ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

Commission File Number 1-12644

Financial Security Assurance Holdings Ltd.

(Exact name of registrant as specified in its charter)

 

Indicate by check if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  o  No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  o  No  x

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  x  No  o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o      Accelerated filer o      Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes  o  No  x

The aggregate market value of common equity, excluding treasury shares, held by non-affiliates of the registrant at June 30, 2005 was $53,993,549. For purposes of the foregoing, directors are deemed to be affiliates of the registrant and the dollar amount shown is based on the price at which shares of the Company’s common stock were valued under the Company’s director share purchase program on June 30, 2005.

At March 27, 2006, there were outstanding 33,263,259 shares of common stock, par value $0.01 per share, of the registrant (excludes 254,736 shares of treasury stock).

Documents Incorporated By Reference

None.

TABLE OF CONTENTS

 

PART I

Item 1.                        Business.

Financial Security Assurance Holdings Ltd., through its insurance company subsidiaries, is primarily engaged in the business of providing financial guaranty insurance on municipal and asset-backed obligations in domestic and international markets. The financial strength of the Company’s insurance company subsidiaries is rated “Triple-A” by the major securities rating agencies and obligations insured by them are generally awarded “Triple-A” ratings by reason of such insurance. The Company’s principal insurance company subsidiary is Financial Security Assurance Inc. (“FSA”), a wholly owned New York insurance company. FSA was the first insurance company organized to insure non-municipal obligations and has been a major insurer of asset-backed and other non-municipal obligations since its inception in 1985. FSA expanded the focus of its business in 1990 to include financial guaranty insurance of municipal obligations and has since become a major insurer of municipal obligations. In addition, the Company offers FSA-insured guaranteed investment contracts and other investment agreements (“GICs”) through other consolidated entities. References to the “Company” are to Financial Security Assurance Holdings Ltd. together with its subsidiaries.

Financial guaranty insurance written by FSA typically guarantees scheduled payments on financial obligations. Upon a payment default on an insured obligation, FSA is generally required to pay the principal, interest or other amounts due in accordance with the obligation’s original payment schedule or may, at its option, pay such amounts on an accelerated basis. FSA’s underwriting policy is to insure obligations that would otherwise be investment grade without the benefit of FSA’s insurance.

For the year ended December 31, 2005, the Company had gross premiums written of $833.8 million, of which approximately 70% related to insurance of municipal obligations and approximately 30% related to insurance of asset-backed and other non-municipal obligations. As of December 31, 2005, the Company had net par outstanding of $337.5 billion, of which approximately 67% represented insurance of municipal obligations and approximately 33% represented insurance of asset-backed and other non-municipal obligations.

The Company provides FSA-insured GICs to municipalities and other market participants. As of December 31, 2005, the Company had $12.7 billion principal amount of outstanding GICs.

Organization

FSA wholly owns FSA Insurance Company (“FSAIC”), which in turn wholly owns Financial Security Assurance (U.K.) Limited (“FSA-UK”). FSA and FSAIC together own Financial Security Assurance International Ltd. (“FSA International”). FSAIC is an Oklahoma insurance company that primarily provides reinsurance to FSA. FSA-UK is a United Kingdom insurance company that primarily provides financial guaranty insurance for transactions in the United Kingdom and other European markets. FSA International is a Bermuda insurance company that provides reinsurance to FSA and financial guaranty insurance for transactions outside United States and European markets.

The Company conducts its GIC business through its affiliates FSA Capital Management Services LLC (“FSACM”), FSA Capital Markets Services (Caymans) Ltd. and, prior to April 2003, FSA Capital Markets Services LLC (collectively, the “GIC Affiliates”). The Company consolidates the results of the GIC Affiliates. FSACM has conducted substantially all of the Company’s GIC business since April 2003, following its receipt of an exemption from the requirements of the Investment Company Act of 1940. The GIC Affiliates lend the proceeds from their sales of GICs to FSA Asset Management LLC (“FSAM”), which invests the funds, generally in obligations that qualify for FSA insurance.

The Company consolidates the results of certain variable interest entities (“VIEs”), including FSA Global Funding Limited (“FSA Global”), Premier International Funding Co. (“Premier”), and Canadian

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Global Funding Corporation (“Canadian Global”). FSA Global is a special purpose funding vehicle 29% owned by the Company. FSA Global issues FSA-insured medium term notes and invests the proceeds from the sale of its notes in FSA-insured obligations with a view towards realizing the yield difference between the notes issued and the obligations purchased with the note proceeds. Premier is principally engaged in debt defeasance for lease transactions. The majority of Canadian Global’s assets were liquidated and its liabilities satisfied during the third quarter of 2004.

The Company refinances certain defaulted transactions by employing special purpose vehicles to raise funds to refinance such transactions. These refinancing vehicles are also consolidated.

The Company’s management believes that the assets held by FSA Global, Premier and the refinancing vehicles, including those that are eliminated in consolidation, are beyond the reach of the Company and its creditors, even in bankruptcy or other receivership. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Variable Interest Entities.”

FSA Portfolio Management Inc. (“FSA Portfolio Management”), a wholly owned subsidiary of the Company, is engaged in the business of managing a portion of the investment portfolios of the Company and certain of its subsidiaries. FSA Portfolio Management also owns various strategic and other investments funded from time to time by the FSA group of companies.

Transaction Services Corporation (“TSC”), a wholly owned subsidiary of the Company, is engaged in the business of managing workout transactions, including, but not limited to, those referred to as refinanced transactions, within the insured portfolios of FSA and its subsidiaries.

The Company is a subsidiary of Dexia Holdings, Inc. (“Dexia Holdings”), which, in turn, is owned 90% by Dexia Crédit Local S.A. (“Dexia Crédit Local”) and 10% by Dexia S.A. (“Dexia”). Dexia is a Belgian corporation whose shares are traded on the Euronext Brussels and Euronext Paris markets as well as on the Luxembourg Stock Exchange. Dexia is primarily engaged in the business of public finance, banking and investment management in France, Belgium, Luxembourg and other European countries, as well as in the United States. Dexia Crédit Local is a wholly owned subsidiary of Dexia.

The Company’s Executive Management Committee manages the Company’s business. The Chief Executive Officer, President, General Counsel, Chief Risk Management Officer and Chief Financial Officer are members of the Executive Management Committee. The heads of Municipal Finance, Corporate Finance, the European Group, the Asia Group and Financial Products serve as part-time members of this committee and, collectively, comprise the “Management Committee.”  Bruno Deletre, a director of the Company and a member of the Executive Board of Dexia Crédit Local, is an ex officio member of the Management Committee.

History

When the Company commenced operations in 1985, it was owned by a number of large insurance companies and other institutional investors. In 1989, the Company was acquired by U S WEST Capital Corporation, which subsequently changed its name to MediaOne Capital Corporation (“MediaOne”). MediaOne was a subsidiary of MediaOne Group, Inc., with operations and investments in domestic cable and broadband communications and international broadband and wireless communication. In 1990, the Company established a strategic relationship with The Tokio Marine and Nichido Fire Insurance Co., Ltd. (“Tokio Marine”), which acquired a minority interest in the Company. Tokio Marine is a major Japanese property and casualty insurance company.

In 1994, the Company completed an initial public offering of common shares, at which time White Mountains Insurance Group, Ltd. (“White Mountains”) (formerly known as Fund American Enterprises Holdings, Inc.) made an investment in the Company, and the chairman of White Mountains became non-executive chairman of the Company. White Mountains is an insurance holding company.

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In 1998, the Company and XL Capital Ltd (“XL”), a major Bermuda-based insurance holding company, entered into a joint venture, establishing two Bermuda domiciled financial guaranty insurance companies—FSA International and XL Financial Assurance Ltd (“XLFA”). In connection with the joint venture, XL acquired a minority interest in the Company and FSA International, and the Company acquired a minority interest in XLFA.

On July 5, 2000, the Company completed a merger in which the Company became a direct subsidiary of Dexia Holdings. At the merger date, each outstanding share of the Company’s common stock was converted into the right to receive $76.00 in cash. As of December 31, 2005, approximately 99% of the Company’s common stock was held by Dexia Holdings. The other holders are a White Mountains affiliate and certain directors of the Company who own shares of the Company’s common stock or economic interests therein as described under “Item 11. Executive Compensation—Director Share Purchase Program.”  Dexia is required to repurchase the shares of the Company held by White Mountain’s affiliate in May 2006.

In October 2005, FSA purchased the interest in FSA International owned by XL for a cash purchase price of $39.1 million in anticipation of the repatriation of earnings and profits of FSA International. Giving effect to such purchase, FSA International became an indirect wholly owned subsidiary of the Company.

Although the Company’s common stock is no longer listed on the New York Stock Exchange (“NYSE”) as a consequence of the merger, the Company continues to file periodic reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), because the Company has debt securities listed on the NYSE.

The principal executive offices of the Company and FSA are located at 31 West 52nd Street, New York, New York, 10019. Subsidiaries of the Company maintain offices domestically in San Francisco and Dallas and abroad in London, Madrid, Mexico City, Paris, Singapore, Sydney, Tokyo and Bermuda.

Business Objectives

Financial Guaranty Business

The Company’s objective for its financial guaranty business is to remain a leading insurer of municipal and asset-backed obligations while generating premium volume at attractive returns and minimizing the occurrence and severity of credit losses in its insured portfolio. The Company believes that the demand for financial guaranty insurance will remain strong over the long term as a result of the anticipated continuation of the following trends:

·       growth of asset securitization;

·       growth of project finance in Europe and the United States through expansion of private finance for funding of infrastructure projects;

·       substantial volume of new domestic municipal bonds that are insured, due, in part, to the continued use of municipal bonds to finance repairs and improvements to the nation’s infrastructure and continued demand for credit enhancement by individuals who purchase municipal bonds; and

·       growing use of financial guaranty insurance in non-U.S. markets.

The Company believes that short term trends for financial guaranty insurance remain uncertain due, among other things, to:

·       narrow interest rate spreads between Triple-A rated obligations and lower rated obligations;

·       potential decline in municipal financings and refundings should interest rates rise; and

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·       increased competition among financial guarantors and other alternative providers of credit enhancement.

The Company expects to continue to originate a diversified insured portfolio characterized by insurance of both municipal and asset-backed obligations, with a broad geographic distribution and a variety of revenue sources and transaction structures. In addition to its domestic business, the Company selectively pursues international opportunities, primarily in Western European and Asia Pacific markets.

Financial Products Business

The Company’s objective for its financial products (“FP”) business is to generate net interest margin through borrowing funds at attractive rates in the municipal GIC and other markets and investing the proceeds in obligations satisfying the Company’s underwriting criteria while minimizing the Company’s exposure to interest rate changes. The Company anticipates continued demand over the long term for its GIC business and other financial products programs that employ financial guaranty insurance provided by FSA. The Company’s ability to continue or grow its financial products business, however, is subject to the conclusion of a review underway by Moody’s Investors Service, Inc. (“Moody’s”) of the non-core business activities of financial guaranty insurers.

Business of the Company

The Company is engaged in the financial guaranty business through its insurance company subsidiaries and in the FP business through its GIC Affiliates and FSAM (collectively, the “FP Segment”).

Financial Guaranty Business

FSA’s insurance is employed in both the new issue and secondary markets. In the case of new issues, the insured obligations are sold with FSA insurance at the time the obligations are issued. For both municipal and asset-backed obligations, FSA participates in negotiated offerings, where the investment banker and often the insurer have been selected by the sponsor or issuer. In addition, FSA participates in competitive offerings, where underwriting syndicates bid for securities and submit bids that may include insurance.

FSA’s Custody Receipt Program provides insurance for municipal obligations trading in the secondary market. Likewise, FSA’s Triple-A Guaranteed Secondary Securities (“TAGSS”®) Program provides insurance for asset-backed obligations trading in the secondary market. Investors and dealers generally obtain secondary-market insurance to upgrade or stabilize the credit ratings of securities they already hold or plan to acquire or to increase the market liquidity of such securities. FSA’s underwriting guidelines require the same underwriting standards on secondary market issues as on new issues, although FSA’s control rights in the event of default are generally more limited.

In many insured transactions, the issuer of insured securities is party to an interest rate, basis or currency swap that matches the issuer’s funding sources to the interest rate or currency of the insured securities or otherwise hedges the issuer’s exposure. In such transactions, FSA typically insures the issuer’s obligations under both the insured securities and the derivative contract.

FSA insures payment obligations of counterparties and issuers under GICs, GIC equivalents, credit-linked notes and obligations under interest rate, currency and credit default swaps (“CDS”), including guaranties issued in connection with the Company’s FP Segment. FSA also issues surety bonds under its Sure-Bid program, which provides an alternative to traditional types of good faith deposits for competitive municipal bond transactions.

FSA insures obligations already carrying insurance from other monoline guarantors, with FSA generally obligated to pay claims on a “second-to-pay” basis, following a default by both the underlying

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obligor and the first-to-pay financial guarantor. In recent years, FSA has reinsured a modest amount of business from other financial guaranty insurers.

The following table indicates the Company’s percentages of par amount (net of reinsurance) outstanding as of December 31, 2005 and 2004 with respect to each type of municipal and asset-backed program:

Net Par Amount and Percentage Outstanding by Program Type