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 September 30, 2011
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)
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Bermuda |
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98-0429991 |
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(State or other jurisdiction |
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(I.R.S. employer |
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of incorporation) |
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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.
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Large accelerated filer x |
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Accelerated filer o |
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Non-accelerated filer o |
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Smaller reporting company o |
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(Do not check if a smaller reporting company) |
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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 November 4, 2011 was 182,228,965 (excludes 76,060 unvested restricted shares).
Assured Guaranty Ltd.
Form 10-Q
Explanatory Note
In this Form 10-Q, the Company is restating its previously issued consolidated financial statements as of and for the three and nine months ended September 30, 2010 and for the year ended December 31, 2010 to reflect the Company’s determination that it did not properly account for the elimination of intercompany activity between the Company’s insurance subsidiaries and its consolidated financial guaranty variable interest entities. Included in this restatement is the correction of other immaterial errors which affected the quarter and nine months ended September 30, 2010. The total effect of this restatement was a decrease to equity of $65.3 million as of December 31, 2010, and decreases to net income of $16.3 million and $29.2 million for the quarter and nine months ended September 30, 2010, respectively. Net income for the six months ended June 30, 2011 was also restated resulting in an increase of $30.3 million.
As a result of the errors discussed above, management has now determined that the Company had a material weakness in its internal control over financial reporting at September 30, 2011. A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. For a discussion of management’s consideration of the Company’s disclosure controls and procedures and the material weakness identified, see Part I, Item 4, Controls and Procedures of this Form 10-Q.
Accordingly, this Form 10-Q should be read in conjunction with the Company’s filings with the U.S. Securities and Exchange Commission subsequent to the filing of the Original 10-K, including any amendments to those filings.
ASSURED GUARANTY LTD.
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Page |
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PART I. FINANCIAL INFORMATION |
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Item 1. |
Financial Statements: |
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|
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Consolidated Balance Sheets (unaudited) as of September 30, 2011 and, December 31, 2010 (restated) |
4 |
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|
5 | |
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6 | |
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7 | |
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8 | |
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9 | |
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9 | |
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11 | |
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3. Business Changes, Risks, Uncertainties and Accounting Developments |
16 |
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|
17 | |
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21 | |
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42 | |
|
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7. Financial Guaranty Contracts Accounted for as Credit Derivatives |
48 |
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55 | |
|
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58 | |
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63 | |
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|
63 | |
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65 | |
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68 | |
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72 | |
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76 | |
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77 | |
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78 | |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
86 | |
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86 | |
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87 | |
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|
87 | |
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|
87 | |
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94 | |
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111 | |
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115 | |
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123 | |
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142 | ||
|
142 | ||
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| |
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143 | ||
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146 | ||
|
148 | ||
|
148 |
Assured Guaranty Ltd.
Consolidated Balance Sheets (Unaudited)
(dollars in thousands except per share and share amounts)
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|
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September 30, |
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December 31, |
| ||
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Assets |
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|
|
|
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Investment portfolio: |
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|
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Fixed maturity securities, available-for-sale, at fair value (amortized cost of $9,650,310 and $9,274,718) |
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$ |
10,091,241 |
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$ |
9,402,287 |
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Short-term investments, at fair value |
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873,268 |
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1,055,567 |
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Other invested assets |
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297,975 |
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283,032 |
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Total investment portfolio |
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11,262,484 |
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10,740,886 |
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Cash |
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173,260 |
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108,389 |
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Premiums receivable, net of ceding commissions payable |
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987,115 |
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1,167,587 |
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Ceded unearned premium reserve |
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747,457 |
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821,819 |
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Deferred acquisition costs |
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230,983 |
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239,805 |
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Reinsurance recoverable on unpaid losses |
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47,976 |
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22,255 |
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Salvage and subrogation recoverable |
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360,161 |
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1,032,369 |
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Credit derivative assets |
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467,252 |
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592,898 |
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Deferred tax asset, net |
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676,198 |
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1,259,125 |
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Current income tax receivable |
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203,659 |
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— |
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Financial guaranty variable interest entities’ assets, at fair value |
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3,005,380 |
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3,657,481 |
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Other assets |
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243,070 |
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199,305 |
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Total assets |
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$ |
18,404,995 |
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$ |
19,841,919 |
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Liabilities and shareholders’ equity |
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Unearned premium reserve |
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$ |
6,111,822 |
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$ |
6,972,894 |
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Loss and loss adjustment expense reserve |
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670,743 |
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574,369 |
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Reinsurance balances payable, net |
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173,575 |
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274,431 |
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Long-term debt |
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1,041,653 |
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1,052,936 |
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Credit derivative liabilities |
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1,495,312 |
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2,462,831 |
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Current income tax payable |
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— |
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93,020 |
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Financial guaranty variable interest entities’ liabilities with recourse, at fair value |
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2,575,548 |
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3,030,908 |
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Financial guaranty variable interest entities’ liabilities without recourse, at fair value |
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1,133,025 |
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1,337,214 |
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Other liabilities |
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436,602 |
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309,862 |
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Total liabilities |
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13,638,280 |
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16,108,465 |
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Commitments and contingencies (See Note 13) |
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Common stock ($0.01 par value, 500,000,000 shares authorized; 182,221,965 and 183,744,655 shares issued and outstanding in 2011 and 2010) |
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1,822 |
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1,837 |
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Additional paid-in capital |
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2,567,668 |
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2,585,423 |
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Retained earnings |
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1,866,664 |
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1,032,445 |
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Accumulated other comprehensive income, net of tax provision (benefit) of $114,226 and $18,341 in 2011 and 2010 |
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327,061 |
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111,749 |
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Deferred equity compensation (320,193 and 181,818 shares in 2011 and 2010) |
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3,500 |
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2,000 |
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Total shareholders’ equity |
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4,766,715 |
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3,733,454 |
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Total liabilities and shareholders’ equity |
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$ |
18,404,995 |
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$ |
19,841,919 |
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The accompanying notes are an integral part of these consolidated financial statements.
Assured Guaranty Ltd.
Consolidated Statements of Operations (Unaudited)
(dollars in thousands except per share amounts)
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Three Months Ended |
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Nine Months Ended |
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2011 |
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2010 |
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2011 |
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2010 |
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Revenues |
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Net earned premiums |
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$ |
211,073 |
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$ |
288,767 |
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$ |
695,118 |
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$ |
900,437 |
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Net investment income |
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93,534 |
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85,615 |
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290,748 |
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260,788 |
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Net realized investment gains (losses): |
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Other-than-temporary impairment losses |
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(33,494 |
) |
(5,719 |
) |
(67,259 |
) |
(24,248 |
) | ||||
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Less: portion of other-than-temporary impairment loss recognized in other comprehensive income |
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(17,061 |
) |
(1,189 |
) |
(34,670 |
) |
(1,850 |
) | ||||
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Other net realized investment gains (losses) |
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5,348 |
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2,156 |
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19,220 |
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20,999 |
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Net realized investment gains (losses) |
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(11,085 |
) |
(2,374 |
) |
(13,369 |
) |
(1,399 |
) | ||||
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Net change in fair value of credit derivatives: |
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Realized gains and other settlements |
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483 |
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52,498 |
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25,074 |
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117,554 |
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Net unrealized gains (losses) |
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1,155,531 |
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(276,427 |
) |
829,836 |
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10,786 |
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Net change in fair value of credit derivatives |
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1,156,014 |
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(223,929 |
) |
854,910 |
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128,340 |
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Fair value gain (loss) on committed capital securities |
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2,443 |
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(5,548 |
) |
3,538 |
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5,770 |
| ||||
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Net change in fair value of financial guaranty variable interest entities |
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(99,230 |
) |
171,258 |
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(153,915 |
) |
134,953 |
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Other income (loss) |
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(7,550 |
) |
33,682 |
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63,376 |
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7,357 |
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Total revenues |
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1,345,199 |
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347,471 |
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1,740,406 |
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1,436,246 |
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Expenses |
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Loss and loss adjustment expenses |
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214,991 |
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110,772 |
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313,324 |
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307,394 |
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Amortization of deferred acquisition costs |
|
7,278 |
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8,023 |
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24,231 |
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23,132 |
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Assured Guaranty Municipal Holdings Inc. acquisition-related expenses |
|
— |
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— |
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— |
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6,772 |
| ||||
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Interest expense |
|
24,968 |
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24,886 |
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74,424 |
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74,851 |
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Other operating expenses |
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41,896 |
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52,139 |
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147,239 |
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162,179 |
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Total expenses |
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289,133 |
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195,820 |
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559,218 |
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574,328 |
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Income (loss) before income taxes |
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1,056,066 |
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151,651 |
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1,181,188 |
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861,918 |
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Provision (benefit) for income taxes |
|
|
|
|
|
|
|
|
| ||||
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Current |
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(12,386 |
) |
(191,867 |
) |
(200,121 |
) |
(185,998 |
) | ||||
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Deferred |
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307,299 |
|
178,919 |
|
522,080 |
|
370,722 |
| ||||
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Total provision (benefit) for income taxes |
|
294,913 |
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(12,948 |
) |
321,959 |
|
184,724 |
| ||||
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Net income (loss) |
|
$ |
761,153 |
|
$ |
164,599 |
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$ |
859,229 |
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$ |
677,194 |
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Earnings per share: |
|
|
|
|
|
|
|
|
| ||||
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Basic |
|
$ |
4.15 |
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$ |
0.89 |
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$ |
4.67 |
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$ |
3.67 |
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Diluted |
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$ |
4.13 |
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$ |
0.88 |
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$ |
4.61 |
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$ |
3.58 |
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Dividends per share |
|
$ |
0.045 |
|
$ |
0.045 |
|
$ |
0.135 |
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$ |
0.135 |
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The accompanying notes are an integral part of these consolidated financial statements.
Assured Guaranty Ltd.
Consolidated Statements of Comprehensive Income (Unaudited)
(in thousands)
|
|
|
Three Months Ended |
|
Nine Months Ended |
| ||||||||
|
|
|
2011 |
|
2010 |
|
2011 |
|
2010 |
| ||||
|
Net income (loss) |
|
$ |
761,153 |
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$ |
164,599 |
|
$ |
859,229 |
|
$ |
677,194 |
|
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Unrealized holding gains (losses) arising during the period, net of tax provision (benefit) of $45,072, $64,025, $90,706 and $62,428 |
|
115,356 |
|
139,638 |
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204,620 |
|
197,035 |
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|
Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $(4,063), $(1,118), $(5,634) and $(2,556) |
|
(8,360 |
) |
(1,256 |
) |
(11,558 |
) |
1,157 |
| ||||
|
Change in net unrealized gains on investments |
|
123,716 |
|
140,894 |
|
216,178 |
|
195,878 |
| ||||
|
Change in cumulative translation adjustment, net of tax provision (benefit) of $(1,146), $3,138, $(286) and $284 |
|
(2,141 |
) |
5,411 |
|
(552 |
) |
152 |
| ||||
|
Change in cash flow hedge, net of tax provision (benefit) of $(56), $(56), $(169) and $(169) |
|
(105 |
) |
(105 |
) |
(314 |
) |
(314 |
) | ||||
|
Other comprehensive income (loss) |
|
121,470 |
|
146,200 |
|
215,312 |
|
195,716 |
| ||||
|
Comprehensive income (loss) |
|
$ |
882,623 |
|
$ |
310,799 |
|
$ |
1,074,541 |
|
$ |
872,910 |
|
The accompanying notes are an integral part of these consolidated financial statements.
Assured Guaranty Ltd.
Consolidated Statement of Shareholders’ Equity (Unaudited)
For the Nine Months Ended September 30, 2011
(dollars in thousands, except share data)
|
|
|
Common Stock |
|
Additional |
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Retained |
|
Accumulated |
|
Deferred |
|
Total |
| ||||||||
|
|
|
Shares |
|
Amount |
|
Capital |
|
Earnings |
|
Income |
|
Compensation |
|
Equity |
| ||||||
|
Balance, December 31, 2010 (restated) |
|
183,744,655 |
|
$ |
1,837 |
|
$ |
2,585,423 |
|
$ |
1,032,445 |
|
$ |
111,749 |
|
$ |
2,000 |
|
$ |
3,733,454 |
|
|
Net income |
|
— |
|
— |
|
— |
|
859,229 |
|
— |
|
— |
|
859,229 |
| ||||||
|
Dividends ($0.135 per share) |
|
— |
|
— |
|
— |
|
(24,830 |
) |
— |
|
— |
|
(24,830 |
) | ||||||
|
Dividends on restricted stock units |
|
— |
|
— |
|
180 |
|
(180 |
) |
— |
|
— |
|
— |
| ||||||
|
Common stock repurchases |
|
(2,000,000 |
) |
(20 |
) |
(23,291 |
) |
— |
|
— |
|
— |
|
(23,311 |
) | ||||||
|
Share-based compensation and other |
|
477,310 |
|
5 |
|
5,356 |
|
— |
|
— |
|
1,500 |
|
6,861 |
| ||||||
|
Change in cumulative translation adjustment |
|
— |
|
— |
|
— |
|
— |
|
(552 |
) |
— |
|
(552 |
) | ||||||
|
Change in cash flow hedge |
|
— |
|
— |
|
— |
|
— |
|
(314 |
) |
— |
|
(314 |
) | ||||||
|
Change in unrealized gains (losses) on: |
|
— |
|
— |
|
— |
|
— |
|
|
|
— |
|
|
| ||||||
|
Investments with no other-than-temporary impairment |
|
— |
|
— |
|
— |
|
— |
|
210,298 |
|
— |
|
210,298 |
| ||||||
|
Investments with other-than-temporary impairment |
|
— |
|
— |
|
— |
|
— |
|
(5,678 |
) |
— |
|
(5,678 |
) | ||||||
|
Less: reclassification adjustment for gains (losses) included in net income (loss) |
|
— |
|
— |
|
— |
|
— |
|
(11,558 |
) |
— |
|
(11,558 |
) | ||||||
|
Balance, September 30, 2011 |
|
182,221,965 |
|
$ |
1,822 |
|
$ |
2,567,668 |
|
$ |
1,866,664 |
|
$ |
327,061 |
|
$ |
3,500 |
|
$ |
4,766,715 |
|
The accompanying notes are an integral part of these consolidated financial statements.
Assured Guaranty Ltd.
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
|
|
|
Nine Months Ended |
| ||||
|
|
|
2011 |
|
2010 |
| ||
|
Net cash flows provided by (used in) operating activities |
|
$ |
600,998 |
|
$ |
(104,267 |
) |
|
Investing activities |
|
|
|
|
| ||
|
Fixed maturity securities: |
|
|
|
|
| ||
|
Purchases |
|
(1,787,990 |
) |
(1,928,744 |
) | ||
|
Sales |
|
848,416 |
|
835,716 |
| ||
|
Maturities |
|
502,929 |
|
729,559 |
| ||
|
Net sales (purchases) of short-term investments |
|
182,407 |
|
731,216 |
| ||
|
Net proceeds from paydowns on financial guaranty variable interest entities’ assets |
|
598,160 |
|
323,626 |
| ||
|
Other |
|
13,988 |
|
15,718 |
| ||
|
Net cash flows provided by (used in) investing activities |
|
357,910 |
|
707,091 |
| ||
|
Financing activities |
|
|
|
|
| ||
|
Dividends paid |
|
(24,830 |
) |
(24,889 |
) | ||
|
Repurchases of common stock |
|
(23,311 |
) |
(10,457 |
) | ||
|
Share activity under option and incentive plans |
|
(2,609 |
) |
(2,323 |
) | ||
|
Net paydowns of financial guaranty variable interest entities’ liabilities |
|
(830,063 |
) |
(497,296 |
) | ||
|
Repayment of long-term debt |
|
(16,902 |
) |
(16,090 |
) | ||
|
Net cash flows provided by (used in) financing activities |
|
(897,715 |
) |
(551,055 |
) | ||
|
Effect of foreign exchange rate changes |
|
3,678 |
|
(1,496 |
) | ||
|
Increase (decrease) in cash |
|
64,871 |
|
50,273 |
| ||
|
Cash at beginning of period |
|
108,389 |
|
44,133 |
| ||
|
Cash at end of period |
|
$ |
173,260 |
|
$ |
94,406 |
|
|
Supplemental cash flow information |
|
|
|
|
| ||
|
Cash paid (received) during the period for: |
|
|
|
|
| ||
|
Income taxes |
|
$ |
89,202 |
|
$ |
138,073 |
|
|
Interest |
|
$ |
58,100 |
|
$ |
58,587 |
|
The accompanying notes are an integral part of these consolidated financial statements.
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited)
September 30, 2011
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 develop insurance, reinsurance and credit derivative products 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. 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’s business has evolved as a result of the recent crisis in the financial markets in several respects. The mix of new business has shifted towards insuring public finance obligations in the primary and secondary markets. The Company has increased its focus on retail investors, which is the portion of the market where the demand for the Company’s product has remained strongest. The Company is selectively underwriting certain structured finance transactions, but has not underwritten a new U.S. residential mortgage-backed security (“RMBS”) since 2008 and will not do so until underwriting standards improve significantly. See Note 4 for the Company’s outstanding U.S. RMBS exposures.
The Company ceased selling credit protection through CDS in the beginning of 2009 following the issuance of regulatory guidelines 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 sell new credit protection through CDS in the foreseeable future. The Company is actively pursuing opportunities to terminate, on favorable terms, existing CDS and in certain cases, may convert 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 enters into ceded reinsurance contracts in order to obtain greater business diversification and reduce the net potential loss from large risks. In recent years, the Company has been reassuming previously ceded business from reinsurers whose ratings have declined to below-investment-grade (“BIG”) levels.
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 facilities and utilities. Structured finance obligations insured by the Company are generally backed by pools of assets such as
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
residential or commercial mortgage loans, consumer or trade receivables, securities or other assets having an ascertainable cash flow or market value and issued by special purpose entities; the Company will also insure other specialized financial obligations.
When a rating agency rates 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 the Company’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 internal ratings. The Company’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. The super senior category, which is not generally used by rating agencies, is used by the Company in instances where Assured Guaranty’s AAA-rated exposure on its internal rating scale 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 cover the three-month period ended September 30, 2011 (“Third Quarter 2011”), the three-month period ended September 30, 2010 (“Third Quarter 2010”), the nine-month period ended September 30, 2011 (“Nine Months 2011”) and the nine-month period ended September 30, 2010 (“Nine Months 2010). The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP.
These 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 AGL and its Subsidiaries have been eliminated, as well as transactions between the Company and the consolidated FG VIEs. 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, as amended by Amendment No. 1 on Form 10-K/A, for the year ended December 31, 2010, both of which have been filed with the U.S. Securities and Exchange Commission (the “SEC”).
AGL’s principal insurance company subsidiaries are Assured Guaranty Corp. (“AGC”), domiciled in Maryland; Assured Guaranty Municipal Corp. (“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 14.
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
In June 2011, the Financial Accounting Standards Board (“FASB”) issued guidance that eliminates the option to report other comprehensive income and its components in the statement of changes in stockholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. Upon adoption, the Company will expand the Consolidated Statements of Comprehensive Income to include the other comprehensive income items now presented in the Consolidated Statement of Shareholders’ Equity. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, which corresponds to the Company’s first quarter of fiscal 2012. Early adoption of the new guidance is permitted and full retrospective application is required when the new guidance is adopted. The Company has not yet adopted this guidance.
Change in Accounting Policy
Prior to January 1, 2011, the Company managed its business and reported financial information for two principal financial guaranty segments: direct and reinsurance. There has been no market for financial guaranty reinsurance in the past two years and one is not expected to develop in the foreseeable future. The Company’s reinsurance subsidiary, AG Re, now only writes new treaties with affiliates that are eliminated in consolidation. As a result, the chief operating decision maker now manages the operations of the Company at a consolidated level and no longer uses underwriting gain (loss) by segment as an operating metric. Therefore, segment financial information is no longer disclosed.
2. Restatement of Previously Issued Financial Statements
AGL, through its insurance subsidiaries, has provided financial guaranties with respect to debt obligations issued by special purpose entities, including FG VIEs. Assured Guaranty does not sponsor such FG VIEs nor does it act as the servicer or collateral manager for any FG VIE debt obligations that it insures. However, when Assured Guaranty provides such financial guaranties, it can obtain certain control rights through the transaction structure which make Assured Guaranty the primary beneficiary of the FG VIE. Assured Guaranty is required under GAAP to consolidate the FG VIE in its financial statements when it is the primary beneficiary. See Note 8. When such consolidation occurs, Assured Guaranty must eliminate the intercompany transactions between the relevant Assured Guaranty insurance subsidiary and the consolidated FG VIE. Assured Guaranty discovered errors in the elimination of such intercompany transactions, which resulted in the restatement of the consolidated financial statements for Third Quarter 2010, Nine Months 2010 and the year ended December 31, 2010.
In addition, the Company was required to correct certain unrelated, immaterial errors as part of the restatement which affected expected losses, the fair value of credit derivatives, and the classification of FG VIE assets and liabilities, which primarily affected Third Quarter 2010, Nine Months 2010 and the year ended December 31, 2010. While these immaterial errors were corrected at the time they were identified, these restated financial statements reflect the correction of such errors in the period in which they arose.
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
The effect of the restatement on the balance sheet is shown in the tables below.
|
|
|
As of December 31, 2010 |
| ||||||||||
|
|
|
As |
|
(1) |
|
(2) |
|
Restated |
| ||||
|
|
|
(in millions) |
| ||||||||||
|
Assets |
|
|
|
|
|
|
|
|
| ||||
|
Total investment portfolio |
|
$ |
10,729.9 |
|
$ |
11.0 |
|
$ |
— |
|
$ |
10,740.9 |
|
|
Cash |
|
107.2 |
|
1.2 |
|
— |
|
108.4 |
| ||||
|
Premiums receivable, net of ceding commissions payable |
|
1,167.6 |
|
— |
|
— |
|
1,167.6 |
| ||||
|
Ceded unearned premium reserve |
|
821.8 |
|
— |
|
— |
|
821.8 |
| ||||
|
Deferred acquisition costs |
|
239.8 |
|
— |
|
— |
|
239.8 |
| ||||
|
Reinsurance recoverable on unpaid losses |
|
22.3 |
|
— |
|
— |
|
22.3 |
| ||||
|
Salvage and subrogation recoverable |
|
1,032.4 |
|
— |
|
— |
|
1,032.4 |
| ||||
|
Credit derivative assets |
|
592.9 |
|
— |
|
— |
|
592.9 |
| ||||
|
Deferred tax asset, net |
|
1,224.0 |
|
32.1 |
|
3.0 |
|
1,259.1 |
| ||||
|
Financial guaranty variable interest entities’ assets, at fair value |
|
4,334.4 |
|
— |
|
(676.9 |
) |
3,657.5 |
| ||||
|
Other assets |
|
199.2 |
|
— |
|
— |
|
199.2 |
| ||||
|
Total assets |
|
$ |
20,471.5 |
|
$ |
44.3 |
|
$ |
(673.9 |
) |
$ |
19,841.9 |
|
|
Liabilities and shareholders’ equity |
|
|
|
|
|
|
|
|
| ||||
|
Unearned premium reserve |
|
$ |
6,972.9 |
|
$ |
— |
|
$ |
— |
|
$ |
6,972.9 |
|
|
Loss and loss adjustment expense reserve |
|
563.0 |
|
— |
|
11.4 |
|
574.4 |
| ||||
|
Reinsurance balances payable, net |
|
274.4 |
|
— |
|
— |
|
274.4 |
| ||||
|
Long-term debt |
|
1,052.9 |
|
— |
|
— |
|
1,052.9 |
| ||||
|
Credit derivative liabilities |
|
2,465.5 |
|
— |
|
(2.7 |
) |
2,462.8 |
| ||||
|
Current income tax payable |
|
93.0 |
|
— |
|
— |
|
93.0 |
| ||||
|
Financial guaranty variable interest entities’ liabilities with recourse, at fair value |
|
2,927.0 |
|
103.9 |
|
— |
|
3,030.9 |
| ||||
|
Financial guaranty variable interest entities’ liabilities without recourse, at fair value |
|
2,014.1 |
|
— |
|
(676.9 |
) |
1,337.2 |
| ||||
|
Other liabilities |
|
309.9 |
|
— |
|
— |
|
309.9 |
| ||||
|
Total liabilities |
|
16,672.7 |
|
103.9 |
|
(668.2 |
) |
16,108.4 |
| ||||
|
Commitments and contingencies |
|
|
|
|
|
|
|
|
| ||||
|
Common stock |
|
1.8 |
|
— |
|
— |
|
1.8 |
| ||||
|
Additional paid-in capital |
|
2,585.4 |
|
— |
|
— |
|
2,585.4 |
| ||||
|
Retained earnings |
|
1,098.9 |
|
(60.7 |
) |
(5.7 |
) |
1,032.5 |
| ||||
|
Accumulated other comprehensive income, net of tax provision (benefit) |
|
110.7 |
|
1.1 |
|
— |
|
111.8 |
| ||||
|
Deferred equity compensation |
|
2.0 |
|
— |
|
— |
|
2.0 |
| ||||
|
Total shareholders’ equity |
|
3,798.8 |
|
(59.6 |
) |
(5.7 |
) |
3,733.5 |
| ||||
|
Total liabilities and shareholders’ equity |
|
$ |
20,471.5 |
|
$ |
44.3 |
|
$ |
(673.9 |
) |
$ |
19,841.9 |
|
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
The effect of the restatement on the consolidated statements of operations is shown in the tables below.
|
|
|
Three Months Ended September 30, 2010 |
| ||||||||||||||||
|
|
|
As |
|
Reclassifications |
|
Subtotal |
|
(1) |
|
(2) |
|
Restated |
| ||||||
|
|
|
(in millions, except per share amounts) |
| ||||||||||||||||
|
Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
|
Net earned premiums |
|
$ |
288.7 |
|
$ |
— |
|
$ |
288.7 |
|
$ |
— |
|
$ |
— |
|
$ |
288.7 |
|
|
Net investment income |
|
85.6 |
|
— |
|
85.6 |
|
— |
|
— |
|
85.6 |
| ||||||
|
Net realized investment gains (losses) |
|
(2.4 |
) |
— |
|
(2.4 |
) |
— |
|
— |
|
(2.4 |
) | ||||||
|
Net change in fair value of credit derivatives |
|
(232.5 |
) |
— |
|
(232.5 |
) |
— |
|
8.5 |
|
(224.0 |
) | ||||||
|
Fair value gain (loss) on committed capital securities |
|
(5.5 |
) |
— |
|
(5.5 |
) |
— |
|
— |
|
(5.5 |
) | ||||||
|
Net change in financial guaranty variable interest entities |
|
76.5 |
|
126.7 |
|
203.2 |
|
(31.9 |
) |
— |
|
171.3 |
| ||||||
|
Other income |
|
33.8 |
|
— |
|
33.8 |
|
— |
|
— |
|
33.8 |
| ||||||
|
Total revenues |
|
244.2 |
|
126.7 |
|
370.9 |
|
(31.9 |
) |
8.5 |
|
347.5 |
| ||||||
|
Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
|
Loss and loss adjustment expenses |
|
109.1 |
|
— |
|
109.1 |
|
1.3 |
|
0.4 |
|
110.8 |
| ||||||
|
Interest and other operating expenses |
|
(41.6 |
) |
126.7 |
|
85.1 |
|
— |
|
— |
|
85.1 |
| ||||||
|
Total expenses |
|
67.5 |
|
126.7 |
|
194.2 |
|
1.3 |
|
0.4 |
|
195.9 |
| ||||||
|
Income (loss) before income taxes |
|
176.7 |
|
— |
|
176.7 |
|
(33.2 |
) |
8.1 |
|
151.6 |
| ||||||
|
Provision (benefit) for income taxes |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
|
Current |
|
(191.9 |
) |
— |
|
(191.9 |
) |
— |
|
— |
|
(191.9 |
) | ||||||
|
Deferred |
|
187.7 |
|
— |
|
187.7 |
|
(11.6 |
) |
2.8 |
|
178.9 |
| ||||||
|
Total provision (benefit) for income taxes |
|
(4.2 |
) |
— |
|
(4.2 |
) |
(11.6 |
) |
2.8 |
|
(13.0 |
) | ||||||
|
Net income (loss) |
|
$ |
180.9 |
|
$ |
— |
|
$ |
180.9 |
|
$ |
(21.6 |
) |
$ |
5.3 |
|
$ |
164.6 |
|
|
Earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
|
Basic |
|
$ |
0.98 |
|
|
|
$ |
0.98 |
|
|
|
|
|
$ |
0.89 |
| |||
|
Diluted |
|
$ |
0.96 |
|
|
|
$ |
0.96 |
|
|
|
|
|
$ |
0.88 |
| |||
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
|
|
|
Nine Months Ended September 30, 2010 |
| ||||||||||||||||
|
|
|
As |
|
Reclassifications |
|
Subtotal |
|
(1) |
|
(2) |
|
Restated |
| ||||||
|
|
|
(in millions except per share amounts) |
| ||||||||||||||||
|
Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
|
Net earned premiums |
|
$ |
900.4 |
|
$ |
— |
|
$ |
900.4 |
|
$ |
— |
|
$ |
— |
|
$ |
900.4 |
|
|
Net investment income |
|
260.8 |
|
— |
|
260.8 |
|
— |
|
— |
|
260.8 |
| ||||||
|
Net realized investment gains (losses) |
|
(1.4 |
) |
— |
|
(1.4 |
) |
— |
|
— |
|
(1.4 |
) | ||||||
|
Net change in fair value of credit derivatives |
|
119.8 |
|
— |
|
119.8 |
|
— |
|
8.5 |
|
128.3 |
| ||||||
|
Fair value gain (loss) on committed capital securities |
|
5.8 |
|
— |
|
5.8 |
|
— |
|
— |
|
5.8 |
| ||||||
|
Net change in financial guaranty variable interest entities |
|
61.6 |
|
131.5 |
|
193.1 |
|
(58.1 |
) |
— |
|
135.0 |
| ||||||
|
Other income |
|
7.4 |
|
— |
|
7.4 |
|
— |
|
— |
|
7.4 |
| ||||||
|
Total revenues |
|
1,354.4 |
|
131.5 |
|
1,485.9 |
|
(58.1 |
) |
8.5 |
|
1,436.3 |
| ||||||
|
Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
|
Loss and loss adjustment expenses |
|
310.8 |
|
— |
|
310.8 |
|
1.4 |
|
(4.8 |
) |
307.4 |
| ||||||
|
Interest and other operating expenses |
|
135.5 |
|
131.5 |
|
267.0 |
|
— |
|
— |
|
267.0 |
| ||||||
|
Total expenses |
|
446.3 |
|
131.5 |
|
577.8 |
|
1.4 |
|
(4.8 |
) |
574.4 |
| ||||||
|
Income (loss) before income taxes |
|
908.1 |
|
— |
|
908.1 |
|
(59.5 |
) |
13.3 |
|
861.9 |
| ||||||
|
Provision (benefit) for income taxes |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
|
Current |
|
(186.0 |
) |
— |
|
(186.0 |
) |
— |
|
— |
|
(186.0 |
) | ||||||
|
Deferred |
|
387.7 |
|
— |
|
387.7 |
|
(20.8 |
) |
3.8 |
|
370.7 |
| ||||||
|
Total provision (benefit) for income taxes |
|
201.7 |
|
— |
|
201.7 |
|
(20.8 |
) |
3.8 |
|
184.7 |
| ||||||
|
Net income (loss) |
|
$ |
706.4 |
|
$ |
— |
|
$ |
706.4 |
|
$ |
(38.7 |
) |
$ |
9.5 |
|
$ |
677.2 |
|
|
Earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
|
Basic |
|
$ |
3.83 |
|
|
|
$ |
3.83 |
|
|
|
|
|
$ |
3.67 |
| |||
|
Diluted |
|
$ |
3.73 |
|
|
|
$ |
3.73 |
|
|
|
|
|
$ |
3.58 |
| |||
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
The effect of the restatement on the consolidated statements of comprehensive income is shown in the tables below.
|
|
|
Three Months Ended September 30, 2010 |
| ||||||||||
|
|
|
As |
|
(1) |
|
(2) |
|
Restated |
| ||||
|
|
|
(in millions) |
| ||||||||||
|
Net income |
|
$ |
180.9 |
|
$ |
(21.6 |
) |
$ |
5.3 |
|
$ |
164.6 |
|
|
Unrealized holding gains (losses) arising during the period |
|
139.6 |
|
— |
|
— |
|
139.6 |
| ||||
|
Less: reclassification adjustment for gains (losses) |
|
(1.3 |
) |
— |
|
— |
|
(1.3 |
) | ||||
|
Change in net unrealized gains on investments |
|
140.9 |
|
— |
|
— |
|
140.9 |
| ||||
|
Change in cumulative translation adjustment |
|
5.4 |
|
— |
|
— |
|
5.4 |
| ||||
|
Change in cash flow hedge |
|
(0.1 |
) |
— |
|
— |
|
(0.1 |
) | ||||
|
Other comprehensive income(loss) |
|
146.2 |
|
— |
|
— |
|
146.2 |
| ||||
|
Comprehensive income (loss) |
|
$ |
327.1 |
|
$ |
(21.6 |
) |
$ |
5.3 |
|
$ |
310.8 |
|
|
|
|
Nine Months Ended September 30, 2010 |
| ||||||||||
|
|
|
As |
|
(1) |
|
(2) |
|
Restated |
| ||||
|
|
|
(in millions) |
| ||||||||||
|
Net income |
|
$ |
706.4 |
|
$ |
(38.7 |
) |
$ |
9.5 |
|
$ |
677.2 |
|
|
Unrealized holding gains (losses) arising during the period |
|
197.0 |
|
— |
|
— |
|
197.0 |
| ||||
|
Less: reclassification adjustment for gains (losses) |
|
1.2 |
|
— |
|
— |
|
1.2 |
| ||||
|
Change in net unrealized gains on investments |
|
195.8 |
|
— |
|
— |
|
195.8 |
| ||||
|
Change in cumulative translation adjustment |
|
0.2 |
|
— |
|
— |
|
0.2 |
| ||||
|
Change in cash flow hedge |
|
(0.3 |
) |
— |
|
— |
|
(0.3 |
) | ||||
|
Other comprehensive income(loss) |
|
195.7 |
|
— |
|
— |
|
195.7 |
| ||||
|
Comprehensive income (loss) |
|
$ |
902.1 |
|
$ |
(38.7 |
) |
$ |
9.5 |
|
$ |
872.9 |
|
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
The effect of the restatement on the consolidated statements of cash flow is shown in the tables below.
|
|
|
Nine Months Ended September 30, 2010 |
| |||||||
|
|
|
As |
|
(1) |
|
Restated |
| |||
|
|
|
(in millions) |
| |||||||
|
Net cash flows provided by (used in) operating activities |
|
$ |
(140.0 |
) |
$ |
35.7 |
|
$ |
(104.3 |
) |
|
Investing activities |
|
|
|
|
|
|
| |||
|
Fixed maturity securities: |
|
|
|
|
|
|
| |||
|
Purchases |
|
(1,928.7 |
) |
— |
|
(1,928.7 |
) | |||
|
Sales |
|
835.7 |
|
— |
|
835.7 |
| |||
|
Maturities |
|
729.6 |
|
— |
|
729.6 |
| |||
|
Net sales (purchases) of short-term investments |
|
759.9 |
|
(28.7 |
) |
731.2 |
| |||
|
Net proceeds from paydowns on financial guaranty variable interest entities’ assets |
|
323.6 |
|
— |
|
323.6 |
| |||
|
Other |
|
15.7 |
|
— |
|
15.7 |
| |||
|
Net cash flows provided by (used in) investing activities |
|
735.8 |
|
(28.7 |
) |
707.1 |
| |||
|
Financing activities |
|
|
|
|
|
|
| |||
|
Dividends paid |
|
(24.9 |
) |
— |
|
(24.9 |
) | |||
|
Repurchases of common stock |
|
(10.5 |
) |
— |
|
(10.5 |
) | |||
|
Share activity under option and incentive plans |
|
(2.2 |
) |
— |
|
(2.2 |
) | |||
|
Net paydowns of financial guaranty variable interest entities’ liabilities |
|
(497.3 |
) |
— |
|
(497.3 |
) | |||
|
Repayment of long-term debt |
|
(16.1 |
) |
— |
|
(16.1 |
) | |||
|
Net cash flows provided by (used in) financing activities |
|
(551.0 |
) |
— |
|
(551.0 |
) | |||
|
Effect of exchange rate changes |
|
(1.5 |
) |
— |
|
(1.5 |
) | |||
|
Increase in cash |
|
43.3 |
|
7.0 |
|
50.3 |
| |||
|
Cash at beginning of year |
|
44.1 |
|
— |
|
44.1 |
| |||
|
Cash at end of year |
|
$ |
87.4 |
|
$ |
7.0 |
|
$ |
94.4 |
|
(1) Represents adjustments related to the correction of FG VIE intercompany eliminations.
(2) Represents other adjustments of immaterial errors. These corrections related to (a) errors in expected losses that had previously been corrected by the Company in the period such errors were identified, but which are now being recorded in the period in which they arose, (b) an error related to one credit derivative contract that resulted from the use of an incorrect par outstanding balance in the pricing model and (c) the correction of an error related to the classification of FG VIE assets and liabilities that resulted from a misinterpretation of a trustee report.
3. Business Changes, Risks, Uncertainties and Accounting Developments
Summarized below are updates of the most significant events since year end 2010, 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. In addition to items discussed below, see Note 5 for a discussion of the Company’s exposure to Greek sovereign debt.
Recoveries for Breaches of Representations and Warranties
On April 14, 2011, Assured Guaranty reached a comprehensive agreement with Bank of America Corporation and its subsidiaries, including Countrywide Financial Corporation and its subsidiaries (collectively, “Bank of America”), regarding their liabilities with respect to 29 RMBS transactions insured by Assured Guaranty, including claims relating to reimbursement for breaches of representations and warranties (“R&W”) and historical loan servicing issues (“Bank of America Agreement”). Of the 29 RMBS transactions, eight are second lien transactions and 21 are first lien transactions. The Bank of America Agreement covers Bank of America-sponsored securitizations that AGM or AGC has insured, as well as certain other securitizations containing concentrations of Countrywide-originated loans that AGM or AGC has insured. The transactions covered by the Bank of America Agreement have a gross par outstanding of $4.6 billion ($4.2 billion net par outstanding) as of September 30, 2011, or 28% of Assured Guaranty’s total BIG RMBS net par outstanding.
Bank of America paid $985.4 million in Nine Months 2011 in respect of covered second lien transactions and is obligated to pay another $114.6 million by March 2012. In consideration of the $1.1 billion, the Company has agreed to
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
release its claims for the repurchase of mortgage loans underlying the eight second lien transactions (i.e., Assured Guaranty will retain the risk of future insured losses without further offset for R&W claims against Bank of America).
In addition, Bank of America will reimburse Assured Guaranty 80% of claims Assured Guaranty pays on the 21 first lien transactions, until aggregate collateral losses on such RMBS transactions reach $6.6 billion. The Company accounts for the 80% loss sharing agreement with Bank of America as subrogation. As the Company calculates expected losses for these 21 first lien transactions, such expected losses will be offset by an R&W benefit from Bank of America for 80% of these amounts. As of September 30, 2011, Bank of America had placed $965.0 million of eligible assets in trust in order to collateralize the reimbursement obligation relating to the first lien transactions. The amount of assets required to be posted may increase or decrease from time to time, as determined by rating agency requirements. As of September 30, 2011, the Company’s estimate of expected R&W recoveries for the first lien transactions covered under the Bank of America Agreement was $615.1 million.
The Company believes the Bank of America Agreement was a significant step in the effort to recover U.S. RMBS losses the Company experienced resulting from breaches of R&W. The Company is continuing to pursue other representation and warranty providers for U.S. RMBS transactions it has insured. See “Recovery Litigation” in Note 5 of these Financial Statements for a discussion of the litigation proceedings the Company has initiated against other R&W providers.
Standard and Poor’s Rating Services Bond Insurer Criteria
The most recent rating action by S&P on AGL and its subsidiaries took place on September 27, 2011, when S&P published a Research Update in which it placed its ratings of Assured Guaranty on CreditWatch Negative. This action included changing the financial strength ratings of AGC and AGM from AA+ (Negative Outlook) to AA+ (CreditWatch Negative), and the AA (Negative Outlook) rating of AG Re to AA (CreditWatch Negative), signifying that S&P may downgrade such financial strength ratings in the near future. In the Research Update, S&P stated that the CreditWatch placement is due to significant concentration risk in Assured Guaranty’s consolidated insured portfolio; the portfolio contains exposures that are not consistent with S&P’s new bond insurance rating criteria and breach the “largest obligor test” in such new criteria. The largest obligor test appears to have the effect of significantly reducing Assured Guaranty’s allowed single risk limits and limiting its financial strength rating level. S&P published updated criteria in Bond Insurance Rating Methodology and Assumptions on August 25, 2011, subsequent to its publication of Request for Comment: Bond Insurance Criteria on January 24, 2011. According to S&P, based on statements from Assured Guaranty’s management that Assured Guaranty intends to take action such as create capital or utilize additional forms of reinsurance to mitigate these concentration risks, it is likely such actions, if taken, would support financial strength ratings in the “AA” category. S&P noted that it expects to resolve this CreditWatch placement no later than November 30, 2011. The Company is considering transactions that are designed to create capital and/or mitigate its concentration risks but can give no assurance that it will be able to complete the transactions at all or on terms that are acceptable. If it cannot do so, S&P may downgrade the financial strength ratings of AGL and its subsidiaries, which downgrade may have an adverse impact on the Company’s financial condition, results of operation, liquidity, business prospects or other aspects of the Company’s business and on its insured portfolio.
The Company’s insurance policies and credit derivative 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 8. The outstanding par and Debt Service amounts presented below include outstanding exposures on VIEs, whether or not they are consolidated.
Debt Service Outstanding
|
|
|
Gross Debt Service Outstanding |
|
Net Debt Service Outstanding |
| ||||||||
|
|
|
September 30, |
|
December 31, |
|
September 30, |
|
December 31, |
| ||||
|
|
|
(in millions) |
| ||||||||||
|
Public finance |
|
$ |
811,423 |
|
$ |
851,634 |
|
$ |
727,401 |
|
$ |
760,167 |
|
|
Structured finance |
|
148,006 |
|
178,348 |
|
138,291 |
|
166,976 |
| ||||
|
Total |
|
$ |
959,429 |
|
$ |
1,029,982 |
|
$ |
865,692 |
|
$ |
927,143 |
|
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
Financial Guaranty Net Par Outstanding by Internal Rating
|
|
|
As of September 30, 2011 |
| |||||||||||||||||||||||
|
|
|
Public Finance |
|
Public Finance |
|
Structured Finance |
|
Structured Finance |
|
Total |
| |||||||||||||||
|
Rating Category |
|
Net Par |
|
% |
|
Net Par |
|
% |
|
Net Par |
|
% |
|
Net Par |
|
% |
|
Net Par |
|
% |
| |||||
|
|
|
(dollars in millions) |
| |||||||||||||||||||||||
|
Super senior |
|
$ |
— |
|
— |
% |
$ |
1,386 |
|
3.5 |
% |
$ |
17,544 |
|
17.9 |
% |
$ |
6,664 |
|
25.2 |
% |
$ |
25,594 |
|
4.5 |
% |
|
AAA |
|
5,073 |
|
1.2 |
|
1,383 |
|
3.5 |
|
37,544 |
|
38.3 |
|
12,159 |
|
46.0 |
|
56,159 |
|
9.8 |
| |||||
|
AA |
|
149,190 |
|
36.6 |
|
1,094 |
|
2.8 |
|
12,532 |
|
12.8 |
|
1,255 |
|
4.7 |
|
164,071 |
|
28.7 |
| |||||
|
A |
|
208,837 |
|
51.2 |
|
12,022 |
|
30.6 |
|
5,086 |
|
5.2 |
|
926 |
|
3.5 |
|
226,871 |
|
39.7 |
| |||||
|
BBB |
|
41,700 |
|
10.2 |
|
21,231 |
|
54.1 |
|
5,283 |
|
5.4 |
|
3,589 |
|
13.7 |
|
71,803 |
|
12.5 |
| |||||
|
BIG |
|
3,265 |
|
0.8 |
|
2,151 |
|
5.5 |
|
19,980 |
|
20.4 |
|
1,831 |
|
6.9 |
|
27,227 |
|
4.8 |
| |||||
|
Total net par outstanding |
|
$ |
408,065 |
|
100.0 |
% |
$ |
39,267 |
|
100.0 |
% |
$ |
97,969 |
|
100.0 |
% |
$ |
26,424 |
|
100.0 |
% |
$ |
571,725 |
|
100.0 |
% |
|
|
|
As of December 31, 2010 |
| |||||||||||||||||||||||
|
|
|
Public Finance |
|
Public Finance |
|
Structured Finance |
|
Structured Finance |
|
Total |
| |||||||||||||||
|
Rating Category |
|
Net Par |
|
% |
|
Net Par |
|
% |
|
Net Par |
|
% |
|
Net Par |
|
% |
|
Net Par |
|
% |
| |||||
|
|
|
(dollars in millions) |
| |||||||||||||||||||||||
|
Super senior |
|
$ |
— |
|
— |
% |
$ |
1,420 |
|
3.5 |
% |
$ |
21,837 |
|
18.4 |
% |
$ |
7,882 |
|
25.7 |
% |
$ |
31,139 |
|
5.0 |
% |
|
AAA |
|
5,784 |
|
1.4 |
|
1,378 |
|
3.4 |
|
45,067 |
|
37.9 |
|
13,573 |
|
44.3 |
|
65,802 |
|
10.7 |
| |||||
|
AA |
|
161,906 |
|
37.9 |
|
1,330 |
|
3.3 |
|
17,355 |
|
14.6 |
|
1,969 |
|
6.4 |
|
182,560 |
|
29.6 |
| |||||
|
A |
|
214,199 |
|
50.2 |
|
12,482 |
|
30.6 |
|
6,396 |
|
5.4 |
|
1,873 |
|
6.1 |
|
234,950 |
|
38.1 |
| |||||
|
BBB |
|
41,948 |
|
9.8 |
|
22,338 |
|
54.8 |
|
7,543 |
|
6.4 |
|
4,045 |
|
13.2 |
|
75,874 |
|
12.3 |
| |||||
|
BIG |
|
3,159 |
|
0.7 |
|
1,795 |
|
4.4 |
|
20,558 |
|
17.3 |
|
1,294 |
|
4.3 |
|
26,806 |
|
4.3 |
| |||||
|
Total net par outstanding |
|
$ |
426,996 |
|
100.0 |
% |
$ |
40,743 |
|
100.0 |
% |
$ |
118,756 |
|
100.0 |
% |
$ |
30,636 |
|
100.0 |
% |
$ |
617,131 |
|
100.0 |
% |
In addition to amounts shown in the tables above, the Company had outstanding commitments to provide guaranties of $2.7 billion for structured finance and $1.2 billion for public finance commitments at September 30, 2011. 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 October 1, 2011 and February 1, 2019, with $0.6 billion expiring prior to December 31, 2011. 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.
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. 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
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
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 5 “Loss estimation process”). 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 more than 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.) A “liquidity claim” is a claim that the Company expects to be reimbursed within one year.
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) 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 $1.9 billion of net par outstanding related to transactions covered by the Bank of America Agreement, which represents 17% of the first lien U.S. RMBS BIG net par outstanding as of September 30, 2011. 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.
Financial Guaranty Exposures
(Insurance and Credit Derivative Form)
|
|
|
September 30, 2011 |
| |||||||||||||||
|
|
|
|
|
|
|
BIG Net Par as a % |
| |||||||||||
|
|
|
BIG Net Par Outstanding |
|
Net Par |
|
of Net Par |
| |||||||||||
|
|
|
BIG 1 |
|
BIG 2 |
|
BIG 3 |
|
Total BIG |
|
Outstanding |
|
Outstanding |
| |||||
|
|
|
(in millions) |
|
|
| |||||||||||||
|
First lien U.S. RMBS: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
|
Prime first lien |
|
$ |
90 |
|
$ |
513 |
|
$ |
— |
|
$ |
603 |
|
$ |
760 |
|
0.1 |
% |
|
Alt-A first lien |
|
1,815 |
|
1,594 |
|
1,433 |
|
4,842 |
|
5,541 |
|
0.9 |
| |||||
|
Option ARM |
|
124 |
|
1,115 |
|
1,148 |
|
2,387 |
|
2,627 |
|
0.4 |
| |||||
|
Subprime (including net interest margin securities) |
|
153 |
|
2,608 |
|
209 |
|
2,970 |
|
8,403 |
|
0.5 |
| |||||
|
Second lien U.S. RMBS: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
|
Closed-end second lien |
|
— |
|
497 |
|
538 |
|
1,035 |
|
1,061 |
|
0.2 |
| |||||
|
Home equity lines of credit (“HELOCs”) |
|
446 |
|
— |
|
2,984 |
|
3,430 |
|
4,072 |
|
0.6 |
| |||||
|
Total U.S. RMBS |
|
2,628 |
|
6,327 |
|
6,312 |
|
15,267 |
|
22,464 |
|
2.7 |
| |||||
|
TruPS |
|
2,232 |
|
— |
|
952 |
|
3,184 |
|
6,467 |
|
0.6 |
| |||||
|
Other structured finance |
|
1,483 |
|
423 |
|
1,454 |
|
3,360 |
|
95,462 |
|
0.6 |
| |||||
|
Public finance |
|
4,216 |
|
339 |
|
861 |
|
5,416 |
|
447,332 |
|
0.9 |
| |||||
|
Total |
|
$ |
10,559 |
|
$ |
7,089 |
|
$ |
9,579 |
|
$ |
27,227 |
|
$ |
571,725 |
|
4.8 |
% |
Assured Guaranty Ltd.
Notes to Consolidated Financial Statements (Unaudited) (continued)
September 30, 2011
|
|
|
December 31, 2010 |
| |||||||||||||||
|
|
|
|
|
|
|
BIG Net Par as a % |
| |||||||||||
|
|
|
BIG Net Par Outstanding |
|
Net Par |
|
of Net Par |
| |||||||||||
|
|
|
BIG 1 |
|
BIG 2 |
|
BIG 3 |
|
Total BIG |
|
Outstanding |
|
Outstanding |
| |||||
|
|
|
(in millions) |
|
|
| |||||||||||||
|
|
|
(restated) |
|
(restated) |
|
|
|
|
|
|
|
|
| |||||
|
First lien U.S. RMBS: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
|
Prime first lien |
|
$ |
82 |
|
$ |
542 |
|
$ |
— |
|
$ |
624 |
|
$ |
849 |
|
0.1 |
% |
|
Alt-A first lien |
|
976 |
|
3,108 |
|
573 |
|
4,657 |
|
6,134 |
|
0.8 |
| |||||
|
Option ARM |
|
33 |
|
2,186 |
|
640 |
|
2,859 |
|
3,214 |
|
0.5 |
| |||||
|
Subprime (including net interest margin securities) |
|
729 |
|
2,248 |
|
106 |
|
3,083 |
|
9,039 |
|
0.4 |
| |||||
|
Second lien U.S. RMBS: |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
|
Closed-end second lien |
|
63 |
|
444 |
|
624 |
|
1,131 |
|
1,164 |
|
0.2 |
| |||||
|
HELOCs |
|
369 |
|
— |
|
3,632 |
|
4,001 |
|
4,730 |
|
0.6 |
| |||||
|
Total U.S. RMBS |
|
2,252 |
|
8,528 |
|
5,575 |
|
16,355 |
|
25,130 |
|
2.6 |
| |||||
|
TruPS |
|
1,846 |
|
— |
|
964 |
|
2,810 |
|
6,833 |
|
0.5 |
| |||||
|
Other structured finance |
|
841 |
|
363 |
|
1,483 |
|
2,687 |
|
117,429 |
|
0.4 |
| |||||
|
Public finance |
|
3,752 |
|
283 |
|
919 |
|
4,954 |
|
467,739 |
|
0.8 |
| |||||
|
Total |
|
$ |
8,691 |
|
$ |
|||||||||||||