XL CAPITAL ASSURANCE INC.
AND SUBSIDIARY
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
FOR THE THREE AND NINE MONTH PERIODS ENDED
SEPTEMBER 30, 2003 AND 2002

XL Capital Assurance Inc. and Subsidiary
Condensed Consolidated Balance Sheets

(UNAUDITED)
(U.S. Dollars in thousands except number of shares and per share amounts)

	As At			As At
	September 30,			December 31,
	2003			2002
Assets
Investments:
Fixed maturities available for sale, at fair value
(amortized cost: 2003 - $144,269; 2002 - $110,927)	$	148,249		$	115,301
Short-term investments, at fair value, which
approximates cost		5,305			20,153
Total investments		153,554			135,454
Cash and cash equivalents		63,287			44,714
Premiums receivable		6,845			2,713
Accrued investment income		1,503			1,375
Reinsurance balances recoverable on unpaid losses		16,467			9,594
Prepaid reinsurance premium		266,767			151,950
Deferred Federal income tax benefit		6,344			5,003
Intangible assets - acquired licenses		11,529			11,529
Other assets		14,494			7,564
Total assets	$	540,790		$	369,896
Liabilities and Shareholder's Equity
Liabilities:
Deferred premium revenue	$	291,780		$	163,129
Unpaid losses and loss adjustment expenses		17,952			10,380
Deferred ceding commissions, net		29,649			11,654
Reinsurance premiums payable		32,057			19,441
Accounts payable and accrued expenses		20,171			12,541
Intercompany payable to affiliates		9,065			10,289
Total liabilities		400,674			227,434
Shareholder's Equity:
Common stock (par value $7,500 at September 30, 2003
and December 31, 2002, 2,000 shares authorized, issued and
outstanding at September 30, 2003 and December 31, 2002)		15,000			15,000
Additional paid-in capital		139,154			139,154
Accumulated other comprehensive income (Net of deferred
Federal income tax liability of: 2003 - $1,376; 2002 - $1,562)		2,604			2,812
Accumulated deficit		(16,642	)		(14,504	)
Total shareholder's equity		140,116			142,462
Total liabilities and shareholder's equity	$	540,790		$	369,896

See notes to condensed consolidated financial statements.

XL Capital Assurance Inc. and Subsidiary
Condensed Consolidated Statements of Operations and Comprehensive Income

(UNAUDITED)
(U.S. Dollars in thousands)

	Three months ended						Nine months ended
	September 30,						September 30,
	2003			2002			2003			2002
Revenues
Gross premiums written	$	72,755		$	18,540		$	183,881		$	106,594
Ceded premiums written		(64,535	)		(17,285	)		(165,685	)		(97,236	)
Net premiums written		8,220			1,255			18,196			9,358
Change in deferred premium revenue		(6,511	)		(401	)		(13,834	)		(7,379	)
Net premiums earned (Net of ceded earned premium for the		1,709			854			4,362			1,979
nine  months of $ 50,868 in 2003 and $21,105 in 2002)
Net investment income		1,515			1,458			4,369			4,374
Net realized (losses) gains on investments		(429	)		339			(233	)		913
Net realized and unrealized gains (losses) on credit derivatives		500			(27	)		1,471			157
Other income		1,200			—			1,200			—
Total revenues		4,495			2,624			11,169			7,423
Expenses
Net losses and loss adjustment expenses (net of ceded losses		140			213			1,028			495
and loss adjustment expenses for the nine months of
$8,607 in 2003 and $5,274 in 2002)
Net operating expenses		4,009			4,067			13,431			14,244
Total expenses		4,149			4,280			14,459			14,739
Income (Loss) before Federal income tax expense (benefit)		346			(1,656	)		(3,290	)		(7,316	)
Deferred Federal income tax expense (benefit)		12			(571	)		(1,152	)		(2,558	)
Net income (loss)		334			(1,085	)		(2,138	)		(4,758	)
Other comprehensive (loss) income		(1,225	)		1,753			(208	)		2,257
Comprehensive (loss) income	$	(891	)	$	668		$	(2,346	)	$	(2,501	)

See notes to condensed consolidated financial statements.

XL Capital Assurance Inc. and Subsidiary
Condensed Consolidated Statements of Changes in Shareholder’s Equity

(UNAUDITED)
(U.S. Dollars in thousands)

	Nine months ended			Year ended
	September 30,			December 31,
	2003			2002
Common Shares
Number of shares, beginning of year		2,000			2,000
Number of shares, end of period		2,000			2,000
Common Stock
Balance - beginning of year		$15,000			$15,000
Balance-end of period		15,000			15,000
Additional Paid-In Capital
Balance - beginning of year		139,154			119,154
Capital contribution		—			20,000
Balance-end of period		139,154			139,154
Accumulated Other Comprehensive Income
Balance - beginning of year		2,812			1,054
Net change in unrealized appreciation of investments, net of
deferred Federal income tax (benefit) expense of $(186) in 2003 and $970
in 2002		(208	)		1,758
Balance-end of period		2,604			2,812
Accumulated Deficit
Balance - beginning of year		(14,504	)		(9,255	)
Net loss		(2,138	)		(5,249	)
Balance-end of period		(16,642	)		(14,504	)
Total shareholder's equity		$140,116			$142,462

See notes to condensed consolidated financial statements.

XL Capital Assurance Inc. and Subsidiary Condensed Consolidated Statements of Cash Flows
(UNAUDITED)
(U.S. Dollars in thousands)

	Nine months ended			Nine months ended
	September 30,			September 30,
	2003			2002
Cash flows from operating activities:
Net loss	$	(2,138	)	$	(4,758	)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities
Net realized losses (gains) on sale of investments		233			(913	)
Net realized and unrealized (gains) losses on credit derivatives		(544	)		166
Amortization of premium on bonds		782			551
Increase in unpaid losses and loss adjustment expenses, net		699			603
Increase in deferred premium revenue, net		13,834			7,379
Increase in deferred ceding commissions, net		17,995			5,635
Increase (decrease) in reinsurance premiums payable		12,616			(10,428	)
Increase in premiums receivable		(4,132	)		(2,111	)
(Increase) decrease in accrued investment income		(128	)		122
Deferred Federal income tax benefit		(1,152	)		(2,558	)
Increase in accounts payable and accrued expenses		1,402			1,578
(Decrease) increase in intercompany payable to affiliates		(1,224	)		227
Other		(1,139	)		242
Total adjustments		39,242			493
Net cash provided by (used in) operating activities		37,104			(4,265	)
Cash flows from investing activities:
Proceeds from sale of fixed maturities and short-term investments		72,095			29,357
Proceeds from maturity of fixed maturities and short-term investments		26,129			125,799
Purchase of fixed maturities and short-term investments		(117,733	)		(167,359	)
Increase (decrease) in payable for securities purchased		978			(12,974	)
Net cash used in investing activities		(18,531	)		(25,177	)
Cash flows from financing activities:
Capital contribution		—			20,000
Net cash provided by financing activities		—			20,000
Increase (decrease) in cash and cash equivalents		18,573			(9,442	)
Cash and cash equivalents-beginning of year		44,714			39,204
Cash and cash equivalents-end of period	$	63,287		$	29,762

See notes to condensed consolidated financial statements.

XL Capital Assurance Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements

(UNAUDITED)
(U.S. Dollars)

1. Organization and Ownership

XL Capital Assurance Inc. and subsidiary (the “Company”) is a wholly owned subsidiary of XL Reinsurance America Inc. (“XL RE AM”), formerly known as NAC Reinsurance Corporation, which is an indirect wholly owned subsidiary of X.L. America, Inc. (“XLA”). XLA is an indirect wholly owned subsidiary of XL Insurance (Bermuda) Ltd. (“XL Insurance”). XL Insurance is an indirect wholly owned subsidiary of XL Capital Ltd. (“XL Capital”), a holding company incorporated in the Cayman Islands. XLA is XL Capital’s U.S. holding company.

The Company is an insurance company domiciled in the State of New York. The Company is engaged in the business of providing credit enhancement by writing financial guaranty insurance policies on asset-backed structured finance, essential infrastructure project finance, future flow, public finance transactions, and credit default swap obligations. The Company issued its first insurance contract in December 2000.

The Company was formed on September 13, 1999 and became licensed as a financial guaranty insurer in New York upon its merger with an affiliate, X.L. Risk Solutions, Inc. on September 30, 1999.

On February 22, 2001 XL RE AM acquired all the outstanding shares of The London Assurance of America, Inc. (“LAA”). LAA was incorporated in New York on July 25, 1991. Prior to its purchase by XL RE AM, LAA was a New York-domiciled property and casualty insurance company that was licensed in 44 states and the District of Columbia. The business previously underwritten through LAA, together with all the liabilities of LAA, was reinsured effective July 1, 2000 to an affiliate of LAA under a reinsurance, assignment and assumption agreement. XL RE AM caused the Company to merge with and into LAA on the day of the acquisition (with LAA as the surviving entity) and for LAA to simultaneously change its name to XL Capital Assurance Inc.

On May 15, 2002, the Company capitalized XL Capital Assurance (U.K.) Limited, (“XLCA-UK”), an insurance company organized under the laws of England. XLCA-UK is a direct wholly owned subsidiary of the Company.

2. Basis of Presentation and Consolidation

The accompanying condensed consolidated financial statements include the accounts of the Company and its subsidiary and are unaudited. The results include the consolidation of XLCA-UK, accounted for as a subsidiary with effect from April 24, 2002. In the opinion of management, all adjustments, which include only normal recurring adjustments, necessary for a fair statement of the financial position, results of operations and cash flows at September 30, 2003 and for all periods presented, have been made and all significant intercompany accounts and transactions have been eliminated.

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These statements should be read in conjunction with the Company’s December 31, 2002 consolidated financial statements and notes thereto. The accompanying condensed consolidated balance sheet as of December 31, 2002 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The results ofoperations for the periods ended September 30, 2003 and 2002 are not necessarily indicative of the operating results for the full year. Certain prior period balances have been reclassified to conform with current period’s presentation.

XL Capital Assurance Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements

(UNAUDITED)
(U.S. Dollars)

2. Basis of Presentation and Consolidation (continued)

The preparation of condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Any such adjustments are reflected in income in the period in which the adjustments are made. The financial statement estimates subject to most uncertainty are estimates for loss reserves and calculation of the fair value of credit default swap instruments.

3. Credit Default Swaps

Credit default swaps are recorded at fair value which is determined using a model developed by the Company and is dependent upon a number of factors including changes in interest rates, credit spreads, changes in credit quality, expected recovery rates and other market factors. The change resulting from movements in these factors is unrealized as the credit default swaps are not traded to realize this value and is included in “net realized and unrealized gains (losses) on credit derivatives”. Other elements of the change in fair value are based upon pricing established at the inception of the contract. Credit default swaps are considered by the Company to be, in substance, financial guaranty contracts as the Company has the intent to hold them to maturity.

The credit default swap portfolio is structured pools of corporate obligations that were awarded investment grade ratings at the deals’ inception. At September 30, 2003, approximately 86% of the portfolio was rated AAA with the remaining 14% allocated to other investment grade ratings. The weighted average term of the contracts in force was approximately 9.13 years, and the credit default swaps represented approximately 16% of the Company’s credit enhancement par exposure at September 30, 2003. The portfolios are currently performing as expected.

The net fair value adjustment for the nine-month periods ended September 30, 2003 and 2002 was an unrealized gain of $544,007 and an unrealized loss of $166,000, respectively. The components of the Company’s net credit default swap asset and liability at September 30, 2003 and December 31, 2002 were as follows:

	At		At
	September 30, 2003		December 31, 2002
Asset
Gross Credit Derivative Gains	$	5,074,851	$	27,498
Reinsurance		4,664,588		21,098
Net Asset	$	410,263	$	6,400
Liability
Gross Credit Derivative Losses	$	8,051,549	$	7,447,219
Reinsurance		7,493,165		6,748,691
Net Liability	$	558,384	$	698,528

XL Capital Assurance Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements

(UNAUDITED)
(U.S. Dollars)

4. Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (“SFAS 148”). SFAS 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”) to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the prior disclosure guidance and requires prominent disclosures about the method of accounting for stock-based employee compensation and the effect of the method used on the reported results. The Company’s ultimate parent, XL Capital Ltd., recorded option expense for options granted on behalf of its subsidiaries subsequent to January 1, 2003, in accordance with SFAS 123, as amended by SFAS 148. The effect of the adoption of SFAS 148 was insignificant.

In January 2003, FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). The objective of FIN 46 is to improve financial reporting by companies involved with variable interest entities. This new model for consolidation applies to an entity in which either (1) the powers or rights of the equity holders do not give them sufficient decision making powers or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. FIN 46 requires a variable interest entity to be consolidated by the company that is subject to a majority of the risk of loss from the variable interest entity’s activities or that is entitled to receive a majority of the entity’s residual returns or both. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. As amended by FASB Sta ff Position No. FIN 46-6, FIN 46 is effective for variable interests in a variable interest entity created before February 1, 2003 at the end of the first interim or annual period ending after December 15, 2003. The adoption of FIN 46 is not expected to have a material effect on the Company’s financial condition and results of operations.

In April 2003, FASB issued Statement No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS 149”). SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS 133. SFAS 149 also clarifies the types of financial guarantee contracts that are included in the scope exception of SFAS 133 and the characteristics of a derivative that contains financing components. SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and should be applied prospectively. The adoption of SFAS 149 did not have a material effect on the Company’s financial condition and results of operations.

5. Variable Interest Entities

The Company participates in transactions which utilize variable interest entities in the ordinary course of business. The Company provides financial guaranty insurance of structured transactions backed by pools of assets of specified types, municipal obligations supported by the issuers’ ability to charge fees for specified services or projects, and corporate risk obligations including essential infrastructure projects and obligations backed by receivables from future sales of commodities and other specified services. The obligations related to these transactions are often securitized through off-balance sheet variable interest entities. In synthetic transactions, the Company guarantees payment obligations of counterparties, including variable interest entities, through credit default swaps referencing asset portfolios. The Company only provides financial guaranty insurance of the senior interests of these variable interest entities that would otherwise be rated investment gra de, without the Company’s credit enhancement, for fixed premiums at market rates, but does not hold any equity positions or subordinated debt in these off-balance sheet arrangements. Accordingly, the Company does not consider its participation to be a significant variable interest in the entity and therefore these variable interest entities are not consolidated.

XL Capital Assurance Inc. and Subsidiary
Notes to Condensed Consolidated Financial Statements

(UNAUDITED)
(U.S. Dollars)

6. Tax Sharing Agreement

The Company’s U.S. Federal income tax return is consolidated with XLA and its subsidiaries. XLA maintains a tax sharing agreement with its subsidiaries, whereby the consolidated U.S. Federal income tax liability is allocated among affiliates in the ratio that each affiliate’s separate return liability bears to the sum of the separate return liabilities of all affiliates that are members of the consolidated group. In addition, a complementary method is used which results in reimbursement by profitable affiliates to loss affiliates for tax benefits generated by loss affiliates. At September 30, 2003 and December 31, 2002, the Company had a deferred Federal income tax asset of $6,344,000 and $5,003,000, respectively. Management has concluded that the Federal tax assets are more likely than not to be realized, therefore, no valuation allowance has been provided.

7. Facultative Quota Share Reinsurance Treaty

On October 6, 1999, the Company entered into a Facultative Quota Share Reinsurance Treaty (“Treaty”) with XL Financial Assurance Ltd. (“XLFA”), a Bermuda financial guaranty insurer, which is 86.8% owned by XL Insurance. The remaining 13.2% is owned by Financial Security Assurance Holdings Ltd., an unrelated company. The Treaty was amended and restated on June 22, 2001. Under the terms of this agreement, XLFA agrees to reinsure up to 90% of the Company’s acceptable risks. The Company is allowed a 30% ceding commission on premiums written ceded under the terms of the Treaty.

XL Insurance entered into a reinsurance agreement dated October 6, 1999 with the Company, that unconditionally and irrevocably guarantees the full and complete performance of all obligations of XLFA to the Company under the above described Facultative Quota Share Reinsurance Treaty. In connection with the amendment and restatement of the Treaty, XL Insurance entered into another reinsurance agreement guarantee on June 22, 2001.

The Company entered into a Facultative Master Certificate (the “XL Re Treaty”) with XL RE AM, a New York insurance corporation with administrative offices in Stamford, Connecticut and the direct parent of the Company. The XL Re Treaty is effective as of November 1, 2002. Under the terms of the XL Re Treaty, XL RE AM agrees automatically to reinsure risk assumed by the Company under financial guaranty insurance policies up to the amount necessary for the Company to comply with single risk limitations set forth in Section 6904(d) of the New York Insurance Laws. The reinsurance provided by XL RE AM may be on an excess of loss or quota share basis. The Company is allowed a 30% ceding commission on premiums written ceded under the terms of the XL Re Treaty.