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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

Commission File No. 1-12644

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

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

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

        At May 13, 2003, there were 33,220,337 outstanding shares of Common Stock of the registrant (excludes 297,658 shares of treasury stock).

INDEX

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

See notes to condensed consolidated financial statements.

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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME

(Dollars in thousands)

See notes to condensed consolidated financial statements.

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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY

(Dollars in thousands)

See notes to condensed consolidated financial statements.

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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

See notes to condensed consolidated financial statements.

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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Three Months Ended March 31, 2003 and 2002

1.     ORGANIZATION AND OWNERSHIP

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

2.     BASIS OF PRESENTATION

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

3.     LOSSES AND LOSS ADJUSTMENT EXPENSES

        The Company establishes a case basis reserve for unpaid losses and loss adjustment expenses for the present value of the estimated loss when, in management's opinion, the likelihood of a future loss on a particular insured obligation is probable and determinable at the balance sheet date. The estimated loss on a transaction is discounted using the then current risk-free rates ranging from 4.77% to 6.1%. For collateralized debt obligations, a case basis reserve is recorded to the extent that the overcollateralization ratio (non-defaulted collateral at par value divided by the debt insured) has fallen below 100%.

        The Company also maintains a non-specific general reserve, which is available to be applied against future additions or accretions to existing case basis reserves or to new case basis reserves to be established in the future. The general reserve is calculated by applying loss factors to the Company's total net par underwritten and discounting the result at the then current risk-free rates. The loss factors used for this purpose has been determined based upon an independent rating agency study of bond defaults and the Company's portfolio characteristics and history.

        Management of the Company periodically evaluates its estimates for losses and loss adjustment expenses and establishes reserves that management believes are adequate to cover the net present value of the ultimate net cost of claims.

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4.     STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 133

        FSA has insured a number of credit default swaps that it intends, in each case, to hold for the full term of the agreement. It considers these agreements to be a normal extension of its financial guaranty insurance business, although they are considered derivatives for accounting purposes. These agreements are recorded at fair value. The Company believes that the most meaningful presentation of the financial statement impact of these derivatives is to reflect premiums as installments are received, to record losses and loss adjustment expenses as incurred and to record changes in fair value as incurred. The Company recorded $11.2 million and $7.0 million in net earned premium under these agreements for the quarters ended March 31, 2003 and March 31, 2002, respectively. The changes in fair value, which were gains of $1.5 million and losses of $4.5 million for the quarter ended March 31, 2003 and 2002, respectively, were recorded in net realized and unrealized losses on derivative instruments in the consolidated statements of operations and comprehensive income and in other assets or liabilities. The losses or gains recognized by recording these contracts at fair value will be determined each quarter based upon market pricing of Super Triple-A (defined as having first-loss protection of 1.3 times the level required for a Triple-A rating) swap guarantees. The Company does not believe the fair value adjustments are an indication of potential claims under FSA's guarantees. The inception-to-date net unrealized loss was recorded in other liabilities and was $42.7 million and $44.2 million at March 31, 2003 and December 31, 2002, respectively.

        Derivative instruments, which are primarily designated as fair-value hedges, are entered into to manage the interest rate exposure of the Company's GICs and GIC bond portfolio and are recorded at fair value. These derivatives generally include interest rate futures and interest rate swap agreements, which are primarily utilized to convert the Company's fixed-rate obligations on its GICs and GIC bond portfolio into floating-rate obligations. The gains and losses relating to these fair-value hedges are included in guaranteed investment contract net interest income and net interest expense, as appropriate, along with the offsetting change in fair value of the hedged item attributable to the risk being hedged, on the consolidated statements of operations and comprehensive income. For the quarters ended March 31, 2003 and 2002, the Company recorded a net loss of $4,509,000 and a net gain of $627,000, respectively, relating to the ineffectiveness of these hedges.

5.     OUTSTANDING EXPOSURE

        The Company limits its exposure to losses from writing financial guarantees by underwriting investment-grade obligations, diversifying its portfolio and maintaining rigorous collateral requirements on asset-backed obligations, as well as through reinsurance. The principal amounts of insured obligations in the asset-backed insured portfolio are backed by the following types of collateral (in millions) at March 31, 2003 and December 31, 2002:

(1)

Excludes $2,517 million and $2,430 million, in 2003 and 2002, respectively, in "Net of Amounts Ceded" relating to FSA-insured GICs issued by CMS.

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

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

7.     GUARANTEED INVESTMENT CONTRACTS

        The obligations under GICs may be called at various times prior to maturity based upon certain agreed-upon events. As of March 31, 2003, the interest rates on these GICs were between 1.2725% and 5.95% per annum.

        Payments due under these GICs, excluding mark-to-market adjustments of $15.3 million, in the remainder of 2003 and each of the next five years ending December 31 and thereafter, based upon expected withdrawal dates, are as follows (in millions):

8.     SEGMENT REPORTING

        The Company operates in two business segments, financial guaranty and financial products. The financial guaranty segment is primarily in the business of providing financial guaranty insurance on asset-backed and municipal obligations. The financial products segment presently consists of the Company's GIC operations. The GICs provide for the return of principal and the payment of interest at a guaranteed rate. The following table is a summary of the financial information (in thousands) by segment as of and for the quarters ended March 31, 2003 and 2002:

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        The inter-segment assets are intercompany loans that are in the financial products investment portfolio. The inter-segment revenues relate to premiums charged by the financial guaranty segment for insuring GICs, and interest income and interest expense on the inter-segment loans.

9.     RECENTLY ISSUED ACCOUNTING STANDARDS

        In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities" (FIN No. 46), which is an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements". FIN No. 46 addresses consolidation of VIEs which have one or both of the following characteristics: (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity; and (ii) the equity investors lack the direct or indirect ability to make decisions about the entity's activities through voting rights or similar rights, the obligation to absorb the expected losses of the entity if they occur or the right to receive the expected residual returns of the entity if they occur. The provisions of FIN No. 46 will be effective immediately for VIEs created after January 31, 2003 and for VIEs in which an enterprise obtains an interest after that date. For VIEs in which an enterprise holds a variable interest that it acquired prior to February 1, 2003, the interpretation is effective in the first fiscal year or interim period beginning after June 15, 2003. Management believes that the implementation of FIN No. 46, on July 1, 2003, will cause the Company to consolidate for financial reporting purposes, for the first time, FSA Global Funding Limited (FSA Global) and Canadian Global Funding Corporation (Canadian Global). FIN No. 46 requires that, upon consolidation, the Company shall initially measure the VIE's assets, liabilities and minority interest at their carrying amounts under existing GAAP as if the entity had been consolidated from the time the Company was considered its primary beneficiary (or parent). Any differences upon consolidation on July 1, 2003 will be reflected as a cumulative effect of a change in accounting principle. At March 31, 2003, FSA Global had total assets and total liabilities of approximately $9.5 billion and $9.5 billion, respectively. The foregoing assets and liabilities include assets and matched liabilities that are "economically defeased" in lease financings in which Company affiliates may play a number of financing roles. These economically defeased liabilities and associated assets are held in separate special purpose entities, FSA Global and Premier International Funding Co. At March 31, 2003, FSA Global's economically defeased obligations were $6.9 billion. FSA Global's net income for the quarter ended March 31, 2003 was $0.3 million. FSA Global's net income is determined net of premiums paid by FSA Global to FSA. For the quarter ended March 31, 2003, FSA Global paid premiums to FSA of approximately $1.2 million. All amounts insured by FSA relating to FSA Global are included in the Company's outstanding exposure, included in the Notes to the Condensed Consolidated Financial Statements for March 31, 2003. As of March 31, 2003, there were no case basis reserves required for any transactions related to FSA Global. At March 31, 2003, Canadian Global had total assets of approximately $197.5 million, of which $87.6 million has been invested in GICs issued by CMS. As of March 31, 2003, the Company was carrying gross and net case basis reserves of $17.0 million and $4.2 million, respectively, against transactions refinanced by Canadian Global. The carrying amounts of assets, liabilities and minority interest of FSA Global and Canadian Global may change significantly from March 31, 2003 to July 1, 2003 as a result of transactions entered into during that period. The Company will continue to analyze the effects of FIN No. 46, considering the timing of its release and the complexity of practical application to the Company's transactions.

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10.   SUBSEQUENT EVENT

        In the second quarter of 2003, Standard & Poor's Ratings Services and Moody's Investors Service, Inc. downgraded the servicer ratings of Fairbanks Capital Corp., the operating subsidiary of Fairbanks Capital Holding Corp. (Fairbanks), from "strong" to "below average". The downgrades were attributable in part to operational and regulatory compliance issues, including uncertainties associated with pending investigations of Fairbanks by regulators. The adverse rating actions constituted events of default under certain of Fairbanks' loan agreements, leading to ongoing discussions between Fairbanks and its lenders. Fairbanks provides mortgage servicing for a substantial portion of the mortgage-backed securities insured by FSA. Fairbanks is owned 56.8% by The PMI Group Inc. and 29.8% by the Company, with the remainder owned by Fairbanks' management. At March 31, 2003, the Company's interest in Fairbanks had a book value of $63.4 million, of which $7.5 million represented goodwill. For the quarter ended March 31, 2003, the Company's equity in the earnings of Fairbanks was $3.4 million. The impact of these adverse developments at Fairbanks upon the value of the Company's investment and the related consolidated earnings remains uncertain at this time.

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

Results of Operations

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

2003 and 2002 First Quarter Results

        The Company's 2003 first quarter net income was $65.8 million, compared with net income of $54.1 million for the same period in 2002. Operating earnings was $64.8 million for the first quarter of 2003 compared to $57.0 million for the first quarter of 2002. In the first quarter of 2003, net income was positively affected by $1.0 million of mark-to-market adjustments for pooled credit default swaps (CDS) under Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133). In the first quarter of 2002, net income was negatively affected by $2.9 million of mark-to-market adjustments for CDS under SFAS No. 133.

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

        The table below shows a reconciliation of net income to operating earnings for the quarters ended March 31, 2003 and 2002: