 | ) | ||||||||
GAAP income to operating earnings adjustments |
431,938 | | | 431,938 | ||||||||||
Pre-tax segment operating earnings (losses) |
(1,646,206 | ) | | | (1,646,206 | ) | ||||||||
Segment assets |
$ | 9,172,500 | $ | 2,427,642 | $ | (7 | ) | $ | 11,600,135 |
70
|
For the Year Ended December 31, 2007 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Variable
Interest Entities |
Intersegment
Eliminations |
Total | ||||||||||
|
(in thousands)
|
|||||||||||||
Revenues: |
||||||||||||||
External |
$ | 98,230 | $ | 248,612 | $ | | $ | 346,842 | ||||||
Intersegment |
3,002 | | (3,002 | ) | | |||||||||
Expenses: |
||||||||||||||
External |
(229,064 | ) | (273,334 | ) | | (502,398 | ) | |||||||
Intersegment |
| (3,002 | ) | 3,002 | | |||||||||
Income (loss) before income taxes |
(127,832 | ) | (27,724 | ) | | (155,556 | ) | |||||||
Minority interest |
| 27,656 | | 27,656 | ||||||||||
GAAP income to operating earnings adjustments |
628,955 | | | 628,955 | ||||||||||
Pre-tax segment operating earnings (losses) |
501,123 | (68 | ) | | 501,055 | |||||||||
Segment assets |
$ | 7,429,956 | $ | 2,746,471 | $ | 360 | $ | 10,176,787 |
|
For the Year Ended December 31, 2006 | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Variable
Interest Entities |
Intersegment
Eliminations |
Total | ||||||||||
|
(in thousands)
|
|||||||||||||
Revenues: |
||||||||||||||
External |
$ | 714,085 | $ | 250,535 | $ | | $ | 964,620 | ||||||
Intersegment |
3,584 | | (3,584 | ) | | |||||||||
Expenses: |
||||||||||||||
External |
(201,705 | ) | (295,335 | ) | | (497,040 | ) | |||||||
Intersegment |
| (3,584 | ) | 3,584 | | |||||||||
Income (loss) before income taxes |
515,964 | (48,384 | ) | | 467,580 | |||||||||
Minority interest |
| 48,660 | | 48,660 | ||||||||||
GAAP income to operating earnings adjustments |
(1,823 | ) | | | (1,823 | ) | ||||||||
Pre-tax segment operating earnings (losses) |
514,141 | 276 | | 514,417 | ||||||||||
Segment assets |
$ | 6,956,967 | $ | 3,212,845 | $ | | $ | 10,169,812 |
Reconciliations of Segments' Pre-Tax Operating Earnings (Losses) to Net Income (Loss)
|
For the Year Ended December 31, 2008 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Variable
Interest Entities |
Intersegment
Eliminations |
Total | |||||||||
|
(in thousands)
|
||||||||||||
Pre-tax operating earnings (losses) |
$ | (1,646,206 | ) | $ | | $ | | $ | (1,646,206 | ) | |||
Operating earnings to GAAP income adjustments |
(431,938 | ) | | | (431,938 | ) | |||||||
Tax (provision) benefit |
822,301 | ||||||||||||
Net income (loss) |
$ | (1,255,843 | ) | ||||||||||
71
|
For the Year Ended December 31, 2007 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Variable
Interest Entities |
Intersegment
Eliminations |
Total | |||||||||
|
(in thousands)
|
||||||||||||
Pre-tax operating earnings (losses) |
$ | 501,123 | $ | (68 | ) | $ | | $ | 501,055 | ||||
Operating earnings to GAAP income adjustments |
(628,955 | ) | | | (628,955 | ) | |||||||
Tax (provision) benefit |
99,823 | ||||||||||||
Net income (loss) |
$ | (28,077 | ) | ||||||||||
|
For the Year Ended December 31, 2006 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Financial
Guaranty |
Variable
Interest Entities |
Intersegment
Eliminations |
Total | |||||||||
|
(in thousands)
|
||||||||||||
Pre-tax operating earnings (losses) |
$ | 514,141 | $ | 276 | $ | | $ | 514,417 | |||||
Operating earnings to GAAP income adjustments |
1,823 | | | 1,823 | |||||||||
Tax (provision) benefit |
(126,739 | ) | |||||||||||
Net income (loss) |
$ | 389,501 | |||||||||||
The intersegment revenues and expenses relate to premiums paid by FSA Global on FSA-insured notes.
GAAP income to operating earnings adjustments are primarily comprised of fair-value adjustments deemed to be non-economic. Such adjustments relate to (1) non-economic fair-value adjustments for credit derivatives in the insured portfolio, (2) non-economic fair-value adjustments for instruments with economically hedged risks and (3) fair-value adjustments attributable to the Company's own credit risk. Management believes that by making such adjustments the measure more closely reflects the underlying economic performance of segment operations.
Net Premiums Earned by Geographic Distribution
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in thousands)
|
||||||||||
United States |
$ | 342,697 | $ | 307,507 | $ | 293,475 | |||||
International |
77,642 | 54,115 | 43,403 | ||||||||
Total premiums |
$ | 420,339 | $ | 361,622 | $ | 336,878 | |||||
24. NON-CASH TRANSACTION
In a non-cash transaction, FSA Global exercised collateral calls under various swap agreements to reduce swap counterparty exposure. Cash collateral from the swap counterparties totaling $194.3 million and $76.5 million in 2008 and 2007, respectively were deposited directly into the GIC Affiliates, which, in turn, issued a GIC of equal values to FSA Global.
In connection with repayment of its entire surplus note obligation of $108.9 million to its Parent, FSA Holdings forgave all interest expense for 2007 which included $1.4 million of accrued interest expense.
The Company received no tax benefit in 2008 and 2007 and received tax benefits of $1.1 million in 2006, by utilizing its Parent's losses. This amount was recorded as a capital contribution.
72
25. RELATED PARTY TRANSACTIONS
The Company enters into various related party transactions, primarily with Dexia, and, until mid-2008, SGR. The primary related party transactions during 2008 between the Company and Dexia are as follows:
SGR had an equity interest in FSA International until 2005, at which time the Company repurchased shares in FSA International held by SGR. The Company had a preferred stock investment in SGR until third quarter of 2008. The primary related party transactions with SGR are as follows.
73
The table below summarizes amounts included in the financial statement captions resulting from various types of transactions executed with related parties as well as outstanding exposures with related parties:
Amounts Reported for Related Party Transactions
in the Consolidated Balance Sheets
|
At December 31, | ||||||||
---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | |||||||
|
(in thousands)
|
||||||||
Dexia(1) |
|||||||||
VIE segment investment portfolio |
$ | 537 | $ | 252 | |||||
VIE segment derivatives |
79,825 | 273,452 | |||||||
Other assets |
31,353 | 31,328 | |||||||
Deferred premium revenue |
(2,541 | ) | (2,839 | ) | |||||
VIE segment debt |
(9,400 | ) | (199,739 | ) | |||||
Net credit derivatives at fair value |
(226,973 | ) | (66,072 | ) | |||||
Other liabilities |
(2,721 | ) | (2,349 | ) | |||||
Exposure: |
|||||||||
Gross par outstanding |
14,498,129 | 18,234,174 | |||||||
SGR(2) |
|||||||||
Prepaid reinsurance |
N/A | 132,560 | |||||||
Reinsurance recoverable for unpaid losses |
N/A | 10,172 | |||||||
Investment in SGR |
| 39,000 | |||||||
GIC Affiliates(3) |
|||||||||
Guaranteed investment contracts from GIC Affiliates at fair value |
801,547 | 639,950 | |||||||
Other assets |
282,197 | 282,645 | |||||||
VIE segment debt |
(25,000 | ) | (25,000 | ) | |||||
Other liabilities |
(161 | ) | (224 | ) |
74
Amounts Reported for Related Party Transactions
in the Consolidated Statements of Operations and Comprehensive Income
|
For the Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in thousands)
|
||||||||||
Dexia(1) |
|||||||||||
Gross premiums earned |
$ | 2,795 | $ | 1,579 | $ | 2,708 | |||||
Net change in fair value of credit derivatives |
(138,727 | ) | (42,792 | ) | 22,749 | ||||||
Net interest income (expense) from VIE segment investment portfolio |
(36,323 | ) | 875 | 3,627 | |||||||
Net realized and unrealized gains (losses) from VIE segment derivatives |
224,846 | (43,226 | ) | 25,709 | |||||||
Net unrealized gains (losses) on financial instruments at fair value |
4,821 | | | ||||||||
Interest income (expense) from VIE segment debt |
(13,474 | ) | (10,327 | ) | (9,775 | ) | |||||
Other operating expenses |
(407 | ) | (531 | ) | (318 | ) | |||||
SGR(2) |
|||||||||||
Ceded premiums |
(127,074 | ) | 39,828 | 46,069 | |||||||
Dividends received from SGR |
1,609 | 3,465 | 4,518 | ||||||||
GIC Affiliates(3) |
|||||||||||
Premiums earned |
43,766 | 43,866 | 35,369 | ||||||||
Net interest income (expense) from VIE segment investment portfolio |
28,135 | 52,080 | 55,450 | ||||||||
Other income |
1,694 | 16,676 | 12,389 | ||||||||
Interest income (expense) from VIE segment debt |
(830 | ) | (12,421 | ) | (20,263 | ) |
26. STATUTORY ACCOUNTING PRACTICES
GAAP differs in certain significant respects from statutory accounting practices, applicable to insurance companies, that are prescribed or permitted by insurance regulatory authorities. The principal differences result from the following statutory accounting practices:
75
principal guaranteed for that category. These amounts are provided each quarter as either 1/60th or 1/80th of the total required for each category, less permitted reductions;
Consolidated statutory net loss was $1,376.7 million for 2008, and net income of $312.9 million for 2007 and $339.6 million for 2006. Statutory surplus totaled $710.7 million for 2008 and $1,608.8 million for 2007. Statutory contingency reserves totaled $1,281.6 million for 2008 and $1,094.3 million for 2007.
27. EXPOSURE TO MONOLINES
The tables below summarize the exposure to each financial guaranty monoline insurer by exposure category and the underlying ratings of the Company's insured risks.
Summary of Exposure to Monolines
|
At December 31, 2008 | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
Insured Portfolios |
|
|||||||||
|
FSA
Insured Par Outstanding(1) |
Ceded Par
Outstanding |
General
Investment Portfolio(2) |
||||||||
|
(in millions)
|
(in thousands)
|
|||||||||
Assured Guaranty Re Ltd. |
$ | 972 | $ | 32,843 | $ | 81,324 | |||||
Radian Asset Assurance Inc. |
96 | 24,449 | 1,941 | ||||||||
RAM Reinsurance Co. Ltd. |
| 11,930 | | ||||||||
Syncora Guarantee Inc. |
1,364 | 4,135 | 26,385 | ||||||||
CIFG Assurance North America Inc. |
195 | 1,901 | 23,955 | ||||||||
Ambac Assurance Corporation |
4,976 | 1,075 | 626,288 | ||||||||
ACA Financial Guaranty Corporation |
19 | 943 | | ||||||||
Financial Guaranty Insurance Company |
5,385 | 279 | 29,119 | ||||||||
MBIA Insurance Corporation(3) |
4,022 | | 938,700 | ||||||||
Total |
$ | 17,029 | $ | 77,555 | $ | 1,727,712 | |||||
76
Exposures to Monolines and Ratings of Underlying Risks
|
At December 31, 2008 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Insured Portfolios(1) |
|
||||||||||
|
FSA
Insured Par Outstanding(2) |
Ceded Par
Outstanding |
General
Investment Portfolio(3) |
|||||||||
|
(dollars in millions)
|
(dollars in
thousands) |
||||||||||
Assured Guaranty Re Ltd. |
||||||||||||
Exposure(4) |
$ | 972 | $ | 32,843 | $ | 81,324 | ||||||
Triple-A |
| % | 5 | % | 2 | % | ||||||
Double-A |
10 | 40 | | |||||||||
Single-A |
24 | 38 | 81 | |||||||||
Triple-B |
8 | 15 | 17 | |||||||||
Below Investment Grade |
58 | 2 | | |||||||||
Radian Asset Assurance Inc. |
||||||||||||
Exposure(4) |
$ | 96 | $ | 24,449 | $ | 1,941 | ||||||
Triple-A |
4 | % | 8 | % | | % | ||||||
Double-A |
| 43 | 100 | |||||||||
Single-A |
14 | 38 | | |||||||||
Triple-B |
57 | 10 | | |||||||||
Below Investment Grade |
25 | 1 | | |||||||||
RAM Reinsurance Co. Ltd. |
||||||||||||
Exposure(4) |
$ | | $ | 11,930 | $ | | ||||||
Triple-A |
| % | 13 | % | | % | ||||||
Double-A |
| 41 | | |||||||||
Single-A |
| 32 | | |||||||||
Triple-B |
| 12 | | |||||||||
Below Investment Grade |
| 2 | | |||||||||
Syncora Guarantee Inc. |
||||||||||||
Exposure(4) |
$ | 1,364 | $ | 4,135 | $ | 26,385 | ||||||
Triple-A |
30 | % | | % | | % | ||||||
Double-A |
| 8 | 22 | |||||||||
Single-A |
21 | 36 | 75 | |||||||||
Triple-B |
25 | 56 | | |||||||||
Below Investment Grade |
24 | | | |||||||||
Not Rated |
| | 3 | |||||||||
CIFG Assurance North America Inc. |
||||||||||||
Exposure(4) |
$ | 195 | $ | 1,901 | $ | 23,955 | ||||||
Triple-A |
| % | 2 | % | | % | ||||||
Double-A |
2 | 27 | | |||||||||
Single-A |
9 | 37 | 100 | |||||||||
Triple-B |
89 | 30 | | |||||||||
Below Investment Grade |
| 4 | | |||||||||
Ambac Assurance Corporation |
||||||||||||
Exposure(4) |
$ | 4,976 | $ | 1,075 | $ | 626,288 | ||||||
Triple-A |
6 | % | | % | | % | ||||||
Double-A |
42 | 9 | 42 | |||||||||
Single-A |
32 | 39 | 53 | |||||||||
Triple-B |
11 | 52 | 4 | |||||||||
Below Investment Grade |
9 | 0 | 1 |
77
|
At December 31, 2008 | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Insured Portfolios(1) |
|
||||||||||
|
FSA
Insured Par Outstanding(2) |
Ceded Par
Outstanding |
General
Investment Portfolio(3) |
|||||||||
|
(dollars in millions)
|
(dollars in
thousands) |
||||||||||
ACA Financial Guaranty Corporation |
||||||||||||
Exposure(4) |
$ | 19 | $ | 943 | $ | | ||||||
Triple-A |
| % | | % | | % | ||||||
Double-A |
69 | 72 | | |||||||||
Single-A |
| 26 | | |||||||||
Triple-B |
11 | 2 | | |||||||||
Below Investment Grade |
20 | | | |||||||||
Financial Guaranty Insurance Company |
||||||||||||
Exposure(4) |
$ | 5,385 | $ | 279 | $ | 29,119 | ||||||
Triple-A |
| % | | % | | % | ||||||
Double-A |
33 | | 64 | |||||||||
Single-A |
57 | 100 | 35 | |||||||||
Triple-B |
8 | | 1 | |||||||||
Below Investment Grade |
2 | | | |||||||||
MBIA Insurance Corporation |
||||||||||||
Exposure(4) |
$ | 4,022 | $ | | $ | 938,700 | ||||||
Triple-A |
| % | | % | | % | ||||||
Double-A |
54 | | 40 | |||||||||
Single-A |
14 | | 55 | |||||||||
Triple-B |
32 | | 4 | |||||||||
Below Investment Grade |
| | 1 |
28. OTHER INCOME
The following table shows the components of "other income". In 2008, other income included $20.1 million related to commutation gains. See Note 27 for more information.
|
Year Ended December 31, | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
|
2008 | 2007 | 2006 | ||||||||
|
(in thousands)
|
||||||||||
Foreign exchange gain (loss) on assets |
$ | (2,201 | ) | $ | 30,061 | $ | 15,186 | ||||
Commutation gain |
20,127 | | | ||||||||
Other |
4,246 | 4,356 | 8,620 | ||||||||
Subtotal |
$ | 22,172 | $ | 34,417 | $ | 23,806 | |||||
78