XNYS:AGO Assured Guaranty Ltd Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2012

 

or

 

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

 

For the transition Period from              to              

 

Commission File No. 001-32141

 

ASSURED GUARANTY LTD.

(Exact name of registrant as specified in its charter)

 

Bermuda

 

98-0429991

(State or other jurisdiction

 

(I.R.S. employer

of incorporation)

 

identification no.)

 

30 Woodbourne Avenue

Hamilton HM 08

Bermuda

(Address of principal executive offices)

 

(441) 279-5700

(Registrant’s telephone number, including area code)

 

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

The number of registrant’s Common Shares ($0.01 par value) outstanding as of May 1, 2012 was 182,592,088 (includes 57,435 unvested restricted shares).

 

 

 



Table of Contents

 

ASSURED GUARANTY LTD.

 

INDEX TO FORM 10-Q

 

 

 

Page

 

PART I. FINANCIAL INFORMATION

 

Item 1.

Financial Statements:

 

 

Consolidated Balance Sheets (unaudited) as of March 31, 2012 and December 31, 2011

1

 

Consolidated Statements of Operations (unaudited) for the Three Months Ended March 31, 2012 and 2011

2

 

Consolidated Statements of Comprehensive Income (unaudited) for the Three Months Ended March 31, 2012 and 2011

3

 

Consolidated Statement of Shareholders’ Equity (unaudited) for Three Months Ended March 31, 2012

4

 

Consolidated Statements of Cash Flows (unaudited) for Three Months Ended March 31, 2012 and 2011

5

 

Notes to Consolidated Financial Statements (unaudited)

6

 

1. Business and Basis of Presentation

6

 

2. Business Changes, Risks, Uncertainties and Accounting Developments

8

 

3. Outstanding Exposure

8

 

4. Financial Guaranty Insurance Contracts

13

 

5. Fair Value Measurement

35

 

6. Financial Guaranty Contracts Accounted for as Credit Derivatives

49

 

7. Consolidation of Variable Interest Entities

55

 

8. Investments

58

 

9. Insurance Company Regulatory Requirements

63

 

10. Income Taxes

64

 

11. Reinsurance and Other Monoline Exposures

66

 

12. Commitments and Contingencies

69

 

13. Long Term Debt and Credit Facilities

73

 

14. Earnings Per Share

77

 

15. Other Comprehensive Income

77

 

16. Subsidiary Information

78

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

84

 

Forward Looking Statements

84

 

Convention

85

 

Introduction

85

 

Available Information

86

 

Executive Summary

86

 

Key Business Strategies

89

 

Results of Operations

91

 

Non-GAAP Financial Measures

110

 

Insured Portfolio

114

 

Significant Risk Management Activities

121

 

Exposure to Residential Mortgage Backed Securities

122

 

Exposures by Reinsurer

125

 

Liquidity and Capital Resources

128

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

146

Item 4.

Controls and Procedures

146

 

PART II. OTHER INFORMATION

147

Item 1.

Legal Proceedings

147

Item 1A.

Risk Factors

151

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

154

Item 6.

Exhibits

155

 



Table of Contents

 

Assured Guaranty Ltd.

 

Consolidated Balance Sheets (Unaudited)

 

(dollars in thousands except per share and share amounts)

 

 

 

As of
March 31, 2012

 

As of
December 31, 2011

 

Assets

 

 

 

 

 

Investment portfolio:

 

 

 

 

 

Fixed maturity securities, available-for-sale, at fair value (amortized cost of $9,659,413 and $9,638,404)

 

$

10,204,938

 

$

10,141,850

 

Short term investments, at fair value

 

903,363

 

734,046

 

Other invested assets

 

203,900

 

222,869

 

Total investment portfolio

 

11,312,201

 

11,098,765

 

Cash

 

182,003

 

214,544

 

Premiums receivable, net of ceding commissions payable

 

1,018,672

 

1,002,852

 

Ceded unearned premium reserve

 

631,398

 

708,872

 

Deferred acquisition costs

 

129,015

 

132,418

 

Reinsurance recoverable on unpaid losses

 

152,898

 

69,300

 

Salvage and subrogation recoverable

 

367,343

 

367,718

 

Credit derivative assets

 

463,556

 

468,933

 

Deferred tax asset, net

 

1,031,805

 

803,529

 

Current income tax receivable

 

50,317

 

76,430

 

Financial guaranty variable interest entities’ assets, at fair value

 

2,827,652

 

2,819,077

 

Other assets

 

337,953

 

262,222

 

Total assets

 

$

18,504,813

 

$

18,024,660

 

Liabilities and shareholders’ equity

 

 

 

 

 

Unearned premium reserve

 

$

5,839,223

 

$

5,962,799

 

Loss and loss adjustment expense reserve

 

954,475

 

679,011

 

Reinsurance balances payable, net

 

204,173

 

170,982

 

Long-term debt

 

1,034,667

 

1,038,302

 

Credit derivative liabilities

 

2,416,268

 

1,772,803

 

Financial guaranty variable interest entities’ liabilities with recourse, at fair value

 

2,365,177

 

2,396,945

 

Financial guaranty variable interest entities’ liabilities without recourse, at fair value

 

1,085,618

 

1,061,497

 

Other liabilities

 

422,694

 

290,756

 

Total liabilities

 

14,322,295

 

13,373,095

 

Commitments and contingencies (See Note 12)

 

 

 

 

 

Common stock ($0.01 par value, 500,000,000 shares authorized; 182,524,573 and 182,235,798 shares issued and outstanding in 2012 and 2011)

 

1,825

 

1,822

 

Additional paid-in capital

 

2,569,526

 

2,569,922

 

Retained earnings

 

1,208,380

 

1,707,922

 

Accumulated other comprehensive income, net of tax of $149,205 and $135,344

 

398,387

 

367,499

 

Deferred equity compensation (320,193 shares in 2012 and 2011)

 

4,400

 

4,400

 

Total shareholders’ equity

 

4,182,518

 

4,651,565

 

Total liabilities and shareholders’ equity

 

$

18,504,813

 

$

18,024,660

 

 

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

 

1



Table of Contents

 

Assured Guaranty Ltd.

 

Consolidated Statements of Operations (Unaudited)

 

(dollars in thousands except per share amounts)

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

Revenues

 

 

 

 

 

Net earned premiums

 

$

193,677

 

$

253,977

 

Net investment income

 

97,762

 

97,412

 

Net realized investment gains (losses):

 

 

 

 

 

Other-than-temporary impairment losses

 

(27,344

)

(6,947

)

Less: portion of other-than-temporary impairment loss recognized in other comprehensive income

 

(22,465

)

(2,369

)

Other net realized investment gains (losses)

 

6,195

 

7,384

 

Net realized investment gains (losses)

 

1,316

 

2,806

 

Net change in fair value of credit derivatives:

 

 

 

 

 

Realized gains (losses) and other settlements

 

(56,881

)

35,427

 

Net unrealized gains (losses)

 

(633,758

)

(271,636

)

Net change in fair value of credit derivatives

 

(690,639

)

(236,209

)

Fair value gain (loss) on committed capital securities

 

(13,904

)

526

 

Fair value gains (losses) on financial guaranty variable interest entities

 

(36,602

)

119,601

 

Other income

 

90,984

 

40,800

 

Total revenues

 

(357,406

)

278,913

 

Expenses

 

 

 

 

 

Loss and loss adjustment expenses

 

246,847

 

(25,580

)

Amortization of deferred acquisition costs

 

5,413

 

3,662

 

Interest expense

 

24,673

 

24,760

 

Other operating expenses

 

61,280

 

62,883

 

Total expenses

 

338,213

 

65,725

 

Income (loss) before income taxes

 

(695,619

)

213,188

 

Provision (benefit) for income taxes

 

 

 

 

 

Current

 

29,528

 

(197,599

)

Deferred

 

(242,123

)

271,531

 

Total provision (benefit) for income taxes

 

(212,595

)

73,932

 

Net income (loss)

 

$

(483,024

)

$

139,256

 

Earnings per share:

 

 

 

 

 

Basic

 

$

(2.65

)

$

0.76

 

Diluted

 

$

(2.65

)

$

0.74

 

Dividends per share

 

$

0.09

 

$

0.045

 

 

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

 

2



Table of Contents

 

Assured Guaranty Ltd.

 

Consolidated Statements of Comprehensive Income (Unaudited)

 

(in thousands)

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

Net income (loss)

 

$

(483,024

)

$

139,256

 

Unrealized holding gains (losses) arising during the period on:

 

 

 

 

 

Investments with no other-than-temporary impairment, net of tax provision (benefit) of $19,049 and $(19,632)

 

42,123

 

(46,390

)

Investments with other-than-temporary impairment, net of tax provision (benefit) of $(7,345) and $9,195

 

(13,736

)

20,845

 

Unrealized holding gains (losses) arising during the period, net of tax

 

28,387

 

(25,545

)

Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $(1,272) and $172

 

(856

)

1,029

 

Change in net unrealized gains on investments

 

29,243

 

(26,574

)

Change in cumulative translation adjustment, net of tax provision (benefit) of $941 and $669

 

1,750

 

1,243

 

Change in cash flow hedge, net of tax provision (benefit) of $(56) and $(56)

 

(105

)

(105

)

Other comprehensive income (loss)

 

30,888

 

(25,436

)

Comprehensive income (loss)

 

$

(452,136

)

$

113,820

 

 

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

 

3



Table of Contents

 

Assured Guaranty Ltd.

 

Consolidated Statement of Shareholders’ Equity (Unaudited)

 

For the Three Months Ended March 31, 2012

 

(dollars in thousands, except share data)

 

 

 

Common Stock

 

Additional
Paid-in

 

Retained

 

Accumulated
Other
Comprehensive

 

Deferred
Equity

 

Total
Shareholders’

 

 

 

Shares

 

Amount

 

Capital

 

Earnings

 

Income

 

Compensation

 

Equity

 

Balance, December 31, 2011

 

182,235,798

 

$

1,822

 

$

2,569,922

 

$

1,707,922

 

$

367,499

 

$

4,400

 

$

4,651,565

 

Net loss

 

 

 

 

(483,024

)

 

 

(483,024

)

Dividends ($0.09 per share)

 

 

 

 

(16,425

)

 

 

(16,425

)

Dividends on restricted stock units

 

 

 

93

 

(93

)

 

 

 

Share-based compensation and other

 

288,775

 

3

 

(489

)

 

 

 

(486

)

Other comprehensive income

 

 

 

 

 

30,888

 

 

30,888

 

Balance, March 31, 2012

 

182,524,573

 

$

1,825

 

$

2,569,526

 

$

1,208,380

 

$

398,387

 

$

4,400

 

$

4,182,518

 

 

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

 

4



Table of Contents

 

Assured Guaranty Ltd.

 

Consolidated Statements of Cash Flows (Unaudited)

 

(in thousands)

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

Net cash flows provided by (used in) operating activities

 

$

75,256

 

$

(122,143

)

Investing activities

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

Purchases

 

(382,588

)

(511,679

)

Sales

 

189,346

 

299,877

 

Maturities

 

253,488

 

183,587

 

Net sales (purchases) of short-term investments

 

(142,735

)

242,296

 

Net proceeds from paydowns on financial guaranty variable interest entities’ assets

 

137,595

 

162,500

 

Other

 

51,607

 

4,246

 

Net cash flows provided by (used in) investing activities

 

106,713

 

380,827

 

Financing activities

 

 

 

 

 

Dividends paid

 

(16,425

)

(8,286

)

Share activity under option and incentive plans

 

(2,478

)

(2,312

)

Net paydowns of financial guaranty variable interest entities’ liabilities

 

(192,882

)

(241,618

)

Repayment of long-term debt

 

(5,461

)

(5,095

)

Net cash flows provided by (used in) financing activities

 

(217,246

)

(257,311

)

Effect of exchange rate changes

 

2,736

 

1,825

 

Increase (decrease) in cash

 

(32,541

)

3,198

 

Cash at beginning of period

 

214,544

 

108,389

 

Cash at end of period

 

$

182,003

 

$

111,587

 

Supplemental cash flow information

 

 

 

 

 

Cash paid (received) during the period for:

 

 

 

 

 

Income taxes

 

$

2,000

 

$

51,465

 

Interest

 

$

12,082

 

$

12,190

 

 

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

 

5



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited)

 

March 31, 2012

 

1. Business and Basis of Presentation

 

Business

 

Assured Guaranty Ltd. (“AGL” and, together with its subsidiaries, “Assured Guaranty” or the “Company”) is a Bermuda-based holding company that provides, through its operating subsidiaries, credit protection products to the United States (“U.S.”) and international public finance, infrastructure and structured finance markets. The Company has applied its credit underwriting judgment, risk management skills and capital markets experience to offer insurance that protect holders of debt instruments and other monetary obligations from defaults in scheduled payments, including scheduled interest and principal payments. The securities insured by the Company include tax-exempt and taxable obligations issued by U.S. state or municipal governmental authorities, utility districts or facilities; notes or bonds issued to finance international infrastructure projects; and asset-backed securities issued by special purpose entities. The Company markets its credit protection products directly to issuers and underwriters of public finance, infrastructure and structured finance securities as well as to investors in such debt obligations. The Company guarantees debt obligations issued in many countries, although its principal focus is on the U.S., Europe and Australia.

 

Financial guaranty insurance contracts provide an unconditional and irrevocable guaranty that protects the holder of a financial obligation against non-payment of principal and interest when due. Upon an obligor’s default on scheduled principal or interest payments due on the obligation, the Company is required under the financial guaranty contract to pay the principal or interest shortfall.

 

In the past, the Company had sold credit protection by issuing policies that guaranteed payment obligations under credit derivatives. Financial guaranty contracts accounted for as credit derivatives are generally structured such that the circumstances giving rise to the Company’s obligation to make loss payments are similar to those for financial guaranty insurance contracts and only occurs upon one or more defined credit events such as failure to pay or bankruptcy, in each case, as defined within the transaction documents, with respect to one or more third party referenced securities or loans. Financial guaranty contracts accounted for as credit derivatives are primarily comprised of credit default swaps (“CDS”). The Company’s credit derivative transactions are governed by International Swaps and Derivative Association, Inc. (“ISDA”) documentation.

 

The Company has not entered into any new CDS in order to sell credit protection since the beginning of 2009, when regulatory guidelines were issued that limited the terms under which such protection could be sold. The potential capital or margin requirements that may apply under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) also contributed to the decision of the Company not to enter into new CDS in the foreseeable future. The Company is actively pursuing opportunities to terminate existing CDS and in certain cases, has converted existing CDS exposure into a financial guaranty insurance contract. These actions have the effect of reducing fair value volatility in income and/or reducing rating agency capital charges.

 

The Company has historically entered into ceded reinsurance contracts in order to obtain greater business diversification and reduce the net potential loss from large risks. In January 2012, Assured Guaranty Municipal Corp. (“AGM”) and Assured Guaranty Corp. (“AGC”) entered into a new $435 million of excess of loss reinsurance facility, which reduced rating agency capital charges. In recent years, however, the Company has been reassuming previously ceded business from reinsurers. In the three-month period ended March 31, 2012 (“First Quarter 2012”), the Company reassumed a total of $19.1 billion in par from two reinsurers. See Note 11, Reinsurance and Other Monoline Exposures.

 

Public finance obligations insured by the Company consist primarily of general obligation bonds supported by the issuers’ taxing powers, tax-supported bonds and revenue bonds and other obligations of states, their political subdivisions and other municipal issuers supported by the issuers’ or obligors’ covenant to impose and collect fees and charges for public services or specific projects. Public finance obligations include obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including government office buildings, toll roads, health care

 

6



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

1. Business and Basis of Presentation (Continued)

 

facilities and utilities. Structured finance obligations insured by the Company are generally issued by special purpose entities and backed by pools of assets such as residential or commercial mortgage loans, consumer or trade receivables, securities or other assets having an ascertainable cash flow or market value. The Company also insures other specialized financial obligations.

 

When a rating agency assigns a public rating to a financial obligation guaranteed by one of AGL’s insurance company subsidiaries, it generally awards that obligation the same rating it has assigned to the financial strength of the AGL subsidiary that provides the guaranty. Investors in products insured by AGL’s insurance company subsidiaries frequently rely on ratings published by nationally recognized statistical rating organizations (“NRSROs”) because such ratings influence the trading value of securities and form the basis for many institutions’ investment guidelines as well as individuals’ bond purchase decisions. Therefore, the Company manages its business with the goal of achieving high financial strength ratings. However, the models used by NRSROs differ, presenting conflicting goals that may make it inefficient or impractical to reach the highest rating level. The models are not fully transparent, contain subjective data (such as assumptions about future market demand for the Company’s products) and change frequently. Ratings reflect only the views of the respective NRSROs and are subject to continuous review and revision or withdrawal at any time.

 

Unless otherwise noted, ratings on Assured Guaranty’s insured portfolio reflect Assured Guaranty’s internal ratings. Assured Guaranty’s ratings scale is similar to that used by the NRSROs; however, the ratings in these financial statements may not be the same as those assigned by any such rating agency. For example, the super senior category, which is not generally used by rating agencies, is used by Assured Guaranty in instances where Assured Guaranty’s AAA-rated exposure on its internal rating scale (which does not take into account Assured Guaranty’s financial guaranty) has additional credit enhancement due to either (1) the existence of another security rated AAA that is subordinated to Assured Guaranty’s exposure or (2) Assured Guaranty’s exposure benefiting from a different form of credit enhancement that would pay any claims first in the event that any of the exposures incurs a loss, and such credit enhancement, in management’s opinion, causes Assured Guaranty’s attachment point to be materially above the AAA attachment point.

 

Basis of Presentation

 

The unaudited interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and, in the opinion of management, reflect all adjustments that are of a normal recurring nature, necessary for a fair statement of the financial condition, results of operations and cash flows of the Company and its consolidated financial guaranty variable interest entities (“FG VIEs”) for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of 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. These unaudited interim consolidated financial statements are as of March 31, 2012 and cover First Quarter 2012 and the three-month period ended March 31, 2011 (“First Quarter 2011”). The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.

 

The unaudited interim consolidated financial statements include the accounts of AGL and its direct and indirect subsidiaries (collectively, the “Subsidiaries”) and its consolidated FG VIEs. Intercompany accounts and transactions between and among all consolidated entities have been eliminated. Certain prior year balances have been reclassified to conform to the current year’s presentation.

 

These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, filed with the U.S. Securities and Exchange Commission (the “SEC”).

 

AGL’s principal insurance company subsidiaries are AGC, domiciled in Maryland; AGM, domiciled in New York; and Assured Guaranty Re Ltd. (“AG Re”), domiciled in Bermuda. In addition, the Company has another U.S. and another Bermuda insurance company subsidiary that participate in a pooling agreement with AGM, two insurance subsidiaries organized in the United Kingdom, and a mortgage insurance company. The Company’s organizational structure includes various holdings companies, two of which—Assured Guaranty US Holdings Inc. (“AGUS”) and Assured Guaranty Municipal Holdings Inc. (“AGMH”)—have public debt outstanding. See Note 13, Long Term Debt and Credit Facilities.

 

7



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

2. Business Changes, Risks, Uncertainties and Accounting Developments

 

Summarized below are updates of the most significant events over the past two years that have had, or may have in the future, a material effect on the financial position, results of operations or business prospects of the Company.

 

Rating Actions

 

Standard and Poor’s Ratings Services (“S&P”) and Moody’s Investors Service, Inc (“Moody’s”) have downgraded the financial strength ratings of all the Company’s insurance subsidiaries over the course of the last several years. On March 20, 2012, Moody’s placed the ratings of AGL and its Subsidiaries, including the insurance financial strength rating of the Company’s insurance subsidiaries, on review for possible downgrade. There can be no assurance that S&P and Moody’s will not take further action on the Company’s ratings. See Note 4, Financial Guaranty Insurance Contracts, Note 6, Financial Guaranty Contracts Accounted for as Credit Derivatives and Note 11, Reinsurance and Other Monoline Exposure, for more information regarding the effect of S&P and Moody’s rating actions on the financial guaranty business, the credit derivative business and the assumed reinsurance business of the Company.  The insurance subsidiaries’ financial strength ratings are an important competitive factor in the financial guaranty insurance and reinsurance markets. If the financial strength or financial enhancement ratings of the Company’s insurance subsidiaries were reduced below current levels, the Company expects it could have adverse effects on its future business opportunities as well as the premiums it could charge for its insurance policies and consequently, a downgrade could harm the Company’s new business production and results of operations in a material respect.

 

Accounting Changes

 

Recently, there has been significant GAAP rule making activity which has affected the accounting policies and presentation of the Company’s financial information, particularly:

 

·                        Adoption of new guidance on January 1, 2012 that restricted the types and amounts of costs that may be deferred. See Note 4, Financial Guaranty Insurance Contracts.

 

·                        Adoption of guidance that changed the presentation of other comprehensive income (“OCI”). See “Consolidated Statements of Comprehensive Income.”

 

·                        Adoption of guidance requiring additional fair value disclosures. See Note 5, Fair Value Measurement.

 

In December 2011, the Financial Accounting Standards Board (“FASB”) issued guidance which will require disclosures for entities with financial instruments and derivatives that are either offset on the balance sheet or subject to a master netting arrangement. The guidance is effective for interim and annual periods beginning on or after January 1, 2013.

 

Deutsche Bank Agreement

 

On May 8, 2012, Assured Guaranty reached a settlement with Deutsche Bank AG and certain of its affiliates (collectively, “Deutsche Bank”), resolving claims related to certain residential mortgage-backed securities (“RMBS”) transactions issued, underwritten or sponsored by Deutsche Bank that were insured by Assured Guaranty under financial guaranty insurance policies and to certain RMBS exposures in re-securitization transactions as to which Assured Guaranty provides credit protection through CDS. As part of the settlement agreement (the “Deutsche Bank Agreement”), Assured Guaranty has settled its litigation against Deutsche Bank on three RMBS transactions.  See Note 4 of the Financial Statements, Financial Guaranty Insurance Contracts, “Recovery Litigation—RMBS Transactions” for information about the RMBS transactions subject to the settlement.

 

The Deutsche Bank Agreement provides for Assured Guaranty to receive a cash payment of $165.6 million from Deutsche Bank upon signing, a portion of which will partially reimburse Assured Guaranty for past losses on certain transactions. Assured Guaranty and Deutsche Bank have also entered into loss sharing arrangements covering future RMBS related losses, which are described below. Under the Deutsche Bank Agreement, Deutsche Bank AG will place approximately $282.7 million of eligible assets in trust in order to collateralize the obligations of a reinsurance affiliate under the loss-sharing arrangements, and the Deutsche Bank reinsurance affiliate may post additional collateral in the future to satisfy rating agency requirements.

 

Included in the settlement are eight RMBS transactions (“Covered Transactions”) that Assured Guaranty has insured through financial guaranty insurance policies. The Covered Transactions are backed by first lien and second lien mortgage loans. Under the Deutsche Bank Agreement, the Deutsche Bank reinsurance affiliate will reimburse 80% of Assured Guaranty’s future losses on the Covered Transactions until Assured Guaranty’s aggregate losses (including those to date that are partially reimbursed by the $165.6 million cash payment) reach $318.8 million. Assured Guaranty currently projects that the Covered Transactions will not generate aggregate losses in excess of $318.8 million. In the event aggregate losses exceed $388.8 million, the reinsurance affiliate is required to resume reimbursement at the rate of 85% of Assured Guaranty’s losses in excess of $388.8 million until such losses reach $600.0 million. The Covered Transactions represented $581 million of gross par outstanding as of April 25, 2012.

 

Certain uninsured tranches (“Uninsured Tranches”) of three of the Covered Transactions are included as collateral in RMBS re- securitization transactions as to which Assured Guaranty provides credit protection through CDS. Under the Deutsche Bank Agreement, the Deutsche Bank reinsurance affiliate will reimburse losses on the CDS in an amount equal to 60% of losses in these Uninsured Tranches until the aggregate losses in the Uninsured Tranches reach $141.1 million. Assured Guaranty currently projects that the Uninsured Tranches will not generate losses in excess of $141.1 million. In the event aggregate losses exceed $161.1 million, reimbursement resumes at the rate of 60% until the aggregate losses reach $185.1 million. The reinsurance affiliate is required to reimburse any losses in excess of $185.1 million at the rate of 100% until the aggregate losses reach $247.8 million. The Uninsured Tranches represent $337 million of gross par outstanding as of April 25, 2012.

 

The terms of the Deutsche Bank settlement were largely reflected in Assured Guaranty’s 2011 financial guaranty insurance expected losses.

 

Except for the Uninsured Tranches, the settlement does not include Assured Guaranty’s CDS with Deutsche Bank. The parties have agreed to continue efforts to resolve CDS-related claims.

 

3. Outstanding Exposure

 

The Company’s financial guaranty contracts are written in different forms, but collectively are considered financial guaranty contracts. They typically guarantee the scheduled payments of principal and interest (“Debt Service”) on public finance and structured finance obligations. The Company seeks to limit its exposure to losses by underwriting obligations that are investment grade at inception, diversifying its portfolio and maintaining rigorous subordination or collateralization requirements on structured finance obligations. The Company also has utilized reinsurance by ceding business to third-party reinsurers. The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs. Based on accounting standards in effect during any given reporting period, some of these VIEs are consolidated as described in Note 7, Consolidation of Variable Interest Entities. The outstanding par and Debt Service amounts presented below include outstanding exposures on VIEs whether or not they are consolidated.

 

8



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

3. Outstanding Exposure (Continued)

 

Debt Service Outstanding

 

 

 

Gross Debt Service
Outstanding

 

Net Debt Service
Outstanding

 

 

 

March 31,
2012

 

December 31,
 2011

 

March 31,
2012

 

December 31,
2011

 

 

 

(in millions)

 

Public finance

 

$

786,373

 

$

798,471

 

$

735,829

 

$

716,890

 

Structured finance

 

130,802

 

137,661

 

122,698

 

128,775

 

Total financial guaranty

 

$

917,175

 

$

936,132

 

$

858,527

 

$

845,665

 

 

As of March 31, 2012, the Company’s net mortgage guaranty insurance in force was approximately $176.7 million. Of the $176.7 million, $140.1 million covers loans originated in Ireland and $36.6 million covers loans originated in the UK.

 

Financial Guaranty Portfolio by Internal Rating

 

 

 

As of March 31, 2012

 

 

 

Public Finance
U.S.

 

Public Finance
Non-U.S.

 

Structured Finance
U.S

 

Structured Finance
Non-U.S

 

Total

 

Rating
Category

 

Net Par
Outstanding

 

%

 

Net Par
Outstanding

 

%

 

Net Par
Outstanding

 

%

 

Net Par
Outstanding

 

%

 

Net Par
Outstanding

 

%

 

 

 

(dollars in millions)

 

Super senior

 

$

 

%

$

1,165

 

2.9

%

$

15,756

 

18.0

%

$

5,219

 

22.8

%

$

22,140

 

3.9

%

AAA

 

4,931

 

1.2

 

1,384

 

3.5

 

34,974

 

39.8

 

10,286

 

44.9

 

51,575

 

9.1

 

AA

 

144,987

 

34.8

 

973

 

2.4

 

10,537

 

12.0

 

936

 

4.1

 

157,433

 

27.7

 

A

 

219,095

 

52.6

 

11,126

 

27.9

 

4,759

 

5.4

 

1,389

 

6.1

 

236,369

 

41.7

 

BBB

 

42,916

 

10.3

 

22,913

 

57.4

 

4,726

 

5.4

 

3,027

 

13.2

 

73,582

 

13.0

 

Below-investment-grade (“BIG”)

 

4,570

 

1.1

 

2,352

 

5.9

 

17,032

 

19.4

 

2,045

 

8.9

 

25,999

 

4.6

 

Total net par outstanding

 

$

416,499

 

100.0

%

$

39,913

 

100.0

%

$

87,784

 

100.0

%

$

22,902

 

100.0

%

$

567,098

 

100.0

%

 

 

 

As of December 31, 2011

 

 

 

Public Finance
U.S.

 

Public Finance
Non-U.S.

 

Structured Finance
U.S

 

Structured Finance
Non-U.S

 

Total

 

Rating
Category

 

Net Par
Outstanding

 

%

 

Net Par
Outstanding

 

%

 

Net Par
Outstanding

 

%

 

Net Par
Outstanding

 

%

 

Net Par
Outstanding

 

%

 

 

 

(dollars in millions)

 

Super senior

 

$

 

%

$

1,138

 

2.9

%

$

16,756

 

18.2

%

$

5,660

 

23.9

%

$

23,554

 

4.2

%

AAA

 

5,074

 

1.3

 

1,381

 

3.5

 

35,736

 

38.7

 

10,231

 

43.2

 

52,422

 

9.4

 

AA

 

139,693

 

34.6

 

1,056

 

2.7

 

12,575

 

13.6

 

976

 

4.1

 

154,300

 

27.7

 

A

 

213,164

 

52.9

 

11,744

 

30.1

 

4,115

 

4.5

 

1,518

 

6.4

 

230,541

 

41.3

 

BBB

 

40,635

 

10.1

 

21,399

 

54.8

 

5,044

 

5.5

 

3,391

 

14.3

 

70,469

 

12.6

 

BIG

 

4,507

 

1.1

 

2,328

 

6.0

 

18,008

 

19.5

 

1,919

 

8.1

 

26,762

 

4.8

 

Total net par outstanding

 

$

403,073

 

100.0

%

$

39,046

 

100.0

%

$

92,234

 

100.0

%

$

23,695

 

100.0

%

$

558,048

 

100.0

%

 

9



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

3. Outstanding Exposure (Continued)

 

In First Quarter 2012, the Company reclassified as AA 80% of the net par outstanding of those first lien transactions that are covered by the Bank of America Agreement (see Note 4, Financial Guaranty Insurance Contracts) and that the Company otherwise internally rated below AA. The Company reclassified those amounts as AA exposure due to the eligible assets that Bank of America has placed into trust in order to collateralize its reimbursement obligation relating to 21 first lien transactions. This reclassification resulted in a decrease of net outstanding par rated BIG as of December 31, 2011 by $1,452 million from that previously reported and, without this change, net outstanding par rated BIG as of March 31, 2012 would have been $1,382 million higher. Prior periods have been revised to conform to this presentation.

 

In addition to amounts shown in the tables above, the Company had outstanding commitments to provide guaranties of $2.1 billion for structured finance and $1.0 billion for public finance obligations at March 31, 2012. The structured finance commitments include the unfunded component of pooled corporate and other transactions. Public finance commitments typically relate to primary and secondary public finance debt issuances. The expiration dates for the public finance commitments range between April 1, 2012 and February 25, 2017, with $0.7 billion expiring prior to December 31, 2012. All the commitments are contingent on the satisfaction of all conditions set forth in them and may expire unused or be cancelled at the counterparty’s request. Therefore, the total commitment amount does not necessarily reflect actual future guaranteed amounts.

 

Economic Exposure to the Selected European Countries

 

Several European countries are experiencing significant economic, fiscal and/or political strains such that the likelihood of default on obligations with a nexus to those countries may be higher than the Company anticipated when such factors did not exist. The Company is closely monitoring its exposures in European countries where it believes heightened uncertainties exist, specifically, Greece, Hungary, Ireland, Italy, Portugal and Spain (the “Selected European Countries”). Published reports have identified countries that may be experiencing reduced demand for their sovereign debt in the current environment. The Company selected these European countries based on these reports and its view that their credit fundamentals are deteriorating. The Company’s economic exposure to the Selected European Countries (based on par for financial guaranty contracts and notional amount for financial guaranty contracts accounted for as derivatives) is shown in the following table net of ceded reinsurance.

 

Net Economic Exposure to Selected European Countries(1)

March 31, 2012

 

 

 

Greece

 

Hungary

 

Ireland

 

Italy

 

Portugal

 

Spain

 

Total

 

 

 

(in millions)

 

Sovereign and sub-sovereign exposure:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Public finance

 

$

291

 

$

 

$

 

$

1,040

 

$

113

 

$

270

 

$

1,714

 

Infrastructure finance

 

 

453

 

25

 

341

 

104

 

174

 

1,097

 

Sub-total

 

291

 

453

 

25

 

1,381

 

217

 

444

 

2,811

 

Non-sovereign exposure:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Regulated utilities

 

 

 

 

226

 

 

17

 

243

 

RMBS

 

 

249

 

140

 

522

 

 

 

911

 

Commercial receivables

 

 

1

 

20

 

27

 

15

 

18

 

81

 

Pooled corporate

 

33

 

 

244

 

251

 

14

 

544

 

1,086

 

Sub-total

 

33

 

250

 

404

 

1,026

 

29

 

579

 

2,321

 

Total

 

$

324

 

$

703

 

$

429

 

$

2,407

 

$

246

 

$

1,023

 

$

5,132

 

Total BIG

 

$

291

 

$

540

 

$

15

 

$

252

 

$

130

 

$

145

 

$

1,373

 

 


(1)                                  While the Company’s exposures are shown in U.S. dollars, the obligations the Company insures are in various currencies, including U.S. dollars, Euros and British pounds sterling. Included in the table above is $140.1 million of reinsurance assumed on a 2004 - 2006 pool of Irish residential mortgages that is part of the Company’s remaining $176.7 million legacy mortgage reinsurance business. The legacy mortgage reinsurance business is not included in the Company’s exposure tables elsewhere in this document because the amount of the exposure is relatively immaterial. One of the residential mortgage-backed securities included in the table above includes residential mortgages in both Italy and Germany, and only the portion of the transaction equal to the portion of the original mortgage pool in Italian mortgages is shown in the table.

 

Included in “Public Finance” in the tables above are $291 million (net of reinsurance) of bonds of the Hellenic Republic of Greece. The Company has not guaranteed any other sovereign bonds of the Selected European Countries. The remainder of the “Public Finance Category” is from transactions backed by receivable payments from sub-sovereigns in Italy, Spain and Portugal. Debt issued by a governmental entity or government backed entity, or supported by such an entity, that is other than direct sovereign debt of the ultimate governing body of the country.

 

10



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

3. Outstanding Exposure (Continued)

 

Surveillance Categories

 

The Company segregates its insured portfolio into investment grade and BIG surveillance categories to facilitate the appropriate allocation of resources to monitoring and loss mitigation efforts and to aid in establishing the appropriate cycle for periodic review for each exposure. BIG exposures include all exposures with internal credit ratings below BBB-. The Company’s internal credit ratings are based on internal assessments of the likelihood of default and loss severity in the event of default. Internal credit ratings are expressed on a ratings scale similar to that used by the rating agencies and are generally reflective of an approach similar to that employed by the rating agencies.

 

The Company monitors its investment grade credits to determine whether any new credits need to be internally downgraded to BIG. The Company refreshes its internal credit ratings on individual credits in quarterly, semi-annual or annual cycles based on the Company’s view of the credit’s quality, loss potential, volatility and sector. Ratings on credits in sectors identified as under the most stress or with the most potential volatility are reviewed every quarter. The Company’s insured credit ratings on assumed credits are based on the Company’s reviews of low-rated credits or credits in volatile sectors, unless such information is not available, in which case, the ceding company’s credit rating of the transactions are used. For example, the Company models all assumed RMBS credits with par above $1 million, as well as certain RMBS credits below that amount.

 

Credits identified as BIG are subjected to further review to determine the probability of a loss (see Note 4, Financial Guaranty Insurance Contracts). Surveillance personnel then assign each BIG transaction to the appropriate BIG surveillance category based upon whether a lifetime loss is expected and whether a claim has been paid. The Company expects “lifetime losses” on a transaction when the Company believes there is at least a 50% chance that, on a present value basis, it will pay more claims over the life of that transaction than it will ultimately have been reimbursed. For surveillance purposes, the Company calculates present value using a constant discount rate of 5%. (A risk free rate is used for recording of reserves for financial statement purposes.)

 

Intense monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly. The three BIG categories are:

 

·                  BIG Category 1: Below-investment-grade transactions showing sufficient deterioration to make lifetime losses possible, but for which none are currently expected. Transactions on which claims have been paid but are expected to be fully reimbursed (other than investment grade transactions on which only liquidity claims have been paid) are in this category.

 

·                  BIG Category 2: Below-investment-grade transactions for which lifetime losses are expected but for which no claims (other than liquidity claims which is a claim that the Company expects to be reimbursed within one year) have yet been paid.

 

·                  BIG Category 3: Below-investment-grade transactions for which lifetime losses are expected and on which claims (other than liquidity claims) have been paid. Transactions remain in this category when claims have been paid and only a recoverable remains.

 

Included in the first lien RMBS BIG exposures below is $345.6 million of net par outstanding related to transactions covered by the Bank of America Agreement which represents the portion of the covered first lien transactions (20%) that are not subject to reimbursement from Bank of America as of March 31, 2012. Under the Bank of America Agreement, 80% of first lien claims paid by Assured Guaranty will be reimbursed, until such time as losses on the collateral underlying the RMBS on which Assured Guaranty is paying claims reach $6.6 billion. See Note 4, Financial Guaranty Insurance Contracts.

 

11



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

3. Outstanding Exposure (Continued)

 

Financial Guaranty Exposures

(Insurance and Credit Derivative Form)

 

 

 

As of March 31, 2012

 

 

 

BIG Net Par Outstanding

 

Net Par

 

BIG Net Par as
a % of Net Par

 

 

 

BIG 1

 

BIG 2

 

BIG 3

 

Total BIG

 

Outstanding

 

Outstanding

 

 

 

 

 

 

 

(in millions)

 

 

 

 

 

 

 

First lien U.S. RMBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prime first lien

 

$

77

 

$

448

 

$

 

$

525

 

$

713

 

0.1

%

Alt-A first lien

 

962

 

1,717

 

1,493

 

4,172

 

5,208

 

0.7

 

Option ARM

 

1

 

687

 

775

 

1,463

 

2,256

 

0.3

 

Subprime (including net interest margin securities)

 

208

 

1,745

 

498

 

2,451

 

7,976

 

0.4

 

Second lien U.S. RMBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Closed end second lien

 

 

493

 

504

 

997

 

1,020

 

0.2

 

Home equity lines of credit (“HELOCs”)

 

401

 

 

2,716

 

3,117

 

3,700

 

0.6

 

Total U.S. RMBS

 

1,649

 

5,090

 

5,986

 

12,725

 

20,873

 

2.3

 

Trust preferred securities (“TruPS”)

 

2,140

 

 

952

 

3,092

 

6,272

 

0.5

 

Other structured finance

 

1,410

 

465

 

1,385

 

3,260

 

83,541

 

0.6

 

U.S. public finance

 

3,480

 

270

 

820

 

4,570

 

416,499

 

0.8

 

Non-U.S. public finance (1)

 

2,061

 

291

 

 

2,352

 

39,913

 

0.4

 

Total

 

$

10,740

 

$

6,116

 

$

9,143

 

$

25,999

 

$

567,098

 

4.6

%

 

 

 

As of December 31, 2011

 

 

 

BIG Net Par Outstanding

 

Net Par

 

BIG Net Par as
a % of Net Par

 

 

 

BIG 1

 

BIG 2

 

BIG 3

 

Total BIG

 

Outstanding

 

Outstanding

 

 

 

 

 

 

 

(in millions)

 

 

 

 

 

 

 

First lien U.S. RMBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prime first lien

 

$

77

 

$

465

 

$

 

$

542

 

$

739

 

0.1

%

Alt-A first lien

 

1,695

 

1,028

 

1,540

 

4,263

 

5,329

 

0.8

 

Option ARM

 

25

 

689

 

882

 

1,596

 

2,433

 

0.3

 

Subprime (including net interest margin securities)

 

795

 

1,200

 

513

 

2,508

 

8,136

 

0.4

 

Second lien U.S. RMBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

Closed end second lien

 

 

495

 

520

 

1,015

 

1,040

 

0.2

 

HELOCs

 

421

 

 

2,858

 

3,279

 

3,890

 

0.6

 

Total U.S. RMBS

 

3,013

 

3,877

 

6,313

 

13,203

 

21,567

 

2.4

 

TruPS

 

2,501

 

 

951

 

3,452

 

6,334

 

0.6

 

Other structured finance

 

1,295

 

548

 

1,429

 

3,272

 

88,028

 

0.6

 

U.S. public finance

 

3,395

 

274

 

838

 

4,507

 

403,073

 

0.8

 

Non-U.S. public finance (1)

 

2,046

 

282

 

 

2,328

 

39,046

 

0.4

 

Total

 

$

12,250

 

$

4,981

 

$

9,531

 

$

26,762

 

$

558,048

 

4.8

%

 


(1)     Include $291 million in net par and $231.9 million in expected loss to be paid as of March 31, 2012 and $282 million in net par and $42.6 million in expected loss to be paid as of December 31, 2011 for bonds of the Hellenic Republic of Greece.

 

By Category Below-Investment-Grade Credits

 

 

 

As of March 31, 2012

 

 

 

Net Par Outstanding

 

Number of Risks(2)

 

Description

 

Financial
Guaranty
Insurance(1)

 

Credit
Derivative

 

Total

 

Financial
Guaranty
Insurance(1)

 

Credit
Derivative

 

Total

 

 

 

(dollars in millions)

 

BIG:

 

 

 

 

 

 

 

 

 

 

 

 

 

Category 1

 

$

7,703

 

$

3,037

 

$

10,740

 

164

 

33

 

197

 

Category 2

 

3,903

 

2,213

 

6,116

 

79

 

35

 

114

 

Category 3

 

6,913

 

2,230

 

9,143

 

125

 

26

 

151

 

Total BIG

 

$

18,519

 

$

7,480

 

$

25,999

 

368

 

94

 

462

 

 

12



Table of Contents

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

3. Outstanding Exposure (Continued)

 

 

 

As of December 31, 2011

 

 

 

Net Par Outstanding

 

Number of Risks(2)

 

Description

 

Financial
Guaranty
Insurance(1)

 

Credit
Derivative

 

Total

 

Financial
Guaranty
Insurance(1)

 

Credit
Derivative

 

Total

 

 

(dollars in millions)

 

BIG:

 

 

 

 

 

 

 

 

 

 

 

 

 

Category 1

 

$

8,297

 

$

3,953

 

$

12,250

 

171

 

40

 

211

 

Category 2

 

3,458

 

1,523

 

4,981

 

71

 

33

 

104

 

Category 3

 

7,204

 

2,327

 

9,531

 

126

 

26

 

152

 

Total BIG

 

$

18,959

 

$

7,803

 

$

26,762

 

368

 

99

 

467

 

 


(1)                                  Includes net par outstanding for FG VIEs.

 

(2)                                  A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making Debt Service payments.

 

4. Financial Guaranty Insurance Contracts

 

Change in accounting for deferred acquisition costs

 

In October 2010, the FASB adopted Accounting Standards Update (“Update”) No. 2010-26. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The Company adopted this new guidance with retrospective application. The amendment in the Update specifies that certain costs incurred in the successful acquisition of new and renewal insurance contracts should be capitalized. These costs include direct costs of contract acquisition that result directly from and are essential to the contract transaction. These costs include expenses such as ceding commissions and the cost of underwriting personnel. Management uses its judgment in determining the type and amount of cost to be deferred. The Company conducts an annual study to determine which operating costs vary with, and are directly related to, the acquisition of new business, and therefore qualify for deferral. Ceding commission income on business ceded to third party reinsurers reduces policy acquisition costs and is deferred. Costs incurred by the insurer for soliciting potential customers, market research, training, administration, unsuccessful acquisition efforts, and product development as well as all overhead type costs are charged to expense as incurred.

 

Expected losses, loss adjustment expenses (“LAE”) and the remaining costs of servicing the insured or reinsured business are considered in determining the recoverability of deferred acquisition costs. When an insured issue is retired early, the remaining related deferred acquisition cost is expensed at that time. Ceding commission expense and income associated with future installment premiums on assumed and ceded business, respectively, are calculated at their contractually defined rates and recorded in deferred acquisition costs on the consolidated balance sheets with a corresponding offset to net premium receivable or reinsurance balances payable.

 

As of January 1, 2011, the effect of retrospective application of the new guidance was a reduction to deferred acquisition costs of $94.4 million and a reduction to retained earnings of $64.0 million.

 

13



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

4. Financial Guaranty Insurance Contracts (Continued)

 

Effect of Retrospective Application of New Deferred Acquisition Cost Guidance

On Consolidated Statements of Operations

 

 

 

As Reported
First Quarter 2011

 

Retroactive
Application
Adjustment

 

As Revised
First Quarter 2011

 

 

 

(in millions except per share amounts)

 

Amortization of deferred acquisition costs

 

$

7.4

 

$

(3.7

)

$

3.7

 

Other operating expenses

 

56.8

 

6.0

 

62.8

 

Total expenses

 

63.5

 

2.3

 

65.8

 

Income (loss) before income taxes

 

215.5

 

(2.3

)

213.2

 

Total provision (benefit) for income taxes

 

74.9

 

(1.0

)

73.9

 

Net income (loss)

 

140.6

 

(1.3

)

139.3

 

Earnings per share:

 

 

 

 

 

 

 

Basic

 

$

0.76

 

$

 

$

0.76

 

Diluted

 

0.75

 

(0.01

)

0.74

 

 

The portfolio of outstanding exposures discussed in Note 3, Outstanding Exposure, includes financial guaranty contracts that meet the definition of insurance contracts as well as those that meet the definition of derivative contracts. Amounts presented in this note relate to financial guaranty insurance contracts. Tables presented herein also present reconciliations to financial statement line items for other less significant types of insurance.

 

Net Earned Premiums

 

 

 

First Quarter

 

 

 

2012

 

2011

 

 

 

(in millions)

 

Scheduled net earned premiums

 

$

152.0

 

$

214.9

 

Acceleration of premium earnings

 

36.6

 

29.6

 

Accretion of discount on net premiums receivable

 

4.7

 

9.0

 

Total financial guaranty

 

193.3

 

253.5

 

Other

 

0.4

 

0.5

 

Total net earned premiums(1)

 

$

193.7

 

$

254.0

 

 


(1)                                  Excludes $17.0 million and $19.1 million in First Quarter 2012 and 2011, respectively, related to consolidated FG VIEs.

 

14



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

4. Financial Guaranty Insurance Contracts (Continued)

 

Gross Premium Receivable, Net of Ceding Commissions Roll Forward

 

 

 

First Quarter

 

 

 

2012

 

2011

 

 

 

(in millions)

 

Gross premium receivable, net of ceding commissions payable:

 

 

 

 

 

Balance beginning of period

 

$

1,002.9

 

$

1,167.6

 

Premium written, net

 

56.3

 

48.0

 

Premium payments received, net

 

(86.1

)

(72.8

)

Adjustments to the premium receivable:

 

 

 

 

 

Changes in the expected term of financial guaranty insurance contracts

 

32.7

 

(51.1

)

Accretion of discount

 

6.1

 

9.2

 

Foreign exchange translation

 

12.2

 

15.9

 

Consolidation of FG VIEs

 

(5.4

)

 

Other adjustments

 

 

1.2

 

Balance, end of period (1)

 

$

1,018.7

 

$

1,118.0

 

 


(1)                                  Excludes $32.6 million and $19.8 million as of March 31, 2012 and 2011, respectively, related to consolidated FG VIEs.

 

Gains or losses due to foreign exchange rate changes relate to installment premium receivables denominated in currencies other than the U.S. dollar. Approximately 48%, 47% and 45% of installment premiums at March 31, 2012, December 31, 2011 and March 31, 2011, respectively, are denominated in currencies other than the U.S. dollar, primarily in euro and British Pound Sterling.

 

Actual collections may differ from expected collections in the tables below due to factors such as foreign exchange rate fluctuations, counterparty collectability issues, refundings, accelerations, commutations and changes in expected lives.

 

Expected Collections of Gross Premiums Receivable,

Net of Ceding Commissions (Undiscounted)

 

 

 

March 31, 2012

 

 

 

(in millions)

 

2012 (April 1 – June 30)

 

$

56.6

 

2012 (July 1 – September 30)

 

30.8

 

2012 (October 1 – December 31)

 

44.6

 

2013

 

109.5

 

2014

 

95.9

 

2015

 

85.7

 

2016

 

79.8

 

2017-2021

 

315.9

 

2022-2026

 

214.6

 

2027-2031

 

158.7

 

After 2031

 

194.4

 

Total(1)

 

$

1,386.5

 

 


(1)                                  Excludes expected cash collections on FG VIEs of $38.9 million.

 

15



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

4. Financial Guaranty Insurance Contracts (Continued)

 

Components of Unearned Premium Reserve

 

 

 

As of March 31, 2012

 

As of December 31, 2011

 

 

 

Gross

 

Ceded

 

Net(1)

 

Gross

 

Ceded

 

Net(1)

 

 

 

(in millions)

 

Deferred premium revenue

 

$

5,918.8

 

$

647.8

 

$

5,271.0

 

$

6,046.3

 

$

727.4

 

$

5,318.9

 

Contra-paid

 

(87.9

)

(16.7

)

(71.2

)

(92.2

)

(18.8

)

(73.4

)

Total financial guaranty

 

5,830.9

 

631.1

 

5,199.8

 

5,954.1

 

708.6

 

5,245.5

 

Other

 

8.3

 

0.3

 

8.0

 

8.7

 

0.3

 

8.4

 

Total

 

$

5,839.2

 

$

631.4

 

$

5,207.8

 

$

5,962.8

 

$

708.9

 

$

5,253.9

 

 


(1)                                  Total net unearned premium reserve excludes $249.7 million and $274.2 million related to FG VIE’s as of March 31, 2012 and December 31, 2011, respectively.

 

The following table provides a schedule of the expected timing of the income statement recognition of financial guaranty insurance net deferred premium revenue and the present value of net expected losses to be expensed, pretax which are not included in loss and LAE reserve. The amount and timing of actual premium earnings and loss and LAE may differ from the estimates shown below due to factors such as refundings, accelerations, commutations, changes in expected lives and updates to loss estimates. A loss and LAE reserve is only recorded for the amount by which net expected loss to be expensed exceeds deferred premium revenue determined on a contract-by-contract basis. This table excludes amounts related to consolidated FG VIEs.

 

Expected Timing of Financial Guaranty Insurance

Premium and Loss Recognition

 

 

 

As of March 31, 2012

 

 

 

Scheduled
Net Earned
Premium

 

Net Expected
Loss to be
Expensed

 

Net

 

 

 

(in millions)

 

2012 (April 1–June 30)

 

$

144.3

 

$

17.8

 

$

126.5

 

2012 (July 1–September 30)

 

138.2

 

17.0

 

121.2

 

2012 (October 1–December 31)

 

131.6

 

15.5

 

116.1

 

Subtotal 2012

 

414.1

 

50.3

 

363.8

 

2013

 

474.1

 

58.4

 

415.7

 

2014

 

436.6

 

46.8

 

389.8

 

2015

 

387.1

 

41.2

 

345.9

 

2016

 

351.9

 

33.2

 

318.7

 

2017 - 2021

 

1,334.4

 

136.9

 

1,197.5

 

2022 - 2026

 

838.9

 

74.0

 

764.9

 

2027 - 2031

 

508.2

 

35.8

 

472.4

 

After 2031

 

525.7

 

27.2

 

498.5

 

Total present value basis(1)(2)

 

5,271.0

 

503.8

 

4,767.2

 

Discount

 

298.8

 

292.6

 

6.2

 

Total future value

 

$

5,569.8

 

$

796.4

 

$

4,773.4

 

 


(1)                                  Balances represent discounted amounts.

 

(2)                                  Consolidation of FG VIEs resulted in reductions of $396.2 million in future scheduled amortization of deferred premium revenue and $211.0 million in net present value of expected loss to be expensed.

 

16



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

4. Financial Guaranty Insurance Contracts (Continued)

 

Selected Information for Policies Paid in Installments

 

 

 

As of
March 31, 2012

 

As of
December 31, 2011

 

 

 

(dollars in millions)

 

Premiums receivable, net of ceding commission payable

 

$

1,018.7

 

$

1,002.9

 

Gross deferred premium revenue

 

2,125.6

 

2,192.6

 

Weighted-average risk-free rate used to discount premiums

 

3.7

 

3.4

 

Weighted-average period of premiums receivable (in years)

 

10.0

 

9.8

 

 

Loss Estimation Process

 

The Company’s loss reserve committees estimate expected loss to be paid. Surveillance personnel present analysis related to potential losses to the Company’s loss reserve committees for consideration in estimating the expected loss to be paid. Such analysis includes the consideration of various scenarios with potential probabilities assigned to them. Depending upon the nature of the risk, the Company’s view of the potential size of any loss and the information available to the Company, that analysis may be based upon individually developed cash flow models, internal credit rating assessments and sector-driven loss severity assumptions or judgmental assessments. In the case of its assumed business, the Company may conduct its own analysis as just described or, depending on the Company’s view of the potential size of any loss and the information available to the Company, the Company may use loss estimates provided by ceding insurers. The Company’s loss reserve committees review and refresh the estimate of expected loss to be paid each quarter. The Company’s estimate of ultimate loss on a policy is subject to significant uncertainty over the life of the insured transaction due to the potential for significant variability in credit performance as a result of economic, fiscal and financial market variability over the long duration of most contracts. The determination of expected loss to be paid is an inherently subjective process involving numerous estimates, assumptions and judgments by management.

 

The following table presents a roll forward of the present value of net expected loss to be paid for financial guaranty insurance contracts by sector. Net expected loss to be paid is the estimate of the present value of future claim payments, net of reinsurance and net of salvage and subrogation, which includes the present value benefit of estimated recoveries for breaches of representations and warranties (“R&W”). The Company used weighted average risk-free rates for U.S. dollar denominated obligations, which ranged from 0.0% to 3.94% as of March 31, 2012 and 0.0% to 3.27% as of December 31, 2011. The weighted average risk-free rates for Euro denominated obligations was 0.0% - 2.84% as of March 31, 2012 and 0.0% - 2.69% as of December 31, 2011.

 

Financial Guaranty Insurance

Present Value of Net Expected Loss to be Paid

Roll Forward by Sector(1)

 

 

 

Net Expected
Loss to be
Paid as of
December 31, 2011(4)

 

Economic Loss
Development(2)

 

(Paid)
Recovered
Losses(3)

 

Net Expected
Loss to be
Paid as of
March 31, 2012(4)

 

 

 

(in millions)

 

U.S. RMBS:

 

 

 

 

 

 

 

 

 

First lien:

 

 

 

 

 

 

 

 

 

Prime first lien

 

$

1.8

 

$

0.4

 

$

 

$

2.2

 

Alt-A first lien

 

134.9

 

(8.6

)

(9.4

)

116.9

 

Option ARM

 

152.9

 

(1.7

)

(75.9

)

75.3

 

Subprime

 

140.3

 

11.3

 

(1.2

)

150.4

 

Total first lien

 

429.9

 

1.4

 

(86.5

)

344.8

 

Second lien:

 

 

 

 

 

 

 

 

 

Closed-end second lien

 

(79.6

)

(1.1

)

(9.0

)

(89.7

)

HELOCs

 

(31.1

)

7.6

 

(19.0

)

(42.5

)

Total second lien

 

(110.7

)

6.5

 

(28.0

)

(132.2

)

Total U.S. RMBS

 

319.2

 

7.9

 

(114.5

)

212.6

 

Other structured finance

 

252.8

 

(23.8

)

(23.7

)

205.3

 

Public finance(5)

 

66.0

 

220.7

 

47.8

 

334.5

 

Total

 

$

638.0

 

$

204.8

 

$

(90.4

)

$

752.4

 

 

17



Table of Contents

 

Assured Guaranty Ltd.

 

Notes to Consolidated Financial Statements (Unaudited) (Continued)

 

March 31, 2012

 

4. Financial Guaranty Insurance Contracts (Continued)

 

 

 

Net Expected
Loss to be
Paid as of
December 31, 2010

 

Economic Loss
Development(2)

 

(Paid)
Recovered
Losses(3)

 

Expected
Loss to be
Paid as of
March 31, 2011(4)

 

 

 

(in millions)

 

U.S. RMBS:

 

 

 

 

 

 

 

 

 

First lien:

 

 

 

 

 

 

 

 

 

Prime first lien

 

$

1.4

 

$

0.1

 

$

 

$

1.5

 

Alt-A first lien

 

184.4

 

6.5

 

(19.5

)

171.4

 

Option ARM

 

523.7

 

(114.7

)

(86.9

)

322.1

 

Subprime

 

200.4

 

(17.8

)

(15.1

)

167.5

 

Total first lien

 

909.9

 

(125.9

)

(121.5

)

662.5

 

Second lien:

 

 

 

 

 

 

 

 

 

Closed-end second lien

 

56.6

 

(106.4

)

(27.1

)

(76.9

)

HELOCs

 

(805.7

)

77.6

 

(64.6

)

(792.7

)

Total second lien

 

(749.1

)

(28.8

)

(91.7

)

(869.6

)

Total U.S. RMBS

 

160.8

 

(154.7

)

(213.2

)

(207.1

)

Other structured finance

 

159.1

 

16.3

 

(2.4

)

173.0

 

Public finance(5)

 

88.9

 

(13.6

)

(9.0

)

66.3

 

Total

 

$

408.8

 

$

(152.0

)

$

(224.6

)

$

32.2

 

 


(1)