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Financial Guaranty Insurance Company Years Ended December 31, 2013 and 2012 With Report of Independent Auditors

Ernst & Young LLP

Financial Guaranty Insurance Company

Statutory-Basis Financial Statements

Years Ended December 31, 2013 and 2012

Contents

Report of Independent Auditors.......................................................................................................1

Statutory-Basis Balance Sheets ........................................................................................................3 Statutory-Basis Statements of Operations .......................................................................................4 Statutory-Basis Statements of Changes in Capital and Surplus (Deficit) ........................................5 Statutory-Basis Statements of Cash Flows ......................................................................................6 Notes to Statutory-Basis Financial Statements ................................................................................7

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Report of Independent Auditors

The Board of Directors Financial Guaranty Insurance Company

We have audited the accompanying statutory-basis financial statements (the “financial statements”) of Financial Guaranty Insurance Company (the “Company”), which comprise the balance sheets as of December 31, 2013 and 2012, and the related statements of operations, changes in capital and surplus (deficit), and cash flows for the years then ended, and the related notes to the financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in conformity with accounting practices prescribed or permitted by the New York State Department of Financial Services (“NYSDFS”), as well as those accounting practices detailed in the NYSDFS Guidelines. Management also is responsible for the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free of material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the 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 involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design the audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinions.

A member firm of Ernst & Young Global Limited

Ernst & Young LLP 5 Times Square New York, NY 10036-6530

Tel: +1 212 773 3000 Fax: +1 212 773 6350 ey.com

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Basis for Adverse Opinion on U.S. Generally Accepted Accounting Principles

As described in Note 4 to the financial statements, to meet the requirements of the NYSDFS, the financial statements have been prepared in conformity with accounting practices prescribed or permitted by the NYSDFS, as well as those accounting practices detailed in the NYSDFS Guidelines, which practices differ from U.S. generally accepted accounting principles. The variances between such practices and U.S. generally accepted accounting principles and the effects on the accompanying financial statements are described in Note 4. The effects on the accompanying financial statements of these variances are not reasonably determinable but presumed to be material.

Adverse Opinion on U.S. Generally Accepted Accounting Principles

In our opinion, because of the effects of the matter described in the preceding paragraph, the statutory-basis financial statements referred to above do not present fairly, in conformity with U.S. generally accepted accounting principles, the financial position of Financial Guaranty Insurance Company at December 31, 2013 and 2012, or the results of its operations or its cash flows for the years then ended.

Opinion on Statutory-Basis of Accounting

However, in our opinion, the statutory-basis financial statements referred to above present fairly, in all material respects, the financial position of Financial Guaranty Insurance Company at December 31, 2013 and 2012, and the results of its operations and its cash flows for the years then ended in conformity with accounting practices prescribed or permitted by the NYSDFS, as well as those accounting practices detailed in the NYSDFS Guidelines.

Adoption of Accounting Practices as detailed in the NYSDFS Guidelines

As disclosed in Note 4 to the statutory-basis financial statements, the Company changed its accounting practices to reflect the NYSDFS Guidelines effective August 19, 2013, and applied it prospectively. Our opinion is not modified with respect to this matter.

ey February 21, 2014

A member firm of Ernst & Young Global Limited

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Statutory-Basis Balance Sheets

(Dollars in Thousands, Except Per Share Amounts)

December 31, 2013 2012 Admitted assets Bonds $ 1,365,097 $ 1,296,051 Common stock 15,218 Other invested assets 16,520 22,371 Short-term investments 566,540 676,681 Cash and cash equivalents 18,298 8,395 Total cash and invested assets 1,981,673 2,003,498 Accrued investment income 15,054 14,376 Other assets 1,731 2,722 Receivable from parent and subsidiaries 827 241 Total admitted assets $ 1,999,285 $ 2,020,837 Liabilities and capital and surplus (deficit) Liabilities:

Losses $ 1,367,388 $ 3,863,104 Loss adjustment expenses 42,422 33,326 Unearned premiums 122,546 172,151 Provision for reinsurance 24,287 Contingency reserves 367,178 543,822 Accounts payable and accrued expenses 8,520 8,115 Payable for securities 10,738 Federal and foreign income tax payable 544 143 Ceded balances payable 351

Total liabilities 1,932,885 4,631,750 Capital and surplus (deficit):

Common stock, par value $1,500 per share; 10,000 shares authorized, issued, and outstanding 15,000 15,000

Redeemable preferred stock, par value $1,000 per share; 3,000 shares authorized, issued and outstanding 300,000 300,000

Paid-in surplus – 439,881 Unassigned deficit (248,600) (3,365,794)

Total capital and surplus (deficit) 66,400 (2,610,913) Total liabilities and capital and surplus (deficit) $ 1,999,285 $ 2,020,837

See accompanying notes.

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Statutory-Basis Statements of Operations

(Dollars in Thousands)

Year Ended December 31, 2013 2012 Premiums earned $ 95,876 $ 70,908 Loss reserve release 2,467,498 972,547 Loss adjustment reserve (expense) release (39,778) 5,012 Other underwriting expenses (50,965) (45,518) Ceding commission income (expense) 104 (7,986) Underwriting income 2,472,735 994,963 Net investment income 51,810 46,995 Net realized capital (losses) gains, net of tax of $0, for the

years ended December 31, 2013 and 2012 (38,283) 5,220 Net investment gain 13,527 52,215 Other income 23,455 18,956 Income before all other federal and foreign income taxes 2,509,717 1,066,134 Federal and foreign income tax expense (benefit) 910 (325) Net income $ 2,508,807 $ 1,066,459


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Statutory-Basis Statements of Changes in Capital and Surplus (Deficit)

December 31, 2013 and 2012

Common

Stock

Redeemable Preferred

Stock Paid-in Surplus

Unassigned Surplus (Deficit)

Total Capital and Surplus

(Deficit) (Dollars in thousands) Balance, January 1, 2012 $ 15,000 $ 300,000 $ 439,881 $ (4,321,957) $ (3,567,076)

Net income 1,066,459 1,066,459 Change in non-admitted assets 1,979 1,979 Change in provision for

reinsurance 1,132 1,132 Change in contingency reserves (114,770) (114,770)Change in foreign exchange

adjustment 1,363 1,363 Balance, December 31, 2012 $ 15,000 $ 300,000 $ 439,881 $ (3,365,794) $ (2,610,913) Balance, January 1, 2013 $ 15,000 $ 300,000 $ 439,881 $ (3,365,794) $ (2,610,913)

Net income 2,508,807 2,508,807 Extinguishment of paid-in surplus (439,881) 439,881 – Change in net unrealized gains 15,218 15,218 Correction of prior year unassigned

surplus (deficit) (4,113) (4,113)Change in non-admitted assets 2,016 2,016 Change in provision for

reinsurance (24,287) (24,287)Change in contingency reserves 176,644 176,644 Change in foreign exchange

adjustment 3,028 3,028 Balance, December 31, 2013 $ 15,000 $ 300,000 $ – $ (248,600) $ 66,400


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Statutory-Basis Statements of Cash Flows


Year Ended December 31, 2013 2012 Operations Premiums collected, net of reinsurance $ 41,698 $ 72,556 Losses paid, net (23,471) (89,465)Loss adjustment expenses paid, net (30,682) (29,412)Underwriting expenses paid (50,320) (48,203)Ceding commission received (paid) 104 (7,986)Net investment income received 60,964 55,131 Other income received 23,455 18,956 Federal and foreign income tax payments (508) (326)Net cash provided by (used in) operations 21,240 (28,749) Investment activities Proceeds from sales, maturities, or repayments of investments:

Bonds and stocks 161,284 180,869 Net gains on short-term investments 40 Other invested assets 5,851 1,257 Miscellaneous proceeds 1,999

Total investment proceeds 167,175 184,125 Cost of investments acquired:

Bonds (277,838) (404,756)Miscellaneous applications (8,358) –

Total investments acquired (286,196) (404,756)Net cash used in investment activities (119,021) (220,631) Financing and miscellaneous activities Other cash applied (2,457) (311) Net decrease in cash, cash equivalents and short-term investments (100,238) (249,691) Cash, cash equivalents and short-term investments:

Beginning of year 685,076 934,767 End of year $ 584,838 $ 685,076


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Notes to Statutory-Basis Financial Statements

December 31, 2013

1. Organization and Background

Financial Guaranty Insurance Company (the “Company” or “FGIC”), a New York stock insurance corporation, is a wholly owned subsidiary of FGIC Corporation (“FGIC Corp.”), a Delaware corporation. The Company previously issued financial guaranty insurance policies insuring public finance, structured finance and other obligations. The Company is responsible for administering its outstanding policies in accordance with the Rehabilitation Plan (defined below), any NYSDFS Guidelines (defined in Note 2 below) and applicable law. The Company is no longer engaged in the business of writing new insurance policies. The Company’s primary regulator is the New York State Department of Financial Services (the “NYSDFS”), which assumed the functions and authority of the New York State Insurance Department (the “NYSID”). FGIC UK Limited (“FGIC UK”), a wholly owned United Kingdom insurance subsidiary of FGIC, previously issued financial guaranties covering public finance, structured finance and other obligations. FGIC UK, whose primary regulator is the UK Prudential Regulation Authority, is responsible for administering its outstanding guaranties in accordance with the terms and conditions of such guaranties and applicable law. FGIC UK is no longer engaged in the business of writing new financial guaranties.

Based on FGIC’s reported statutory surplus deficit as of September 30, 2009, on November 24, 2009, the NYSID issued an order pursuant to Section 1310 of the New York Insurance Law (the “NYIL”) requiring FGIC, effective that day, to suspend paying any and all claims, to cease writing any new policies and to operate only in the ordinary course of business and as necessary to effectuate its plan to eliminate its policyholders’ surplus deficit (the "1310 Order"). FGIC developed a comprehensive surplus restoration plan that it submitted to the NYSID, but ultimately FGIC was unable to implement that plan. By petition of the Superintendent of Financial Services of the State of New York (the “Superintendent”) based on FGIC’s statutory insolvency and its inability to eliminate its policyholders’ surplus deficit, the Supreme Court of the State of New York (the “Rehabilitation Court”), on June 28, 2012, issued an order pursuant to Article 74 of the NYIL (“Article 74”) placing FGIC in rehabilitation (the “Rehabilitation Order”). On June 11, 2013, the Rehabilitation Court approved the First Amended Plan of Rehabilitation for FGIC, dated June 4, 2013, together with all exhibits and the plan supplement thereto (collectively, the "Rehabilitation Plan"). The Rehabilitation Plan became effective on August 19, 2013 (the "Effective Date"), whereupon FGIC's rehabilitation proceeding terminated, the 1310 Order was lifted and FGIC resumed possession of its property and conduct of its business subject to the limitations described in the Rehabilitation Plan (See Note 2).


Notes to Statutory-Basis Financial Statements (continued)

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1. Organization and Background (continued)

FGIC Corp. commenced a proceeding under Chapter 11 of the United States Bankruptcy Code on August 3, 2010, and FGIC Corp. emerged from that proceeding on April 19, 2013 (the “Chapter 11 Effective Date”). On the Chapter 11 Effective Date, the transactions contemplated under the Plan of Reorganization for FGIC Corp. were consummated. None of the subsidiaries or affiliates of FGIC Corp., including FGIC, was a debtor in FGIC Corp.’s Chapter 11 case.

2. FGIC Rehabilitation Proceeding

On June 28, 2012, the Rehabilitation Court issued the Rehabilitation Order (i) appointing the Superintendent as rehabilitator of FGIC (the “Rehabilitator”), (ii) directing the Rehabilitator to take possession of the property and assets of FGIC and to conduct the business thereof, and (iii) directing the Rehabilitator to take steps towards the removal of the causes and conditions that made FGIC’s rehabilitation proceeding (the “Rehabilitation Proceeding”) necessary. FGIC consented to the commencement of the Rehabilitation Proceeding and, upon such commencement, the board of directors of FGIC resigned. The Rehabilitation Proceeding was styled as In the Matter of the Rehabilitation of Financial Guaranty Insurance Company, Index No. 401265/2012.

Subsequent to the Rehabilitation Order, and as part of the Rehabilitation Proceeding, the Rehabilitator developed the Rehabilitation Plan. The goal of the Rehabilitation Plan is to treat FGIC’s policyholders in a fair and equitable manner while at the same time removing the causes and conditions that made the Rehabilitation Proceeding necessary.

On June 11, 2013, the Rehabilitation Court issued an order pursuant to Article 74, among other things, (i) approving the Rehabilitation Plan and authorizing its implementation, (ii) approving the forms of amended and restated charter and amended and restated by-laws for FGIC filed as part of the Rehabilitation Plan, which constitute the charter and by-laws for FGIC as of the Effective Date, (iii) approving the Novation Agreement (defined below) and the consummation of the transactions contemplated thereby, (iv) approving an initial cash payment percentage (“CPP”) of 17.25% subject to adjustment by the Rehabilitator in his sole discretion on or before the Effective Date (by notice dated on the Effective Date, the Rehabilitator set the initial CPP at 17.00%), (v) terminating the Rehabilitation Proceeding on the Effective Date without further order of the Rehabilitation Court, and (vi) providing that on the Effective Date, FGIC shall resume possession of its property and conduct of its business subject to the limitations described in the Rehabilitation Plan.



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2. FGIC Rehabilitation Proceeding (continued)

On the Effective Date, FGIC emerged from the Rehabilitation Proceeding as a solvent insurance company under the NYIL and the Rehabilitation Plan became the exclusive means for resolving and paying (i) all policy claims, whenever arising, (ii) all other claims arising during, or relating to, the period prior to the Effective Date and (iii) all equity interests in FGIC in existence as of the date of the Rehabilitation Order (June 28, 2012), in each case other than claims (including policy claims) paid in full by FGIC prior to the date of the Rehabilitation Order. The Rehabilitation Plan designated six categories of claims and equity interests that are covered by the Rehabilitation Plan: secured claims; administrative expense claims; policy claims; non-policy claims; late-filed claims and equity interests. Claims arising during or relating to the period on and after the Effective Date (other than policy claims) are not covered by the Rehabilitation Plan and will be resolved and paid by FGIC in the ordinary course of business. FGIC continues to be subject to oversight by the NYSDFS pursuant to the NYIL and the additional requirements set forth in the Rehabilitation Plan (including any guidelines the NYSDFS has or may issue to carry out the purposes and effects of the Rehabilitation Plan (“NYSDFS Guidelines”)).

As of the Effective Date, any and all policies in force as of the Effective Date (except for the policies novated by the Novation Agreement (defined below)) were automatically modified by the Rehabilitation Plan. The Rehabilitation Plan, including the restructured policy terms attached to the Rehabilitation Plan as Exhibit B (the “Restructured Policy Terms”), supersedes any and all provisions of each policy that are inconsistent with the Rehabilitation Plan. FGIC is responsible for administering, reviewing, verifying, reconciling, objecting to, compromising or otherwise resolving all claims (including policy claims) not resolved prior to the Effective Date, in each case in compliance with the Rehabilitation Plan and any applicable NYSDFS Guidelines.

With respect to any policy claim permitted by FGIC, pursuant to the Rehabilitation Plan and the applicable policy (as modified by the Rehabilitation Plan), FGIC shall be obligated to pay in cash to the applicable policy payee only an upfront amount equal to the product of the then-existing CPP and the amount of such permitted policy claim. The portion of such permitted policy claim not paid or deemed to be paid by FGIC generally will comprise a deferred payment obligation (“DPO”) with respect to the applicable policy. The DPO with respect to any policy generally represents the aggregate amount of all permitted policy claims under such policy minus the aggregate amount paid, or deemed to be paid, in cash by FGIC with respect to such policy (other than DPO Accretion, defined below) from and after the Effective Date, subject to further adjustments as provided in the Rehabilitation Plan. From and after the Effective Date, each



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policy with an outstanding DPO accrues an amount (“DPO Accretion”) based on such DPO (using the balance then applicable pursuant to the Rehabilitation Plan) at a rate of 3% per annum on a daily basis on the basis of a 365-day year. All DPO Accretion shall be calculated on a simple basis, and no DPO Accretion shall be added to the amount of any DPO. The DPO for any policy and any related DPO Accretion shall only be payable by FGIC when, if and to the extent provided in the Restructured Policy Terms and the Rehabilitation Plan. In the absence of an upward adjustment of the CPP, FGIC shall have no obligation to pay any portion of any DPO or DPO Accretion.

The Rehabilitator set the initial CPP at 17.00%. FGIC is required to re-evaluate the CPP (at least annually) pursuant to the procedures set forth in the Restructured Policy Terms to determine whether the CPP should remain the same or be adjusted upward or downward (each, a “CPP Revaluation”). All CPP Revaluations shall require review and approval by the board of directors of FGIC, and any change in the CPP (among other things) shall require the approval of the NYSDFS.

In January 2014, FGIC made its first payments in cash totaling $255.5 million to policyholders for permitted policy claims related to the period from the 1310 Order through the Effective Date at the then-current CPP of 17.00%. The Company will continue to pay permitted claims in accordance with the Rehabilitation Plan.

The percentage of permitted policy claims that FGIC ultimately pays in cash in accordance with the Rehabilitation Plan, and the timing of any such payments, are subject to various factors and the outcome of future events, including the performance of FGIC’s insured and investment portfolios and the results of FGIC’s litigation and other loss mitigation efforts, and no assurance can be given with respect to the amount of any such percentage or the timing of any such payments. Based on the magnitude of FGIC’s accrued and projected policy claims, while the CPP may increase over time, FGIC expects to make payments in cash pursuant to the Rehabilitation Plan of only a fractional portion of its permitted policy claims and it does not expect to make any payments pursuant to the Rehabilitation Plan with respect to non-policy claims or equity interests.



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In an effort to mitigate its liabilities and increase recoveries for policyholders, as part of the Rehabilitation Plan, FGIC entered into a Novation Agreement dated as of September 14, 2012 (the “Novation Agreement”) with National Public Finance Guarantee Corporation (“National Public”), pursuant to which the parties agreed, subject to approval of the Rehabilitation Court and the other terms of such agreement, to novate the National Public Reinsured Policies (as defined below) from FGIC to National Public. Pursuant to a Reinsurance Agreement dated as of September 30, 2008, National Public provided FGIC with reinsurance on FGIC policies covering U.S. public finance credits with total net par in force of approximately $92.6 billion as of the Effective Date (collectively, the “National Public Reinsured Policies"). On June 11, 2013, the Novation Agreement was approved by the Rehabilitation Court. The novation of the National Public Reinsured Policies and the other transactions contemplated by the Novation Agreement became effective on the Effective Date, whereupon (i) National Public (rather than FGIC) became the issuer of the National Public Reinsured Policies and became directly responsible for all obligations under the National Public Reinsured Policies and (ii) FGIC was released from all obligations under the National Public Reinsured Policies.

In a further effort to mitigate its liabilities and increase recoveries for policyholders, FGIC entered into agreements (the “CDS Commutation Agreements”) with all counterparties to credit default swaps (“CDS”) insured by FGIC whose CDS had not previously been terminated (as well as Société Générale, whose CDS had been terminated but which termination was at that time the subject of litigation between FGIC and Société Générale) (collectively, the “CDS Counterparties”), pursuant to which the CDS Counterparties and FGIC agreed, subject to approval by the Rehabilitation Court and the other terms of such agreements, to terminate all of the CDS Counterparties’ FGIC-insured CDS and the related FGIC policies, and to mutually release all related obligations, claims and liabilities, in exchange for payments by FGIC aggregating approximately $176.4 million. On December 19, 2012, the Rehabilitation Court approved the CDS Commutation Agreements and FGIC made such payments, whereupon the CDS and the related FGIC policies were terminated and FGIC and the CDS Counterparties were released from all obligations, claims and liabilities thereunder or relating thereto.

References to and descriptions of provisions of the Rehabilitation Plan (and related agreements) and orders of the Rehabilitation Court included in these financial statements are merely summaries thereof, and do not contain all information necessary to fully understand such provisions and orders. Please refer to the specific terms, requirements and conditions of the Rehabilitation Plan (and related agreements) and orders of the Rehabilitation Court for a full understanding thereof, which in all cases shall govern, rather than any summary description contained in these financial statements.



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3. Assessment of the Company’s Ability to Continue as a Going Concern

As a result of uncertainties associated with the Rehabilitation Plan prior to the Effective Date, including the risk that the Rehabilitator at any time prior to the Effective Date may have determined that efforts to rehabilitate the Company would be futile and may have sought to convert the Rehabilitation Proceeding into a liquidation proceeding under Article 74, management concluded that there was substantial doubt about the ability of the Company to continue as a going concern. On the Effective Date, FGIC emerged from the Rehabilitation Proceeding as a solvent company with its policies restructured in a manner intended to ensure that it remains solvent. As a result, these uncertainties about the ability of the Company to continue as a going concern were removed. The Company’s financial statements as of and for the years ended December 31, 2013 and 2012 were prepared assuming the Company continues as a going concern and did not include any adjustment that might have resulted from its inability to continue as a going concern as described above.

4. Significant Accounting Policies

The accompanying financial statements of the Company have been prepared in conformity with statutory accounting practices prescribed or permitted by the NYSDFS as well as those accounting practices detailed in NYSDFS Guidelines, as described below (“SAP”). The preparation of financial statements in conformity with SAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates, and those differences could be material.

SAP differs in some respects from accounting principles generally accepted in the United States (“GAAP”). The effects of the variances from GAAP on the accompanying statutory-basis financial statements have not been determined for the years ended December 31, 2013 and 2012, but are presumed to be material. Significant accounting policies and variances from GAAP, where applicable, are as follows:

Pursuant to the provisions of the Rehabilitation Plan, the NYSDFS has issued NYSDFS Guidelines that define certain accounting practices for FGIC for reporting periods ending on or after the Effective Date. In accordance with such NYSDFS Guidelines, for reporting periods ending on or after the Effective Date, FGIC will record loss reserves at the applicable reporting date in an amount equal to the excess of (i) the amount of FGIC’s admitted assets minus FGIC’s



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4. Significant Accounting Policies (continued)

minimum required statutory surplus to policyholders at the reporting date (the “Minimum Surplus Amount,” currently $66.4 million) over (ii) the sum of FGIC’s statutory reserves excluding loss reserves (e.g., unearned premiums, contingency reserves, loss adjustment expense reserves) and other liabilities. In accordance with such NYSDFS Guidelines, the loss reserve amount comprises the total amount of (i) the sum, net of reinsurance, of (x) the total amount of all policy claims submitted to FGIC in accordance with the Rehabilitation Plan that are unpaid (excluding any portions of such policy claims that are being disputed by FGIC) and (y) the net present value of the total amount of all policy claims that the Company expects to receive in the future in accordance with the Rehabilitation Plan (using the prescribed statutory discount rate which is based on the average rate of return on FGIC’s admitted assets) (such sum is referred to as the “Claims Reserve”), (ii) the DPO for all policies at such reporting date and (iii) the DPO Accretion for all policies at such reporting date, minus an adjustment (the “Policy Revision Adjustment”) in an amount that will permit FGIC to report a surplus to policyholders at such reporting date equal to the Minimum Surplus Amount (See Note 10, Loss Reserves – December 31, 2013).

As of the Effective Date, FGIC extinguished its paid-in surplus of $439.9 million through a transfer to unassigned deficit.

Investments

Investments in bonds and common stock are valued in accordance with the requirements of the National Association of Insurance Commissioners (“NAIC”).

Bonds are generally stated at amortized cost, with premiums and discounts amortized to net income using the effective interest method over the remaining term of the securities. Bonds with NAIC ratings of 3 or lower are carried at the lower of amortized cost or fair value as determined by the Securities Valuation Office. Under GAAP, bonds are designated at purchase as either held-to-maturity or available-for-sale. Held-to-maturity bonds are reported at amortized cost and bonds designated as available-for-sale are reported at fair value with unrealized gains and losses reported in stockholders equity, net of tax.



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Under SAP, investments in wholly owned subsidiaries are recorded based on the underlying equity adjusted to a statutory basis and reported as common stock investments, not to exceed 50% of the Company’s statutory surplus or 60% of surplus to shareholders, whichever is higher. Changes in the value of subsidiaries are recorded as unrealized gains and losses and reported as a component of unassigned surplus. Under SAP, the reporting entity can discontinue applying the equity method when the investment in a subsidiary is reduced to zero, and SAP does not provide for additional losses unless the reporting entity has guaranteed obligations of the investee or is otherwise committed to provide further financial support for the investee. Under GAAP, subsidiaries are consolidated with the Company.

Short-term investments, including Class 1 NAIC money market securities, are stated at amortized cost, which approximates fair value. Realized gains and losses on the sale of investments are determined based on the specific identification method.

All single class and multi-class mortgage-backed/asset-backed securities are valued at amortized cost using the interest method, including anticipated prepayments. Prepayment assumptions are obtained from dealer surveys or internal estimates and are based on the current interest rate and economic environment. All such securities are adjusted for the effects of changes in prepayment assumptions on the related accretion of discount or amortization of premium of such securities using the retrospective method.

Investments (excluding investments in wholly owned subsidiaries) that are determined to be other-than-temporarily impaired are reduced to realizable value, establishing a new cost basis, with a charge to realized loss at such date. The Company has determined that it either has the intent to sell or it is more likely than not that it will be required to sell its bonds before recovery of their amortized cost basis. Therefore, all unrealized losses are recorded through earnings and the new cost basis is not adjusted for subsequent recoveries in fair value.

Fair Value Measurements

The Company discloses the fair value of its investments in bonds, other invested assets, short-term investments and other financial instruments in accordance with Statement of Statutory Accounting Principles (“SSAP”) 100, Fair Value Measurements (“SSAP 100”), which requires the use of a fair value hierarchy with the highest priority given to quoted prices in active markets. The general disclosure requirements are for those items measured and reported at fair value in



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the balance sheet. Securities that are reported at amortized cost, but for which amortized cost equals fair value (such as a bond with a recognized other-than-temporary impairment on the reporting date) would not be included in the disclosures. SSAP 100 also requires certain disclosures of fair value measurements and valuation techniques, where practicable to determine, for financial instruments not carried at fair value in the balance sheet. SSAP 100 does not require companies to distinguish between recurring and non-recurring fair value measurements, which is required under GAAP.

Cash and Cash Equivalents

The Company considers all bank deposits and all certificates of deposit with maturities of three months or less at the date of purchase to be cash equivalents. Cash equivalents are carried at cost, which approximates fair value. In the event that a highly liquid security is determined to be impaired, the security is adjusted to fair value in accordance with NAIC regulations. Under GAAP, these securities are adjusted to fair value and included in cash and cash equivalents.

Other Invested Assets

Other invested assets are comprised of FGIC-insured residential mortgage-backed securities (“RMBS”) that were purchased by FGIC as part of its loss mitigation efforts. Under SAP, these securities are carried at the lower of amortized cost or fair value as these are rated NAIC 3 or below. Under GAAP, these securities are carried at fair value.

Premium Revenue Recognition

For SAP, premiums collected in a single payment at policy inception are earned in proportion to the scheduled principal and interest payments over the legal lives of the insured bonds. Premiums collected periodically are reflected in income pro rata over the period covered by the premium payment. Under GAAP, premiums are earned in proportion to the amount of insurance protection provided over the expected life for homogeneous pools and over the legal life for non-homogeneous pools of policies. The liability for unearned premiums is reflected net of reinsurance. Ceded premiums are earned in a manner consistent with the underlying policies. Under GAAP, ceded unearned premiums are reported as an asset. When an obligation insured by the Company is refunded prior to the end of the expected policy coverage period, any remaining



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unearned premium is recognized at that time. A refunding occurs when an insured obligation is legally defeased or retired prior to stated maturity. Net premiums earned on refundings were $52.5 million and $20.2 million for the years ended December 31, 2013 and 2012, respectively.

Non-admitted Assets

Certain assets are charged directly against surplus, but are reflected as assets under GAAP. Such assets principally include prepaid expenses, property and equipment, and adjusted gross deferred tax assets. The Company recorded non-admitted assets of $0.5 million and $2.5 million at December 31, 2013 and 2012, respectively.

Ceded Balances Payable

Reinsurance receivables are netted against ceded balances payable on the statutory-basis balance sheets. Under GAAP, reinsurance receivables are classified as an asset.

Loss Adjustment Expense Reserve

A reserve for loss adjustment expense is recorded as a liability on the balance sheet. The loss adjustment expense reserve represents management’s best estimate of the ultimate future net cost, determined using internally developed estimates, of the efforts involved in managing and mitigating existing and future policy claims. Such loss adjustment expense reserve is not subject to a Policy Revision Adjustment. The Company’s loss adjustment expense reserve is disclosed as part of Note 12.

Contingency Reserves

Contingency reserves are computed on the basis of statutory requirements for the security of all policyholders, regardless of whether loss contingencies actually exist. The Company establishes contingency reserves in accordance with the NYIL, which is consistent with the requirements of SSAP 60, Financial Guaranty Insurance. Changes in the contingency reserve are charged directly to surplus. Under GAAP, contingency reserves are not required.

During 2013, the Company applied to the NYSDFS to adjust its contingency reserves to reflect changes in its exposure and was granted permission to decrease contingency reserves by $277.5 million.



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Federal Income Taxes

Deferred tax assets and liabilities are recognized to reflect the tax impact attributable to temporary differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases.

Deferred tax assets and liabilities are measured using statutory tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled and are recorded as a component of surplus. Under SAP and GAAP, a valuation allowance is established for deferred tax assets that are not expected to be realized. Under SAP, a net deferred tax asset is subject to limitations and may be non-admitted.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits where the ultimate recognition is uncertain.

Reinsurance

A liability is recorded for uncollateralized amounts due from unauthorized reinsurers. Changes in this liability are charged or credited directly to unassigned surplus. Amounts due from unauthorized reinsurers that are secured by letters of credit or trust agreements are not included in this liability. Under GAAP, an allowance for amounts deemed uncollectible would be established through a charge to earnings.

Ceded loss reserves are calculated as reductions of the related reserves rather than assets, as would be required under GAAP. Prospective losses are accounted for on a basis consistent with that used in accounting for the original policies issued, the terms of the reinsurance contracts, and the terms of the Rehabilitation Plan, which provides that payments are due in full from reinsurers with respect to any permitted policy claims covered by the reinsurance without regard to (i) the timing or amount of any cash payment made by FGIC on the underlying claims, (ii) the modification pursuant to the Rehabilitation Plan of FGIC’s obligations to pay such Permitted Claims in cash or (iii) any language in the applicable reinsurance agreements that would contradict this result. The net loss reserve amount is reduced to give effect to such reinsurance.



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Ceded loss adjustment expense reserves and unearned premiums ceded to reinsurers have been reported as reductions of the related reserves rather than as assets, as would be required under GAAP. Prospective reinsurance premiums and loss adjustment expenses are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts.

Consolidation

The accounts and operations of the Company’s subsidiaries are not consolidated with the accounts and operations of the Company, as would be required under GAAP.

As part of its structured finance business, the Company insures debt obligations or certificates issued by special purpose entities. Under SAP, the Company does not consolidate the assets and liabilities of a variable interest entity (“VIE”). Under GAAP, the Company is required to consolidate the assets and liabilities of a VIE if the Company is determined to be the primary beneficiary because it directs the significant activities of and holds an economic interest in the entity.

Foreign Currency Translation

The Company has foreign branches in the United Kingdom and France. The Company has determined that these are foreign operations with transactions in their respective local currencies, which are their functional currencies. Accordingly, the assets and liabilities of these foreign branches are translated into U.S. dollars at the rates of exchange existing at the balance sheet date, and the associated revenues and expenses are translated into U.S. dollars at the weighted average exchange rate for the period. These foreign exchange gains (losses) are recorded as unrealized capital gains and losses within capital and surplus (deficit) under SAP and as other comprehensive income under GAAP.

Statements of Cash Flow

The statutory-basis statements of cash flow are presented in a specified format, which differs from the format prescribed under GAAP. Cash, cash equivalents, and short-term investments in the statements of cash flow represent cash balances and investments with initial maturities of one year or less. Under GAAP, the corresponding caption of cash and cash equivalents includes cash balances and investments with initial maturities of three months or less.



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Comprehensive Income

Comprehensive income is not determined under SAP.

Property and Equipment

Property and equipment consists of office furniture, fixtures, computer equipment and software that are reported at cost less accumulated depreciation for GAAP reporting. Under SAP, these assets are non-admitted.

Reclassifications

Certain 2012 amounts in the Company’s statutory-basis financial statements have been reclassified to conform to the 2013 statutory-basis financial statement presentation.

Correction to Prior Year Unassigned Surplus (Deficit)

The Company’s January 1, 2013 surplus balance has been reduced by $4.1 million to reflect the correction of an error in prior reporting periods in the recording of impairments on loan-backed securities. These securities were impaired in earlier years, but the recovery of a portion of the impairment was erroneously recorded in prior years.

5. Financial Guaranty Contracts

The expected future premiums shown below are based on various prepayment, collection and other assumptions and circumstances as of December 31, 2013, and actual premiums collected could differ materially. In addition, the expected future premiums shown below do not give effect to policy terminations that have occurred after, or may occur after, December 31, 2013, which could materially reduce the actual premiums collected.



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5. Financial Guaranty Contracts (continued)

The following is a roll-forward of the undiscounted expected future premiums for the years ended December 31, 2013 and 2012:

Year Ended December 31, 2013 2012 (In Thousands) Beginning expected future premiums $ 318,548 $ 404,309 Premium payments received (34,022) (47,855) Adjustments for changes in expected premiums, including

impact of terminations and FX movement

(93,482)

(37,906) Ending expected future premiums $ 191,044 $ 318,548

The following is a schedule of undiscounted premiums expected to be collected on financial guaranty contracts as of December 31, 2013:

Undiscounted Premiums

Expected to be Collected

(In Thousands)Quarter ended March 31, 2014 $ 4,326 June 30, 2014 4,896 September 30, 2014 4,946 December 31, 2014 4,939 Total 2014 19,107 Year ended December 31, 2015 18,124 December 31, 2016 15,307 December 31, 2017 13,383 December 31, 2018 11,074 Five years ended December 31, 2023 43,359 December 31, 2028 30,098 December 31, 2033 23,191 December 31, 2038 11,359 December 31, 2043 4,767 December 31, 2048 1,275



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5. Financial Guaranty Contracts (continued)

The following table presents the expected unearned premiums and the expected future premium earnings on non-installment policies as of and for the periods presented:

Expected Future Premium Earnings

Total Expected Future

Unearned Premiums Upfront

Other Non – Installment

Premium Earnings

In thousands December 31, 2013 $ 122,546 $ – $ – $ – Quarter ended March 31, 2014 120,256 1,157 1,133 2,290 June 30, 2014 118,545 781 930 1,711 September 30, 2014 115,142 2,564 839 3,403 December 31, 2014 113,605 861 676 1,537 Year ended December 31, 2015 106,247 5,797 1,561 7,358 December 31, 2016 99,717 5,416 1,114 6,530 December 31, 2017 94,280 4,970 467 5,437 December 31, 2018 88,327 5,632 321 5,953 Five years ended December 31, 2023 58,041 28,711 1,575 30,286 December 31, 2028 42,026 14,917 1,098 16,015 December 31, 2033 20,189 21,337 500 21,837 December 31, 2038 6,928 12,761 500 13,261 December 31, 2043 2,610 4,294 24 4,318 December 31, 2048 4 2,606 2,606 December 31, 2053 4 4

The remaining amount of unearned premiums that would have been recorded if all premiums had been received at inception amounted to $129.5 million as of December 31, 2013.



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6. Fair Value Measurements

SSAP 100 specifies a fair value hierarchy based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s assumptions about market participants’ assumptions based on the best information available in the circumstances. The fair value hierarchy prioritizes model inputs into three broad levels: quoted prices for identical instruments in active markets are Level 1 inputs; quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets are Level 2 inputs; and model-driven valuations in which one or more significant inputs or significant value drivers are unobservable are Level 3 inputs.

The Company did not report any securities at fair value on the balance sheets as of December 31, 2013 and 2012.

Transfers among levels 1, 2 and 3 are recognized at the end of the period when the transfer occurs. The Company reviews the classification of financial instruments in levels 1, 2 and 3 quarterly to determine whether a transfer is necessary.



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6. Fair Value Measurements (continued)

The fair values of admitted investments in bonds, other invested assets and short-term investments by level are as follows:

Level 1 Level 2 Level 3 Admitted

Value (In Thousands) December 31, 2013 Bonds: Obligations of states and political

subdivisions $ – $ 771,882 $ – $ 745,959 Asset- and mortgage-backed

securities – 375,298 – 363,495 U.S. Treasury securities and

obligations of U.S. Government corporations and agencies – 43,794 – 38,370

Debt securities issued by foreign governments – 23,558 – 23,524

Corporate – 199,183 – 193,749 Total bonds – 1,413,715 – 1,365,097 Other invested assets – 64,416 16,520 Short-term investments – 566,540 – 566,540 Total $ – $ 1,980,255 $ 64,416 $ 1,948,157



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Level 1 Level 2 Level 3 Admitted

Value In thousands December 31, 2012 Bonds: Obligations of states and

political subdivisions $ – $ 776,894 $ – $ 723,948 Asset- and mortgage-backed

securities –

383,751

– 359,532

U.S. Treasury securities and obligations of corporations and agencies – 49,109 – 38,533

Debt securities issued by foreign governments – 32,427 – 31,899

Corporate – 152,279 – 142,139 Total bonds – 1,394,460 – 1,296,051 Other invested assets – – 55,922 22,371 Short-term investments – 676,681 – 676,681 Total $ – $ 2,071,141 $ 55,922 $ 1,995,103

There have been no transfers in and out of Level 3 during the period.

(a) Fair Value of Financial Instruments

The following methods and assumptions were used by the Company in estimating fair values of financial instruments. Fair values estimated based upon internal valuation models are not necessarily indicative of the amount the Company could realize in a current market exchange.

Bonds: Fair values for bonds are based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Because many bonds do not trade on a daily basis, information and other data, including benchmark curves, benchmarking of like securities and matrix pricing, are utilized to value the securities. Inputs to the valuation process include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and other reference data. Any investments in preferred or common stock of unaffiliated entities are valued consistent with the method used to value bonds.



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Short-Term Investments: Short-term investments are carried at amortized cost, which approximates fair value.

Cash and Cash Equivalents: Cash and cash equivalents are carried at cost, which approximates fair value.

Other Invested Assets: Any of the Company’s investments in bonds that are classified as NAIC rated 3 through 6 are recorded at the lower of amortized cost or fair value as determined by the Securities Valuation Office. Fair value of other invested assets is based on third-party proprietary pricing models. These models consider inputs such as expected cash flows, estimated prepayment speeds and estimated default rates for each security or for similar securities as well as the Company’s financial guaranty to pay the CPP and its own credit rating. Because these significant inputs are not observable, these assets are considered Level 3.

(b) Financial Instruments for which Measurement of Fair Value is Not Practicable

Financial Guaranty Insurance Contracts: The carrying value of financial guaranty insurance contracts includes loss reserves, unearned premiums, premiums receivable and ceded balances payable. Loss reserves have been determined in accordance with the statutory accounting practices prescribed by NYSDFS Guidelines and comprise the total amount of (i) the Claims Reserve, (ii) the DPO for all policies and (iii) the DPO Accretion for all policies, minus the Policy Revision Adjustment.

The fair value of the Company’s financial guaranty insurance contracts accounted for as insurance was not practicable to determine. The Company has not developed or obtained valuation models, and the cost of developing valuation models necessary to make the estimate or of obtaining an independent valuation appears excessive considering that the Company no longer writes insurance contracts but rather is responsible for administering its outstanding guaranties in accordance with the terms and conditions of such guaranties and applicable law. The calculation would be based on management’s estimate of what a similarly rated financial guaranty insurance company would demand to acquire the Company’s in-force book of financial guaranty insurance business. This amount would be based on pricing assumptions management would observe for portfolio transfers that have occurred in the financial guaranty market. It would include adjustments to the carrying value



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of loss reserves for the current and potential future CPP the Company is obligated to pay, and adjustments for stressed losses as well as ceding commissions and return on capital. It would also include the present value of premiums expected to be collected on installment contracts over the contract period. These significant inputs were not readily observable, and any fair value measurement would be considered Level 3.

7. Investments

The amortized cost and fair value of admitted investments in bonds, other invested assets and short-term investments are as follows:

Amortized

Cost

Gross Unrealized

Holding Gains

Gross Unrealized

Holding Losses

Fair Value

(In Thousands) December 31, 2013 Obligations of states and political

subdivisions $ 745,959 $ 25,923 $ – $ 771,882 Asset- and mortgage-backed

securities 363,495 11,803 – 375,298 U.S. Treasury securities and

obligations of U.S. Government corporations and agencies 38,370 5,424 – 43,794

Debt securities issued by foreign governments 23,524 34 – 23,558

Corporate 193,749 5,434 – 199,183 Total bonds 1,365,097 48,618 – 1,413,715 Other invested assets 16,520 47,896 – 64,416 Short-term investments 566,540 – – 566,540 Total $ 1,948,157 $ 96,514 $ – $ 2,044,671



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7. Investments (continued)

Amortized Cost

Gross Unrealized

Holding Gains

Gross Unrealized

Holding Losses

Fair Value

(In Thousands) December 31, 2012 Obligations of states and political

subdivisions $ 723,948 $ 52,946 $ – $ 776,894 Asset- and mortgage-backed

securities 359,532 24,219 – 383,751 U.S. Treasury securities and

obligations of U.S. Government corporations and agencies 38,533 10,576 – 49,109

Debt securities issued by foreign governments 31,899 528 – 32,427

Corporate 142,139 10,140 – 152,279 Total bonds 1,296,051 98,409 – 1,394,460 Other invested assets 22,371 33,551 – 55,922 Short-term investments 676,681 – – 676,681 Total $ 1,995,103 $ 131,960 $ – $ 2,127,063

The Company has determined either that it does not intend to hold certain fixed income securities until their fair value exceeds their amortized cost or that it intends to sell, or it is more likely than not that the Company will be required to sell, certain fixed income securities before recovery of their amortized cost basis. The Company has recorded other-than-temporary impairment (“OTTI”) of $39.1 million and $1.3 million on its fixed income securities for the years ended December 31, 2013 and 2012, respectively. OTTI is included in “Net realized capital gains or losses net of tax” in the statutory-basis statements of operations and represents the difference between the amortized cost bases of these securities and their fair values at the balance sheet date.



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7. Investments (continued) In accordance with SSAP 43R, the Company is required to categorize its OTTI on loan-backed and structured securities based upon the reason for which the Company recognized an OTTI. The following summarizes those securities held at December 31, 2013 and 2012 for which the OTTI was recorded during the years ended December 31, 2013 and 2012:

Year Ended December 31, 2013 2012 (In Thousands)

Intent to sell $ 11,252

$ 65

Inability to retain the investment in the security for a period of time sufficient to recover the amortized cost basis – –

Present value of the cash flows expected to be collected is less than the amortized cost basis of the security – –

Total OTTI on loan-backed and structured securities $ 11,252 $ 65 The amortized cost and fair value of investments in bonds at December 31, 2013, by contractual maturity date, are shown below. As asset and mortgage-backed securities are generally more likely to be prepaid than other fixed maturity securities, they are shown separately. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Amortized

Cost Fair

Value (In Thousands) Due in one year $ 31,589 $ 31,969Due after one through five years 219,300 227,864Due after five years through ten years 273,077 281,360Due after ten years 477,636 497,224Asset- and mortgage-backed securities 363,495 375,298Total $ 1,365,097 $ 1,413,715



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As of December 31, 2013, the Company did not have more than 5% of its investment portfolio concentrated in a single issuer or industry other than obligations of the U.S. government or U.S. government agencies and Money Market Fund(s); however, the Company had the following investment concentrations by state.

Fair Value (In Thousands) New York $ 88,184 Texas 87,031 California 79,262 Illinois 73,840 Florida 58,662 Pennsylvania 53,591 Nevada 41,436 Virginia 41,405 Arizona 40,630 Ohio 39,943 Subtotal 603,984 All other states 366,253 All other investments 1,074,434 Total $ 2,044,671

Net investment income of the Company was derived from the following sources:

Year Ended December 31, 2013 2012 (In Thousands) Income from bonds $ 53,244 $ 46,632 Income from preferred stocks - 449 Income from cash, cash equivalents and short-term

investments

838

2,006 Total investment income 54,082 49,087 Investment expenses (2,272) (2,092)Net investment income $ 51,810 $ 46,995



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For the years ended December 31, 2013 and 2012, proceeds from sales of investments in bonds carried at amortized cost were $30.4 million and $17.5 million, respectively. For the years ended December 31, 2013 and 2012, gross realized gains of $0.8 million and $0.9 million, respectively, were realized on such sales. For the years ended December 31, 2013 and 2012, gross realized losses of $0 and $0, respectively, were realized on such sales. For the years ended December 31, 2013 and 2012, proceeds from sales of investments in preferred stock were $0 and $9.4 million, respectively. For the year ended December 31, 2012, gross realized gains and gross realized losses of $5.6 million and $0, respectively, were realized on such sales.

Investments in cash, cash equivalents, short-term investments and bonds carried at amortized cost of $25.3 million and $24.2 million as of December 31, 2013 and 2012, respectively, were on deposit with various regulatory authorities.

The carrying values of the Company’s investment in the equity of subsidiaries were $15.2 million and $0 as of December 31, 2013 and 2012, respectively. Included in the change in net unrealized gains or losses for the years ended December 31, 2013 and 2012 were gains of $15.2 million and $0, respectively, related to the change in carrying values of the Company’s investments in subsidiaries.

8. Income Taxes

The Company files a consolidated U.S. federal income tax return with FGIC Corp. The method of allocation between FGIC Corp. and FGIC is determined under an amended and restated income tax allocation agreement approved by the NYSDFS, and is based upon separate return calculations.

The Company has applied to the Internal Revenue Service for a change in accounting method (“CAM”) for the computation of tax basis loss reserves as of January 1, 2013. The CAM was requested to align the Company’s tax basis loss reserves with the Internal Revenue Code by recognizing only those loss reserves in “payment mode,” defined as those policies for which an event of default has already occurred under the terms of the insurance contract. The weight of authority would not support a tax loss reserve deduction for policies where a default or any other event that creates a legal liability under the terms of the insurance contract has not yet occurred (i.e., “non-payment mode” reserves), irrespective of whether such a reserve may be appropriate under the relevant statutory accounting guidance. In such case, there is no actual loss for which a tax deduction is permitted. Under SAP, there has been no change in the Company’s method of calculating the Claims Reserve.



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8. Income Taxes (continued)

The following is a reconciliation of current federal income taxes computed on income before provision for federal and foreign income taxes at the statutory rate and the provision for current federal income taxes.

Year Ended December 31, 2013 2012 (In Thousands) Income tax expense at the statutory rate, computed on

income before provision for federal and foreign income taxes $ 878,401 $ 373,147

Tax effect of: Tax-exempt interest (8,740) (7,562) NOL adjustment for FGIC Corp.’s cancellation of debt 72,171 Change in valuation allowance (941,654) (371,717) Other, net 732 5,807 Expense (benefit) for federal and foreign income taxes $ 910 $ (325)

The composition of total tax expense (benefit) for the years ended December 31, 2013 and 2012 is as follows:

Year Ended December 31, 2013 2012 (In Thousands) Current:

Federal $ – $ – Foreign 910 (325)

Federal and foreign income tax expense (benefit) $ 910 $ (325) There was no change in net deferred income taxes, inclusive of non-admitted assets, for the years ended December 31, 2013 and 2012.

As of December 31, 2013, the Company had a domestic net operating loss (“NOL”) carryforward of $2.0 billion for federal income tax purposes, which will be available (subject to the limitations discussed below) to offset future taxable income. If not used, the NOL will start expiring in 2029 through 2032 depending on the originating year.



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FGIC’s ability to utilize its NOLs could be limited after an “ownership change” under Section 382 of the Internal Revenue Code (“Section 382”). Section 382 limits the ability of a corporation that experiences an ownership change to utilize its NOLs and certain built-in losses after the ownership change. An ownership change is generally any change in ownership of more than 50 percentage points of a corporation’s stock over a rolling 3-year period. Generally under Section 382, upon an ownership change, the amount of taxable income that a corporation can offset by its “pre-change losses” (which include its NOLs) is restricted to an annual amount equal to the equity value of the corporation immediately prior to the ownership change multiplied by the long-term tax-exempt rate.

Notwithstanding Section 382’s restriction on a corporation’s use of NOLs, Section 382 provides significant relief to a corporation if an ownership change occurs in the context of a Chapter 11 case. Specifically, section 382(l)(5) of the Internal Revenue Code provides that a corporation under the jurisdiction of a court in a Chapter 11 case is not subject to the general limitations imposed by Section 382 if historic stockholders and/or the corporation’s “qualified creditors” own at least 50% of the total value and voting power of the corporation’s stock after the ownership change occurs (the “Section 382(l)(5) Exception”). The ownership change of FGIC Corp. and FGIC that occurred on the Chapter 11 Effective Date when the then existing equity in FGIC Corp. was cancelled and creditors of FGIC Corp. acquired the new equity of reorganized FGIC Corp., as well as the possession of the property and assets of FGIC by the Rehabilitator during the Rehabilitation Proceeding, qualified for the Section 382(l)(5) Exception.

The amount of federal income taxes incurred and available for recoupment in the event of future losses is $0.

In accordance with SSAP 101, Income Taxes, A Replacement of SSAP No. 10R and SSAP No. 10 (“SSAP 101”), the Company evaluates its deferred income tax asset to determine if valuation allowances are required. SSAP 101 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified. Management believes it is more likely than not that the amortization of the net unearned premium reserve, collection of future installment premiums on contracts already written, and income from the investment portfolio will not generate sufficient taxable income to realize the entire deferred tax asset that currently exists. Accordingly, a full valuation allowance was established against the Company’s domestic net deferred tax asset of $724.7 million as of December 31, 2013. The Company will continue to analyze the need for a valuation allowance on a quarterly basis.



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The Company’s tax returns are subject to routine audits by the Internal Revenue Service and other taxing authorities; however, there are currently no audits for any tax periods in progress. Management believes the Company remains subject to income tax examinations for the years 2010, 2011 and 2012.

The following table presents the total of deferred tax assets and liabilities by tax character:

December 31, 2013 2012 (In Thousands) Deferred tax assets:

Ordinary income $ 885,174 $ 1,658,034 Capital losses 24,141 10,610

Gross deferred tax asset 909,315 1,668,644 Valuation allowance (724,730) (1,666,384)Adjusted deferred tax asset 184,585 2,260 Non-admitted adjusted deferred tax asset - − Total admitted gross deferred tax asset 184,585 2,260 Deferred tax liabilities:

Ordinary income (183,222) (1,266)Capital gains (1,363) (994)

Total gross deferred tax liability (184,585) (2,260)Net admitted deferred tax asset $ – $ –



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The tax effects of temporary differences that give rise to significant portions of the net deferred tax asset at December 31, 2013 and 2012 are presented below by tax component:

December 31, 2013 2012 (In Thousands) Deferred tax assets:

Premiums revenue recognition $ 4,830 $ 7,659 Net operating loss carryforward 684,165 1,425,177 Impairment losses on investments 22,607 9,122 Losses-salvage and subrogation recoverable 190,974 219,851 Other 6,739 6,835

Gross deferred tax asset 909,315 1,668,644 Valuation allowance (724,730) (1,666,384) Adjusted deferred tax asset 184,585 2,260 Non-admitted adjusted deferred tax asset – Total admitted gross deferred tax asset 184,585 2,260 Deferred tax liabilities:

Non-deductible tax basis losses due to CAM (181,516) Foreign currency (1,248) (879) Discount on bonds and other (1,821) (1,381)

Total gross deferred tax liability (184,585) (2,260) Net admitted deferred tax asset $ – $ –

9. Reinsurance

Reinsurance is a commitment by one insurance company (the reinsurer) to reimburse another insurance company (the ceding company) for a specified portion of the insurance risks under policies issued by the ceding company in consideration for a portion of the related premiums received. The ceding company typically will receive a ceding commission from the reinsurer. The ceding company is not relieved of its primary obligation to the policyholder in a reinsurance transaction.



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9. Reinsurance (continued)

The Company used reinsurance to increase its capacity to write insurance for obligations of large, frequent issuers; to meet internal, rating agency or regulatory single risk limits; to diversify risk; and to manage rating agency and regulatory capital requirements. The Company arranged reinsurance on both a facultative (transaction-by-transaction) basis and on a proportional share basis.

As a primary insurer, the Company is required to fulfill all its obligations to policyholders under its policies (as modified by the Restructured Policy Terms and other Rehabilitation Plan provisions) even where a reinsurer fails to perform its obligations under the applicable reinsurance agreement. The Company regularly monitors the financial condition of its reinsurers. The Company evaluated the financial condition of its reinsurers and recorded a provision for reinsurance of $24.3 million and $1.1 million at December 31, 2013 and 2012, respectively.

Under most of the Company’s reinsurance agreements, the Company has the right to reassume all the exposure ceded to a reinsurer (and receive all the remaining unearned premiums ceded) in the event of a ratings downgrade of the reinsurer or the occurrence of certain other events. In certain of these cases, the Company also has the right to impose additional ceding commissions.

Under certain reinsurance agreements, the Company holds collateral in the form of letters of credit or trust accounts. Such collateral totaled $210.7 million at December 31, 2013 and can be drawn on in the event of default by a reinsurer.

The effects of reinsurance on premiums written and earned are as follows:

Year Ended December 31, 2013 2012 Written Earned Written Earned (In Thousands) Direct premiums $ 38,053 $ 181,728 $ 43,234 $ 188,788 Assumed premiums:

Affiliates (83) (129) 3,479 4,370 Non-affiliates – – – –

Ceded premiums: Affiliates – – – – Non-affiliates 8,599 (85,723) 25,642 (122,250)

Net premiums $ 46,569 $ 95,876 $ 72,355 $ 70,908



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9. Reinsurance (continued)

In January 2013, following approval by the Rehabilitation Court and the satisfaction of all other conditions to closing, Radian Asset Assurance Inc. (“Radian”) paid approximately $52.3 million to FGIC pursuant to a reinsurance commutation agreement entered into by FGIC and Radian in November 2012 (the “Radian Commutation Agreement”), and FGIC reassumed approximately $732.8 million of par exposure and $38.3 million of loss reserves previously ceded to Radian. In accordance with SSAP 62, Property and Casualty Reinsurance (“SSAP 62”), FGIC recognized a net underwriting gain of approximately $3.3 million from the completion of the Radian Commutation Agreement during the year ended December 31, 2013. Also during 2013, FGIC completed several reinsurance commutation agreements with certain other reinsurance companies to settle all obligations between FGIC and the respective reinsurers relating to the subject reinsurance agreements and related reinsurance. Pursuant to these commutation agreements, FGIC received a total of $1.4 million from reinsurers, and FGIC reassumed approximately $52.7 million of par exposure previously ceded to these reinsurers. In accordance with SSAP 62, FGIC recognized an underwriting gain of approximately $0.1 million from the completion of these reinsurance commutation agreements in the year ended December 31, 2013.

In October 2012, FGIC and American Overseas Reinsurance Company Limited, a reinsurance company formerly known as RAM Reinsurance Company (“AORe”), completed a reinsurance commutation agreement (the “AORe Commutation Agreement”) to settle all of their obligations to one another under various reinsurance agreements. Pursuant to the AORe Commutation Agreement, AORe paid $64.8 million to FGIC, and FGIC reassumed approximately $4.3 billion of par exposure previously ceded to AORe. In accordance with SSAP 62, FGIC recognized an underwriting gain of approximately $0.8 million from the completion of the AORe Commutation Agreement in the year ended December 31, 2012.

The amount deducted from unearned premiums for reinsurance ceded to other companies was $10.7 million and $612.2 million at December 31, 2013 and 2012, respectively. The amount of commissions that would be required to be returned by the Company if all reinsurance was canceled was $3.1 million and $124.7 million at December 31, 2013 and 2012, respectively. The amount deducted from loss reserves for reinsurance ceded was $203.6 million and $76.1 million at December 31, 2013 and 2012, respectively. The amount of loss adjustment expenses for reinsurance ceded was $3.2 million and $1.4 million for December 31, 2013 and 2012, respectively.

Amounts payable or recoverable for reinsurance on paid or unpaid losses are not subject to periodic or maximum limits.



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10. Loss Reserves – December 31, 2013

In accordance with NYSDFS Guidelines, FGIC records loss reserves for any reporting period ending on or after the Effective Date in an amount equal to the excess at the applicable reporting date of (i) the amount of FGIC’s admitted assets minus FGIC’s Minimum Surplus Amount (currently $66.4 million) over (ii) the sum of FGIC’s statutory reserves excluding loss reserves (e.g., unearned premiums, contingency reserves, loss adjustment expense reserves) and other liabilities. The loss reserve amount comprises the total amount of (i) the Claims Reserve, (ii) the DPO for all policies and (iii) the DPO Accretion for all policies, minus the Policy Revision Adjustment. The Policy Revision Adjustment shown in the table below is prescribed by NYSDFS Guidelines and reflects the reduction in the loss reserve components necessary to reflect a Minimum Surplus Amount of $66.4 million. Under GAAP, unpaid losses are reported on a gross basis (i.e., before reinsurance), and are discounted based on the risk-free rate for the anticipated shortfall in excess of the related unearned premium revenue, and the Policy Revision Adjustment is not recognized.

The loss reserve components as of December 31, 2013 are summarized as follows:

(In Thousands) Claims Reserve $ 3,429,852

DPO DPO Accretion Total 3,429,852 Policy Revision Adjustment (2,062,464)

Loss reserve as of December 31, 2013 $ 1,367,388



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10. Loss Reserves – December 31, 2013 (continued)

Claims Reserve

The Claims Reserve is calculated on a policy-by-policy basis for insured obligations as the sum, net of reinsurance, of (x) the total amount of all policy claims submitted to FGIC in accordance with the Rehabilitation Plan that are unpaid as of December 31, 2013 (excluding any portion of such policy claims that are being disputed by FGIC) and (y) the net present value of the total amount of all policy claims the Company expects to receive in the future in accordance with the Rehabilitation Plan determined as of December 31, 2013 (using the prescribed statutory discount rate which is based upon the average rate of return on the Company’s admitted assets, which was 2.92% at December 31, 2013). The amount of the discount as of December 31, 2013 was $960. million. For reporting periods ending prior to the Effective Date, the loss reserve established by the Company would have been equivalent to the Claims Reserve.

Permitted policy claims that are paid by FGIC in accordance with the Rehabilitation Plan are not included in the Claims Reserve; the DPO portion of such claims will, however, be reflected in the DPO balance. No permitted policy claims were paid by FGIC pursuant to the Rehabilitation Plan on or prior to December 31, 2013.

The net present value of the total amount of all policy claims the Company expects to receive in the future is determined for each policy using internally developed cash flow projections or other methods for estimating losses and represents an estimate of the anticipated shortfall between (1) the insured payments of principal and interest due on the insured obligations and (2) the insured payments of principal and interest due on the insured obligations that are anticipated to be made by the issuer or other obligor of the insured obligations, including payments from the projected cash flows from, and proceeds to be received on, any collateral or other security supporting the insured obligation and/or other anticipated recoveries and/or premiums expected to be earned and/or collected in the future.

The Company’s cash flow projection models are dependent on a number of assumptions that require management to make judgments about the outcome of future events based on facts and circumstances at the time such estimates are made, including historical and current market data. Significant assumptions include the liquidation value of the assets supporting the insured obligations, the volume and timing of collateral cash flows and the behavior of the underlying borrower. In addition, FGIC’s liability in RMBS, asset-backed securities and other securitization transactions, as such liability may be modified by the Rehabilitation Plan, is governed by the



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structure of the waterfall of cash flows in the transaction documents, which may be subject to interpretation. Changes in any significant assumptions from time to time will affect the Company’s calculations of the amount of policy claims the Company expects to receive in the future, but will not affect the Company’s loss reserve or operating results due to and as long as there is the Policy Revision Adjustment.

If the Company identifies credit impairment and determines that policy claims are probable and estimable under a particular policy, the Claims Reserve is increased to reflect such expected claims under such policy.

The Company believes that the Claims Reserve as of December 31, 2013 is adequate to reflect the sum of (i) the net policy claims submitted to the Company in accordance with the Rehabilitation Plan that are unpaid and not objected to by FGIC as of such date and (ii) the net policy claims that are expected to be received by FGIC in the future. However, the establishment of the appropriate level of the Claims Reserve to reflect the future policy claims expected by the Company is an inherently uncertain process involving numerous estimates and subjective judgments by management, and differences between estimated and actual results may be material. Small changes in the assumptions underlying these estimates could result in significant changes in the Company’s loss expectations. There can be no assurance that the Company’s estimate of the Claims Reserve is accurate. Accordingly, there can be no assurance that the total amount of policy claims permitted by the Company after December 31, 2013 will not exceed or be less than its Claims Reserve at December 31, 2013, and it is possible that they could significantly exceed such reserve.

Additionally, further deterioration in the performance of RMBS and changes in the financial condition of certain Public Finance obligations including Detroit and Puerto Rico credits insured by the Company could lead to an increase in the Claims Reserve.



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Activity related to the Claims Reserve for the year ended December 31, 2013 is summarized as follows:

(In Thousands) Loss reserves, January 1, 2013 $ 3,863,104 Incurred (releases) related to:

Current year 1,048,509 Prior years (1,453,543)

Total releases (405,034) Recoveries related to:

Current year 1,966 Prior years (25,437)

Total recoveries (23,471) Claims Reserve before offset as of December 31, 2013 3,434,599 Less: premiums receivable offset (4,747) Claims Reserve as of December 31, 2013 $ 3,429,852

In January 2014, FGIC made its first payments in cash totaling $255.5 million to policyholders for permitted policy claims related to the period from the 1310 Order through the Effective Date at the then-current CPP of 17.00%. The Company will continue to pay permitted claims in accordance with the Rehabilitation Plan.

The Claims Reserve as of December 31, 2013 includes a reduction in the amount of $4.7 million related to unpaid premium amounts owed and not paid to FGIC in respect of certain policies as of December 31, 2013, which have been offset against unpaid claims in accordance with the Restructured Policy Terms.

The Claims Reserve decreased to $3.4 billion at December 31, 2013 from $3.9 billion of loss reserves at December 31, 2012. The net Claims Reserve activity for the year ended December 31, 2013 was mainly attributable to (a) a reduction in estimated losses associated with (i) the policies insuring RMBS that are subject to the FGIC-ResCap Settlement (see Note 17), (ii) the policies insuring sewer warrants issued by Jefferson County, Alabama, (iii) a policy insuring



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an ABS CDO that was consensually terminated and (iv) a policy insuring certain first lien RMBS that was consensually terminated and (b) the benefits associated with the consensual commutation of certain reinsurance agreements, which was partially offset by higher estimated policy claims for (i) public finance transactions arising from changes in the Company's views concerning the insured public finance obligor's ability to make debt service payments when due and (ii) RMBS backed by first lien mortgage loans arising from deteriorating mortgage loan performance and projected increases in insured interest obligations due to changes in the forward LIBOR curve. The Claims Reserve at December 31, 2013 relates predominantly to RMBS transactions and Public Finance transactions.

The Company evaluates the portfolio of insured financial obligations on a regular basis to determine if there has been credit deterioration. The Company evaluates such factors as rating agency downgrades, significant changes in a specific industry and specific events impacting a particular credit, such as a negative credit event, performance below expectations, breaches of representations, warranties, covenants or deal triggers, management changes, regulatory changes, material litigation and other legal issues. Based on the Company’s evaluation of these and other factors, the Company assigns credits to risk ratings categories, which assignment determines the level of on-going monitoring and surveillance efforts required and whether a Claims Reserve is recorded.

The Company uses the following risk categories to define and monitor insured financial obligations:

Risk Category 1 – Performing Credits

Transactions are performing with no expectation of loss. Financial strength of the transaction would enable it to withstand volatility in performance without risk of non-payment on timely debt service. Transactions are considered to be investment grade by the Company. Although rating changes may occur, it is not expected that a downgrade would be to below investment grade.

Risk Category 2 – Watchlist Credits Under Heightened Surveillance

Credits in this category typically would be considered marginal investment grade or higher rated “non-investment grade”. Credits in this risk category have been determined to require heightened surveillance, taking into account the totality of circumstances surrounding the particular credit, but have not deteriorated to the level that they would be considered impaired and require a Claims Reserve.



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Risk Category 3 – Watchlist Credits Experiencing Credit Deterioration

Credit deterioration has occurred and there is substantial uncertainty as to the credit’s ability or willingness to pay its debt service obligations in a timely manner. Credits in this category typically would have suffered sustained negative trends or would have been the subject of a significant adverse event, but are currently not in payment default. Credits in this category have been determined to be impaired, and there is an increased probability of default, but FGIC has not determined, or been able to determine, that policy claims are probable and estimable.

Risk Category 4 – Watchlist Credits Currently or Likely to Be in Payment Default

Credits that have deteriorated to the point where payment default on their debt service obligations has occurred or is probable and the ultimate loss can be reasonably estimated. Claims Reserves are established on a case basis and are inclusive of any anticipated recoveries from the particular credit or the related collateral. Credits in this category would be consistent with the lowest or in-default credit ratings. Credits in risk category 4 are reviewed and updated on at least a quarterly basis for any change in status.



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The following table is a breakdown, as of December 31, 2013, of the Company’s portfolio of insured financial obligations assigned to risk category 4:

Risk Category 4


Number of policies 87

Remaining weighted-average contract period (in years) 21

Insured contractual payments outstanding: Principal $ 7,018,730 Interest 1,354,469

Total $ 8,373,199

Gross Claims Reserve $ 5,431,504 Less:

Gross projected recoveries (577,819)Discount, net (1,047,819)

Gross Claims Reserve, net of discount and projected recoveries $ 3,805,866

Unearned premiums $ 30,394

Reinsurance recoverable reported in the balance sheet $ 228 In RMBS, asset-backed securities and other securitization transactions insured by FGIC, the structure of the waterfall of cash flows in the transaction documents and applicable terms and conditions of the Rehabilitation Plan may permit FGIC to recover claims paid from subsequent cash flows. The projected recoveries in the above table reflect FGIC’s current estimate of these recoveries, but there can be no assurance that such recoveries will be received by FGIC. The Company’s insured financial obligations are structured to provide for rights and remedies in order to mitigate claim loss exposure. Loss mitigation activities may include making repurchase claims or pursuing other claims for breaches of representations and warranties by the originator or others, obtaining appraisals of collateral or reviews of loan files, enforcing collateral provisions and covenants of the servicer or others, more frequent meetings with the issuer or



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servicer, evaluating the financial position of the originator or servicer, renegotiating financial covenants, triggers, or terms of servicing, enforcing rights to remove and replace the servicer, evaluating restructuring plans or bankruptcy proceedings, and commencing litigation or arbitration proceedings as and where appropriate. There can be no assurance that any loss mitigation efforts will be successful, or as to the magnitude of any benefit that might be derived from any such efforts that are successful.

In accordance with the Rehabilitation Plan, each reinsurer is obligated to pay FGIC in full in cash for such reinsurer’s reinsured portion of the entire amount of each permitted policy claim covered by the reinsurance, in each case without giving effect to the modification of FGIC’s policy obligations and regardless of the amount paid in cash by FGIC on account of such policy claim. Any reinsurance recoverable on losses is calculated in a manner consistent with the calculation of gross Claims Reserve and reflected in the Claims Reserve as a reduction of the liability. During 2013, FGIC received funds from reinsurers in payment of their proportionate reinsurer’s share of claims on reinsured policies, which decreased the reinsurance recoverable, thus increasing the Claims Reserve liability.

DPO

When FGIC pays (or is deemed to have paid) in cash the CPP of a permitted policy claim, the remaining unpaid balance of such permitted policy claim will be added to the DPO under the related policy. Upon payment by FGIC, permitted policy claims with distribution or scheduled payment dates on or after the date of the Rehabilitation Order (June 28, 2012) are generally deemed to have been paid by FGIC as of the distribution or scheduled payment date to which the particular claim relates, even though the actual payment date typically will occur later. Upon payment by FGIC, permitted policy claims with distribution or scheduled payment dates prior to the Rehabilitation Order are generally deemed to have been paid as of the first distribution or scheduled payment date after the date of the Rehabilitation Order, even though the actual payment date will occur later. Accordingly, upon payment of a permitted policy claim by FGIC, the DPO will be increased and deemed to exist as of such applicable distribution or scheduled payment date. Because no permitted policy claims were paid by FGIC pursuant to the Rehabilitation Plan on or prior to December 31, 2013, no DPO balances were established on or prior to that date.



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If, as a result of any CPP Revaluation, the CPP is adjusted upward, FGIC will be obligated to make payments to the applicable policy payee in respect of the DPO under each policy to true up the amounts of cash paid (or deemed to have been paid) by FGIC in respect of permitted policy claims paid at the prior CPP, which cash payments (or deemed cash payments) will reduce the DPO by an equal amount. As FGIC did not pay any permitted policy claims prior to December 31, 2013, the DPO balance as of December 31, 2013 was $0.

DPO Accretion

Under the Restructured Policy Terms, each policy with an outstanding DPO shall accrue DPO Accretion based on such DPO at a rate of 3% per annum (on a daily basis on the basis of a 365-day year). DPO Accretion shall be calculated using the DPO with respect to the applicable policy as of the preceding June 30 or, with respect to the first year in which there is a DPO under such policy and until the next June 30, the first day on or after the Effective Date on which the DPO exists (the “First Payment Date”). DPO Accretion for any policy with a DPO shall commence on the First Payment Date for such policy and continue until such time (if ever) as the DPO for such policy is permanently reduced to zero. All DPO Accretion shall be calculated on a simple basis rather than a compound basis (i.e., no DPO Accretion shall accrete based on accumulated DPO Accretion). No DPO Accretion shall be added to a DPO, but shall be recorded separately. If, as a result of any CPP Revaluation, the CPP is adjusted upward, it is expected that FGIC will pay in cash to the applicable policy payee a portion of the DPO Accretion under each policy having a DPO, which will reduce the DPO Accretion balance. Because no DPO balances were established on or prior to December 31, 2013, the DPO Accretion balance was $0 at that date. However, with respect to policies that have permitted policy claims with distribution or scheduled payment dates on or prior to August 19, 2013 (the Effective Date) that are paid by FGIC (including any such permitted policy claims paid by FGIC in January 2014), the DPO relating to such policy claims will be deemed to exist on August 19, 2013, and DPO Accretion shall begin to accrue as of that date; this DPO Accretion shall be recorded in future reporting periods.



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11. Loss Reserves – December 31, 2012

Activity for loss reserves for the year ended December 31, 2012 is summarized as follows:

In Thousands Net balance as of January 1, 2012 $ 4,925,116 Incurred (releases) related to:

Current year 2,710 Prior years (975,257)

Total releases (972,547) (Paid) recoveries related to:

Current year 2 Prior years (89,467)

Total paid (89,465) Net balance as of December 31, 2012 $ 3,863,104

The loss reserve established by the Company for reporting periods ending prior to the Effective Date would have been equivalent to the Claims Reserve. The discussion in Note 10 concerning the Claims Reserve and the Company’s calculation of the Claims Reserve applies to the calculation of the loss reserve for such periods.

In reporting periods prior to the Effective Date, a loss reserve was recognized on a contract-by-contract basis for insured obligations as the present value of expected net cash outflows to be paid under the contract using a discount rate as of the measurement date. The discount rate used in calculating the net present value of estimated losses was based upon the average rate of return on the Company’s admitted assets, which was 2.72% at December 31, 2012. Changes to the measurement of the loss reserves were recognized as losses incurred in the period of change. The amount of the discount as of December 31, 2012 was $789.4 million.

12. Loss Adjustment Expense Reserves

The Company estimates a loss adjustment expense reserve based on the ultimate future net cost, determined using internally developed estimates, of the efforts involved in managing and mitigating existing and future policy claims.



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12. Loss Adjustment Expense Reserves (continued)

Activity in the loss adjustment expense reserve is summarized as follows:

Year Ended December 31, 2013 2012 (In Thousands)

Net balance at beginning of year $ 33,326 $ 67,750 Incurred (released) related to:

Current year 25,357 Prior years 14,421 (5,012)

Total (released) incurred 39,778 (5,012) Paid related to:

Current year (4,933) Prior years (25,749) (29,412)

Total paid (30,682) (29,412) Net balance at end of year $ 42,422 $ 33,326

13. Related Party Transactions

On February 3, 2012, FGIC entered into a Plan Sponsor Agreement with FGIC Corp. pursuant to which FGIC agreed to act as the sponsor of FGIC Corp.’s Reorganization Plan and make a cash payment to FGIC Corp. in the amount of $11.0 million on the terms and subject to the conditions set forth in the Plan Sponsor Agreement. On April 19, 2013, the Chapter 11 Effective Date, pursuant to the Plan Sponsor Agreement and the Reorganization Plan, (i) FGIC made a cash payment to FGIC Corp. in the amount of $11.0 million, (ii) FGIC Corp., FGIC and certain subsidiaries of FGIC entered into an amended and restated income tax allocation agreement, (iii) FGIC Corp. and FGIC entered into an amended and restated space and cost sharing agreement, and (iv) FGIC Corp. issued to FGIC’s designee one share of FGIC Corp.’s Class B Common Stock, which represents all the authorized shares of Class B Common Stock and entitles the holder to certain consent rights relating to FGIC Corp.



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13. Related Party Transactions (continued)

At December 31, 2012, affiliates of the Blackstone Group L.P., the Cypress Group L.L.C. and CIVC Partners L.P. owned approximately 39.5%, 39.5% and 12% of FGIC Corp.’s common stock, respectively. As of December 31, 2012, an affiliate of General Electric Capital Corp. owned 2,346 shares, or 100%, of FGIC Corp.’s senior participating mandatorily convertible modified preferred stock, and approximately 7.7% of FGIC Corp.’s outstanding common stock. Upon the completion of the transactions contemplated by FGIC Corp.’s Reorganization Plan on the Chapter 11 Effective Date, the then existing equity of FGIC Corp., including the above holdings, was canceled, and the creditors of FGIC Corp. acquired the new equity of reorganized FGIC Corp. No entity holds more than 10% of the new equity other than one entity that has applied to the NYSDFS for a determination of non-control pursuant to Section 1501(c) of the NYIL.

In 2009, FGIC and their legal counsel engaged Blackstone Advisory to be the exclusive financial advisor in connection with a FGIC restructuring or remediation. The Company incurred expenses related to this engagement of $0 and $1.2 million during the years ended December 31, 2013 and 2012, respectively. Blackstone Advisory ceased providing services to FGIC prior to entry of the Rehabilitation Order.

Under the NYIL, any contribution by the Company to FGIC UK Ltd. cannot exceed 35% of the Company’s surplus to policyholders or 50% of its statutory surplus over and above its liabilities and capital (statutory earned surplus, at the time of such contribution), without the prior approval of the NYSDFS. At December 31, 2013 and 2012, the Company’s aggregate investment in FGIC UK Ltd. exceeded such amounts. As a result, the Company is required to obtain NYSDFS approval prior to making additional capital contributions to FGIC UK Ltd.

FGIC Credit Products issued CDS to certain buyers of credit protection. FGIC issued financial guaranty insurance policies for the benefit of the counterparties to CDS issued by FGIC Credit Products, which guaranteed timely payment of FGIC Credit Products’ payment obligations under the CDS. As of December 31, 2012, all such underlying FGIC-insured CDS had been terminated. The Company recorded premiums written and earned of $3.5 million and $4.4 million during 2012, respectively, related to these policies. The total par outstanding on these policies was $0 at both December 31, 2013 and 2012.



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13. Related Party Transactions (continued)

The Company shares office facilities and personnel with its affiliates. Such shared costs and expenses are allocated to affiliates and vary depending on the assumptions underlying the allocations. The Company allocated overhead costs of $0.1 million and $0.2 million to FGIC Corp. for the years ended December 31, 2013 and 2012, respectively. The Company allocated overhead costs of $1.5 million and $1.9 million to its wholly-owned subsidiaries in 2013 and 2012, respectively.

14. Compensation Plan

Since January 1, 2004, the Company has offered a defined contribution savings plan under Section 401(k) of the Internal Revenue Code (the “401(k) Plan”). This plan covers substantially all employees who meet minimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis (for 2013, up to $17,500 for employees under age 50, plus an additional “catch up” contribution of up to $5,500 for employees 50 and older). The Company may also make discretionary contributions to the plan on behalf of employees. The Company contributed $0.3 million and $0.4 million to the plan on behalf of employees for the years ended December 31, 2013 and 2012, respectively.

15. Dividends

Under the Rehabilitation Plan, equity interests (i.e., the interests of any holders of the issued and outstanding shares of the common or preferred stock of the Company remain in existence; provided, however, that no holder of any of these shares shall be entitled to any distributions, dividends or other payments on account of its shares until all actual and expected permitted secured claims, permitted administrative expense claims, permitted policy claims, permitted non-policy claims and permitted late-filed claims are paid in full in cash or fully reserved for, as determined by FGIC with the express written consent of the NYSDFS.

During the years ended December 31, 2013 and 2012, FGIC did not declare or pay dividends.

16. Underwriting Exposure

Concentrations of Credit Risk

The Company’s insured portfolio as of December 31, 2013 was diversified by geographic and bond market sector, with no single obligor representing more than 5.7% of the Company’s net par outstanding.



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16. Underwriting Exposure (continued)

The following presents the Company’s net par outstanding by category as of December 31, 2013:

Net Par Outstanding

% of Total

(Dollars in Thousands) Public Finance

General obligation $ 2,729,330 13.5%Leases 1,623,561 8.1 Healthcare 270,384 1.3 Other Tax Back 932,667 4.6 Global Utilities 1,846,257 9.2 Transportation 2,927 0.0 Higher Education 75,120 0.4 Project Finance 691,105 3.4 Housing 569,420 2.8 Water and Sewer 681,305 3.4 Other Public Finance 156,686 0.8

Total Public Finance 9,578,762 47.5% Structured Finance

Auto ABS 4,657 0.0%ABS CDO 198,062 1.0 Insurance 981 0.0 Other Structured Finance 303,063 1.5 Pooled Aircraft/Aircraft Engines 1,256,317 6.2 Receivables 23,742 0.1 RMBS 6,397,862 31.7 Student Loan 250,000 1.3 Total Structured Finance 8,434,684 41.9

International Sub-Sovereign 4,202 0.0%

Utility 469,850 2.3 Toll Road 12,582 0.1 Project Finance 1,495,889 7.4 Other Structured Finance 156,742 0.8 Total International 2,139,265 10.6 Total $ 20,152,711 100.0%



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As of December 31, 2013, the Company’s total net par outstanding relating to RMBS aggregated approximately $6.4 billion, representing approximately 31.7% of the Company’s total net par outstanding at such date. The RMBS exposure consisted of various collateral types as set forth in the table below.

Number of Policies

OutstandingNet Par

Outstanding % of Total (Dollars in Thousands) Alt-A (1st lien) 15 $ 757,714 11.8%HELOC 23 2,212,524 34.6 High LTV 1 7,969 0.1 Closed end seconds 9 1,502,462 23.5 Subprime (1st lien) 43 1,745,942 27.3 Prime (1st lien) 5 171,251 2.7 Total 96 $ 6,397,862 100.0%

As of December 31, 2013, the Company’s total net par outstanding relating to ABS CDOs was approximately $198.1 million, representing approximately 1.0% of the Company’s total net par outstanding at such date. Such exposure was terminated in January 2014.

Underlying Collateral

Number of Transactions

Net Par Outstanding % of Total

(Dollars in Thousands) Mezzanine ABS (ABS CDOs) 1 $ 198,062 100.0%Total 1 $ 198,062 100.0%



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As of December 31, 2013, the composition of par outstanding ceded to reinsurers was as follows:

Reinsurer

Reinsurer Rating

(S&P/Moody’s)

Ceded Principal

Outstanding Ceded UPR

Reinsurance Recoverable on Paid and

Unpaid Losses (Dollars in Thousands) Assured Guaranty Re Ltd. AA-/Baa1 $ 1,229,942 $ 10,348 $ 206,852 Assured Guaranty Corp. AA-/A3 57,150 297 26 Assured Guaranty Re Overseas Ltd. AA-/Baa1 712 9 Axa Assurances IARD A+/Aa3 6,907 19 Toa Re America A+/NR 523 3 14 Other 323 1 75 Total $ 1,295,557 $ 10,668 $ 206,976 17. Legal Proceedings

In City of Phoenix v. Ambac Financial Group, Inc., et al. (United States District Court, District of Arizona, filed on or about March 11, 2010), FGIC is named as a defendant in a lawsuit in which the plaintiff asserts causes of action based principally on alleged violations of Arizona insurance law prohibiting unfair discrimination in the rate or amount of premium charged. FGIC filed an answer to the complaint in May 2010. The case has been stayed as against FGIC by stipulation of the parties since November 2012.

In Wilson v. JP Morgan Chase & Co., et al. (Circuit Court of Jefferson County, Alabama, filed on or about June 17, 2008), FGIC and a number of other defendants were named in a purported class action case on behalf of customers that paid for sewer service within Jefferson County, Alabama (“Jefferson County”), since January 1, 1993. On December 15, 2011, the case was transferred to the U.S. Bankruptcy Court for the Northern District of Alabama, Southern Division, which was hearing the Chapter 9 bankruptcy proceeding commenced by Jefferson County. Pursuant to the order confirming Jefferson County’s plan of adjustment entered by the Bankruptcy Court on November 22, 2013, this litigation has been dismissed with prejudice as to all defendants, including FGIC.



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17. Legal Proceedings (continued)

FGIC has received various subpoenas, regulatory inquiries, requests for information and document preservation letters. In addition, FGIC is involved from time to time in various routine legal proceedings.

Management is unable to make a meaningful estimate of the amount or range of loss that could result from unfavorable outcomes in the litigation against FGIC. However, pursuant to the Rehabilitation Plan, all persons are prohibited from commencing, continuing, advancing or otherwise prosecuting any litigation against FGIC with respect to any claims that arose or relate to the period prior to the Effective Date, such as the claims asserted in the lawsuits described above. Furthermore, should any claims against FGIC for monetary damages be awarded in any such lawsuit notwithstanding the injunctive relief in the Rehabilitation Plan, such claims would constitute non-policy claims under the Rehabilitation Plan. Pursuant to the Rehabilitation Plan, claims (other than policy claims) against FGIC arising during, or relating to, the period prior to the Effective Date constitute non-policy claims, and FGIC has no obligation to make any payments in respect of such non-policy claims until all actual and expected permitted policy claims are paid in full in cash or fully reserved for. FGIC does not expect to have the ability to pay all permitted policy claims in full in cash, and accordingly it does not expect to make any payments pursuant to the Rehabilitation Plan with respect to non-policy claims.

It is not possible to predict whether additional lawsuits or other proceedings will be filed against FGIC, including lawsuits as to which previously filed claims against FGIC have been dismissed, either voluntarily or by an order that has not become final and non-appealable, or whether FGIC will receive additional subpoenas, regulatory inquiries, requests for information or document preservation letters, and it is also not possible to predict the outcome of any of the foregoing. Additionally, defending against lawsuits and proceedings and responding to subpoenas, regulatory inquiries, requests for information and document preservation letters may involve significant expense and diversion of management’s attention and other FGIC resources.

FGIC has asserted, and from time to time may assert, claims in legal or arbitration proceedings against third parties to recover losses already incurred by FGIC or to mitigate future losses that FGIC may incur, including the lawsuits described below. The amount of losses that FGIC may recover or mitigate as a result of these proceedings is uncertain, although, in the event of favorable outcomes or settlements, such amount could be material to FGIC’s results of operations, financial position, profitability or cash flows.



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In Financial Guaranty Insurance Co. v. Countrywide Home Loans, Inc. (N.Y. Sup.Ct., Index No. 650736/2009, filed on December 11, 2009), FGIC sued Countrywide, alleging fraud and negligent misrepresentation by Countrywide and its affiliates in the origination of several RMBS transactions that closed in 2006 and 2007, and breach of contract in connection with Countrywide’s failure to repurchase certain mortgage loans as provided by the operational agreements for those RMBS transactions, as well as a number of other RMBS transactions that closed in the period from 2004 to 2005. On April 30, 2010, FGIC filed an amended complaint adding Countrywide Financial Corp., Countrywide Securities Corporation, Countrywide Bank, FSB, and Bank of America Corporation (“BAC”) as defendants. FGIC’s complaint alleges damages to FGIC in excess of $1 billion.

In February 2010, Countrywide filed a motion to dismiss certain of FGIC’s claims in its initial complaint. On June 15, 2010, Countrywide’s motion to dismiss was generally denied by the court, but granted with respect to FGIC’s claims based on negligent misrepresentation and the breach of the covenant of good faith. The court’s ruling on Countrywide’s motion to dismiss has become final since, on October 20, 2011, FGIC and Countrywide jointly filed a stipulation withdrawing their respective appeals of the court’s ruling on Countrywide’s motion to dismiss.

On June 3, 2011, BAC filed a motion for the severance of FGIC’s successor liability claim against BAC from FGIC’s other claims in this case, and the consolidation of the successor liability claim with similar claims forming parts of three other cases brought by bond insurance companies against Countrywide and BAC. On October 31, 2011, the court denied BAC’s motion insofar as it applied to discovery, but held in abeyance the motion insofar as it applies to trial of the successor liability claim, until final submission of summary judgment motions on the successor liability claim in FGIC’s or any of the other bond insurance companies’ cases. BAC appealed the court’s decision on BAC’s motion to the Appellate Division of the N.Y. Supreme Court; on April 5, 2012, the Appellate Division unanimously affirmed the decision of the lower court.

On January 21, 2014, BAC and Countrywide filed a motion to strike the testimony of an expert witness for FGIC, and FGIC filed a motion to strike the testimony of an expert witness for Countrywide. Oral argument for both motions is scheduled for March 25, 2014.



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From November 2011 through March 2012, FGIC initiated twelve lawsuits against Residential Capital, LLC and one or more of its affiliates, including in certain cases Ally Financial, Inc. and Ally Bank (collectively, the “Ally Financial Actions”), variously alleging against the defendants, with respect to certain RMBS transactions insured by FGIC, fraud and breach of contract claims. On May 14, 2012, Residential Capital, LLC and certain of its direct and indirect subsidiaries (collectively, “ResCap”) filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code. In December 2013, FGIC’s claims against ResCap in the Ally Financial Actions were released and settled when the settlement contemplated by a settlement agreement entered into on May 23, 2013, by ResCap, the trustees (the “ResCap Trustees”) under certain ResCap securitization trusts that issued RMBS insured by FGIC, certain institutional investors, and FGIC (the “FGIC-ResCap Settlement”) was effectuated. Also, in December 2013, FGIC’s claims against Ally Financial, Inc. and Ally Bank in the Ally Financial Actions were released and settled when ResCap’s chapter 11 plan of reorganization (the “ResCap Plan”) became effective. Accordingly, the Ally Financial Actions were dismissed with prejudice in January 2014.

The FGIC-ResCap Settlement provided for, among other things, (1) the settlement of the ResCap Trustees’ present and future policy claims against FGIC in exchange for a $253.3 million payment from FGIC to the ResCap Trustees and FGIC’s release of its rights to receive certain payments under the transaction documents and (2) the settlement of all of FGIC’s outstanding claims against ResCap in exchange for an allowed non-subordinated general unsecured claim in the ResCap bankruptcy. Upon the effective date of the ResCap Plan, (1) FGIC received an increased allowed non-subordinated general unsecured claim in the ResCap bankruptcy and (2) FGIC’s claims against Ally Financial, Inc. and Ally Bank were released and settled.

On December 30, 2013, FGIC received a cash distribution of approximately $149.0 million on the 8,442,870 units of the ResCap Liquidating Trust that FGIC received pursuant to the ResCap Plan in respect of its allowed claims; further amounts may be distributed in the future with respect to the units.

In Financial Guaranty Insurance Company v. The Putnam Advisory Company, LLC (U.S. District Court for the Southern District of New York, filed October 1, 2012 and thereafter amended on November 19, 2012), FGIC sued The Putnam Advisory Company (“Putnam”), alleging fraud, negligent misrepresentation and negligence by Putnam in connection with the Pyxis ABS CDO 2006-1 transaction for which Putnam acted as collateral manager. On September 10, 2013, FGIC’s complaint was dismissed, with leave to file a further amended complaint. On September 30, 2013, FGIC filed a further amended complaint. On October 15, 2013, Putnam moved for dismissal of all of FGIC’s claims, and FGIC filed its opposition to the motion on October 29, 2013. The motion was argued on November 20, 2013.



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In Financial Guaranty Insurance Co. v. Credit Suisse Securities (USA) LLC, et al. (N.Y. Sup.Ct., Index No. 651178/2013, filed on April 2, 2013), FGIC sued Credit Suisse Securities (USA) LLC (“CS Securities”) and DLJ Mortgage Capital, Inc. (“DLJ”), alleging, inter alia, that (i) CS Securities and DLJ fraudulently induced FGIC to insure the RMBS transaction known as Home Equity Mortgage Trust 2006-2 and (ii) DLJ breached various representations, warranties and affirmative covenants, including its obligation to repurchase breaching or fraudulent mortgage loans and to reimburse FGIC for payments made under the related FGIC policy. On June 11, 2013, CS Securities and DLJ filed a motion to dismiss FGIC’s claims, and this motion was fully briefed. On December 24, 2013, the court requested supplemental briefing with respect to the effect of the decision of the Appellate Division in ACE Securities Corp. v. DB Structured Products, Inc., 2013 NY App. Div. LEXIS 8429 (1st Dept. Dec. 19, 2013). The motion to dismiss is scheduled for oral argument on February 26, 2014.

18. Subsequent Events

In addition to subsequent events described elsewhere in these Notes, which include the resumption of claims payments in January 2014, the following subsequent event has occurred:

In February 2014, the Board of Directors determined that the Company shall conduct a new CPP Revaluation pursuant to Section 1.5(A)(ii) of the Restructured Policy Terms with respect to the applicable excess cash recoveries it received within six months of the Effective Date. Such new CPP Revaluation is being conducted in conjunction with the Company’s annual CPP Revaluation, which is currently underway and expected by the Company to be completed by June 30, 2014.

SSAP 9, Subsequent Events defines events subsequent to the financial statement date requiring disclosure. The date through which subsequent events have been evaluated was February 21, 2014.

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