UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

 

For the Quarterly Period Ended March 31, 2006

OR

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

 

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 of incorporation)		(I.R.S. employer identification no.)

 

30 Woodbourne Avenue
Hamilton HM 08
Bermuda
(address of principal executive office)

(441) 299-9375
(Registrants 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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

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

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, 2006 was 73,930,701.

ASSURED GUARANTY LTD.

INDEX TO FORM 10-Q

PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements:
		Consolidated Balance Sheets as of March 31, 2006 (unaudited) and December 31, 2005
		Consolidated Statements of Operations and Comprehensive Income (unaudited) for the Three Months Ended March 31, 2006 and 2005
		Consolidated Statements of Shareholders’ Equity (unaudited) for the Three Months Ended March 31, 2006
		Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2006 and 2005
		Notes to Consolidated Financial Statements (unaudited)
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.		Quantitative and Qualitative Disclosures About Market Risk
Item 4.		Controls and Procedures
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings
Item 1A.		Risk Factors
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds
Item 4.		Submission of Matters to a Vote of Security Holders
Item 5.		Other Information
Item 6.		Exhibits

 

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Assured Guaranty Ltd.
Consolidated Balance Sheets
(in thousands of U.S. dollars except per share and share amounts)
(Unaudited)

		March 31,			December 31,
		2006			2005
Assets
Fixed maturity securities, at fair value (amortized cost: $2,090,157 in 2006 and $2,082,363 in 2005)		$	2,114,115		$	2,133,997
Short-term investments, at cost which approximates fair value		134,981			115,826
Total investments		2,249,096			2,249,823
Cash and cash equivalents		3,746			6,190
Accrued investment income		21,767			22,676
Deferred acquisition costs		195,897			193,442
Prepaid reinsurance premiums		13,344			12,478
Reinsurance recoverable on ceded losses		12,158			12,350
Premiums receivable		26,984			33,011
Goodwill		85,417			85,417
Unrealized gains on derivative financial instruments		52,202			53,037
Current income taxes receivable		3,101			3,005
Other assets		14,281			17,694
Total assets		$	2,677,993		$	2,689,123
Liabilities and shareholders’ equity
Liabilities
Unearned premium reserves		$	540,744		$	537,149
Reserves for losses and loss adjustment expenses		117,171			121,219
Profit commissions payable		28,048			52,993
Reinsurance balances payable		9,060			3,724
Deferred income taxes		25,390			26,629
Funds held by Company under reinsurance contracts		21,962			19,186
Unrealized losses on derivative financial instruments		11,788			12,652
Long-term debt		197,352			197,344
Other liabilities		53,061			56,714
Total liabilities		1,004,576			1,027,610
Commitments and contingencies
Shareholders’ equity
Common stock ($0.01 par value, 500,000,000 shares authorized; 73,801,852 and 74,761,577 shares issued and outstanding in 2006 and 2005)		738			748
Additional paid-in capital		870,415			881,998
Unearned stock grant compensation		—			(14,756		)
Retained earnings		779,939			747,691
Accumulated other comprehensive income		22,325			45,832
Total shareholders’ equity		1,673,417			1,661,513
Total liabilities and shareholders’ equity		$	2,677,993		$	2,689,123

 

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

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Assured Guaranty Ltd.
Consolidated Statements of Operations and Comprehensive Income
(in thousands of U.S. dollars except per share amounts)
(Unaudited)

		Three Months Ended March 31,
		2006			2005
Revenues
Gross written premiums		$	55,384		$	78,097
Ceded premiums		(4,600		)	(1,628		)
Net written premiums		50,784			76,469
Increase in net unearned premium reserves		(2,729		)	(28,379		)
Net earned premiums		48,055			48,090
Net investment income		26,238			23,132
Net realized investment (losses) gains		(1,006		)	1,791
Unrealized gain on derivative financial instruments		29			3,072
Other income		—			283
Total revenues		73,316			76,368
Expenses
Loss and loss adjustment expenses		(382		)	(9,396		)
Profit commission expense		1,308			987
Acquisition costs		10,785			10,216
Other operating expenses		17,150			14,508
Interest expense		3,375			3,296
Other expense		614			—
Total expenses		32,850			19,611
Income before provision for income taxes		40,466			56,757
Provision for income taxes
Current		2,643			5,083
Deferred		2,941			7,326
Total provision for income taxes		5,584			12,409
Net income		34,882			44,348
Other comprehensive income, net of taxes
Unrealized holding losses on fixed maturity securities arising during the period		(24,060		)	(20,638		)
Reclassification adjustment for realized losses (gains) included in net income		658			(1,501		)
Change in net unrealized gains on fixed maturity securities		(23,402		)	(22,139		)
Cash flow hedge		(105		)	(105		)
Other comprehensive loss, net of tax		(23,507		)	(22,244		)
Comprehensive income		$	11,375		$	22,104
Earnings per share:
Basic		$	0.47		$	0.60
Diluted		$	0.47		$	0.59
Dividends per share		$	0.035		$	0.03

 

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

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Assured Guaranty Ltd.
Consolidated Statements of Shareholders’ Equity
For the Three Months Ended March 31, 2006
(in thousands of U.S. dollars except per share amounts)
(Unaudited)

		Common Stock			Additional Paid-in Capital			Unearned Stock Grant Compensation			Retained Earnings			Accumulated Other Comprehensive Income			Total Shareholders’ Equity
Balance, December 31, 2005		$	748		$	881,998		$	(14,756	)	$	747,691		$	45,832		$	1,661,513
Net income		—			—			—			34,882			—			34,882
Dividends ($0.035 per share)		—			—			—			(2,634		)	—			(2,634		)
Share activity under options and incentive plans, net		—			(622		)	—			—			—			(622		)
Cash flow hedge, net of tax of $(56)		—			—			—			—			(105		)	(105		)
Unrealized loss on fixed maturity securities, net of tax of $(4,066)		—			—			—			—			(23,402		)	(23,402		)
Reclassification due to adoption of FAS 123R		(10		)	(14,746		)	14,756			—			—			—
Share-based compensation		—			3,785			—			—			—			3,785
Balance, March 31, 2006		$	738		$	870,415		$	—		$	779,939		$	22,325		$	1,673,417

 

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

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Assured Guaranty Ltd.
Consolidated Statements of Cash Flows
(in thousands of U.S. dollars)
(Unaudited)

		Three Months Ended March 31,
		2006			2005
Operating activities
Net income		$	34,882		$	44,348
Adjustments to reconcile net income to net cash flows provided by operating activities:
Non-cash interest and operating expenses		3,893			1,493
Net amortization of premium on fixed maturity securities		1,521			1,673
Provision for deferred income taxes		2,941			7,326
Net realized investment (losses)gains		1,006			(1,791		)
Change in unrealized gains on derivative financial instruments		(29		)	(3,072		)
Change in deferred acquisition costs		(2,455		)	(5,845		)
Change in accrued investment income		909			(1,206		)
Change in premiums receivable		6,027			(1,913		)
Change in prepaid reinsurance premiums		(866		)	924
Change in unearned premium reserves		3,595			27,464
Change in reserves for losses and loss adjustment expenses, net		1,480			(2,303		)
Change in profit commissions payable		(24,945		)	(17,790		)
Change in funds held by Company under reinsurance contracts		2,776			1,631
Change in current income taxes		(96		)	1,017
Tax benefit from employee stock options		—			4,059
Other		(10,229		)	1,166
Net cash flows provided by operating activities		20,410			57,181
Investing activities
Fixed maturity securities:
Purchases		(260,522		)	(317,195		)
Sales		259,952			169,515
(Purchases) sales of short-term investments, net		(19,238		)	112,309
Net cash flows used in investing activities		(19,808		)	(35,371		)
Financing activities
Dividends paid		(2,632		)	(2,274		)
Share activity under option and incentive plans		(436		)	—
Repurchases of common stock		—			(14,740		)
Net cash flows used in financing activities		(3,068		)	(17,014		)
Effect of exchange rate changes		22			(51		)
(Decrease) increase in cash and cash equivalents		(2,444		)	4,745
Cash and cash equivalents at beginning of period		6,190			16,978
Cash and cash equivalents at end of period		$	3,746		$	21,723
Supplementary cash flow information
Cash paid during the period for:
Income taxes		$	2,740		$	—

 

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

 

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Assured Guaranty Ltd.
Notes to Consolidated Financial Statements
March 31, 2006
(Unaudited)

 

1. Business and Organization

Assured Guaranty Ltd. (the “Company”) is a Bermuda-based holding company which provides, through its operating subsidiaries, credit enhancement products to the public finance, structured finance and mortgage markets. Credit enhancement products are financial guarantees or other types of support, including credit derivatives, that improve the credit of underlying debt obligations. Assured Guaranty Ltd. applies its credit expertise, risk management skills and capital markets experience to develop insurance, reinsurance and derivative products that meet the credit enhancement needs of its customers. Under a reinsurance agreement, the reinsurer, in consideration of a premium paid to it, agrees to indemnify another insurer, called the ceding company, for part or all of the liability of the ceding company under one or more insurance policies that the ceding company has issued. A derivative is a financial instrument whose characteristics and value depend upon the characteristics and value of an underlying security. Assured Guaranty Ltd. markets its products directly to and through financial institutions, serving the U.S. and international markets. Assured Guaranty Ltd.’s financial results include four principal business segments: financial guaranty direct, financial guaranty reinsurance, mortgage guaranty and other. These segments are further discussed in Note 9.

Financial guaranty insurance provides an unconditional and irrevocable guaranty that protects the holder of a financial obligation against non-payment of principal and interest when due. Financial guaranty insurance may be issued to the holders of the insured obligations at the time of issuance of those obligations, or may be issued in the secondary market to holders of public bonds and structured securities. A loss event occurs upon existing or anticipated credit deterioration, while a payment under a policy occurs when the insured obligation defaults. This requires the Company to pay the required principal and interest when due in accordance with the underlying contract. The principal types of obligations covered by the Company’s financial guaranty direct and financial guaranty assumed reinsurance businesses are structured finance obligations and public finance obligations. Because both businesses involve similar risks, the Company analyzes and monitors its financial guaranty direct portfolio and financial guaranty assumed reinsurance portfolio on a coordinated basis.

Mortgage guaranty insurance is a specialized class of credit insurance that provides protection to mortgage lending institutions against the default of borrowers on mortgage loans that, at the time of the advance, had a loan to value in excess of a specified ratio. Reinsurance in the mortgage guaranty insurance industry is used to increase the insurance capacity of the ceding company, to assist the ceding company in meeting applicable regulatory and rating agency requirements, to augment the financial strength of the ceding company, and to manage the ceding company’s risk profile. The Company provides mortgage guaranty protection on an excess of loss basis.

The Company has participated in several lines of business that are reflected in its historical financial statements but that the Company exited in connection with the IPO, including, but not limited to, equity layer credit protection, trade credit reinsurance and title reinsurance. These lines of business make up the Company’s other segment.

2. Basis of Presentation

The unaudited interim consolidated financial statements, which include the accounts of the Company, 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, consisting only of normal recurring adjustments, necessary for a fair statement of the Company’s financial condition, results of operations and cash flows 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

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unaudited interim consolidated financial statements cover the three-month period ended March 31, 2006 (“First Quarter 2006”) and the three-month period ended March 31, 2005 (“First Quarter 2005”). Operating results for the three-month periods ended March 31, 2006 and 2005 are not necessarily indicative of the results that may be expected for a full year. Certain items in the prior year unaudited interim consolidated financial statements have been reclassified to conform with the current period presentation. These unaudited interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, filed with the Securities and Exchange Commission.

Certain of the Company’s subsidiaries are subject to U.S. income tax. The provision for income taxes is calculated in accordance with Statement of Financial Accounting Standards (“FAS”) FAS No. 109, “Accounting for Income Taxes”. The Company’s provision for income taxes for interim financial periods is not based on an estimated annual effective rate due to the variability in changes in fair value of its derivative financial instruments. A discrete calculation of the provision is calculated for each interim period.

3. Recent Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (“FASB”) issued FAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“FAS 155”) which amends FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”) and FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“FAS 140”), and addresses issues raised in FAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” The primary objectives of FAS 155 are: (i) with respect to FAS 133, to address the accounting for beneficial interests in securitized financial assets and (ii) with respect to FAS 140, eliminate a restriction on the passive derivative instruments that a qualifying special purpose entity may hold. FAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company is currently evaluating the implications of FAS 155 on its financial statements.

4. Impact of Reinsurance Transactions

To limit its exposure on assumed risks, at the time of the IPO, the Company entered into certain proportional and non-proportional retrocessional agreements with other insurance companies, primarily subsidiaries of ACE Limited (“ACE”), to cede a portion of the risk underwritten by the Company. In addition, the Company enters into reinsurance agreements with non-affiliated companies to limit its exposure to risk on an on-going basis.

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In the event that any or all of the reinsurers are unable to meet their obligations, the Company would be liable for such defaulted amounts. Direct, assumed, and ceded amounts were as follows:

 

		Three Months Ended March 31,
		2006			2005
		(in thousands of U.S. dollars)
Premiums Written
Direct		$	30,248		$	23,755
Assumed		25,136			54,342
Ceded		(4,600		)	(1,628		)
Net		$	50,784		$	76,469
Premiums Earned
Direct		$	21,228		$	21,230
Assumed		30,528			29,412
Ceded		(3,701		)	(2,552		)
Net		$	48,055		$	48,090
Loss and Loss Adjustment Expenses
Direct		$	(3,031	)	$	(2,067	)
Assumed		3,292			(9,189		)
Ceded		(643		)	1,860
Net		$	(382	)	$	(9,396	)

 

Net written premiums for First Quarter 2006 were $50.8 million compared with  $76.5 million for First Quarter 2005. Gross written premiums from our financial guaranty direct operations increased $6.4 million in 2006 compared with 2005, as we continue to execute our direct business strategy.  Offsetting this increase was a  $10.4 million and $4.8 million reduction in treaty and facultative assumed premiums, respectively. Further offsetting the financial guaranty direct increase was an excess of loss reinsurance transaction of  $16.3 million written during First Quarter 2005 in our mortgage guaranty segment.

Loss and loss adjustment expenses (“LAE”) were $(0.4) million and $(9.4) million for First Quarter 2006 and First Quarter 2005, respectively. During First Quarter 2006, the Company increased the financial guaranty reinsurance segment’s case reserves $2.6 million and also incurred and paid a $0.6 million loss in this segment. Offsetting these increases was a $3.2 million settlement of a sub-prime mortgage transaction, offset by a related $0.7 million subrogation receivable and a $4.5 million release of case reserves in our financial guaranty direct segment and a litigation recovery of $1.2 million in our other segment. During First Quarter 2005 the Company recovered $6.8 million relating to a reinsurance claim incurred in 1998 and 1999. This recovery was received in connection with the completion of two settlements and is shown in the statements of operations and comprehensive income in loss and loss adjusted expenses. Recovery efforts relating to this and other claims are continuing. In addition, during First Quarter 2005,  the Company recovered $1.1 million relating to a litigation recovery.

Reinsurance recoverable on ceded losses and LAE as of March 31, 2006 and December 31, 2005 were $12.2 million and $12.4 million, respectively and are all related to our other segment. Of these amounts, $12.1 million and $12.3 million, respectively, relate to reinsurance agreements with ACE.

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The following summarizes the Company’s gross written premiums by significant client:

 

		Three Months Ended March 31,
Gross Written Premiums by Client		2006			2005
		($ in millions)
Financial Security Assurance Inc.		$	7.5		$	22.2
Ambac Assurance Corporation		4.3			10.7
MBIA Insurance Corporation		3.5			4.6
Financial Guaranty Insurance Company		3.4			2.3

 

5. Commitments and Contingencies

Lawsuits arise in the ordinary course of the Company’s business. It is the opinion of the Company’s management, based upon the information available, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the Company’s financial position, results of operations or liquidity, although an adverse resolution of a number of these items could have a material adverse effect on the Company’s results of operations or liquidity in a particular quarter or fiscal year.

On April 10, 2006, the Company’s wholly owned subsidiary, Assured Guaranty Re Overseas Ltd. (“AGRO”), and a number of other parties, completed a settlement with JP Morgan Chase & Co. and certain of its related entities and affiliated persons, all of which were among the defendants in the In re: National Century Financial Enterprises Inc. Investment Litigation now pending in the United States District Court for the Southern District of Ohio - Eastern District. AGRO received approximately $8.0 million (pre-tax) in April 2006, from the settlement. AGRO originally paid claims in 1999 of approximately $41.7 million (pre-tax) related to National Century Financial Enterprises Inc. To date, including the settlement described above, the Company has recovered $14.5 million (pre-tax). This is a partial settlement of the litigation, and the litigation will continue against other parties.

In April 2005, Assured Guaranty Corp. (“AGC”) received a Notice of Order to Preserve (“Order”) from the Office of the Commissioner of Insurance, State of Georgia (“Commissioner”). The Order was directed to “ACE Limited, and all affiliates” and requires the preservation of documents and other items related to “finite insurance” and a broad group of other insurance and reinsurance agreements. Also in April 2005, AGC, and numerous other insurers, received a subpoena from the Commissioner related to the “initial phase” of the Commissioner’s investigation into “finite-risk” transactions. The subpoena requests information on AGC’s assumed and ceded reinsurance contracts in force during 2004. AGC is cooperating with the Commissioner.

In the ordinary course of their respective businesses, certain of the Company’s subsidiaries assert claims in legal proceedings against third parties to recover losses paid in prior periods. The amounts, if any, the Company will recover in these proceedings are uncertain, although recoveries in any one or more of these proceedings during any quarter or fiscal year could be material to the Company’s results of operations in that particular quarter or fiscal year.

The Company is party to reinsurance agreements with all of the major monoline primary financial guaranty insurance companies. The Company’s facultative and treaty agreements are generally subject to termination (i) upon written notice (ranging from 90 to 120 days) prior to the specified deadline for renewal, (ii) at the option of the primary insurer if the Company fails to maintain certain financial, regulatory and rating agency criteria which are equivalent to or more stringent than those the Company is otherwise required to maintain for its own compliance with state mandated insurance laws and to maintain a specified financial strength rating for the particular insurance subsidiary or (iii) upon certain changes of control of the Company. Upon termination under the conditions set forth in (ii) and (iii) above, the Company may be required (under some of its reinsurance agreements) to return to the primary insurer all statutory unearned premiums, less ceding commissions, attributable to reinsurance ceded pursuant to such agreements after which the Company would be released from liability with respect to the ceded business. Upon the occurrence of the conditions set forth in (ii) above, whether or not an agreement is terminated, the Company may be required to obtain a letter of credit or alternative form of security to collateralize its obligation to perform under such agreement or it may be obligated to increase the level of ceding commission paid.

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6. Long-Term Debt and Credit Facilities

The Company’s unaudited interim consolidated financial statements  include long-term debt used to fund the Company’s insurance operations, and related interest expense, as described below.

Senior Notes

On May 18, 2004, Assured Guaranty US Holdings Inc., a subsidiary of the Company, issued $200.0 million of 7.0% Senior Notes due 2034 for net proceeds of $197.3 million. The proceeds of the offering were used to repay substantially all of a $200.0 million promissory note issued to a subsidiary of ACE in April 2004 as part of the initial public offering (“IPO”) related formation transactions. The coupon on the Senior Notes is 7.0%, however, the effective rate will be approximately 6.4%, taking into account the effect of a cash flow hedge executed by the Company in March 2004. The Company recorded interest expense of $3.3 million, including $0.2 million of amortized gain on the cash flow hedge, for both the three months ended March 31, 2006 and 2005. These Senior Notes are fully and unconditionally guaranteed by Assured Guaranty Ltd.

Credit Facilities

$300.0 million Credit Facility

On April 15, 2005, Assured Guaranty Ltd. and certain of its subsidiaries entered into a $300.0 million three-year unsecured revolving credit facility (the “$300.0 million credit facility”) with a syndicate of banks, for which ABN AMRO Incorporated and Bank of America, N.A. acted as lead arrangers and KeyBank National Association (“KeyBank”) acted as syndication agent. Under the $300.0 million credit facility, each of AGC, AG (UK), a subsidiary of AGC organized under the laws of the United Kingdom, Assured Guaranty Ltd., Assured Guaranty Re Ltd. (“AG Re”) a subsidiary of the Company and AGRO are entitled to request the banks to make loans to such borrower or to request that letters of credit be issued for the account of such borrower. Two letters of credit have been issued, both on behalf of AGRO, with an aggregate stated amount of approximately $20.7 million.

If drawn, the proceeds of the loans and letters of credit are to be used for working capital and other general corporate purposes of the borrowers and to support reinsurance transactions.

At the closing of the $300.0 million credit facility, (i) AGC guaranteed the obligations of AG (UK) under such facility, (ii) Assured Guaranty Ltd. guaranteed the obligations of AG Re and AGRO under such facility and agreed that, if the Company Consolidated Assets (as defined in the related credit agreement) of AGC and its subsidiaries were to fall below $1.2 billion, it would, within 15 days, guarantee the obligations of AGC and AG (UK) under such facility and (iii) Assured Guaranty Overseas US Holdings Inc., as a Material Non-AGC Subsidiary (as defined in the related credit agreement), guaranteed the obligations of Assured Guaranty Ltd., AG Re and AGRO under such facility. Subsequently, AG Re and AGRO, as Material Non-AGC Subsidiaries, both guaranteed the obligations of the other and of Assured Guaranty Ltd. under such facility.

The $300.0 million credit facility’s financial covenants require that Assured Guaranty Ltd. (a) maintain a minimum net worth of $1.2 billion, (b) maintain an interest coverage ratio of at least 2.5:1, and (c) maintain a maximum debt-to-capital ratio of 30%. In addition, the $300.0 million credit facility requires that AGC: (x) maintain qualified statutory capital of at least 80% of its statutory capital as of the fiscal quarter prior to the closing date of the facility and (y) maintain a ratio of aggregate net par outstanding to qualified statutory capital of not more than 150:1. Furthermore, the $300.0 million credit facility contains restrictions on Assured Guaranty Ltd. and its subsidiaries, including, among other things, in respect of their ability to incur debt, permit liens, become liable in respect of guaranties, make loans or investments, pay dividends or make distributions, dissolve or become party to a merger, consolidation or acquisition, dispose of assets or enter into affiliate transactions. Most of these restrictions are subject to certain minimum thresholds and exceptions. A default by one borrower will give rise to a right of the lenders to terminate the facility and accelerate all amounts then outstanding. As of March 31, 2006 and December 31, 2005, Assured Guaranty was in compliance with all of those financial covenants.

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As of March 31, 2006 and December 31, 2005, no amounts were outstanding under this facility nor have there been any borrowings under this facility.

Non-Recourse Credit Facility

AGC is also party to a non-recourse credit facility with a syndicate of banks which provides up to $175.0 million specifically designed to provide rating agency-qualified capital to further support AGC’s claims paying resources. The facility expires in December 2010. As of March 31, 2006 and December 31, 2005, no amounts were outstanding under this facility nor have there been any borrowings under the life of this facility.

The Company’s failure to comply with certain covenants under the Company’s credit facilities could, subject to grace periods in the case of certain covenants, result in an event of default. This could require the Company to repay any outstanding borrowings in an accelerated manner.

Committed Capital Securities

On April 8, 2005, AGC entered into four separate agreements with four different unaffiliated custodial trusts pursuant to which AGC may, at its option, cause each of the custodial trusts to purchase up to $50.0 million of perpetual preferred stock of AGC. The custodial trusts were created as a vehicle for providing capital support to AGC by allowing AGC to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option. If the put options were exercised, AGC would receive $200.0 million in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose including the payment of claims. The put options were not exercised as of March 31, 2006. Initially, all of the CCS Securities were issued to a special purpose pass-through trust (the “Pass-Through Trust”). The Pass-Through Trust is a newly created statutory trust organized under the Delaware Statutory Trust Act formed for the purposes of (i) issuing $200,000,000 of Pass-Through Trust Securities to qualified institutional buyers within the meaning of Rule 144A under the Securities Act of 1933, as amended, (ii) investing the proceeds from the sale of the Pass-Through Trust Securities in, and holding, the CCS Securities issued by the Custodial Trusts and (iii) entering into related agreements. Neither the Pass-Through Trust nor the Custodial Trusts are consolidated in Assured Guaranty Ltd.’s financial statements.

During First Quarter 2006, AGC incurred $0.6 million of put option premiums which are an on-going expense. These expenses are presented in the Company’s unaudited interim consolidated statements of operations and comprehensive income under other expense.

7. Share-Based Compensation

Effective January 1, 2006, the Company adopted FAS No. 123 (revised), “Share-Based Payment” (“FAS 123R”), which replaces FAS No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”) and supersedes Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). FAS 123R requires all share-based compensation transactions with employees, including grants of employee stock options, to be recognized as compensation expense over the requisite service period based on their relative fair values.

Prior to the adoption of FAS 123R, the Company followed the guidance of APB 25 and did not record share-based compensation expense related to employee stock options in the statement of operations, since for all grants the exercise price was equal to the market value of the common stock on the grant date.

The Company elected to use the modified prospective transition method for implementing FAS 123R. Under this transition method, compensation expense includes:  (a) compensation expense for all share-based payments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FAS 123, and (b) compensation expense for all share-based payments granted on or after January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of FAS 123R. Because we elected to use the modified prospective transition method, results for prior periods have not been restated and new awards are valued and accounted for prospectively upon adoption.

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Beginning January 1, 2006, upon adoption of FAS 123R, the Company recorded share-based compensation for the cost of stock options, restricted stock and the Stock Purchase Plan. Share-based compensation expense in First Quarter 2006 was $3.2 million ($2.7 million after tax). The effect on basic and diluted earnings per share for First Quarter 2006 was $0.04. Included in First Quarter 2006 expense was $0.6 million for stock award grants to retirement-eligible employees. The amount of share-based compensation capitalized in First Quarter 2006 as deferred acquisition costs (“DAC”) was $0.6 million. Share-based compensation expense in First Quarter 2005 was $1.4 million ($1.2 million after tax), respectively. FAS 123R requires these awards to be expensed over the period through the date the employee first becomes eligible to retire  and is no longer required to provide service to earn part or all of the award, regardless of the employees intent of retirement. The following table presents pre-DAC and pre-tax, share-based compensation cost by share-based type:

 

 

For First Quarter 2005, had the compensation expense been determined in accordance with the fair value method recommended in FAS 123, the Company’s net income and net income per share would have been adjusted to the pro forma amounts indicated below:

 

Assured Guaranty Ltd. Share-Based Compensation Plans

As of April 27, 2004, the Company adopted the Assured Guaranty Ltd. 2004 Long-Term Incentive Plan (the “Incentive Plan”). The Incentive Plan authorizes the grant of incentive stock options, non-qualified stock

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options, stock appreciation rights, and full value awards that are based on the Company’s common shares. The number of common shares that may be delivered under the Incentive Plan may not exceed 7,500,000. As of March 31, 2006, 2,583,545 common shares were available for grant under the Incentive Plan. In January 2005, the Company implemented the Stock Purchase Plan (“Stock Purchase Plan”) in accordance with Internal Revenue Code Section 423. The Company reserved for issuance and purchases under the Stock Purchase Plan 100,000 shares of its common stock. As of March 31, 2006, 80,512 common shares were available for grant under the Stock Purchase Plan. The Incentive Plan and the Stock Purchase Plan are described more fully in the Company’s 2005 Annual Report on Form 10-K.

Stock Options

Nonqualified or incentive stock options may be granted to employees and directors of the Company.  To date, the Company has only issued nonqualified stock options. All stock options granted to employees vest in equal annual installments over a three-year period and expire 10 years from the date of grant. None of our options have a performance or market condition. The following table summarizes stock option activity for the three months ended March 31, 2006:

 

(1)          The aggregate intrinsic value was calculated based on the positive difference between the closing price of the Company’s common stock on March 31, 2006 (i.e. $25.00) and the weighted average exercise price of the underlying options.

The Company recorded $1.2 million ($1.0 million after tax) in share-based compensation related to stock options during First Quarter 2006. As of March 31, 2006 the total unrecognized compensation expense related to outstanding non-vested stock options was $6.2 million, which will be adjusted in the future for actual forfeitures. The Company expects to recognize that expense over the weighted-average remaining service period of 1.7 years.

The weighted-average grant-date fair value of options granted were $6.71 and $4.51 for First Quarter 2006 and First Quarter 2005, respectively. The fair value of options issued is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted-average assumptions used for grants in 2006 and 2005:

 

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These assumptions were based on the following:

·                  The expected dividend yield is based on the current expected annual dividend and company share price on the grant date,

·                  Expected volatility is estimated at the date of grant based on the historical share price volatility, calculated on a daily basis,

·                  The risk-free interest rate is the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term to the granted stock options,

·                  The expected life is based on the average expected term of our guideline companies, which are defined as similar entities, since the Company has insufficient expected life data.

·                  The forfeiture rate is based on the rate used by our guideline companies, since  the Company has insufficient forfeiture data. Estimated forfeitures will be reassessed at each balance sheet date and may change based on new facts and circumstances.

For options granted before January 1, 2006, the Company amortizes the fair value on an accelerated basis. For options granted on or after January 1, 2006, the Company amortizes the fair value on a straight-line basis. All options are amortized over the requisite service periods of the awards, which are generally the vesting periods, with the exception of retirement-eligible employees. For retirement-eligible employees options are amortized over the period through the date the employee first becomes eligible to retire and is no longer required to provide service to earn part or all of the award. The Company may elect to use different assumptions under the Black-Scholes option valuation model in the future, which could materially affect the Company’s net income or earnings per share.

The total intrinsic value of options exercised during for First Quarter 2006 was $0.1 million. During First Quarter 2006, an immaterial amount of  cash was received from the exercise of stock options and a corresponding immaterial related tax benefit was recorded. No options were exercised during First Quarter 2005. The Company has a policy of issuing new shares to satisfy stock option exercises.

Restricted Stock Awards

The Company has granted restricted stock awards to employees and directors of the Company. Restricted stock awards generally vest in equal annual installments over a four-year period.  Restricted stock awards are amortized over the requisite service periods of the awards, which are generally the vesting periods, with the exception of retirement-eligible employees, discussed above. Prior to the adoption of FAS 123R, the Company presented restricted stock issuances on the balance sheet in common stock and additional paid-in capital with an offset in unearned stock grant compensation as a separate component of shareholders’ equity. In accordance with the provisions of FAS 123R, on January 1, 2006, the Company reclassified the balance in unearned stock grant compensation to common stock and additional paid-in capital in shareholders’ equity. The following table summarizes restricted stock award activity for the three months ended March 31, 2006:

 

 

The Company recorded $2.3 million ($1.8 million after tax) in share-based compensation, related to restricted stock awards, during First Quarter 2006. Restricted stock awards are expensed on a straight-line basis over the vesting period. As of March 31, 2006 the total unrecognized compensation cost related to outstanding nonvested restricted stock awards was $23.4 million, which the Company expects to recognize over the weighted-average remaining service period of 2.6 years.

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Restricted Stock Units

The Company has granted restricted stock units to directors of the Company. Restricted stock units vest over a one-year period. The following table summarizes restricted stock unit activity (excluding dividend equivalents) for the three months ended March 31, 2006:

 

The Company recorded $0.2 million ($0.2 million after tax) in share-based compensation during First Quarter 2006. The compensation for restricted stock units is expensed on a straight-line basis over the vesting period. As of March 31, 2006, the total unrecognized compensation cost related to outstanding nonvested restricted stock units was $0.1 million, which the Company expects to recognize over the weighted-average remaining service period of 0.1 years.

Employee Stock Purchase Plan

Participation in the Stock Purchase Plan is available to all eligible employees. Maximum annual purchases by participants are limited to the number of whole shares that can be purchased by an amount equal to 10 percent of the participant’s compensation or, if less, shares having a value of $25,000. Participants may purchase shares at a purchase price equal to 85 percent of the lesser of the fair market value of the stock on the first day or the last day of the subscription period. The Company recorded $32,000 ($23,000 after tax) in share-based compensation during First Quarter 2006.

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8. Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share (“EPS”):

		Three Months Ended March 31,
		2006			2005
		(in thousands of U.S. dollars except per share amounts)
Net income		$	34,882		$	44,348
Basic shares		73,768			74,458
Effect of dilutive securities:
Stock awards		1,085			445
Diluted shares		74,853			74,903
Basic EPS		$	0.47		$	0.60
Diluted EPS		$	0.47		$	0.59

 

9. Segment Reporting

The Company has four principal business segments: (1) financial guaranty direct, which includes transactions whereby the Company provides an unconditional and irrevocable guaranty that indemnifies the holder of a financial obligation against non-payment of principal and interest when due, and could take the form of a credit derivative; (2) financial guaranty reinsurance, which includes agreements whereby the Company is a reinsurer and agrees to indemnify a primary insurance company against part or all of the loss which the latter may sustain under a policy it has issued; (3) mortgage guaranty, which includes mortgage guaranty insurance and reinsurance whereby the Company provides protection against the default of borrowers on mortgage loans; and (4) other, which includes several lines of business in which the Company is no longer active, including, but not limited to equity layer credit protection, trade credit reinsurance and title reinsurance.

The Company does not segregate assets and liabilities at a segment level since management reviews and controls these assets and liabilities on a consolidated basis. The Company allocates operating expenses to each segment based on a comprehensive cost study. During 2006, the Company implemented a new operating expense methodology to more closely apply expenses to the individual operating segments. This new methodology was based on a comprehensive study and is based on departmental time estimates and headcount. 2005 amounts have been restated to show this new methodology on a comparative basis. Management uses underwriting gains as the primary measure of each segment’s financial performance.

The following table summarizes the components of underwriting gain for each reporting segment:

		Three Months Ended March 31, 2006
		Financial Guaranty Direct			Financial Guaranty Reinsurance			Mortgage Guaranty			Other			Total
		(in millions of U.S. dollars)
Gross written premiums		$	30.2		$	18.8		$	2.6		$	3.8		$	55.4
Net written premiums		29.7			18.5			2.6			—			50.8
Net earned premiums		20.7			23.3			4.2			—			48.1
Loss and loss adjustment expenses		(1.8		)	2.8			(0.2		)	(1.2		)	(0.4		)
Profit commission expense		—			0.4			0.9			—			1.3
Acquisition costs		1.8			8.7			0.3			—			10.8
Other operating expenses		13.4			3.4			0.3			—			17.2
Underwriting gain		$	7.2		$	8.0		$	2.8		$	1.2		$	19.2

 

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		Three Months Ended March 31, 2005
		Financial Guaranty Direct			Financial Guaranty Reinsurance			Mortgage Guaranty			Other			Total
		(in millions of U.S. dollars)
Gross written premiums		$	23.8		$	34.0		$	19.4		$	0.9		$	78.1
Net written premiums		23.1			34.0			19.4			—			76.5
Net earned premiums		20.4			23.0			4.6			—			48.1
Loss and loss adjustment expenses		(1.5		)	(7.1		)	0.2			(1.1		)	(9.4		)
Profit commission expense		—			—			1.0			—			1.0
Acquisition costs		1.5			8.1			0.5			—			10.2
Other operating expenses		11.4			2.8			0.3			—			14.5
Underwriting gain		$	9.0		$	19.2		$	2.6		$	1.1		$	31.9

 

The following is a reconciliation of total underwriting gain to income before provision for income taxes for the periods ended:

 

 

The following table provides the lines of businesses from which each of the Company’s segments derive their net earned premiums:

 

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The other segment had an underwriting gain of $1.2 million and $1.1 million for First Quarter 2006 and First Quarter 2005, respectively, as the equity layer credit protection business recorded loss recoveries in both periods.

10. Subsidiary Information

The following tables present the unaudited condensed consolidated financial information for Assured Guaranty Ltd., Assured Guaranty US Holdings Inc., of which AGC is a subsidiary and other subsidiaries of Assured Guaranty Ltd. as of March 31, 2006 and December 31, 2005 and for the three months ended March 31, 2006 and 2005.

CONDENSED CONSOLIDATING BALANCE SHEET

AS OF MARCH 31, 2006

(in thousands of U. S. dollars)

 

		Assured Guaranty Ltd. (Parent Company)			Assured Guaranty US Holdings Inc.			AG Re and Other Subsidiaries			Consolidating Adjustments			Assured Guaranty Ltd. (Consolidated)
Assets
Total investments and cash		$	76		$	1,132,042		$	1,120,724		$	—		$	2,252,842
Investment in subsidiaries		1,687,289			—			—			(1,687,289		)	—
Deferred acquisition costs		—			75,660			120,237			—			195,897
Reinsurance recoverable		—			11,504			4,147			(3,493		)	12,158
Goodwill		—			85,417			—			—			85,417
Premiums receivable		—			18,306			14,491			(5,813		)	26,984
Other		744			95,705			49,764			(41,518		)	104,695
Total assets		$	1,688,109		$	1,418,634		$	1,309,363		$	(1,738,113	)	$	2,677,993
Liabilities and shareholders’ equity
Liabilities
Unearned premium reserves		$	—		$	196,391		$	368,650		$	(24,297	)	$	540,744
Reserves for losses and loss adjustment expenses		—			64,822			55,842			(3,493		)	117,171
Profit commissions payable		—			3,790			24,258			—			28,048
Deferred income taxes		—			33,020			(7,630		)	—			25,390
Long-term debt		—			197,352			—			—			197,352
Other		14,692			48,653			55,560			(23,034		)	95,871
Total liabilities		14,692			544,028			496,680			(50,824		)	1,004,576
Total shareholders’ equity		1,673,417			874,606			812,683			(1,687,289		)	1,673,417
Total liabilities and shareholders’ equity		$	1,688,109		$	1,418,634		$	1,309,363		$	(1,738,113	)	$	2,677,993

 

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CONDENSED CONSOLIDATING BALANCE SHEET

AS OF DECEMBER 31, 2005

(in thousands of U. S. dollars)

 

		Assured Guaranty Ltd. (Parent Company)			Assured Guaranty US Holdings Inc.			AG Re and Other Subsidiaries			Consolidating Adjustments			Assured Guaranty Ltd. (Consolidated)
Assets
Total investments and cash		$	163		$	1,116,387		$	1,139,463		$	—		$	2,256,013
Investment in subsidiaries		1,665,392			—			—			(1,665,392		)	—
Deferred acquisition costs		—			73,803			119,639			—			193,442
Reinsurance recoverable		—			11,410			4,108			(3,168		)	12,350
Goodwill		—			85,417			—			—			85,417
Premiums receivable		—			17,168			17,278			(1,435		)	33,011
Other		1,172			107,211			27,121			(26,614		)	108,890
Total assets		$	1,666,727		$	1,411,396		$	1,307,609		$	(1,696,609	)	$	2,689,123
Liabilities and shareholders’ equity
Liabilities
Unearned premium reserves		$	—		$	196,435		$	362,273		$	(21,559	)	$	537,149
Reserves for losses and loss adjustment expenses		—			63,491			60,896			(3,168		)	121,219
Profit commissions payable		—			4,237			48,756			—			52,993
Deferred income taxes		—			35,997			(9,368		)	—			26,629
Long-term debt		—			197,344			—			—			197,344
Other		5,214			55,384			38,168			(6,490		)	92,276
Total liabilities		5,214			552,888			500,725			(31,217		)	1,027,610
Total shareholders’ equity		1,661,513			858,508			806,884			(1,665,392		)	1,661,513
Total liabilities and shareholders’ equity		$	1,666,727		$	1,411,396		$	1,307,609		$	(1,696,609	)	$	2,689,123

 

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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2006

(in thousands of U. S. dollars)

 

		Assured Guaranty Ltd. (Parent Company)			Assured Guaranty US Holdings Inc.			AG Re and Other Subsidiaries			Consolidating Adjustments *			Assured Guaranty Ltd. (Consolidated)
Revenues
Net premiums written		$	—		$	25,117		$	25,667		$	—		$	50,784
Net premiums earned		—			26,729			21,326			—			48,055
Net investment income		—			12,829			13,421			(12		)	26,238
Net realized investment (losses) gains		—			(1,146		)	140			—			(1,006		)
Unrealized gains (losses) on derivative financial instruments		—			720			(691		)	—			29
Equity in earnings of subsidiaries		38,342			—			—			(38,342		)	—
Other revenues		—			—			—			—			—
Total revenues		38,342			39,132			34,196			(38,354		)	73,316
Expenses
Loss and loss adjustment expenses		—			2,045			(2,427		)	—			(382		)
Acquisition costs and other operating expenses		3,450			15,294			10,499			—			29,243
Other		10			3,978			1			—			3,989
Total expenses		3,460			21,317			8,073			—			32,850
Income before provision for income taxes		34,882			17,815			26,123			(38,354		)	40,466
Total provision for income taxes		—			3,505			2,059			20			5,584
Net income		$	34,882		$	14,310		$	24,064		$	(38,374	)	$	34,882

*       The net income in the consolidating adjustment column will not equal parent company equity in earnings of subsidiaries, due to the residual effects of the 2005 reinsurance agreement with FSA.

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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2005

(in thousands of U. S. dollars)

 

		Assured Guaranty Ltd. (Parent Company)			Assured Guaranty US Holdings Inc.			AG Re and Other Subsidiaries			Consolidating Adjustments			Assured Guaranty Ltd. (Consolidated)
Revenues
Net premiums written		$	—		$	25,929		$	50,540		$	—		$	76,469
Net premiums earned		—			31,087			17,003			—			48,090
Net investment income		—			13,280			9,852			—			23,132
Net realized investment gains		—			162			1,629			—			1,791
Unrealized gains (losses) on derivative financial instruments		—			4,923			(1,851		)	—			3,072
Equity in earnings of subsidiaries		47,944			—			—			(47,944		)	—
Other revenues		—			—			283			—			283
Total revenues		47,944			49,452			26,916			(47,944		)	76,368
Expenses
Loss and loss adjustment expenses		—			(1,828		)	(7,568		)	—			(9,396		)
Acquisition costs and other operating expenses		3,596			16,631			5,484			—			25,711
Other		—			3,326			(30		)	—			3,296
Total expenses		3,596			18,129			(2,114		)	—			19,611
Income before provision for income taxes		44,348			31,323			29,030			(47,944		)	56,757
Total provision for income taxes		—			8,205			4,204			—			12,409
Net income		$	44,348		$	23,118		$	24,826		$	(47,944	)	$	44,348

 

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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2006

(in thousands of U. S. dollars)

 

		Assured Guaranty Ltd. (Parent Company)			Assured Guaranty US Holdings Inc.			AG Re and Other Subsidiaries			Consolidating Adjustments			Assured Guaranty Ltd. (Consolidated)
Net cash flows provided by (used in) operating activities		$	2,981		$	26,948		$	(9,519	)	$	—		$	20,410
Cash flows from investing activities
Fixed maturity securities:
Purchases		—			(144,847		)	(115,675		)	—			(260,522		)
Sales		—			144,257			115,695			—			259,952
Maturities		—			—			—			—			—
Sales (purchases) of short-term investments, net		87			(27,398		)	8,073			—			(19,238		)
Net cash flows (used in) provided by investing activities		87			(27,988		)	8,093			—			(19,808		)
Cash flows from financing activities
Dividends paid		(2,632		)	—			—			—			(2,632		)
Share activity under option and incentive plans		(436		)	—			—			—			(436		)
Net cash flows used in financing activities		(3,068		)	—			—			—			(3,068		)
Effect of exchange rate changes		—			17			5			—			22
Decrease in cash and cash equivalents		—			(1,023		)	(1,421		)	—