financial guaranty insurance company

S T A T U T O R Y - B A S I S F I N A N C I A L S T A T E M E N T S

Financial Guaranty Insurance Company June 30, 2013

Financial Guaranty Insurance Company

Statutory-Basis Financial Statements

June 30, 2013

Contents

Statutory-Basis Financial Statements Statutory-Basis Balance Sheets at June 30, 2013 (Unaudited) and December 31, 2012.................1 Statutory-Basis Statements of Operations for the Three Months and Six Months

Ended June 30, 2013 and 2012 (Unaudited).................................................................................2 Statutory-Basis Statements of Cash Flows for the Six Months Ended

June 30, 2013 and 2012 (Unaudited) ............................................................................................3 Notes to Statutory-Basis Financial Statements (Unaudited)............................................................4

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Statutory-Basis Balance Sheets (Dollars in Thousands, except per share amounts)

June 30, December 31, 2013 2012 (Unaudited) Admitted assets Bonds $ 1,392,858 $ 1,296,051 Other invested assets 20,110 22,371 Receivable for securities 4,556 – Short-term investments, at cost, which approximates fair value 615,357 676,681 Cash and cash equivalents 19,073 8,395 Total cash and invested assets 2,051,954 2,003,498 Accrued investment income 15,854 14,376 Other assets 2,142 2,722 Receivable from parent and subsidiaries 384 241 Total admitted assets $ 2,070,334 $ 2,020,837 Liabilities and capital and deficit Liabilities:

Losses $ 4,825,680 $ 3,863,104 Loss adjustment expenses 39,293 33,326 Unearned premiums 169,276 172,151 Contingency reserves 416,851 543,822 Accounts payable and accrued expenses 10,323 8,115 Payable for securities 19,038 10,738 Federal and foreign income tax payable 80 143 Ceded balances payable - 351

Total liabilities 5,480,541 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 439,881 439,881 Unassigned deficit (4,165,088) (3,365,794)

Total capital and deficit (3,410,207) (2,610,913) Total liabilities and capital and deficit $ 2,070,334 $ 2,020,837

See accompanying notes.

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Statutory-Basis Statements of Operations (Unaudited)

(Dollars in Thousands)

Three Months Ended

June 30, Six Months Ended

June 30, 2013 2012 2013 2012 Premiums earned $ 10,078 $ 18,528 $ 31,485 $ 40,942 Loss (expenses) releases incurred (820,127) 154,442 (921,332) (15,963)Loss adjustment (expenses) releases (10,970) 25,695 (18,998) 26,782 Other underwriting expenses (20,953) (9,925) (31,035) (25,225)Ceding commission income (expense) 81 (82) (99) (373)Underwriting (loss) gain (841,891) 188,658 (939,979) 26,163 Net investment income 12,574 11,858 24,728 22,957 Net realized capital (losses) gains, net of

tax of $0, for the three and six months ended June 30, 2013 and 2012 (24,758)

5,974 (28,056)

5,590

Net investment (loss) gain (12,184) 17,832 (3,328) 28,547 Other income 15,131 4,705 17,942 9,300 (Loss) income before all other federal and

foreign income taxes (838,944) 211,195 (925,365) 64,010 Federal and foreign income tax expense

(benefit) 4 (9) 93 (485)Net (loss) income $ (838,948) $ 211,204 $ (925,458) $ 64,495 Capital and Deficit Deficit as regards policyholders,

beginning of period $ (2,726,112) $ (3,742,513) $ (2,610,913) $ (3,567,076)Net (loss) income (838,948) 211,204 (925,458) 64,495 Change in net unrealized capital gains 3,534 – 6,384 – Change in net unrealized foreign

exchange 2,570 (712) (1,566) (260)Change in non-admitted assets (4,394) 82 (5,625) 175 Change in provision for reinsurance – 1,124 – 1,132 Decrease in contingency reserve 153,143 (25,873) 126,971 (55,154)Change in deficit as regards policyholders (684,095) 185,825 (799,294) 10,388 Deficit as regards policyholders as of

statement date $ (3,410,207) $ (3,556,688) $ (3,410,207) $ (3,556,688)


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Statutory-Basis Statements of Cash Flows (Unaudited)

(Dollars in Thousands)

Six Months Ended June 30, 2013 2012 Operations Premiums collected, net of reinsurance $ 28,645 $ 26,138 Losses and loss adjustment expenses paid 28,213 (15,464) Underwriting expenses paid (29,184) (31,023) Ceding commission paid (99) (373) Net investment income received 29,185 27,066 Other income 17,942 9,300 Federal and foreign income taxes payments (156) (283) Net cash provided by operations 74,546 15,361 Investment activities Proceeds from sales, maturities, or repayments of investments:

Bonds and stocks 106,571 82,653 Net gains on short-term investments 40 – Other invested assets 2,260 166,639 Miscellaneous proceeds 3,777 –

Total investment proceeds 112,648 249,292 Cost of investments acquired:

Bonds (237,874) (219,781) Total investments acquired (237,874) (219,781) Net cash (used in) provided by investment activities (125,226) 29,511 Financing and miscellaneous activities

Other cash applied 34 (165) Net (decrease) increase in cash, cash equivalents and short-term investments (50,646) 44,707

Cash, cash equivalents and short-term investments:

Beginning of year 685,076 934,767 End of period $ 634,430 $ 979,474



Notes to Statutory-Basis Financial Statements (Unaudited)

June 30, 2013

1. Organization and Background

Financial Guaranty Insurance Company (the “Company” or “FGIC”), a wholly owned subsidiary of FGIC Corporation (“FGIC Corp.”), is a New York stock insurance corporation regulated by 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”) on October 3, 2011. The Company provided financial guaranty insurance and other forms of credit enhancement for public finance and structured finance obligations. FGIC UK Limited (“FGIC UK Ltd.”) is a wholly owned United Kingdom insurance subsidiary of FGIC that was engaged in the business of writing financial guaranties in the United Kingdom and in other European Union member countries.

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 “Insurance Law”) requiring FGIC, effective that day, to suspend paying any and all claims, not to write 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. As a result, on June 28, 2012, the Supreme Court of the State of New York (the “Rehabilitation Court”) issued an order pursuant to Article 74 of the Insurance Law (“Article 74”) placing FGIC in rehabilitation. On June 11, 2013, the Rehabilitation Court issued an order pursuant to Article 74 approving 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”), and authorizing its implementation. The Rehabilitation Plan will become effective on the first business day (the “Effective Date”) on which certain conditions have been satisfied or have been waived by the Superintendent of Financial Services of the State of New York (the “Superintendent”) as rehabilitator of FGIC (the “Rehabilitator”), whereupon FGIC's rehabilitation proceeding will terminate and FGIC will resume possession of its property and conduct of its business subject to the limitations described in the Rehabilitation Plan. Although FGIC expects to emerge from rehabilitation in the third quarter of 2013, there can be no assurance as to whether or when all the conditions to the Effective Date will be satisfied or waived by the Rehabilitator and no assurance can be given as to whether, when or to what extent claims may be paid by FGIC (See Note 2).

FGIC Corp. reorganized under Chapter 11 of the United States Bankruptcy Code from August 3, 2010 until emergence 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. (the “Reorganization Plan”) were consummated. None of the subsidiaries or affiliates of FGIC Corp., including FGIC, were debtors in FGIC Corp.’s Chapter 11 case.

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Notes to Statutory-Basis Financial Statements (continued) (Unaudited)

2. FGIC Rehabilitation Proceeding

As a result of FGIC’s continuing statutory insolvency and its inability to eliminate its policyholders’ surplus deficit, on June 11, 2012, the Superintendent filed a verified petition with the Rehabilitation Court for an order of rehabilitation (the “Rehabilitation Order”) pursuant to Article 74.

On June 28, 2012, the Rehabilitation Court issued the Rehabilitation Order (i) appointing the Superintendent as 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 which have made FGIC’s rehabilitation proceeding (the “Rehabilitation Proceeding”) necessary. The Rehabilitation Order also provides for certain injunctive relief during the continuation of the Rehabilitation Proceeding. FGIC consented to the commencement of the Rehabilitation Proceeding and, upon such commencement, the board of directors of FGIC resigned. The Rehabilitation Proceeding is currently pending before the Rehabilitation Court, styled as In the Matter of the Rehabilitation of Financial Guaranty Insurance Company, Index No. 401265/2012, and is assigned to the Honorable Justice Doris Ling-Cohan.

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 (the "Plan Approval Order") pursuant to Article 74 (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 (as defined below) and the consummation of the transactions contemplated thereby, (iv) approving an initial CPP (as defined below) of 17.25%, subject to adjustment by the Rehabilitator in his sole discretion on or before the Effective Date, (v) terminating the Rehabilitation Proceeding on the Effective Date without further order of the Rehabilitation Court, (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, and (vii) providing that from and after the Effective Date the Plan Approval Order, including the terms of the Rehabilitation Plan, shall supersede the Rehabilitation Order and the related order to show cause. Pursuant to the Rehabilitation Plan, the 1310 Order will be lifted on the Effective Date should it occur. In an effort to mitigate its liabilities and increase recoveries for policyholders, as contemplated by the Rehabilitation Plan, 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

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2. FGIC Rehabilitation Proceeding (continued)

terminated but which termination was the subject of litigation between FGIC and Société Générale in the U.S. District Court for the Southern District of New York (Société Générale v. Financial Guaranty Insurance Co., et al., 10 Civ. 0472 (NRB)) (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 their FGIC-insured CDS and all 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 (the “Payment Amount”). Following the hearing held by the Rehabilitation Court on December 18, 2012, the Rehabilitation Court approved the CDS Commutation Agreements by Order dated December 19, 2012. FGIC paid the Payment Amount pursuant to the CDS Commutation Agreements on December 19, 2012, upon which payment 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. Accordingly, based on a joint stipulation filed by FGIC and Société Générale following such payment, the litigation referred to above was dismissed by the court with prejudice and without costs.

In a further 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 they 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 provides FGIC with reinsurance on FGIC policies covering U.S. public finance credits with total NPIF of approximately $107.0 billion as of December 31, 2012 (collectively, the “National Public Reinsured Policies”). However, as the issuer of the National Public Reinsured Policies, FGIC continues to be directly responsible for all obligations under the National Public Reinsured Policies and, as such, FGIC is subject to the risk that National Public is unable or unwilling to perform its reinsurance obligations relating to the National Public Reinsured Policies. The Novation Agreement was approved by the Rehabilitation Court on June 11, 2013. Should the Effective Date occur and the Novation Agreement become effective as expected by FGIC in the third quarter of 2013, (i) National Public (rather than FGIC) would thereafter be the issuer of the National Public Reinsured Policies and would be directly responsible for all obligations under the National Public Reinsured Policies and (ii) FGIC would be released from all obligations thereunder.

Although FGIC expects the Effective Date to occur in the third quarter of 2013, there can be no assurance as to whether or when all the conditions to the Effective Date will be satisfied or waived by the Rehabilitator. Accordingly, no assurance can be given as to whether, when or to what extent any claims may be paid by FGIC.

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If the Rehabilitator at any time prior to the Effective Date determines that efforts to rehabilitate FGIC would be futile, whether pursuant to the Rehabilitation Plan or otherwise, the Rehabilitator may seek to convert the Rehabilitation Proceeding into a liquidation proceeding under Article 74. Such a conversion could materially adversely impact FGIC and the amount and timing of recoveries by FGIC’s policyholders.

Should the Effective Date occur, FGIC will emerge from the Rehabilitation Proceeding as a solvent insurance company under the Insurance Law and the Rehabilitation Plan will be 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 designates 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. After the Effective Date, FGIC will continue to be subject to oversight by the NYSDFS pursuant to the Insurance Law as an insurance company licensed under Article 69 of the Insurance Law and the additional requirements set forth in the Rehabilitation Plan (including any guidelines the NYSDFS may issue in accordance with the terms of the Rehabilitation Plan (“NYSDFS Plan Guidelines”)). Should the Effective Date occur, any and all policies in force as of the Effective Date (except for the policies novated by the Novation Agreement) will be automatically modified by the Rehabilitation Plan, and the Rehabilitation Plan, including the restructured policy terms attached to the Rehabilitation Plan as Exhibit B (the “Restructured Policy Terms”), will supersede any and all provisions of each policy that are inconsistent with the Rehabilitation Plan. After the Effective Date, FGIC will be 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 Plan Guidelines. Based on the magnitude of FGIC’s accrued and projected policy claims, FGIC expects to make payments in cash pursuant to the Rehabilitation Plan of a fractional percentage of its policy claims and it does not expect to make any payments pursuant to the Rehabilitation Plan with respect to non-policy claims (other than in respect of administrative expenses and certain other costs) or equity interests.

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The percentage of policy claims that FGIC ultimately pays in cash in accordance with the Rehabilitation Plan should the Effective Date occur, 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. 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.

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

As a result of uncertainties associated with the Rehabilitation Plan described in Note 2, management has concluded that there is substantial doubt about the ability of the Company to continue as a going concern. The Company’s financial statements as of June 30, 2013 and 2012 and for the three and six months ended June 30, 2013 and 2012 were prepared assuming the Company continues as a going concern and do not include any adjustment that might result from its inability to continue as a going concern.

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 State of New York Insurance Department (“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. Operating results for the three and six months ended June 30, 2013 are not necessarily indicative of results that may be expected for the year ending December 31, 2013. These unaudited interim financial statements should be read in conjunction with the audited Statutory-Basis Financial Statements for the year ended December 31, 2012, including the accompanying notes. The December 31, 2012 balance sheet was derived from audited financial statements, but does not include all disclosures required by SAP for annual periods.

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4. Significant Accounting Policies (continued)

Certain amounts have been reclassified in prior years’ financial statements to conform to the current presentation.

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 three and six months ended June 30, 2013 and 2012, but are presumed to be material. Significant accounting policies, and variances from GAAP, where applicable, are as follows:

Investments

Investments in bonds, preferred stock, 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.

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. 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.

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Investments (continued)

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 and short-term investments in accordance with 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 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. SAP does not require companies to distinguish between recurring and non-recurring fair value measurements, which is required under GAAP.

Other Invested Assets

Other invested assets include 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. Under GAAP, these securities are carried at fair value.

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.

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 rather than over a period in proportion to the amount of insurance protection provided, as is the case under GAAP. Premiums collected periodically are reflected in income pro rata over the period covered by the premium payment. 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

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Premium Revenue Recognition (continued)

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 unearned premium is recognized at that time. A refunding occurs when an insured obligation is retired or legally defeased prior to stated maturity.

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. In accordance with the Insurance Law, investments in subsidiaries are non-admitted if their aggregate value is in excess of fifty percent of the surplus to policyholders or sixty percent of the surplus of such insurer, whichever is greater.

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 and Loss Adjustment Expense Reserves

A loss reserve is 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 is based upon the average rate of return on the Company’s admitted assets. The loss reserve is subsequently remeasured each reporting period using a current discount rate for expected increases or decreases due to changes in the likelihood of default and potential recoveries. Subsequent changes to the measurement of the loss liability are recognized as loss incurred in the period of change. Under GAAP, unpaid losses and loss adjustment expenses 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. The Company’s loss and loss adjustment expenses incurred are disclosed in Note 9.

The future expected net cash outflows are determined using internally developed models and represent an estimate of the anticipated shortfall, net of reinsurance, between (1) the insured payments of principal and interest due on the insured obligations plus anticipated loss adjustment expenses 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 flow 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.

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Loss and Loss Adjustment Expense Reserves (continued)

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 using 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. Changes in any significant assumptions from time to time will affect the Company’s reserves and financial results, possibly materially.

Reinsurance recoverable on losses is calculated in a manner consistent with the calculation of loss and loss adjustment expenses.

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 Insurance Law, 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.

In June 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 $177.8 million.

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 GAAP and SAP, a valuation allowance is established for deferred tax assets that are not expected to be realized.

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

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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.

Reserves for losses and loss adjustment expenses 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, losses, 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. For GAAP purposes, the Company would be required to consolidate the assets and liabilities of a variable interest entity (“VIE”) if the Company is determined to be the primary beneficiary. For SAP, the VIE is not consolidated.

Foreign Currency Translation

The Company has a foreign branch in the United Kingdom, a wholly-owned insurance company subsidiary in the United Kingdom (FGIC UK Ltd.), and insured exposure from a branch in France. The Company has determined that the functional currencies of these entities or exposures are their local currencies. Accordingly, the assets and liabilities of these foreign entities or exposures are translated into U.S. dollars at the rates of exchange existing at June 30, 2013 and 2012, and revenues and expenses are translated at average monthly exchange rates. Under SAP, foreign exchange gains (losses) on balance sheet items are recorded as unrealized capital gains and losses until settled. At that time, the foreign exchange gain (loss) is recognized. There would be foreign exchange gains (losses) recognized for GAAP balance sheet items that are recorded in non functional currency.

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

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Statements of Cash Flow (continued)

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.

Comprehensive Income

Comprehensive income is not determined under SAP.

Property and Equipment

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

5. 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 June 30, 2013 and December 31, 2012.

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5. Fair Value Measurements (continued)

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

Level 1 Level 2 Level 3 Admitted

Value In thousands June 30, 2013 Obligations of states and

political subdivisions $ – $ 801,526

$ – $ 770,289

Asset- and mortgage-backed securities

– 409,688

– 395,254

U.S. Treasury securities and obligations of U.S. Government corporations and agencies

– 45,469

– 38,452 Debt securities issued by

foreign governments – 26,418

– 26,256

Corporate – 168,113 – 162,607 Total bonds – 1,451,214 – 1,392,858 Other invested assets – – 55,911 20,110 Short-term investments – 615,357 – 615,357 Total $ – $ 2,066,571 $ 55,911 $ 2,028,325

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Level 1 Level 2 Level 3 Admitted

Value In thousands December 31, 2012 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 U.S. Government 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

Level 3 activity during 2013 is as follows:

Balance at

January 1, 2013

Transfers In

(Level 3)

Transfers Out

(Level 3)

Total Gains (Losses)

Included in Net Income

Total Gains (Losses)

Included in Surplus Sales

Balance at June 30, 2013

In thousands

Other

invested assets $ 55,922 $ – $ – $ 2,662 $ (1,707) $ (966) $ 55,911

$ 55,922 $ – $ – $ 2,662 $ (1,707) $ (966) $ 55,911

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

Bonds, Preferred Stock, Common Stock and Other Invested Assets

Any of the Company’s investments in bonds that are classified as NAIC rated 3 through 6 are recorded at lower of amortized cost or fair value as determined by the Securities Valuation

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Office. Short-term investments are classified at cost which approximates fair value. Unrealized gains and losses on these investments are recorded as a separate component of surplus.

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.

6. 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 June 30, 2013 Obligations of states and

political subdivisions $ 770,289 $ 31,237 $ – $ 801,526 Asset- and mortgage-

backed securities 395,254 14,434 – 409,688 U.S. Treasury securities

and obligations of U.S. Government corporations and agencies 38,452 7,017 – 45,469

Debt securities issued by foreign governments 26,256 162 – 26,418

Corporate 162,607 5,506 – 168,113 Total bonds 1,392,858 58,356 – 1,451,214 Other invested assets 20,110 35,801 – 55,911 Short-term investments 615,357 – – 615,357 Total $ 2,028,325 $ 94,157 $ – $ 2,122,482

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6. 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 $ – $ 776,894Asset- and mortgage-

backed securities 359,532 24,219 – 383,751U.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 – 152,279Total bonds 1,296,051 98,409 – 1,394,460Other invested assets 22,371 33,551 – 55,922Short-term investments 676,681 – – 676,681Total $ 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 losses of $24.9 million and $28.9 million, $0.2 million and $0.5 million on its fixed income securities for the three and six months ended June 30, 2013 and 2012, respectively. These losses are included in “Net realized capital gains or losses net of tax” in the Statements of Operations and represent the difference between the amortized cost basis of these securities and their fair value at the balance sheet date.

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The amortized cost and fair value of investments in bonds at June 30, 2013, by contractual maturity date, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Amortized Cost

Fair Value

In thousands Due in one year $ 11,291 $ 11,441Due after one through five years 189,404 196,453Due after five years through ten years 309,984 321,579Due after ten years 486,924 512,052Asset- and mortgage-backed securities 395,255 409,689Total $ 1,392,858 $ 1,451,214

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

Three Months Ended

June 30, Six Months Ended

June 30, 2013 2012 2013 2012 In thousands In thousands Income from bonds $ 13,151 $ 10,608 $ 25,771 $ 20,353 Income from preferred

stocks - 400 -

449 Income from cash, cash

equivalents and short-term investments 7 1,384 125 3,163

Total investment income 13,158 12,392 25,896 23,965 Investment expenses (584) (534) (1,168) (1,008)Net investment income $ 12,574 $ 11,858 $ 24,728 $ 22,957

For the three and six months ended June 30, 2013, there were $1.3 million and $30.1 million, respectively, of sales of investments in bonds carried at amortized cost. For both the three and six months ended June 30, 2012, there were $8.7 million of sales of investments in bonds. For the three and six months ended June 30, 2013, gross realized gains of $0.1 and $0.8 million, respectively, were realized on such sales. For both the three and six months ended June 30, 2012, gross realized gains of $0.5 million were realized on such sales. For the three and six months ended June 30, 2013 and 2012 there were no gross realized losses on such sales. For

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both the three and six months ended June 30, 2012, proceeds from sales of investments in preferred stock were $9.4 million and gross realized gains of $5.6 million and gross realized losses of $0 were realized on such sales.

Investments in cash, cash equivalents, short-term investments and bonds carried at amortized cost of $24.5 million and $24.2 million as of June 30, 2013 and December 31, 2012, respectively, were on deposit with various regulatory authorities.

The non-admitted carrying values of the Company’s investment in the equity of subsidiaries were $5.3 million and $0 at June 30, 2013 and December 31, 2012. Included in the change in net unrealized gains or losses for the six months ended June 30, 2013 and 2012 were gains of $6.4 million and $0, respectively, related to the change in carrying values of the Company’s investments in subsidiaries.

7. Business Restructuring

In connection with a workforce reduction in 2008, the Company ceased using approximately 50% of its leased office space in 2008. Further, in 2009, the Company ceased using an additional 25% of its leased office space. In February 2010, the Company subleased approximately two-thirds of the unused office space and in June 2012, the remaining unused office space was also subleased.

Beginning in 2008, the Company recorded a liability for the unused leased office space, representing the Company’s obligation for the remaining lease term reduced by estimated sublease rentals. The liability is adjusted in each period to reflect revisions to estimated net cash flows. The liability is recorded as a component of “Accounts payable and accrued expenses” on the Balance Sheets and the corresponding expense (benefit) is recorded in “Other underwriting expenses incurred” in the Statements of Operations. “Other underwriting expenses incurred” in the Statements of Operations include an expense (benefit) related to vacated office space for the three and six months ended June 30, 2013 and 2012 of $0.1 million and $0.3 million, $(1.3 million) and ($0.9 million), respectively.

8. Federal 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.

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8. Federal Income Taxes (continued)

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

Three Months Ended

June 30,

Six Months Ended

June 30,

2013 2012 2013 2012 In thousands In thousands Income tax (benefit) expense

computed on (loss) income before provision for federal and foreign income taxes, at the statutory rate $ (293,630) $ 72,804 $ (323,825) $ 22,403

Tax effect of: Tax-exempt interest (2,150) (1,909) (4,203) (3,596) NOL adjustment for FGIC Corp.’s

cancellation of debt 88,563 – 88,563 – Change in valuation allowance 207,060 (71,278) 239,617 (19,450) Other, net 161 374 (59) 158 Benefit for federal and foreign

income taxes $ 4 $ (9) $ 93 $ (485)

The composition of total tax (benefit) expense for the three and six months ended June 30, 2013 and 2012 is as follows:

Three Months Ended

June 30,

Six Months Ended

June 30,

2013 2012 2013 2012 In thousands In thousands Current:

Federal $ – $ – $ – $ – Foreign 4 (9) 93 (485)

Federal and foreign income tax expense (benefit) $ 4

$ (9) $ 93

$ (485)

There was no change in net deferred income taxes, inclusive of non-admitted assets, for the three and six months ended June 30, 2013 and 2012. As of June 30, 2013, the Company had a domestic net operating loss (“NOL”) carryforward of $4.7 billion for federal income tax purposes, which will be available (subject to the limitations

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discussed below) to offset future taxable income. If not used, the NOL will start expiring in 2027 through 2031 depending on the originating year. The Company’s NOL was reduced by $253,037 as of June 30, 2013 as a result of the cancellation of debt in FGIC Corp.’s bankruptcy.

FGIC’s ability to utilize its NOLs could have been 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., 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 $1.9 billion as of June 30, 2013. The Company will continue to analyze the need for a valuation allowance on a quarterly basis.

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

June 30,

2013

December 31,

2012

In thousands Deferred tax assets:

Ordinary income $ 1,887,378 $ 1,658,034

Capital losses 20,883 10,610

Gross deferred tax asset 1,908,261 1,668,644

Valuation allowance (1,906,153) (1,666,384)

Adjusted deferred tax asset 2,108 2,260 Non-admitted adjusted deferred tax asset – – Total admitted gross deferred tax asset 2,108 2,260

Deferred tax liabilities:

Ordinary income (1,266) (1,266)

Capital gains (842) (994)

Total gross deferred tax liability (2,108) (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 June 30, 2013 and December 31, 2012 are presented below by tax component:

June 30,

2013

December 31,

2012

In thousands Deferred tax assets:

Premiums revenue recognition $ 6,607 $ 7,659 Net operating loss carryforward 1,638,297 1,425,177 Impairment losses on investments 19,019 9,122 Losses-salvage and subrogation recoverable 237,027 219,851

Other 7,311 6,835 Gross deferred tax asset 1,908,261 1,668,644

Valuation allowance (1,906,153) (1,666,384) Adjusted deferred tax asset 2,108 2,260 Non-admitted adjusted deferred tax asset – – Total admitted gross deferred tax asset 2,108 2,260 Deferred tax liabilities:

Foreign currency (727) (879) Discount on bonds and other (1,381) (1,381)

Total gross deferred tax liability (2,108) (2,260) Net admitted deferred tax asset $ – $ –

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9. Loss and Loss Adjustment Expense Reserves

Activity for loss and loss adjustment expenses (LAE) reserves is summarized as follows:

June 30,

2013

December 31,

2012

In thousands Net balance at beginning of period $ 3,896,430 $ 4,992,866 Incurred (releases) related to: Current year 904,078 2,710

Prior years 36,252 (980,269) Total incurred 940,330 (977,559)

Recovery (paid) related to: Current year 1,966 2

Prior years 26,247 (118,879) Total recovery (paid) 28,213 (118,877)

Net balance at end of period $ 4,864,973 $ 3,896,430 Loss and LAE reserves have increased to $4.9 billion at June 30, 2013 from $3.9 billion at December 31, 2012. The net loss and loss adjustment expense activity for the six months ended June 30, 2013 was mainly attributable to higher estimated losses 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) residential mortgage-backed securities (“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, partially offset by a reinsurance commutation settlement and a consensual termination of a policy insuring certain first lien RMBS. Loss reserves were discounted at 2.80% and 2.72% at June 30, 2013 and December 31, 2012, respectively. The reserves at June 30, 2013 relate predominantly to RMBS transactions and Public Finance transactions. The estimated losses were based on estimates and subjective judgments about the potential outcomes of future events, including the potential outcomes of any applicable bankruptcy proceedings, and will be adjusted as additional information becomes available. Differences between actual and estimated results may be material.

Pursuant to applicable reinsurance agreements, upon the commencement of the Rehabilitation Proceeding, the reinsurance assumed by FGIC’s reinsurers is payable on the basis of the liability of FGIC under the related reinsured policies, without diminution because of the insolvency of FGIC or because FGIC or the Rehabilitator has failed to pay all or a portion of any claim. During 2013, FGIC received funds from reinsurers in payment of their proportionate reinsurer’s

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9. Loss and Loss Adjustment Expense Reserves (continued)

share of claims on reinsured policies, which decreased the reinsurance receivable, thus increasing the net loss reserve liability.

As of June 30, 2013, the Company has received, but as a result of the 1310 Order and the Rehabilitation Order, has not paid $2.3 billion in claims which is included in “Loss Reserves” on the Balance Sheet.

FGIC’s liability in RMBS, Asset Backed Securities (“ABS”) and other securitization transactions is governed by the structure of the waterfall of cash flows in the transaction documents. In certain cases, these transaction documents are subject to interpretation. Loss reserves have been established based on the impact that the performance of the underlying collateral has on FGIC’s duty to support the cash flows of the transaction. If the Company identifies credit impairment, a provision for loss and loss adjustment expense is recorded. At each reporting date, loss reserves are evaluated and may be adjusted to reflect the impact of any loss mitigation efforts, including the purchase of, or the effective removal of insurance coverage on, FGIC insured securities by FGIC, that have yielded results that are probable and estimable. The Company believes that the reserve for estimated losses as of June 30, 2013 is adequate to cover expected future net claims. However, the establishment of the appropriate level of reserves is an inherently uncertain process involving numerous estimates and subjective judgments by management.

For public finance transactions, FGIC’s estimated incurred losses were established using cash flow projections and subjective judgments about the outcomes of future events based upon the facts and circumstances at the time the estimates were made. The incurred losses will be adjusted as additional information becomes available 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. At present, there remains a considerable amount of uncertainty relating to risks in real estate prices, credit markets and the economy as a whole, and there is no historical precedent for the current conditions. There can be no assurance that the Company’s estimates of probable and estimable losses are accurate. Accordingly, there can be no assurance that actual claims paid by the Company will not exceed or be less than its reserves at June 30, 2013, and it is possible that they could significantly exceed those reserves. Additionally, further deterioration in the performance of RMBS and other obligations the Company insures could lead to the establishment of additional loss reserves and further loss or reduction to income. The Company’s loss and loss adjustment expense reserves do not reflect the impact of any termination agreements that have been entered into but not completed and the potential impact, if any, of additional ongoing commutation, settlement and restructuring efforts by the Company. There can be no assurance that any loss mitigation efforts will be successful, and it is not possible to predict the magnitude of any benefit that might be derived from any such efforts that are successful.

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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 or specific events impacting a particular credit, such as a negative credit event, performance below expectations, breaches of representations, warranties, covenants or deal triggers, changes of management, regulatory changes, material litigation or other legal issues. Based on the evaluation of these factors the Company assigns credits to risk ratings categories, which then determines the level of on-going monitoring and surveillance efforts required, and whether loss reserves are recognized.

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 loss reserve.

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.

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. 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 June 30, 2013, of the Company’s portfolio of insured financial obligations assigned to risk category 4.

Risk Category 4

Dollars in thousands

Number of policies 132 Remaining weighted-average contract period (in years) 22 Insured contractual payments outstanding:

Principal $ 12,902,670 Interest 3,184,108

Total $ 16,086,779 Gross loss reserves $ 7,642,125 Less:

Gross projected recoveries (1,162,615)Discount, net (1,119,788)

Gross loss reserves, net of discount $ 5,359,722 Unearned premiums $ 47,104 Reinsurance recoverable on paid losses reported in the balance sheet $ 265

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 servicer, evaluating the financial position of the originator or servicer, renegotiation of financial covenants, triggers, or terms of servicing, enforcing rights to remove and replace the servicer, evaluation of restructuring plans or bankruptcy proceedings, and in some cases, litigation or arbitration as and where appropriate.

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 No. 62, Property and Casualty Reinsurance, FGIC recognized a net

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underwriting gain of approximately $3.3 million from the completion of the Radian Commutation Agreement in January, 2013.

10. 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, MBIA Insurance Corporation (“MBIA”), and Ambac Assurance Corporation (“Ambac”) are named as defendants in a lawsuit in which the plaintiff asserts causes of action based principally on the defendants’ 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. Fact discovery has been completed. Plaintiff has explicitly acknowledged that it is bound by the Rehabilitation Order and that the Rehabilitation Order has effected a stay of plaintiff’s litigation against FGIC. Plaintiff and FGIC have, therefore, agreed that neither party will pursue expert discovery or engage in motion practice against each other until such time as the injunction in the Rehabilitation Order is lifted. On November 29, 2012, FGIC filed a notice of acknowledgment of injunction with the court. All claims against MBIA and Ambac were dismissed with prejudice pursuant to a stipulation dated July 29, 2013.

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. The complaint alleges, inter alia, that the Jefferson County Commissioners, in a conspiracy with several individuals, financial companies, law firms and bond insurers, refinanced certain fixed-rate sewer system warrants with a combination of variable rate and auction rate sewer system warrants that were hedged by interest rate swaps. These transactions, the complaint alleges, were purportedly done to facilitate the payment of fees to several bond brokers and financial advisors that in turn were paid to certain Jefferson County officials. With respect to the bond insurers, including FGIC, the most recent amended complaint alleges, inter alia, that the bond insurers were undercapitalized and failed to make payments to certain holders following Jefferson County’s payment default on certain of its sewer system warrants. The plaintiffs seek rescission of the warrants and a declaration “that payments pursuant to all contracts for insurance and reinsurance be honored and payment thereunder be used for the use and benefit of the rate payers to the Jefferson County sewer system.” FGIC’s and the other defendants’ motions to dismiss the complaint for lack of standing were denied in January 2011. On December 15, 2011, based upon FGIC’s filing for removal of the case, the case was transferred to the U.S. Bankruptcy Court for the Northern District of Alabama, Southern Division, which is hearing the Chapter 9 bankruptcy proceeding commenced by Jefferson County (the “Chapter 9 Proceeding”). On December 22, 2011, FGIC filed an answer to the complaint. On April 10, 2013, the bankruptcy judge stayed the case during the pendency of the Chapter 9 Proceeding.

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10. Legal Proceedings (continued)

In Bennett, et al. v. Jefferson County, et al. filed on or about September 6, 2012, and thereafter amended (Case No. 11-05736-TBB9, Adv. No. 12-00120-TBB), in the U.S. Bankruptcy Court for the Northern District of Alabama, Southern Division, plaintiffs commenced a purported class action adversary proceeding within the Chapter 9 Proceeding against FGIC and certain other defendants on behalf of Jefferson County sewer system ratepayers. Plaintiffs are seeking, inter alia, declaratory judgments invalidating certain Jefferson County sewer system warrants (certain of which are insured by FGIC) and/or the liens on sewer system revenues securing such warrants and monetary damages relating thereto. On November 19, 2012, FGIC and certain other defendants filed a motion to dismiss the case on the basis of, inter alia, plaintiffs’ standing. At a December 6, 2012 status conference in the Chapter 9 Proceeding, the plaintiffs voluntarily dismissed (with prejudice) all monetary damage claims against FGIC and the other defendants. On April 4, 2013, plaintiffs filed a second amended complaint that omitted FGIC as a defendant.

In Museum Associates, dba Los Angeles County Museum of Art v. Financial Guaranty Insurance Co. (United States District Court for the Central District of California, filed on or about November 4, 2008), plaintiff alleges, inter alia, that it incurred increased interest costs in respect of its FGIC-insured auction rate securities as a result of misrepresentations by FGIC concerning its exposure to securities backed by residential mortgages and the risk of a downgrade of FGIC’s credit ratings. The case has been stayed voluntarily by the parties since early 2010.

In April 2009, a monoline insurance company from which FGIC assumed certain risks under a facultative reinsurance agreement demanded arbitration to resolve certain disputes relating to the reinsurance agreement and such company’s demand for a $46 million termination payment from FGIC. The arbitration has been dormant since early 2010.

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

It is not possible to predict whether additional suits will be filed against FGIC, including suits 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 additional inquiries or requests for information will be made, and it is also not possible to predict the outcome of litigation, inquiries or requests for information. Management is unable to make a meaningful estimate of the amount or range of loss that could result from unfavorable outcomes but, under some circumstances, adverse results in certain proceedings could have a material and adverse impact on FGIC. Additionally, defending against lawsuits and proceedings and responding to inquiries and requests for information may involve significant expense and diversion of management’s attention and other FGIC resources.

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In addition to the lawsuits described above, 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. 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.

In Financial Guaranty Insurance Co. v. Countrywide Home Loans, Inc. (N.Y. Sup.Ct., Index No. 650736/2009, filed on December 11, 2009) (the “Countrywide Litigation”), 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 in the Countrywide Litigation 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.

In November and December 2011, FGIC initiated the following seven actions: (1) Financial Guaranty Insurance Company v. GMAC Mortgage, LLC (f/k/a GMAC Mortgage Corporation); Ally Bank (f/k/a GMAC Bank); Residential Capital, LLC (f/k/a Residential Capital Corporation) (S.D.N.Y. Case No. 11-cv-9729) (relating to GMACM Series 2006-HE1), which was amended on March 30, 2012, to include allegations against Ally Financial, Inc. (f/k/a GMAC, LLC);

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(2) Financial Guaranty Insurance Company v. Residential Funding Company, LLC (f/k/a Residential Funding Corporation); Residential Capital, LLC (f/k/a Residential Capital Corporation) (S.D.N.Y. Case No. 11-cv-9737) (relating to RAMP Series 2005-RS9); (3) Financial Guaranty Insurance Company v. Residential Funding Company, LLC (f/k/a Residential Funding Corporation); Residential Capital, LLC (f/k/a Residential Capital Corporation) (S.D.N.Y. Case No. 11-cv-9736) (relating to RFMSII Series 2005-HS1 and RFMSII Series 2005-HS2); (4) Financial Guaranty Insurance Company v. Ally Financial, Inc. (f/k/a GMAC LLC), Residential Capital, LLC (f/k/a Residential Capital Corporation) and Residential Funding Company, LLC (f/k/a Residential Funding Corporation) (S.D.N.Y. Case No. 12-cv-0341) (relating to RASC Series 2005-EMX5); (5) Financial Guaranty Insurance Company v. Ally Financial, Inc. (f/k/a GMAC LLC); Residential Capital, LLC (f/k/a Residential)Capital Corporation) and Residential Funding Company, LLC (f/k/a Residential Funding Corporation) (S.D.N.Y. Case No. 12-cv-0338) (relating to RAMP Series 2005-EFC7); (6) Financial Guaranty Insurance Company v. Ally Financial, Inc. (f/k/a GMAC LLC); Residential Capital, LLC (f/k/a Residential Capital Corporation) and Residential Funding Company, LLC (f/k/a Residential Funding Corporation) (S.D.N.Y. Case No. 12-cv-0339) (relating to RAMP Series 2005-NC1); and (7) Financial Guaranty Insurance Company v. Ally Financial, Inc. (f/k/a GMAC LLC); Residential Capital, LLC (f/k/a Residential Capital Corporation) and Residential Funding Company, LLC (f/k/a Residential Funding Corporation) (S.D.N.Y. Case No. 12-cv-0340) (relating to RFMSII Series 2005-HSA1, RFMSII Series 2006-HSA1 and RFMSII Series 2006-HSA2). These actions were initiated by FGIC in New York state court, but have been removed to the U.S. District Court for the Southern District of New York.

In January and March 2012, FGIC initiated the following five actions: (1) Financial Guaranty Insurance Company v. Ally Financial, Inc. (f/k/a GMAC LLC); Residential Capital, LLC (f/k/a Residential Capital Corporation); Ally Bank (f/k/a GMAC Bank); and GMAC Mortgage, LLC (f/k/a GMAC Mortgage Corporation) (S.D.N.Y., Case No. 12-cv-0780) (relating to GMACM Series 2005-HE1); (2) Financial Guaranty Insurance Company v. Ally Financial, Inc. (f/k/a GMAC LLC), Residential Capital, LLC and Residential Funding Company, LLC (S.D.N.Y. Case No. 12-cv-1601) (relating to RASC Series 2007-EMX1); (3) Financial Guaranty Insurance Company v. Ally Financial, Inc. (f/k/a GMAC LLC); Residential Capital, LLC (f/k/a Residential Capital Corporation); Ally Bank (f/k/a GMAC Bank); and GMAC Mortgage, LLC (f/k/a GMAC Mortgage Corporation) (S.D.N.Y., Case No. 12-cv-1658) (relating to GMACM Series 2006-HE3); (4) Financial Guaranty Insurance Company v. Ally Financial, Inc. (f/k/a GMAC LLC); Residential Capital, LLC (f/k/a Residential Capital Corporation); Ally Bank (f/k/a GMAC Bank); and GMAC Mortgage, LLC (f/k/a GMAC Mortgage Corporation) (S.D.N.Y., Case No. 12-cv-1818) (relating to GMACM Series 2006-HE2 and GMACM Series 2007-HE2); and (5) Financial Guaranty Insurance Company v. Ally Financial, Inc. (f/k/a GMAC LLC), Residential Capital, LLC (f/k/a Residential Capital Corporation) and Residential Funding Company, LLC (f/k/a Residential Funding Corporation) (S.D.N.Y. Case No. 12-cv-1860) (relating to RFMSII Series 2006-HI2, RFMSII Series 2006-HI3, RFMSII Series 2006-HI4,

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RFMSII Series 2006-HI5 and RFMSII Series 2007-HI1) (together with the aforementioned actions initiated against Ally Financial, Inc. or its affiliates, the “Ally Financial Actions”).

In the Ally Financial Actions, FGIC variously alleges against the above entities, with respect to certain RMBS transactions (noted parenthetically in the case descriptions above), inter alia: (i) fraudulent inducement of the subject transactions, (ii) breaches of representations, warranties and affirmative covenants, (iii) breaches of the obligation to repurchase certain mortgage loans, (iv) breaches of the obligation to provide information to, and allow inspection of records by, FGIC, (v) improper transfer of additional mortgage collateral, and (vi) improper amendment of operative agreements.

On May 14, 2012, defendants Residential Capital LLC, Residential Funding Company, LLC, and GMAC Mortgage LLC and certain of their direct and indirect subsidiaries (collectively, the “Debtors”) filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code (the “Chapter 11 Cases”). Pursuant to that bankruptcy filing, the Ally Financial Actions as against those defendants were automatically stayed. In addition, FGIC entered into a stipulation with defendants Ally Financial and Ally Bank to stay the Ally Financial Actions as against Ally Financial and Ally Bank, which was approved by the court on July 19, 2012, and which stay was continued through April 30, 2013.

In May, 2013, FGIC, the Debtors, and most of the Debtors’ other major creditor groups reached an agreement regarding the terms of a chapter 11 plan to be filed in the Chapter 11 Cases (the “Plan Support Agreement”). Concurrently, FGIC, the Trustees of certain of the Debtors’ securitization trusts for which FGIC issued policies (the “FGIC Trustees”), certain investors in such trusts and the Debtors agreed to the terms of an interrelated, albeit stand alone, settlement (the “Settlement Agreement”) that would, among other things, (1) settle the FGIC Trustees’ present and future policy claims against FGIC in exchange for a $253.3 million payment from FGIC to the FGIC Trustees and FGIC’s release of its rights to receive certain other payments under the transaction documents; and (2) settle all of FGIC’s outstanding claims against the Debtors in exchange for an allowed general unsecured claim in the Chapter 11 Cases in an amount not less than $596.5 million in the aggregate. The Plan Support Agreement may be terminated if the Settlement Agreement is not approved by both the Rehabilitation Court and the United States Bankruptcy Court for the Southern District of New York on or before August 19, 2013.

If the plan contemplated by the Plan Support Agreement is ultimately approved and becomes effective in the Chapter 11 Cases, (1) FGIC will receive an increased allowed general unsecured claim against the Debtors in the aggregate amount of approximately $943 million, and (2) FGIC will release Ally Financial and Ally Bank from all claims it has or may have against them relating to the Debtors.

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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 December 20, 2012, Putnam moved for dismissal of all of the claims in FGIC’s complaint. On February 8, 2013, FGIC filed its opposition to Putnam’s motion to dismiss. The motion was heard by the court on March 22, 2013.

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; FGIC filed its opposition to the motion on July 17, 2013.

11. Subsequent Events

SSAP No. 9, Subsequent Events defines events subsequent to the financial statement date requiring disclosure. The date through which subsequent events have been evaluated was August 15, 2013.

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