XL FINANCIAL ASSURANCE LTD.

(Incorporated in Bermuda)

CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

FOR THE THREE AND NINE MONTH PERIODS ENDED

SEPTEMBER 30, 2003 AND 2002

XL FINANCIAL ASSURANCE LTD.

CONDENSED BALANCE SHEET S

AS AT SEPTEMBER 30, 2003 AND DECEMBER 31, 2002

(UNAUDITED)

(U.S. dollars in thousands, except number of shares and per share amounts)

	2003 $		2002 $
Assets:
Investments :
Fixed maturities, at fair value
(amortized cost: 2003 - $363,951; 2002 - $273,241)		368,759		279,296
Short-term investments, at fair value
(amortized cost: 2003 - $192,693; 2002 - $76,411)		192,722		76,451
Total investments available for sale		561,481		355,747
Cash and cash equivalents		21,625		125,073
Accrued investment income		3,195		1,926
Reinsurance balances receivable		34,205		21,066
Deferred acquisition costs		46,407		19,324
Prepaid reinsurance premiums		92,231		71,129
Unpaid losses and loss expenses recoverable		6,444		3,678
Net receivable for investments sold		1,605		—
Amounts due from parent and affiliates		9,956		13,769
Derivative assets		4,664		1,375
Other assets		88		79
Total assets		781,901		613,166
Liabilities, Redeemable Preferred Shares and Shareholders’ Equity
Liabilities:
Accounts payable and accrued liabilities		705		1,139
Derivative liabilities		7,493		17,643
Deferred premium revenue		324,083		188,464
Unpaid losses and loss expenses		28,082		14,064
Reinsurance premiums payable		8,873		23,697
Net payable for investments purchased		—		168
Dividend payable on preferred shares		1,458		1,950
Total liabilities		370,694		247,125
Redeemable Preferred Shares:
Redeemable preferred shares (par value of $120 per share;
10,000 shares authorized; 363 issued and outstanding as at
September 30, 2003 and December 31, 2002, respectively)		44		44
Additional paid-in capital		38,956		38,956
Total redeemable preferred shares		39,000		39,000
Shareholders’ Equity:
Common shares (par value of $120 per share;
10,000 shares authorized; 2,057 issued and outstanding as at
September 30, 2003 and December 31, 2002, respectively)		247		247
Additional paid-in capital		220,653		220,653
Accumulated other comprehensive income		4,837		6,095
Retained earnings		146,470		100,046
Total shareholders’ equity		372,207		327,041
Total liabilities, redeemable preferred shares and shareholders’ equity		781,901		613,166

The accompanying notes are an integral part of these condensed financial statements.

XL FINANCIAL ASSURANCE LTD.

CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME FOR
THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND 2002

(UNAUDITED)

( U.S. dollars in thousands )

	Three Months ended September 30,						Nine Months ended September 30,
	2003 $			2002 $			2003 $			2002 $
REVENUES :
Net premiums earned		19,964			9,465			52,076			23,949
Net investment income		3,904			6,324			11,378			16,028
Net realized gains (losses) on investments		(609	)		8,643			1,825			12,671
Net realized and unrealized gains (losses) on derivative instruments		5,480			(654	)		27,009			12,370
Total revenues		28,739			23,778			92,288			65,018
EXPENSES :
Losses and loss expenses		2,031			2,395			12,907			6,079
Acquisition costs		7,905			3,172			21,668			9,963
Operating expenses		1,550			1,585			5,140			4,785
Total expenses		11,486			7,152			39,715			20,827
NET INCOME		17,253			16,626			52,573			44,191
COMPREHENSIVE INCOME
Net income		17,253			16,626			52,573			44,191
Unrealized (losses) gains		(2,447	)		13,682			567			18,730
Less: reclassification for (losses) gains realized in income		(609	)		8,643			1,825			12,671
Other comprehensive (losses) gains		(1,838	)		5,039			(1,258	)		6,059
COMPREHENSIVE INCOME		15,415			21,665			51,315			50,250

The accompanying notes are an integral part of these condensed financial statements.

XL FINANCIAL ASSURANCE LTD.

CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2003 AND FOR THE
YEAR ENDED DECEMBER 31, 2002

(UNAUDITED)

( U.S. dollars in thousands, except share amounts )

	September 30, 2003			December 31, 2002
Common Shares – Authorized
Number of shares, beginning of year and period		2,057			2,057
Number of shares, end of year and period		2,057			2,057
		$			$
Common Shares – Issued
Balance - beginning of year and period		247			247
Balance - end of year and period		247			247
Additional Paid-in Capital
Balance - beginning of year and period		220,653			220,653
Balance - end of year and period		220,653			220,653
Accumulated Other Comprehensive (Loss) Income
Balance - beginning of year and period		6,095			1,998
Net change in unrealized (depreciation) appreciation of investments		(1,258	)		4,097
Balance - end of year and period		4,837			6,095
Retained Earnings
Balance - beginning of year and period		100,046			37,237
Net income		52,573			69,492
Dividends on preferred shares		(6,149	)		(6,683	)
Balance - end of year and period		146,470			100,046
TOTAL SHAREHOLDERS’ EQUITY		372,207			327,041

The accompanying notes are an integral part of these condensed financial statements.

XL FINANCIAL ASSURANCE LTD.

CONDENSED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND 2002

(UNAUDITED)

( U.S. dollars in thousands )

	2003 $			2002 $
Cash flows provided by operating activities:
Net income for the period		52,573			44,191
Adjustments to reconcile net income to net cash provided by operating activities:
Realized gains on investments		(1,825	)		(12,671	)
Amortization of discount on fixed maturities		(429	)		(857	)
Net realized gains on investment derivatives		(3,267	)		—
Net realized and unrealized gains on credit derivatives excluding cash received and paid		(13,439	)		(3,637	)
Accrued investment income		(1,269	)		1,362
Reinsurance premiums receivable		(13,139	)		9,675
Deferred acquisition costs		(27,083	)		1,608
Prepaid reinsurance premiums		(21,102	)		(51,894	)
Unpaid losses and loss expenses recoverable		(2,766	)		(3,051	)
Amounts due from parent and affiliates		3,813			(7,722	)
Accounts payable and accrued liabilities		(434	)		(624	)
Reinsurance premiums payable		(14,824	)		12,124
Deferred premium revenue		135,619			75,220
Unpaid losses and loss expenses		14,018			12,040
Other assets and liabilities		(9	)		(9	)
Total adjustments		53,864			31,564
Net cash provided by operating activities		106,437			75,755
Cash flows used in investing activities:
Proceeds from sale of fixed maturities and short-term investments		238,602			1,927,070
Proceeds from redemption of fixed maturities and short-term investments		4,111,110			179,452
Purchase of fixed maturities and short-term investments		(4,552,957	)		(2,133,939	)
Net cash used in investing activities		(203,245	)		(27,417	)
Cash flows used in financing activities:
Dividends paid on preferred shares		(6,640	)		(6,665	)
Increase (decrease) in Cash and Cash Equivalents		(103,448	)		41,673
Cash and Cash Equivalents – Beginning of year		125,073			50,243
Cash and Cash Equivalents – End of period		21,625			91,916

The accompanying notes are an integral part of these condensed financial statements.

XL FINANCIAL ASSURANCE LTD.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND 2002

(UNAUDITED)

( U.S. dollars in thousands )

1. Organization and Business

XL Financial Assurance Ltd. (the "Company") was incorporated with limited liability under the Bermuda Companies Act 1981 on October 14, 1998 and is registered as a Class 3 insurer under The Insurance Act 1978, amendments thereto and related regulations ("The Act"). At September 30, 2003 and December 31, 2002, the Company was approximately 85% owned by XL Insurance (Bermuda) Ltd (a wholly-owned subsidiary of XL Capital Ltd); 6% by Financial Security Assurance Inc. (a wholly-owned subsidiary of Financial Security Assurance Holdings Ltd.) and 9% by Financial Security Assurance International Ltd. (owned 20% by XL Insurance (Bermuda) Ltd and 80% by Financial Security Assurance Inc.). The Company is an integral part of a joint venture agreement between XL Capital Ltd and Financial S ecurity Assurance Holdings Ltd.

The Company is primarily engaged in the business of providing reinsurance of financial guaranties on asset-backed and municipal obligations underwritten by XL Insurance (Bermuda) Ltd, Financial Security Assurance Inc. and XL Capital Assurance Inc. (a wholly-owned subsidiary of XL Capital Ltd) and other monoline and multiline insurance companies. This may be in the form of traditional financial guaranty insurance or via a credit default swap execution. The Company’s underwriting policy is to provide reinsurance of asset-backed and municipal obligations that would be of a lower investment-grade quality without the benefit of the Company’s reinsurance. The asset-backed obligations reinsured by the Company are generally issued in structured transactions and are backed by pools of assets such as residential mortgage loans, consumer or trade receivables, securities or other assets having ascertainable cash flows or market value. The municipal obligations reinsured by the Company consist primarily of general obligation bonds that are supported by the issuers’ taxing power and of special revenue bonds and other special obligations of states and local governments that are supported by the issuers’ ability to impose and collect fees and charges for public services or specific projects. Reinsurance written by the Company guarantees payment when due of scheduled payments on an issuers’ obligation. In the case of a payment default on an insured obligation, the Company is generally required to pay the principal, interest or other such amounts due in accordance with the obligations’ original payment schedule or, at its option, to pay such amounts on an accelerated basis. The Company conducts surveillance on its exposures to try and ensure early identification of an y loss events. In addition, in the normal course of business, the Company seeks to reduce the loss that may arise from such events by reinsuring certain levels of risks in various areas of exposure with other insurance enterprises or reinsurers.

On October 6, 1999, the Company entered into a Facultative Quota Share Reinsurance Treaty ("Treaty") with XL Capital Assurance Inc. ("XLCA"). The Treaty was amended and restated on June 22, 2001. Under the terms of this Treaty, the Company agrees to reinsure up to 90% of XLCA’s compliant risks. The Company is subject to ceding commissions of up to 30% on business assumed under the terms of this Treaty.

On December 6, 2000, the Company entered into an excess of loss agreement, which reinsures 100% of net incurred losses in excess of $250 million up to a limit of liability of $100 million. On June 30, 2003, the Company terminated the agreement. On October 3, 2001, the Company entered into an excess of loss reinsurance agreement with XL Insurance (Bermuda) Ltd, which indemnifies the Company up to an aggregate limit of liability of $500 million in excess of defined obligor losses.

2. Significant Accounting Policies

Basis of Preparation

The accompanying condensed financial statements have been prepared by the Company and are unaudited. In the opinion of management, all adjustments, which include only normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows at September 30, 2003 and for all periods presented, have been made.

XL FINANCIAL ASSURANCE LTD.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND 2002

(UNAUDITED)

( U.S. dollars in thousands )

Certain information and footnote disclosures normally included in 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 financial statements and notes thereto. The year-end condensed balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The results of operations for the periods ended September 30, 2003 and 2002 are not necessarily indicative of the operating results for the full year.

The preparation of condensed 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.

Certain comparative figures have been reclassified to conform with the current year’s presentation.

Recent Accounting Pronouncements

In April 2003, FASB issued Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS No. 149"). SFAS No. 149 is intended to amend and clarify financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement 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 No. 149 is effective for contracts entered into or modified after June 30, 2003 and is applied prospectively. The effect of adoption of this standard on the Company's financial condition has been evaluated and there is no impact.

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 Staff Position ("FSP") No. FIN 46-6, FIN 46 is effective for variable interests in a VIE created before February 1, 2003 at the end of the first interim or annual period ending after December 15, 2003. The Company does not expect the adoption of FIN 46 to have a material effect on our results of operation or financial position.

In December 2002, the Financial Accounting Standards Board ("FASB") issued FAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure". FAS 148 amends FAS 123, "Accounting for Stock-Based Compensation," by providing alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, FAS 148 amends the disclosure requirements of FAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company’s ultimate parent, XL Capital Ltd, recorded option expense for options granted on behalf of its

XL FINANCIAL ASSURANCE LTD.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND 2002

(UNAUDITED)

( U.S. dollars in thousands )

subsidiaries subsequent to January 1, 2003, in accordance with SFAS No. 123, as amended by SFAS No. 148. The effect of the adoption of SFAS No. 148 on the Company for the first nine months of 2003 was not significant.

3. Derivative Instruments

Credit default swaps issued by the Company meet the definition of a derivative under FAS 133. The Company has recorded these products at fair value, modeled on prevailing market conditions and certain other factors relating to the structure of the transaction. The Company considers credit default swaps to be, in substance, financial guaranty contracts as the Company has the intent to hold them to maturity. The change resulting from movement in credit spreads is unrealized as the credit default swaps are not traded to realize this value and is included in net realized and unrealized gains and losses on derivatives, along with the other elements of the change in fair value which are based on pricing established at the inception of the contact.

Credit default swaps generally enhance a synthetic portfolio of securities. The credit ratings of the underlying securities vary and a single rating is calculated for the portfolio at the inception of the transaction by an independent agency. In order to effectively price and market the transaction, different tranches are modeled for the purpose of assigning credit ratings based upon the level of subordination. Generally, a primary layer is created to enable the originator of the transaction to participate in the risk. The Company generally participates in senior or rated tranches of a risk. The Company has not participated in any primary layers.

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 88.7% of the portfolio was rated “AAA” and the remaining 11.3% is allocated to other investment grade ratings. The weighted average remaining term of the contracts in force is approximately 8.23 years, and the credit default swaps represented approximately 16.8% of the Company’s credit enhancement par exposure at September 30, 2003. The portfolios are currently performing as expected.

The rated tranches are fair valued using changes in credit spreads to reflect current market conditions. The Company will also consider the characteristics and credit ratings of the underlying portfolio in order to apply the model to obtain an estimate of fair value. The change in fair value recorded for the rated tranches as of September 30, 2003 and 2002 was a gain of $13,439 and $3,637 respectively.

The Company’s credit default swap portfolio generally requires the Company to meet payment obligations for referenced credits within the portfolio in the event of specific credit events after erosion or exhaustion of various first loss protection levels. These credit events are contract specific, but generally cover bankruptcy, failure to pay and repudiation.

4. Variable Interest Entities

The Company utilizes variable interest entities (as defined in FIN 46) indirectly in the ordinary course of the Company’s business. The obligations related to these transactions are often securitized through variable interest entities. The Company generally provides financial guaranty reinsurance or enters into a credit default swap on the senior interests that would otherwise be rated investment grade. The Company does not hold any equity positions or subordinated debt in these 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 expected to be consolidated.

XL FINANCIAL ASSURANCE LTD.

NOTES TO CONDENSED FINANCIAL STATEMENTS

FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2003 AND 2002

(UNAUDITED)

( U.S. dollars in thousands )

5. Reinsurance

The effect of reinsurance on premiums written and earned for the three and nine month periods ended September 30, 2003 and 2002 is shown below:

	Assumed $		Ceded $			Net $
Three months ended September 30, 2003
Premium written		78,863		(12,442	)		66,421
Premium earned		26,053		(6,089	)		19,964
Losses and loss adjustment expenses		1,695		336			2,031
Three months ended September 30, 2002
Premium written		24,627		(23,148	)		1,479
Premium earned		15,387		(5,922	)		9,465
Losses and loss adjustment expenses		3,906		(1,511	)		2,395
Nine months ended September 30, 2003
Premium written		206,412		(39,820	)		166,592
Premium earned		70,794		(18,718	)		52,076
Losses and loss adjustment expenses		15,672		(2,765	)		12,907
Nine months ended September 30, 2002
Premium written		110,777		(63,770	)		47,007
Premium earned		36,555		(12,606	)		23,949
Losses and loss adjustment expenses		9,311		(3,232	)		6,079