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Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________________________________
FORM 10-Q
ý
 
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2018
Or
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition Period from              to               
Commission File No. 001-32141 
ASSURED GUARANTY LTD.
(Exact name of registrant as specified in its charter) 
Bermuda
 
98-0429991
(State or other jurisdiction
 
(I.R.S. employer
of incorporation)
 
identification no.)
 
30 Woodbourne Avenue
Hamilton HM 08
Bermuda
(Address of principal executive offices)
(441) 279-5700
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
                 Accelerated filer o
  Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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, 2018 was 112,361,521 (includes 50,225 unvested restricted shares).
 

Table of Contents


ASSURED GUARANTY LTD.

INDEX TO FORM 10-Q
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Table of Contents

PART I.    FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS

Assured Guaranty Ltd.

Condensed Consolidated Balance Sheets (unaudited)
 
(dollars in millions except per share and share amounts) 

 
As of
March 31, 2018
 
As of
December 31, 2017
Assets
 

 
 

Investment portfolio:
 

 
 

Fixed-maturity securities, available-for-sale, at fair value (amortized cost of $9,969 and $10,187)
$
10,297

 
$
10,674

Short-term investments, at fair value
751

 
627

Other invested assets
103

 
94

Total investment portfolio
11,151

 
11,395

Cash
114

 
144

Premiums receivable, net of commissions payable
944

 
915

Ceded unearned premium reserve
122

 
119

Deferred acquisition costs
100

 
101

Salvage and subrogation recoverable
430

 
572

Financial guaranty variable interest entities’ assets, at fair value
651

 
700

Other assets
507

 
487

Total assets
$
14,019

 
$
14,433

Liabilities and shareholders’ equity
 

 
 

Unearned premium reserve
$
3,395

 
$
3,475

Loss and loss adjustment expense reserve
1,299

 
1,444

Long-term debt
1,281

 
1,292

Credit derivative liabilities
237

 
271

Financial guaranty variable interest entities’ liabilities with recourse, at fair value
598

 
627

Financial guaranty variable interest entities’ liabilities without recourse, at fair value
110

 
130

Other liabilities
315

 
355

Total liabilities
7,235

 
7,594

Commitments and contingencies (see Note 14)

 

Common stock ($0.01 par value, 500,000,000 shares authorized; 113,709,322 and 116,020,852 shares issued and outstanding)
1

 
1

Additional paid-in capital
466

 
573

Retained earnings
6,102

 
5,892

Accumulated other comprehensive income, net of tax of $51 and $89
214

 
372

Deferred equity compensation
1

 
1

Total shareholders’ equity
6,784

 
6,839

Total liabilities and shareholders’ equity
$
14,019

 
$
14,433


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

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Assured Guaranty Ltd.

Condensed Consolidated Statements of Operations (unaudited)
 
(dollars in millions except per share amounts)

 
Three Months Ended March 31,
 
2018
 
2017
Revenues
 
 
 
Net earned premiums
$
145

 
$
164

Net investment income
101

 
122

Net realized investment gains (losses):
 
 
 
Other-than-temporary impairment losses
(11
)
 
(1
)
Less: portion of other-than-temporary impairment loss recognized in other comprehensive income
(3
)
 
8

Net impairment loss
(8
)
 
(9
)
Other net realized investment gains (losses)
3

 
41

Net realized investment gains (losses)
(5
)
 
32

Net change in fair value of credit derivatives:
 
 
 
Realized gains (losses) and other settlements
2

 
15

Net unrealized gains (losses)
32

 
39

Net change in fair value of credit derivatives
34

 
54

Fair value gains (losses) on financial guaranty variable interest entities
4

 
10

Bargain purchase gain and settlement of pre-existing relationships
—

 
58

Commutation gains
1

 
73

Other income (loss)
13

 
14

Total revenues
293

 
527

Expenses
 
 
 
Loss and loss adjustment expenses
(18
)
 
59

Amortization of deferred acquisition costs
5

 
4

Interest expense
24

 
24

Other operating expenses
65

 
68

Total expenses
76

 
155

Income (loss) before income taxes
217

 
372

Provision (benefit) for income taxes
 
 
 
Current
(37
)
 
51

Deferred
57

 
4

Total provision (benefit) for income taxes
20

 
55

Net income (loss)
$
197

 
$
317

 
 
 
 
Earnings per share:
 
 
 
Basic
$
1.71

 
$
2.53

Diluted
$
1.68

 
$
2.49

Dividends per share
$
0.16

 
$
0.1425

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

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Assured Guaranty Ltd.

Condensed Consolidated Statements of Comprehensive Income (unaudited)
 
(in millions)
 
 
Three Months Ended March 31,
 
2018
 
2017
Net income (loss)
$
197

 
$
317

Unrealized holding gains (losses) arising during the period on:
 
 
 
Investments with no other-than-temporary impairment, net of tax provision (benefit) of $(29) and $23
(122
)
 
44

Investments with other-than-temporary impairment, net of tax provision (benefit) of $(3) and $28
(11
)
 
50

Unrealized holding gains (losses) arising during the period, net of tax
(133
)
 
94

Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $(2) and $21
(3
)
 
39

Change in net unrealized gains (losses) on investments
(130
)
 
55

 
 
 
 
Net unrealized gains (losses) arising during the period on FG VIE liabilities with recourse attributable to changes in instrument-specific credit risk, net of tax provision (benefit) of $(1) (see Note 1)
(4
)
 
—

Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $(1)
(2
)
 
—

Change in net unrealized gains (losses) on FG VIE liabilities with recourse
(2
)
 
—

 
 
 
 
Other, net of tax provision
6

 
2

Other comprehensive income (loss)
(126
)
 
$
57

Comprehensive income (loss)
$
71

 
$
374

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

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Assured Guaranty Ltd.

Condensed Consolidated Statement of Shareholders’ Equity (unaudited)
 
For the Three Months Ended March 31, 2018
 
(dollars in millions, except share data)

 
Common Shares Outstanding
 
 
Common 
Stock
Par Value
 
Additional
Paid-in
Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive Income
 
Deferred
Equity Compensation
 
Total
Shareholders’ Equity
Balance at
December 31, 2017
116,020,852

 
 
$
1

 
$
573

 
$
5,892

 
$
372

 
$
1

 
$
6,839

Net income
—

 
 
—

 
—

 
197

 
—

 
—

 
197

Dividends ($0.16 per share)
—

 
 
—

 
—

 
(19
)
 
—

 
—

 
(19
)
Common stock repurchases
(2,787,936
)
 
 
0

 
(98
)
 
—

 
—

 
—

 
(98
)
Share-based compensation and other
476,406

 
 
0

 
(9
)
 
—

 
—

 
—

 
(9
)
Other comprehensive loss
—

 
 
—

 
—

 
—

 
(126
)
 
—

 
(126
)
Effect of adoption of ASU 2016-01 (see Note 1)
—

 
 
—

 
—

 
32

 
(32
)
 
—

 
—

Balance at
March 31, 2018
113,709,322

 
 
$
1

 
$
466

 
$
6,102

 
$
214

 
$
1

 
$
6,784

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

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Assured Guaranty Ltd.

Condensed Consolidated Statements of Cash Flows (unaudited)
 
(in millions)
 
 
Three Months Ended March 31,
 
2018
 
2017
Net cash flows provided by (used in) operating activities
$
27

 
$
102

Investing activities
 

 
 

Fixed-maturity securities:
 

 
 

Purchases
(411
)
 
(517
)
Sales
409

 
323

Maturities
225

 
265

Net sales (purchases) of short-term investments
(116
)
 
12

Net proceeds from paydowns on financial guaranty variable interest entities’ assets
33

 
46

Acquisition of MBIA UK, net of cash acquired
—

 
95

Other
(14
)
 
(13
)
Net cash flows provided by (used in) investing activities
126

 
211

Financing activities
 

 
 

Dividends paid
(18
)

(19
)
Repurchases of common stock
(100
)

(216
)
Repurchases of common stock to pay withholding taxes
(12
)
 
(12
)
Net paydowns of financial guaranty variable interest entities’ liabilities
(33
)
 
(48
)
Paydown of long-term debt
(19
)
 
(1
)
Proceeds from option exercises
1

 
2

Net cash flows provided by (used in) financing activities
(181
)
 
(294
)
Effect of foreign exchange rate changes
1

 
2

Increase (decrease) in cash and restricted cash
(27
)
 
21

Cash and restricted cash at beginning of period (see Note 10)
144

 
127

Cash and restricted cash at end of period (see Note 10)
$
117

 
$
148

Supplemental cash flow information
 

 
 

Cash paid (received) during the period for:
 

 
 

Income taxes
$
10

 
$
(5
)
Interest
$
21

 
$
8


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

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Assured Guaranty Ltd.

Notes to Condensed Consolidated Financial Statements (unaudited)
 
March 31, 2018

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 (including infrastructure) and structured finance markets. The Company applies its credit underwriting judgment, risk management skills and capital markets experience primarily to offer financial guaranty insurance that protects holders of debt instruments and other monetary obligations from defaults in scheduled payments. If an obligor defaults on a scheduled payment due on an obligation, including a scheduled principal or interest payment (debt service), the Company is required under its unconditional and irrevocable financial guaranty to pay the amount of the shortfall to the holder of the obligation. The Company markets its financial guaranty insurance directly to issuers and underwriters of public finance and structured finance securities as well as to investors in such obligations. The Company guarantees obligations issued principally in the U.S. and the United Kingdom (U.K.), and also guarantees obligations issued in other countries and regions, including Australia and Western Europe. The Company also provides other forms of insurance (non-financial guaranty insurance) that are in line with its risk profile and benefit from its underwriting experience.

In the past, the Company sold credit protection by issuing policies that guaranteed payment obligations under credit derivatives, primarily credit default swaps (CDS). 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. The Company’s credit derivative transactions are governed by International Swaps and Derivative Association, Inc. (ISDA) documentation. The Company has not entered into any new CDS in order to sell credit protection in the U.S. since the beginning of 2009, when regulatory guidelines were issued that limited the terms under which such protection could be sold. The capital and margin requirements applicable under the Dodd-Frank Wall Street Reform and Consumer Protection Act also contributed to the Company not entering into such new CDS in the U.S. since 2009. The Company actively pursues opportunities to terminate existing CDS, which terminations have the effect of reducing future fair value volatility in income and/or reducing rating agency capital charges.

Basis of Presentation
 
The unaudited interim condensed 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 material 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 variable interest entities (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 condensed consolidated financial statements are as of March 31, 2018 and cover the three-month period ended March 31, 2018 (First Quarter 2018) and the three-month period ended March 31, 2017 (First Quarter 2017). Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but is not required for interim reporting purposes, has been condensed or omitted. The year-end balance sheet data was derived from audited financial statements.
 
The unaudited interim condensed consolidated financial statements include the accounts of AGL, its direct and indirect subsidiaries and its consolidated VIEs. Intercompany accounts and transactions between and among all consolidated entities have been eliminated. Certain prior year balances have been reclassified to conform to the current year's presentation.
 
These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in AGL’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the U.S. Securities and Exchange Commission (SEC).


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The Company's principal insurance company subsidiaries are:

•
Assured Guaranty Municipal Corp. (AGM), domiciled in New York;
•
Municipal Assurance Corp. (MAC), domiciled in New York;
•
Assured Guaranty Corp. (AGC), domiciled in Maryland;
•
Assured Guaranty (Europe) plc (AGE), organized in the U.K.; and
•
Assured Guaranty Re Ltd. (AG Re) and Assured Guaranty Re Overseas Ltd. (AGRO), domiciled in Bermuda.

The Company’s organizational structure includes various holding companies, two of which - Assured Guaranty US Holdings Inc. (AGUS) and Assured Guaranty Municipal Holdings Inc. (AGMH) - have public debt outstanding. See Note 15, Long-Term Debt and Credit Facilities and Note 18, Subsidiary Information.

The Company is actively working to combine the operations of its European subsidiaries, AGE, Assured Guaranty (UK) plc (AGUK), Assured Guaranty (London) plc (AGLN) and CIFG Europe S.A. (CIFGE), through a multi-step transaction, which ultimately is expected to result in AGUK, AGLN and CIFGE transferring their insurance portfolios to and merging with and into AGE. Any such combination will be subject to regulatory and court approvals. As a result, the Company cannot predict when, or if, such combination will be completed, and, if so, what conditions may be attached.

Adopted Accounting Standards

Financial Instruments
    
In January 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities.  The amendments in this ASU are intended to make targeted improvements to GAAP by addressing certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Amendments under this ASU apply to the Company's FG VIE liabilities, which the Company has historically elected to measure through the statement of operations under the fair value option, and to certain equity securities in the Company’s investment portfolio.

For FG VIE liabilities with recourse, the portion of the change in fair value caused by changes in instrument specific credit risk (ISCR) must now be separately presented in other comprehensive income (OCI) as opposed to the statement of operations. See Note 9, Consolidated Variable Interest Entities for additional information.

Amendments under this ASU also apply to equity securities, except those that are accounted for under the equity method of accounting or that resulted in consolidation of the investee by the Company. For equity securities accounted for at fair value, changes in fair value that previously were recorded in OCI, are recorded in other income in the condensed consolidated statements of operations effective January 1, 2018. Equity securities carried at cost as of December 31, 2017, are recorded at cost less impairment plus or minus the change resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. See Note 10, Investments and Cash for additional information.

Effective January 1, 2018, the Company adopted this ASU with a cumulative-effect adjustment to the statement of financial position as of January 1, 2018. This resulted in a reclassification of a net $32 million loss, net of tax, from retained earnings to accumulated OCI (AOCI). See Note 17, Shareholders' Equity, for additional information.

Income Taxes

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory, which removes the current prohibition against immediate recognition of the current and deferred income tax effects of intra-entity transfers of assets other than inventory.  Under the ASU, the selling (transferring) entity is required to recognize a current income tax expense or benefit upon transfer of the asset.  Similarly, the purchasing (receiving) entity is required to recognize a deferred tax asset or deferred tax liability, as well as the related deferred tax benefit or expense, upon receipt of the asset.  The ASU is to be applied on a modified retrospective basis (i.e. by recording a cumulative effect adjustment to the statement of financial position as of the beginning of the first reporting period in which the guidance is adopted). The ASU was adopted on January 1, 2018 with no material effect on the condensed consolidated financial statements.


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Future Application of Accounting Standards

Premium Amortization on Purchased Callable Debt Securities

In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Topic 310-20) - Premium Amortization on Purchased Callable Debt Securities.  This ASU shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date.  This ASU has no effect on the accounting for purchased callable debt securities held at a discount. It is to be applied using a modified retrospective approach and the ASU is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2018. The Company does not expect this ASU to have a material effect on its condensed consolidated financial statements.

Leases
    
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU requires lessees to present right-of-use assets and lease liabilities on the balance sheet. ASU 2016-02 is to be applied using a modified retrospective approach and is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company intends to adopt this ASU on January 1, 2019. The Company is evaluating the effect that this ASU will have on its condensed consolidated financial statements. The Company currently accounts for its lease agreements where the Company is the lessee as operating leases and, therefore, recognizes its lease expense on a straight-line basis. See Note 14, Commitments and Contingencies for additional information on the Company's leases.

Credit Losses on Financial Instruments

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.  The amendments in this ASU are intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions will be required to use forward-looking information to better inform their credit loss estimates as a result of the ASU. While many of the loss estimation techniques applied today will still be permitted, the inputs to those techniques will change to reflect the full amount of expected credit losses. The ASU requires enhanced disclosures to help investors and other financial statement users to better understand significant estimates and judgments used in estimating credit losses, as well as credit quality and underwriting standards of an organization’s portfolio. 

In addition, the ASU amends the accounting for credit losses on available-for-sale securities and purchased financial assets with credit deterioration. The ASU also eliminates the concept of “other than temporary” from the impairment model for certain available-for-sale securities. Accordingly, the ASU states that an entity must use an allowance approach, must limit the allowance to an amount by which the security’s fair value is less than its amortized cost basis, may not consider the length of time fair value has been less than amortized cost, and may not consider recoveries in fair value after the balance sheet date when assessing whether a credit loss exists. For purchased financial assets with credit deterioration, the ASU requires an entity’s method for measuring credit losses to be consistent with its method for measuring expected losses for originated and purchased non-credit-deteriorated assets.

The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. For debt instruments such as reinsurance recoverables, loans and held to maturity securities, entities will be required to record a cumulative-effect adjustment to the statement of financial position as of the beginning of the first reporting period in which the guidance is adopted.  The changes to the impairment model for available-for-sale securities and changes to purchased financial assets with credit deterioration are to be applied prospectively.  The Company is evaluating the effect that this ASU will have on its condensed consolidated financial statements. See Note 10, Investments and Cash for the Company's current accounting policy with respect to available-for-sale securities.

2.
Acquisitions

AGC completed its acquisition of MBIA UK Insurance Limited (MBIA UK), the U.K. operating subsidiary of MBIA Insurance Corporation (MBIA) (the MBIA UK Acquisition) on January 10, 2017 (the MBIA UK Acquisition Date). As consideration for the outstanding shares of MBIA UK plus $23 million in cash, AGC exchanged all its holdings of notes issued in the Zohar II 2005-1 transaction (Zohar II Notes), which were insured by MBIA. AGC’s Zohar II Notes had total outstanding principal of approximately $347 million and fair value of $334 million as of the MBIA UK Acquisition Date. The MBIA UK Acquisition added approximately $12 billion of net par insured on January 10, 2017. In connection with the MBIA UK

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Acquisition in First Quarter 2017, the Company recognized a $56 million bargain purchase gain and a $2 million gain on settlement of pre-existing relationships.

MBIA UK was renamed Assured Guaranty (London) Ltd. and on June 1, 2017, was re-registered as a public limited company (plc). Further, as part of a multi-step transaction, which ultimately is expected to result in AGUK, AGLN and CIFGE transferring their insurance portfolios to and merging with and into AGE, AGLN was sold by AGC to AGM and then contributed by AGM to AGE on June 26, 2017. See Note 1, Business and Basis of Presentation for additional information on the Company's European subsidiaries combination.

For additional information on the acquisition of MBIA UK, including the purchase price and the allocation of the purchase price to net assets acquired and the resulting bargain purchase gain and the gain on settlement of pre-existing relationships, see Note 2, Acquisitions, in Part II, Item 8. “Financial Statements and Supplementary Data” of AGL’s Annual Report on Form 10-K for the year ended December 31, 2017.

3.    Ratings
 
The financial strength ratings (or similar ratings) for the Company’s insurance companies, along with the date of the most recent rating action (or confirmation) by the rating agency, are shown in the table below. Ratings are subject to continuous rating agency review and revision or withdrawal at any time. In addition, the Company periodically assesses the value of each rating assigned to each of its companies, and as a result of such assessment may request that a rating agency add or drop a rating from certain of its companies.

 
S&P Global Ratings, a division of Standard & Poor’s Financial Services LLC
 
Kroll Bond Rating
Agency
 
Moody’s Investors Service, Inc.
 
A.M. Best Company,
Inc.
AGM
AA (stable) (6/26/17)
 
AA+ (stable) (1/23/18)
 
A2 (stable) (8/8/16)
 
—
AGC
AA (stable) (6/26/17)
 
AA (stable) (12/1/17)
 
(1)
 
—
MAC
AA (stable) (6/26/17)
 
AA+ (stable) (7/14/17)
 
—
 
—
AG Re
AA (stable) (6/26/17)
 
—
 
—
 
—
AGRO
AA (stable) (6/26/17)
 
—
 
—
 
A+ (stable) (6/15/17)
AGE
AA (stable) (6/26/17)
 
—
 
A2 (stable) (8/8/16)
 
—
AGUK
AA (stable) (6/26/17)
 
—
 
(1)
 
—
AGLN
BB (positive) (1/12/17)
 
—
 
(2)
 
—
CIFGE
—
 
—
 
—
 
—
____________________
(1)
AGC requested that Moody’s Investors Service, Inc. (Moody's) withdraw its financial strength ratings of AGC and AGUK in January 2017, but Moody's denied that request. Moody’s continues to rate AGC A3 (stable) and AGUK A3; Moody's put AGUK on review for upgrade on June 27, 2017, following its transfer to AGM.

(2)
Assured Guaranty did not request that Moody's rate AGLN. Moody's continues to rate AGLN, and upgraded its rating to Baa2 (stable) on January 13, 2017, following its acquisition by AGC, and then to Baa1 on review for further upgrade on June 27, 2017, following its transfer to AGM.


There can be no assurance that any of the rating agencies will not take negative action on their financial strength ratings of AGL's insurance subsidiaries in the future.
    
For a discussion of the effects of rating actions on the Company, see Note 6, Contracts Accounted for as Insurance, and Note 13, Reinsurance and Other Monoline Exposures.

4.
Outstanding Exposure
 
The Company primarily writes financial guaranty contracts in insurance form. Until 2009, the Company also wrote some of its financial guaranty contracts in credit derivative form, and has acquired or reinsured portfolios both before and after 2009 that include financial guaranty contracts in credit derivative form. Whether written as an insurance contract or as a credit derivative, the Company considers these financial guaranty contracts. The Company also writes a relatively small amount of non-financial guaranty insurance. The Company seeks to limit its exposure to losses by underwriting obligations that it views

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as investment grade at inception, although, as part of its loss mitigation strategy for existing troubled exposures, it may underwrite new issuances that it views as below-investment-grade (BIG). The Company diversifies its insured portfolio across asset classes and, in the structured finance portfolio, requires rigorous subordination or collateralization requirements. Reinsurance may be used in order to reduce net exposure to certain insured transactions.

     Public finance obligations insured by the Company consist primarily of general obligation bonds supported by the taxing powers of U.S. state or municipal governmental authorities, as well as tax-supported bonds, revenue bonds and other obligations supported by covenants from state or municipal governmental authorities or other municipal obligors to impose and collect fees and charges for public services or specific infrastructure projects. The Company also includes within public finance obligations those obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including utilities, toll roads, health care facilities and government office buildings. The Company also includes within public finance similar obligations issued by territorial and non-U.S. sovereign and sub-sovereign issuers and governmental authorities.

Structured finance obligations insured by the Company are generally issued by special purpose entities, including VIEs, and backed by pools of assets having an ascertainable cash flow or market value or other specialized financial obligations. Some of these VIEs are consolidated as described in Note 9, Consolidated Variable Interest Entities. Unless otherwise specified, the outstanding par and debt service amounts presented in this note include outstanding exposures on VIEs whether or not they are consolidated.

Surveillance Categories
 
The Company segregates its insured portfolio into investment grade and BIG surveillance categories to facilitate the appropriate allocation of resources to monitoring and loss mitigation efforts and to aid in establishing the appropriate cycle for periodic review for each exposure. BIG exposures include all exposures with internal credit ratings below BBB-. The Company’s internal credit ratings are based on internal assessments of the likelihood of default and loss severity in the event of default. Internal credit ratings are expressed on a ratings scale similar to that used by the rating agencies and are generally reflective of an approach similar to that employed by the rating agencies, except that the Company's internal credit ratings focus on future performance rather than lifetime performance.
 
The Company monitors its insured portfolio and refreshes its internal credit ratings on individual exposures in quarterly, semi-annual or annual cycles based on the Company’s view of the exposure’s quality, loss potential, volatility and sector. Ratings on exposures in sectors identified as under the most stress or with the most potential volatility are reviewed every quarter. For assumed exposures, the Company may use the ceding company’s credit ratings of transactions where it is impractical for it to assign its own rating.
 
Exposures identified as BIG are subjected to further review to determine the probability of a loss. See Note 5, Expected Loss to be Paid, for additional information. Surveillance personnel then assign each BIG transaction to the appropriate BIG surveillance category based upon whether a future loss is expected and whether a claim has been paid. The Company uses a tax-equivalent yield, which reflects long-term trends in interest rates to calculate the present value of projected payments and recoveries and determine whether a future loss is expected in order to assign the appropriate BIG surveillance category to a transaction. On the other hand, the Company uses risk-free rates, which are determined each quarter to calculate the expected loss for financial statement measurement purposes.
 
More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly. The Company expects “future losses” on a transaction when the Company believes there is at least a 50% chance that, on a present value basis, it will pay more claims on that transaction in the future than it will have reimbursed. The three BIG categories are:
 
•
BIG Category 1: Below-investment-grade transactions showing sufficient deterioration to make future losses possible, but for which none are currently expected.
 
•
BIG Category 2: Below-investment-grade transactions for which future losses are expected but for which no claims (other than liquidity claims, which are claims that the Company expects to be reimbursed within one year) have yet been paid.
 
•
BIG Category 3: Below-investment-grade transactions for which future losses are expected and on which claims (other than liquidity claims) have been paid.


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Unless otherwise noted, ratings disclosed herein on the Company's insured portfolio reflect its internal ratings. The Company classifies those portions of risks benefiting from reimbursement obligations collateralized by eligible assets held in trust in acceptable reimbursement structures as the higher of 'AA' or their current internal rating.

Financial Guaranty Exposure

The Company purchases securities that it has insured, and for which it has expected losses to be paid, in order to
mitigate the economic effect of insured losses (loss mitigation securities). The Company excludes amounts attributable to loss mitigation securities from par and debt service outstanding, which amounts are included in the investment portfolio, because it manages such securities as investments and not insurance exposure. As of March 31, 2018 and December 31, 2017, the Company excluded $2.0 billion and $2.0 billion, respectively, of net par attributable to loss mitigation securities (which are mostly BIG), and other loss mitigation strategies. The following table presents the gross and net debt service for financial guaranty contracts.

Financial Guaranty
Debt Service Outstanding

 
Gross Debt Service
Outstanding
 
Net Debt Service
Outstanding
 
March 31,
2018
 
December 31,
2017
 
March 31,
2018
 
December 31,
2017
 
(in millions)
Public finance
$
382,557

 
$
393,010

 
$
375,747

 
$
386,092

Structured finance
14,676

 
15,482

 
14,270

 
15,026

Total financial guaranty
$
397,233

 
$
408,492

 
$
390,017

 
$
401,118


    
In addition to amounts shown in the tables above, the Company had outstanding commitments to provide guaranties of $7 million as of the date of this filing. The commitments are contingent on the satisfaction of all conditions set forth in them and may expire unused or be canceled at the counterparty’s request. Therefore, the total commitment amount does not necessarily reflect actual future guaranteed amounts.

Financial Guaranty Portfolio by Internal Rating
As of March 31, 2018

 
 
Public Finance
U.S.
 
Public Finance
Non-U.S.
 
Structured Finance
U.S
 
Structured Finance
Non-U.S
 
Total
Rating
Category
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
 
(dollars in millions)
AAA
 
$
866

 
0.4
%
 
$
2,568

 
5.9
%
 
$
1,654

 
15.5
%
 
$
289

 
21.8
%
 
$
5,377

 
2.1
%
AA
 
27,283

 
13.6

 
206

 
0.5

 
3,763

 
35.2

 
68

 
5.1

 
31,320

 
12.2

A
 
115,123

 
57.2

 
14,309

 
32.7

 
1,405

 
13.2

 
213

 
16.1

 
131,050

 
51.0

BBB
 
51,419

 
25.5

 
24,909

 
56.9

 
768

 
7.2

 
647

 
48.9

 
77,743

 
30.2

BIG
 
6,646

 
3.3

 
1,755

 
4.0

 
3,091

 
28.9

 
107

 
8.1

 
11,599

 
4.5

Total net par outstanding
 
$
201,337

 
100.0
%

$
43,747


100.0
%

$
10,681


100.0
%

$
1,324


100.0
%

$
257,089


100.0
%



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Financial Guaranty Portfolio by Internal Rating
As of December 31, 2017 

 
 
Public Finance
U.S.
 
Public Finance
Non-U.S.
 
Structured Finance
U.S
 
Structured Finance
Non-U.S
 
Total
Rating
Category
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
 
(dollars in millions)
AAA
 
$
877

 
0.4
%
 
$
2,541

 
5.9
%
 
$
1,655

 
14.7
%
 
$
319

 
22.5
%
 
$
5,392

 
2.1
%
AA
 
30,016

 
14.3

 
205

 
0.5

 
3,915

 
34.9

 
76

 
5.4

 
34,212

 
12.9

A
 
118,620

 
56.7

 
13,936

 
32.5

 
1,630

 
14.5

 
210

 
14.9

 
134,396

 
50.7

BBB
 
52,739

 
25.2

 
24,509

 
57.1

 
763

 
6.8

 
703

 
49.7

 
78,714

 
29.7

BIG
 
7,140

 
3.4

 
1,731

 
4.0

 
3,261

 
29.1

 
106

 
7.5

 
12,238

 
4.6

Total net par outstanding
 
$
209,392

 
100.0
%
 
$
42,922

 
100.0
%
 
$
11,224

 
100.0
%
 
$
1,414

 
100.0
%
 
$
264,952

 
100.0
%


Components of BIG Portfolio

Financial Guaranty Portfolio
Components of BIG Net Par Outstanding
As of March 31, 2018

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
1,875

 
$
391

 
$
4,380

 
$
6,646

 
$
201,337

Non-U.S. public finance
1,476

 
279

 
—

 
1,755

 
43,747

Public finance
3,351

 
670

 
4,380

 
8,401

 
245,084

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. Residential mortgage-backed securities (RMBS)
331

 
292

 
2,043

 
2,666

 
4,678

Triple-X life insurance transactions
—

 
—

 
85

 
85

 
1,194

Trust preferred securities (TruPS)
99

 
—

 
—

 
99

 
1,188

Other structured finance
199

 
79

 
70

 
348

 
4,945

Structured finance
629

 
371

 
2,198

 
3,198

 
12,005

Total
$
3,980

 
$
1,041

 
$
6,578

 
$
11,599

 
$
257,089




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Financial Guaranty Portfolio
Components of BIG Net Par Outstanding
As of December 31, 2017

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
2,368

 
$
663

 
$
4,109

 
$
7,140

 
$
209,392

Non-U.S. public finance
1,455

 
276

 
—

 
1,731

 
42,922

Public finance
3,823

 
939

 
4,109

 
8,871

 
252,314

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. RMBS
374

 
304

 
2,083

 
2,761

 
4,818

Triple-X life insurance transactions
—

 
—

 
85

 
85

 
1,199

TruPS
161

 
—

 
—

 
161

 
1,349

Other structured finance
170

 
118

 
72

 
360

 
5,272

Structured finance
705

 
422

 
2,240

 
3,367

 
12,638

Total
$
4,528

 
$
1,361

 
$
6,349

 
$
12,238

 
$
264,952



Financial Guaranty Portfolio
BIG Net Par Outstanding
and Number of Risks
As of March 31, 2018

 
 
Net Par Outstanding
 
Number of Risks(2)
Description
 
Financial
Guaranty
Insurance(1)
 
Credit
Derivative
 
Total
 
Financial
Guaranty
Insurance(1)
 
Credit
Derivative
 
Total
 
 
(dollars in millions)
BIG:
 
 

 
 

 
 

 
 

 
 

 
 

Category 1
 
$
3,822

 
$
158

 
$
3,980

 
134

 
5

 
139

Category 2
 
1,024

 
17

 
1,041

 
43

 
3

 
46

Category 3
 
6,495

 
83

 
6,578

 
149

 
8

 
157

Total BIG
 
$
11,341

 
$
258

 
$
11,599

 
326

 
16

 
342




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 Financial Guaranty Portfolio
BIG Net Par Outstanding
and Number of Risks
As of December 31, 2017

 
 
Net Par Outstanding
 
Number of Risks(2)
Description
 
Financial
Guaranty
Insurance(1)
 
Credit
Derivative
 
Total
 
Financial
Guaranty
Insurance(1)
 
Credit
Derivative
 
Total
 
 
(dollars in millions)
BIG:
 
 

 
 

 
 

 
 

 
 

 
 

Category 1
 
$
4,301

 
$
227

 
$
4,528

 
139

 
7

 
146

Category 2
 
1,344

 
17

 
1,361

 
46

 
3

 
49

Category 3
 
6,255

 
94

 
6,349

 
150

 
9

 
159

Total BIG
 
$
11,900

 
$
338

 
$
12,238

 
335

 
19

 
354

_____________________
(1)    Includes net par outstanding for VIEs.
 
(2)
A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making debt service payments.   


Exposure to Puerto Rico
    
The Company has insured exposure to general obligation bonds of the Commonwealth of Puerto Rico (Puerto Rico or the Commonwealth) and various obligations of its related authorities and public corporations aggregating $5.0 billion net par as of March 31, 2018, all of which was rated BIG. Puerto Rico experienced significant general fund budget deficits and a challenging economic environment since at least the financial crisis. Beginning on January 1, 2016, a number of Puerto Rico exposures have defaulted on bond payments, and the Company has now paid claims on all of its Puerto Rico exposures except for Puerto Rico Aqueduct and Sewer Authority (PRASA), Municipal Finance Agency (MFA) and University of Puerto Rico (U of PR).

On November 30, 2015 and December 8, 2015, the former governor of Puerto Rico (Former Governor) issued executive orders (Clawback Orders) directing the Puerto Rico Department of Treasury and the Puerto Rico Tourism Company to "claw back" certain taxes pledged to secure the payment of bonds issued by the Puerto Rico Highways and Transportation Authority (PRHTA), Puerto Rico Infrastructure Financing Authority (PRIFA), and Puerto Rico Convention Center District Authority (PRCCDA). The Puerto Rico exposures insured by the Company subject to clawback are shown in the table “Puerto Rico Net Par Outstanding”.

On June 30, 2016, the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) was signed into law by the President of the United States. PROMESA established a seven-member federal financial oversight board (Oversight Board) with authority to require that balanced budgets and fiscal plans be adopted and implemented by Puerto Rico. PROMESA provides a legal framework under which the debt of the Commonwealth and its related authorities and public corporations may be voluntarily restructured, and grants the Oversight Board the sole authority to file restructuring petitions in a federal court to restructure the debt of the Commonwealth and its related authorities and public corporations if voluntary negotiations fail, provided that any such restructuring must be in accordance with an Oversight Board approved fiscal plan that respects the liens and priorities provided under Puerto Rico law.

In May and July 2017 the Oversight Board filed petitions under Title III of PROMESA with the Federal District Court of Puerto Rico for the Commonwealth, the Puerto Rico Sales Tax Financing Corporation (COFINA), PRHTA, and Puerto Rico Electric Power Authority (PREPA). Title III of PROMESA provides for a process analogous to a voluntary bankruptcy process under chapter 9 of the United States Bankruptcy Code (Bankruptcy Code).
Judge Laura Taylor Swain of the Southern District of New York was selected by Chief Justice John Roberts of the United States Supreme Court to preside over any legal proceedings under PROMESA. Judge Swain has selected a team of five federal judges to act as mediators for certain issues and disputes.


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On September 20, 2017, Hurricane Maria made landfall in Puerto Rico as a Category 4 hurricane on the Saffir-Simpson scale, causing loss of life and widespread devastation in the Commonwealth. Damage to the Commonwealth’s infrastructure, including the power grid, water system and transportation system, was extensive, and rebuilding and economic recovery are expected to take years. While the federal government is expected to provide substantial resources for relief and rebuilding -- which is expected to help economic activity and address the Commonwealth’s infrastructure needs in the intermediate and longer term -- economic activity in general and tourism in particular, as well as tax collections, have declined in the aftermath of the storm, and out migration to the mainland also has increased.

In December 2017, legislation known as the 2017 Tax Cuts and Jobs Act (Tax Act) was enacted. Many of the provisions under the new law are geared toward increasing production in the U.S. and discouraging companies from having operations or intangibles off-shore.  Since Puerto Rico is considered a foreign territory under the U.S. tax system, it is possible the new law may have adverse consequences to Puerto Rico’s economy.  However, the Company is unable to predict the full impact of the new law on Puerto Rico.

The Commonwealth released fiscal plans for itself and for a number of its authorities and public corporations, and in response to notices of violation from the Oversight Board and the enactment of a significant federal disaster relief package by the U.S. Congress, Puerto Rico released one or more revised fiscal plans for the Commonwealth and a number of its authorities and public corporations. The most recent fiscal plans submitted by the Commonwealth for the Commonwealth, PRHTA, PREPA and PRASA were released on April 5, 2018. The Commonwealth and the Oversight Board did not agree on final fiscal plans, and on April 18 and April 19, 2018, the Oversight Board released its own versions of fiscal plans for the Commonwealth, PRHTA, PREPA and PRASA, which it certified on April 19 or 20, 2018. The current governor of Puerto Rico (Governor) has announced that he will refuse to implement certain aspects of the fiscal plans certified by the Oversight Board, and there has been speculation in the press that the differences between the Governor and the Oversight Board will be litigated.

The certified Commonwealth fiscal plan (which the Company believes covers its general obligations as well as obligations of certain of its other authorities and public corporations) indicates a primary budget of $6.7 billion that would be available for debt service over the six-year forecast period (as compared to contractual debt service of approximately $15.5 billion over the same period). The certified PRHTA fiscal plan projects very limited capacity to pay debt service over the six-year forecast period, as the Commonwealth anticipates continuing to retain approximately three-fourths of PRHTA's total revenues. The certified PREPA fiscal plan indicates that no funds will be available for legacy debt service payments over the six-year forecast period unless rates are adjusted. Additionally, the Governor has announced an intention to privatize PREPA. The certified PRASA fiscal plan projects cash flows available for debt service to equal approximately 56% of aggregate debt service during the six-year projection period, based on projection assumptions (including receipt of certain federal funding). The Company does not believe the certified fiscal plans for the Commonwealth, PRHTA, PREPA or PRASA comply with certain mandatory requirements of PROMESA.

The Company believes that a number of the actions taken by the Commonwealth, the Oversight Board and others with respect to obligations the Company insures are illegal or unconstitutional or both, and has taken legal action, and may take additional legal action in the future, to enforce its rights with respect to these matters. See “Puerto Rico Recovery Litigation” below.

Litigation and mediation related to the Commonwealth’s debt have been delayed by Hurricane Maria. The final form and timing of responses to Puerto Rico’s financial distress and the devastation of Hurricane Maria eventually taken by the federal government or implemented under the auspices of PROMESA and the Oversight Board or otherwise, and the final impact, after resolution of legal challenges, of any such responses on obligations insured by the Company, are uncertain.

The Company groups its Puerto Rico exposure into three categories:

•
Constitutionally Guaranteed. The Company includes in this category public debt benefiting from Article VI of the Constitution of the Commonwealth, which expressly provides that interest and principal payments on the public debt are to be paid before other disbursements are made.

•
Public Corporations – Certain Revenues Potentially Subject to Clawback. The Company includes in this category the debt of public corporations for which applicable law permits the Commonwealth to claw back, subject to certain conditions and for the payment of public debt, at least a portion of the revenues supporting the bonds the Company insures. As a constitutional condition to clawback, available Commonwealth revenues for any fiscal year must be insufficient to pay Commonwealth debt service before the payment of any appropriations for that year. The Company believes that this condition has not been satisfied to date, and accordingly that the Commonwealth has not to date been entitled to claw back revenues supporting debt insured by the Company.

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Prior to the enactment of PROMESA, the Company sued various Puerto Rico governmental officials in the United States District Court, District of Puerto Rico asserting that Puerto Rico's attempt to “claw back” pledged taxes is unconstitutional, and demanding declaratory and injunctive relief. See "Puerto Rico Recovery Litigation" below.

•
Other Public Corporations. The Company includes in this category the debt of public corporations that are supported by revenues it does not believe are subject to clawback.

Constitutionally Guaranteed

General Obligation. As of March 31, 2018, the Company had $1,419 million insured net par outstanding of the general obligations of Puerto Rico, which are supported by the good faith, credit and taxing power of the Commonwealth. Despite the requirements of Article VI of its Constitution, the Commonwealth defaulted on the debt service payment due on July 1, 2016, and the Company has been making claim payments on these bonds since that date. As noted above, the Oversight Board filed a petition under Title III of PROMESA with respect to the Commonwealth.

Puerto Rico Public Buildings Authority (PBA). As of March 31, 2018, the Company had $141 million insured net par outstanding of PBA bonds, which are supported by a pledge of the rents due under leases of government facilities to departments, agencies, instrumentalities and municipalities of the Commonwealth, and that benefit from a Commonwealth guaranty supported by a pledge of the Commonwealth’s good faith, credit and taxing power. Despite the requirements of Article VI of its Constitution, the PBA defaulted on most of the debt service payment due on July 1, 2016, and the Company has been making claim payments on these bonds since then.

Public Corporations - Certain Revenues Potentially Subject to Clawback

PRHTA. As of March 31, 2018, the Company had $882 million insured net par outstanding of PRHTA (transportation revenue) bonds and $495 million insured net par of PRHTA (highways revenue) bonds. The transportation revenue bonds are secured by a subordinate gross lien on gasoline and gas oil and diesel oil taxes, motor vehicle license fees and certain tolls, plus a first lien on up to $120 million annually of taxes on crude oil, unfinished oil and derivative products. The highways revenue bonds are secured by a gross lien on gasoline and gas oil and diesel oil taxes, motor vehicle license fees and certain tolls. The non-toll revenues consisting of excise taxes and fees collected by the Commonwealth on behalf of PRHTA and its bondholders that are statutorily allocated to PRHTA and its bondholders are potentially subject to clawback. Despite the presence of funds in relevant debt service reserve accounts that the Company believes should have been employed to fund debt service, PRHTA defaulted on the full July 1, 2017 insured debt service payment, and the Company has been making claim payments on these bonds since that date. As noted above, the Oversight Board filed a petition under Title III of PROMESA with respect to PRHTA.

PRCCDA. As of March 31, 2018, the Company had $152 million insured net par outstanding of PRCCDA bonds, which are secured by certain hotel tax revenues. These revenues are sensitive to the level of economic activity in the area and are potentially subject to clawback. There were sufficient funds in the PRCCDA bond accounts to make only partial payments on the July 1, 2017 PRCCDA bond payments guaranteed by the Company, and the Company has been making claim payments on these bonds since that date.

PRIFA. As of March 31, 2018, the Company had $18 million insured net par outstanding of PRIFA bonds, which are secured primarily by the return to Puerto Rico of federal excise taxes paid on rum. These revenues are potentially subject to the clawback. The Company has been making claim payments on the PRIFA bonds since January 2016.

Other Public Corporations

PREPA. As of March 31, 2018, the Company had $853 million insured net par outstanding of PREPA obligations, which are secured by a lien on the revenues of the electric system.

On December 24, 2015, AGM and AGC entered into a Restructuring Support Agreement (RSA) with PREPA, an ad hoc group of uninsured bondholders and a group of fuel-line lenders that, subject to certain conditions, would have resulted in, among other things, modernization of the utility and a restructuring of current debt.

The Oversight Board did not certify the RSA under Title VI of PROMESA as the Company believes was required by PROMESA, but rather, on July 2, 2017, commenced proceedings for PREPA under Title III of PROMESA. The Company has been making claim payments on these bonds since July 1, 2017.


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PRASA. As of March 31, 2018, the Company had $373 million of insured net par outstanding of PRASA bonds, which are secured by a lien on the gross revenues of the water and sewer system. On September 15, 2015, PRASA entered into a settlement with the U.S. Department of Justice and the U.S. Environmental Protection Agency that requires it to spend $1.6 billion to upgrade and improve its sewer system island-wide. The PRASA bond accounts contained sufficient funds to make the PRASA bond payments due through the date of this filing that were guaranteed by the Company, and those payments were made in full.
    
MFA. As of March 31, 2018, the Company had $360 million net par outstanding of bonds issued by MFA secured by a lien on local property tax revenues. The MFA bond accounts contained sufficient funds to make the MFA bond payments due through the date of this filing that were guaranteed by the Company, and those payments were made in full.

COFINA. As of March 31, 2018, the Company had $273 million insured net par outstanding of junior COFINA bonds, which are secured primarily by a second lien on certain sales and use taxes. As noted above, the Oversight Board filed a petition on behalf of COFINA under Title III of PROMESA. COFINA bond debt service payments were not made on August 1, 2017, and the Company made its first claim payments on these bonds. The Company has continued to make claim payments on these bonds.
   
U of PR. As of March 31, 2018, the Company had $1 million insured net par outstanding of U of PR bonds, which are general obligations of the university and are secured by a subordinate lien on the proceeds, profits and other income of the University, subject to a senior pledge and lien for the benefit of outstanding university system revenue bonds. As of the date of this filing, all debt service payments on U of PR bonds insured by the Company have been made.

Puerto Rico Recovery Litigation
 
The Company believes that a number of the actions taken by the Commonwealth, the Oversight Board and others with respect to obligations it insures are illegal or unconstitutional or both, and has taken legal action, and may take additional legal action in the future, to enforce its rights with respect to these matters.

On January 7, 2016, AGM, AGC and Ambac Assurance Corporation commenced an action for declaratory judgment and injunctive relief in the U.S. District Court for the District of Puerto Rico (Federal District Court in Puerto Rico) to invalidate the executive orders issued by the Former Governor on November 30, 2015 and December 8, 2015 directing that the Secretary of the Treasury of the Commonwealth of Puerto Rico and the Puerto Rico Tourism Company claw back certain taxes and revenues pledged to secure the payment of bonds issued by the PRHTA, the PRCCDA and the PRIFA. The Commonwealth defendants filed a motion to dismiss the action for lack of subject matter jurisdiction, which the Court denied on October 4, 2016. On October 14, 2016, the Commonwealth defendants filed a notice of PROMESA automatic stay. While the PROMESA automatic stay expired on May 1, 2017, on May 17, 2017, the Court stayed the action under Title III of PROMESA.
    
On May 16, 2017, The Bank of New York Mellon, as trustee for the bonds issued by COFINA, filed an adversary complaint for interpleader and declaratory relief with the Federal District Court in Puerto Rico to resolve competing and conflicting demands made by various groups of COFINA bondholders, insurers of certain COFINA Bonds and COFINA, regarding funds held by the trustee for certain COFINA bond debt service payments scheduled to occur on and after June 1, 2017. On May 19, 2017, an order to show cause was entered permitting AGM to intervene in this matter.

On June 3, 2017, AGC and AGM filed an adversary complaint in Federal District Court in Puerto Rico seeking (i) a judgment declaring that the application of pledged special revenues to the payment of the PRHTA Bonds is not subject to the PROMESA Title III automatic stay and that the Commonwealth has violated the special revenue protections provided to the PRHTA Bonds under the Bankruptcy Code; (ii) an injunction enjoining the Commonwealth from taking or causing to be taken any action that would further violate the special revenue protections provided to the PRHTA Bonds under the Bankruptcy Code; and (iii) an injunction ordering the Commonwealth to remit the pledged special revenues securing the PRHTA Bonds in accordance with the terms of the special revenue provisions set forth in the Bankruptcy Code. On January 30, 2018, the district court rendered an opinion dismissing the complaint and holding, among other things, that (i) even though the special revenue provisions of the Bankruptcy Code protect a lien on pledged special revenues, those provisions do not mandate the turnover of pledged special revenues to the payment of bonds and (ii) actions to enforce liens on pledged special revenues remain stayed. On February 9, 2018, AGC and AGM filed a notice of appeal of the district court’s decision to the United States Court of Appeals for the First Circuit.

On June 26, 2017, AGM and AGC filed a complaint in Federal District Court in Puerto Rico seeking (i) a declaratory judgment that the PREPA RSA is a “Preexisting Voluntary Agreement” under Section 104 of PROMESA and the Oversight

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Board’s failure to certify the PREPA RSA is an unlawful application of Section 601 of PROMESA; (ii) an injunction enjoining the Oversight Board from unlawfully applying Section 601 of PROMESA and ordering it to certify the PREPA RSA; and (iii) a writ of mandamus requiring the Oversight Board to comply with its duties under PROMESA and certify the PREPA RSA. On July 21, 2017, in light of its PREPA Title III petition on July 2, 2017, the Oversight Board filed a notice of stay under PROMESA.

On July 18, 2017, AGM and AGC filed a motion for relief from the automatic stay in the PREPA Title III bankruptcy proceeding and a form of complaint seeking the appointment of a receiver for PREPA. That motion was denied on September 14, 2017. AGM and AGC are appealing the trial court's decision with the United States Court of Appeals for the First Circuit.

Puerto Rico Par and Debt Service Schedules

All Puerto Rico exposures are internally rated BIG. The following tables show the Company’s insured exposure to general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations.

Puerto Rico
Gross Par and Gross Debt Service Outstanding

 
Gross Par Outstanding
 
Gross Debt Service Outstanding
 
March 31, 2018
 
December 31, 2017
 
March 31, 2018
 
December 31, 2017
 
(in millions)
Exposure to Puerto Rico
$
5,187

 
$
5,186

 
$
8,385

 
$
8,514



Puerto Rico
Net Par Outstanding

 
As of
March 31, 2018
 
As of
December 31, 2017
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds (1)
$
1,419

 
$
1,419

PBA
141

 
141

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
PRHTA (Transportation revenue) (1)
882

 
882

PRHTA (Highways revenue) (1)
495

 
495

PRCCDA
152

 
152

PRIFA
18

 
18

Other Public Corporations
 
 
 
PREPA (1)
853

 
853

PRASA
373

 
373

MFA
360

 
360

COFINA (1)
273

 
272

U of PR
1

 
1

Total net exposure to Puerto Rico
$
4,967

 
$
4,966

____________________
(1)
As of the date of this filing, the Oversight Board has certified a filing under Title III of PROMESA for these exposures.



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The following table shows the scheduled amortization of the insured general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations. The Company guarantees payments of interest and principal when those amounts are scheduled to be paid and cannot be required to pay on an accelerated basis. In the event that obligors default on their obligations, the Company would only be required to pay the shortfall between the principal and interest due in any given period and the amount paid by the obligors.

     Amortization Schedule of Puerto Rico Net Par Outstanding
and Net Debt Service Outstanding
As of March 31, 2018

 
Scheduled Net Par Amortization
 
Scheduled Net Debt Service Amortization
 
(in millions)
2018 (April 1 - June 30)
$
0

 
$
3

2018 (July 1 - September 30)
200

 
322

2018 (October 1 - December 31)
0

 
3

Subtotal 2018
200

 
328

2019
223

 
464

2020
285

 
516

2021
148

 
364

2022
137

 
345

2023-2027
1,229

 
2,128

2028-2032
812

 
1,437

2033-2037
1,217

 
1,572

2038-2042
453

 
602

2043-2047
263

 
316

Total
$
4,967

 
$
8,072



Exposure to the U.S. Virgin Islands
 
As of March 31, 2018, the Company had $498 million insured net par outstanding to the U.S. Virgin Islands and its related authorities (USVI), of which it rated $224 million BIG. The $274 million USVI net par the Company rated investment grade was comprised primarily of bonds secured by a lien on matching fund revenues related to excise taxes on products produced in the USVI and exported to the U.S., primarily rum. The $224 million BIG USVI net par comprised (a) Public Finance Authority bonds secured by a gross receipts tax and the general obligation, full faith and credit pledge of the USVI and (b) bonds of the Virgin Islands Water and Power Authority secured by a net revenue pledge of the electric system.
 
Hurricane Irma caused significant damage in St. John and St. Thomas, while Hurricane Maria made landfall on St. Croix as a Category 4 hurricane on the Saffir-Simpson scale, causing loss of life and substantial damage to St. Croix’s businesses and infrastructure, including the power grid. The USVI is benefiting from the federal response to the 2017 hurricanes and has made its debt service payments to date.

Non-Financial Guaranty Exposure

The Company also provides non-financial guaranty reinsurance in transactions with similar risk profiles to its structured finance exposures written in financial guaranty form. All non-financial guaranty exposures shown in the table below are rated investment grade internally.


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Non-Financial Guaranty Exposure

 
 
As of March 31, 2018
 
As of December 31, 2017
 
 
Gross Exposure
 
Net Exposure
 
Gross Exposure
 
Net Exposure
 
 
(in millions)
Capital relief triple-X life reinsurance (1)
 
$
809

 
$
705

 
$
773

 
$
675

Reinsurance on aircraft residual value insurance (RVI) policies
 
201

 
140

 
201

 
140

____________________
(1)
The capital relief triple-X life reinsurance net exposure is expected to increase to approximately $1.0 billion prior to September 30, 2036.

    
5.
Expected Loss to be Paid
 
This note provides information regarding expected claim payments to be made under all contracts in the insured portfolio.

Loss Estimation Process

The Company’s loss reserve committees estimate expected loss to be paid for all contracts by reviewing analyses that consider various scenarios with corresponding probabilities assigned to them. Depending upon the nature of the risk, the Company’s view of the potential size of any loss and the information available to the Company, that analysis may be based upon individually developed cash flow models, internal credit rating assessments, sector-driven loss severity assumptions and/or judgmental assessments. In the case of its assumed business, the Company may conduct its own analysis as just described or, depending on the Company’s view of the potential size of any loss and the information available to the Company, the Company may use loss estimates provided by ceding insurers. The Company monitors the performance of its transactions with expected losses and each quarter the Company’s loss reserve committees review and refresh their loss projection assumptions, scenarios and the probabilities they assign to those scenarios based on actual developments during the quarter and their view of future performance.
 
The financial guaranties issued by the Company insure the credit performance of the guaranteed obligations over an extended period of time, in some cases over 30 years, and in most circumstances, the Company has no right to cancel such financial guaranties. As a result, the Company's estimate of ultimate losses on a policy is subject to significant uncertainty over the life of the insured transaction. Credit performance can be adversely affected by economic, fiscal and financial market variability over the life of most contracts.

The determination of expected loss to be paid is an inherently subjective process involving numerous estimates, assumptions and judgments by management, using both internal and external data sources with regard to frequency, severity of loss, economic projections, governmental actions, negotiations and other factors that affect credit performance. These estimates, assumptions and judgments, and the factors on which they are based, may change materially over a reporting period, and as a result the Company’s loss estimates may change materially over that same period.

The Company does not use traditional actuarial approaches to determine its estimates of expected losses. Actual losses will ultimately depend on future events or transaction performance and may be influenced by many interrelated factors that are difficult to predict. As a result, the Company's current projections of losses may be subject to considerable volatility and may not reflect the Company's ultimate claims paid. For information on the Company's loss estimation process, see Note 5, Expected Loss to be Paid, of Part II, Item 8, Financial Statements and Supplementary Data in AGL's Annual Report on Form 10-K for the year ended December 31, 2017.

In some instances, the terms of the Company's policy gives it the option to pay principal losses that have been recognized in the transaction but which it is not yet required to pay, thereby reducing the amount of guaranteed interest due in the future. The Company has sometimes exercised this option, which uses cash but reduces projected future losses.

The following tables present a roll forward of net expected loss to be paid for all contracts. The Company used risk-free rates for U.S. dollar denominated obligations that ranged from 0.0% to 3.11% with a weighted average of 2.82% as of March 31, 2018 and 0.00% to 2.78% with a weighted average of 2.38% as of December 31, 2017. Expected losses to be paid

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for transactions denominated in currencies other than the U.S. dollar represented approximately 3.5% and 3.7% of the total as of March 31, 2018 and December 31, 2017, respectively.

Net Expected Loss to be Paid
Roll Forward

 
First Quarter
 
2018
 
2017
 
(in millions)
Net expected loss to be paid, beginning of period
$
1,303

 
$
1,198

Net expected loss to be paid on the MBIA UK portfolio as of January 10, 2017
—

 
21

Economic loss development (benefit) due to:
 
 
 
Accretion of discount
8

 
8

Changes in discount rates
(6
)
 
11

Changes in timing and assumptions
(26
)
 
28

Total economic loss development (benefit)
(24
)
 
47

Net (paid) recovered losses
19

 
(22
)
Net expected loss to be paid, end of period
$
1,298

 
$
1,244



Net Expected Loss to be Paid
Roll Forward by Sector
First Quarter 2018
 
Net Expected
Loss to be Paid (Recovered) as of
December 31, 2017 (2)
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be Paid (Recovered) as of
March 31, 2018 (2)
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
1,157

 
$
(39
)
 
$
(111
)
 
$
1,007

Non-U.S. public finance
46

 
(3
)
 
—

 
43

Public finance
1,203

 
(42
)
 
(111
)
 
1,050

Structured finance:
 
 
 
 
 
 
 
U.S. RMBS
73

 
16

 
130

 
219

Other structured finance
27

 
2

 
0

 
29

Structured finance
100

 
18

 
130

 
248

Total
$
1,303

 
$
(24
)
 
$
19

 
$
1,298


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Net Expected Loss to be Paid
Roll Forward by Sector
First Quarter 2017

 
Net Expected
Loss to be
Paid (Recovered) as of
December 31, 2016
 
Net Expected
Loss to be Paid
on MBIA UK
as of
January 10, 2017
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be
Paid (Recovered) as of
March 31, 2017
 
(in millions)
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
871

 
$
—

 
$
124

 
$
(25
)
 
$
970

Non-U.S. public finance
33

 
13

 
(5
)
 
—

 
41

Public finance
904

 
13

 
119

 
(25
)
 
1,011

Structured finance:
 

 
 
 
 

 
 

 
 

U.S. RMBS
206

 
—

 
(22
)
 
13

 
197

Other structured finance
88

 
8

 
(50
)
 
(10
)
 
36

Structured finance
294

 
8

 
(72
)
 
3

 
233

Total
$
1,198

 
$
21

 
$
47

 
$
(22
)
 
$
1,244

____________________
(1)
Net of ceded paid losses, whether or not such amounts have been settled with reinsurers. Ceded paid losses are typically settled 45 days after the end of the reporting period. Such amounts are recorded in reinsurance recoverable on paid losses included in other assets. The Company paid $5 million and $2 million in loss adjustment expenses (LAE) for First Quarter 2018 and 2017, respectively.

(2)
Includes expected LAE to be paid of $19 million as of March 31, 2018 and $23 million as of December 31, 2017.


The following table presents the present value of net expected loss to be paid and the net economic loss development for all contracts by accounting model.

Net Expected Loss to be Paid (Recovered) and
Net Economic Loss Development (Benefit)
By Accounting Model

 
Net Expected Loss to be Paid (Recovered)
 
Net Economic Loss Development (Benefit)
 
As of
March 31, 2018
 
As of
December 31, 2017
 
First Quarter 2018
 
First Quarter 2017
 
(in millions)
Financial guaranty insurance
$
1,211

 
$
1,226

 
$
(33
)
 
$
66

FG VIEs (1) and other
93

 
91

 
2

 
(4
)
Credit derivatives (2)
(6
)
 
(14
)
 
7

 
(15
)
Total
$
1,298

 
$
1,303

 
$
(24
)
 
$
47

___________________
(1)    See Note 9, Consolidated Variable Interest Entities.

(2)    See Note 8, Contracts Accounted for as Credit Derivatives.



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Selected U.S. Public Finance Transactions
 
The Company insured general obligation bonds of the Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations aggregating $5.0 billion net par as of March 31, 2018, all of which was BIG. For additional information regarding the Company's exposure to general obligations of the Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations, see "Exposure to Puerto Rico" in Note 4, Outstanding Exposure.

As of March 31, 2018, the Company had insured $341 million net par outstanding of general obligation bonds issued by the City of Hartford, Connecticut, most of which was rated BIG at December 31, 2017. In First Quarter 2018, the State of Connecticut entered into a contract assistance agreement with the City of Hartford under which the state will pay the debt service costs of the City’s general obligation bonds, including those insured by the Company. As a result, the Company reduced the corresponding expected losses as of March 31, 2018 and upgraded this exposure to investment grade.
    
The Company had approximately $19 million of net par exposure as of March 31, 2018 to bonds issued by Parkway East Public Improvement District (District), which is located in Madison County, Mississippi (the County). The bonds, which are rated BIG, are payable from special assessments on properties within the District, as well as amounts paid under a contribution agreement with the County in which the County covenants that it will provide funds in the event special assessments are not sufficient to make a debt service payment. The special assessments have not been sufficient to pay debt service in full. In earlier years, the County provided funding to cover the balance of the debt service requirement, but subsequently claimed the District’s failure to reimburse it within the two years stipulated in the contribution agreement means that the County is not required to provide funding until it is reimbursed.  On May 31, 2017, the United States Court of Appeals for the Fifth Circuit reversed a district court ruling favorable to the Company in its declaratory judgment action disputing the County’s interpretation. See “Recovery Litigation” at the end of this note.

On February 25, 2015, a plan of adjustment resolving the bankruptcy filing of the City of Stockton, California under chapter 9 of the U.S. Bankruptcy Code became effective. As of March 31, 2018, the Company’s net par subject to the plan consisted of $113 million of pension obligation bonds. As part of the plan of adjustment, the City will repay any claims paid on the pension obligation bonds from certain fixed payments and certain variable payments contingent on the City’s revenue growth. 

The Company projected that its total net expected loss across its troubled U.S. public finance exposures as of March 31, 2018 including those mentioned above, would be $1,007 million, compared with a net expected loss of $1,157 million as of December 31, 2017. The economic benefit in First Quarter 2018 was $39 million, which was primarily attributable to the State of Connecticut's agreement to pay the debt service costs of certain bonds of the City of Hartford, including the bonds insured by the Company.

Selected Non - U.S. Public Finance Transactions

The Company insures and reinsures transactions with sub-sovereign exposure to various Spanish and Portuguese issuers where a Spanish and Portuguese sovereign default may cause the sub-sovereigns also to default. The Company's exposure net of reinsurance to these Spanish and Portuguese exposures is $470 million and $73 million, respectively. The Company rates all of these exposures BIG due to the financial condition of Spain and Portugal and their dependence on the sovereign. The Company's Hungary exposure is to infrastructure bonds dependent on payments from Hungarian governmental entities. The Company's exposure, net of reinsurance, to these Hungarian exposures is $207 million, all of which is rated BIG.
 
The Company also insures an obligation backed by the availability and toll revenues of a major arterial road into a city in the U.K. with $223 million of net par outstanding as of March 31, 2018. This transaction has been underperforming due to higher costs compared with expectations at underwriting. In First Quarter 2018, the Company changed its traffic assumptions for this road, resulting in a benefit.

These transactions, together with other non-U.S. public finance insured obligations, had expected loss to be paid of $43 million as of March 31, 2018, compared with $46 million as of December 31, 2017. The economic benefit of approximately $3 million during First Quarter 2018 was attributable mainly to the U.K. arterial road mentioned above.


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Table of Contents

Approach to Projecting Losses in U.S. RMBS
 
The Company projects losses on its insured U.S. RMBS on a transaction-by-transaction basis by projecting the performance of the underlying pool of mortgages over time and then applying the structural features (i.e., payment priorities and tranching) of the RMBS and any expected representation and warranty (R&W) recoveries/payables to the projected performance of the collateral over time. The resulting projected claim payments or reimbursements are then discounted using risk-free rates.

U.S. RMBS Loss Projections
 
Based on its observation during the period of the performance of its insured transactions (including delinquencies, liquidation rates and loss severities) as well as the residential property market and economy in general, the Company chose to make the changes to the assumptions it uses to project RMBS losses shown in the tables of assumptions in the sections below. In First Quarter 2018, the economic loss development was $24 million for first lien U.S. RMBS and the economic benefit was $8 million for second lien U.S. RMBS. In First Quarter 2017, the economic benefit was $9 million for first lien U.S. RMBS and $13 million for second lien U.S. RMBS.

U.S. First Lien RMBS Loss Projections: Alt-A First Lien, Option ARM, Subprime and Prime

     The majority of projected losses in first lien RMBS transactions are expected to come from non-performing mortgage loans (those that are or in the past twelve months have been two or more payments behind, have been modified, are in foreclosure, or have been foreclosed upon). Changes in the amount of non-performing loans from the amount projected in the previous period are one of the primary drivers of loss development in this portfolio. In order to determine the number of defaults resulting from these delinquent and foreclosed loans, the Company applies a liquidation rate assumption to loans in each of various non-performing categories. The Company arrived at its liquidation rates based on data purchased from a third party provider and assumptions about how delays in the foreclosure process and loan modifications may ultimately affect the rate at which loans are liquidated. Each quarter the Company reviews the most recent twelve months of this data and (if necessary) adjusts its liquidation rates based on its observations. The following table shows liquidation assumptions for various non-performing categories.


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Table of Contents

First Lien Liquidation Rates

 
March 31, 2018
 
December 31, 2017
Delinquent/Modified in the Previous 12 Months
 
 
 
Alt A and Prime
20%
 
20%
Option ARM
20
 
20
Subprime
20
 
20
30 – 59 Days Delinquent
 
 
 
Alt A and Prime
30
 
30
Option ARM
35
 
35
Subprime
45
 
40
60 – 89 Days Delinquent
 
 
 
Alt A and Prime
40
 
40
Option ARM
45
 
50
Subprime
50
 
50
90+ Days Delinquent
 
 
 
Alt A and Prime
45
 
55
Option ARM
55
 
60
Subprime
55
 
55
Bankruptcy
 
 
 
Alt A and Prime
45
 
45
Option ARM
50
 
50
Subprime
40
 
40
Foreclosure
 
 
 
Alt A and Prime
55
 
65
Option ARM
65
 
70
Subprime
65
 
65
Real Estate Owned
 
 
 
All
100
 
100

    
While the Company uses liquidation rates as described above to project defaults of non-performing loans (including current loans modified or delinquent within the last 12 months), it projects defaults on presently current loans by applying a conditional default rate (CDR) trend. The start of that CDR trend is based on the defaults the Company projects will emerge from currently nonperforming, recently nonperforming and modified loans. The total amount of expected defaults from the non-performing loans is translated into a constant CDR (i.e., the CDR plateau), which, if applied for each of the next 36 months, would be sufficient to produce approximately the amount of defaults that were calculated to emerge from the various delinquency categories. The CDR thus calculated individually on the delinquent collateral pool for each RMBS is then used as the starting point for the CDR curve used to project defaults of the presently performing loans.
 
In the most heavily weighted scenario (the base case), after the initial 36-month CDR plateau period, each transaction’s CDR is projected to improve over 12 months to an intermediate CDR (calculated as 20% of its CDR plateau); that intermediate CDR is held constant for 36 months and then trails off in steps to a final CDR of 5% of the CDR plateau. In the base case, the Company assumes the final CDR will be reached 5.25 years after the initial 36-month CDR plateau period. Under the Company’s methodology, defaults projected to occur in the first 36 months represent defaults that can be attributed to loans that were modified or delinquent in the last 12 months or that are currently delinquent or in foreclosure, while the defaults projected to occur using the projected CDR trend after the first 36 month period represent defaults attributable to borrowers that are currently performing or are projected to reperform.

     Another important driver of loss projections is loss severity, which is the amount of loss the transaction incurs on a loan after the application of net proceeds from the disposal of the underlying property. Loss severities experienced in first lien transactions have reached historically high levels, and the Company is assuming in the base case that these high levels

25
Table of Contents

generally will continue for another 18 months. The Company determines its initial loss severity based on actual recent experience. Each quarter the Company reviews available data and (if necessary) adjusts its severities based on its observations. The Company then assumes that loss severities begin returning to levels consistent with underwriting assumptions beginning after the initial 18 month period, declining to 40% in the base case over 2.5 years.
 
The following table shows the range as well as the average, weighted by outstanding net insured par, for key assumptions used in the calculation of expected loss to be paid for individual transactions for direct vintage 2004 - 2008 first lien U.S. RMBS.

Key Assumptions in Base Case Expected Loss Estimates
First Lien RMBS
 
 
As of
March 31, 2018
 
As of
December 31, 2017
 
Range
 
Weighted Average
 
Range
 
Weighted Average
Alt-A First Lien
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
1.4
%
-
9.2%
 
4.7%
 
1.3
%
–
9.8%
 
5.2%
Final CDR
0.1
%
-
0.5%
 
0.2%
 
0.1
%
–
0.5%
 
0.3%
Initial loss severity:
 
 
 
 
 
 
 
2005 and prior
60%
 
 
 
60%
 
 
2006
80%
 
 
 
80%
 
 
2007+
70%
 
 
 
70%
 
 
Option ARM
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
1.4
%
-
7.8%
 
5.8%
 
2.5
%
–
7.0%
 
5.9%
Final CDR
0.1
%
-
0.4%
 
0.3%
 
0.1
%
–
0.3%
 
0.3%
Initial loss severity:
 
 
 
 
 
 
 
2005 and prior
60%
 
 
 
60%
 
 
2006
70%
 
 
 
70%
 
 
2007+
75%
 
 
 
75%
 
 
Subprime
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
4.2
%
-
11.8%
 
7.7%
 
3.5
%
–
13.1%
 
7.8%
Final CDR
0.2
%
-
0.6%
 
0.4%
 
0.2
%
–
0.7%
 
0.4%
Initial loss severity:
 
 
 
 
 
 
 
2005 and prior
80%
 
 
 
80%
 
 
2006
85%
 
 
 
90%
 
 
2007+
95%
 
 
 
95%
 
 

 
The rate at which the principal amount of loans is voluntarily prepaid may impact both the amount of losses projected (since that amount is a function of the CDR, the loss severity and the loan balance over time) as well as the amount of excess spread (the amount by which the interest paid by the borrowers on the underlying loan exceeds the amount of interest owed on the insured obligations). The assumption for the voluntary conditional prepayment rate (CPR) follows a similar pattern to that of the CDR. The current level of voluntary prepayments is assumed to continue for the plateau period before gradually increasing over 12 months to the final CPR, which is assumed to be 15% in the base case. For transactions where the initial CPR is higher than the final CPR, the initial CPR is held constant and the final CPR is not used. These CPR assumptions are the same as those the Company used for December 31, 2017.
 
In estimating expected losses, the Company modeled and probability weighted sensitivities for first lien transactions by varying its assumptions of how fast a recovery is expected to occur. One of the variables used to model sensitivities was how quickly the CDR returned to its modeled equilibrium, which was defined as 5% of the initial CDR. The Company also stressed CPR and the speed of recovery of loss severity rates. The Company probability weighted a total of five scenarios as of March 31, 2018.
    

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Total expected loss to be paid on all first lien U.S. RMBS was $152 million and $123 million as of March 31, 2018 and December 31, 2017, respectively. The Company used a similar approach to establish its pessimistic and optimistic scenarios as of March 31, 2018 as it used as of December 31, 2017, increasing and decreasing the periods of stress from those used in the base case.

In the Company's most stressful scenario where loss severities were assumed to rise and then recover over nine years and the initial ramp-down of the CDR was assumed to occur over 15 months, expected loss to be paid would increase from current projections by approximately $65 million for all first lien U.S. RMBS transactions.

In the Company's least stressful scenario where the CDR plateau was six months shorter (30 months, effectively assuming that liquidation rates would improve) and the CDR recovery was more pronounced, (including an initial ramp-down of the CDR over nine months), expected loss to be paid would decrease from current projections by approximately $41 million for all first lien U.S. RMBS transactions.

U.S. Second Lien RMBS Loss Projections
 
Second lien RMBS transactions include both home equity lines of credit (HELOC) and closed end second lien mortgages. The Company believes the primary variable affecting its expected losses in second lien RMBS transactions is the amount and timing of future losses in the collateral pool supporting the transactions. Expected losses are also a function of the structure of the transaction, the voluntary prepayment rate (typically also referred to as CPR of the collateral), the interest rate environment, and assumptions about loss severity.
 
In second lien transactions the projection of near-term defaults from currently delinquent loans is relatively straightforward because loans in second lien transactions are generally “charged off” (treated as defaulted) by the securitization’s servicer once the loan is 180 days past due. The Company estimates the amount of loans that will default over the next six months by calculating current representative liquidation rates. Similar to first liens, the Company then calculates a CDR for six months, which is the period over which the currently delinquent collateral is expected to be liquidated. That CDR is then used as the basis for the plateau CDR period that follows the embedded plateau losses.

For the base case scenario, the CDR (the plateau CDR) was held constant for six months. Once the plateau period has ended, the CDR is assumed to gradually trend down in uniform increments to its final long-term steady state CDR. (The long-term steady state CDR is calculated as the constant CDR that would have yielded the amount of losses originally expected at underwriting.) In the base case scenario, the time over which the CDR trends down to its final CDR is 28 months. Therefore, the total stress period for second lien transactions is 34 months, comprising six months of delinquent loan liquidations, followed by 28 months of decrease to the steady state CDR, the same as of December 31, 2017.

HELOC loans generally permit the borrower to pay only interest for an initial period (often ten years) and, after that period, require the borrower to make both the monthly interest payment and a monthly principal payment. This causes the borrower's total monthly payment to increase, sometimes substantially, at the end of the initial interest-only period. In the prior periods, as the HELOC loans underlying the Company's insured HELOC transactions reached their principal amortization period, the Company incorporated an assumption that a percentage of loans reaching their principal amortization periods would default around the time of the payment increase.

Most of the HELOC loans underlying the Company's insured HELOC transactions are now past their interest only reset date, although a significant number of HELOC loans were modified to extend the interest only period for another five years. As a result, in 2017, the Company eliminated the CDR increase that was applied when such loans reached their principal amortization period. In addition, based on the average performance history, starting in third quarter 2017, the Company applied a CDR floor of 2.5% for the future steady state CDR on all its HELOC transactions .

When a second lien loan defaults, there is generally a very low recovery. The Company assumed as of March 31, 2018 that it will generally recover only 2% of future defaulting collateral at the time of charge-off, with additional amounts of post charge-off recoveries assumed to come in over time. This is the same assumption used as of December 31, 2017.
 
The rate at which the principal amount of loans is prepaid may impact both the amount of losses projected as well as the amount of excess spread. In the base case, an average CPR (based on experience of the past year) is assumed to continue until the end of the plateau before gradually increasing to the final CPR over the same period the CDR decreases. The final CPR is assumed to be 15% for second lien transactions (in the base case), which is lower than the historical average but reflects the Company’s continued uncertainty about the projected performance of the borrowers in these transactions. For transactions where the initial CPR is higher than the final CPR, the initial CPR is held constant and the final CPR is not used. This pattern is

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generally consistent with how the Company modeled the CPR as of December 31, 2017. To the extent that prepayments differ from projected levels it could materially change the Company’s projected excess spread and losses.
 
In estimating expected losses, the Company modeled and probability weighted five possible CDR curves applicable to the period preceding the return to the long-term steady state CDR. The Company used five scenarios at March 31, 2018 and December 31, 2017. The Company believes that the level of the elevated CDR and the length of time it will persist and the ultimate prepayment rate are the primary drivers behind the likely amount of losses the collateral will suffer.

The Company continues to evaluate the assumptions affecting its modeling results. The Company believes the most important driver of its projected second lien RMBS losses is the performance of its HELOC transactions. Total expected loss to be paid on all second lien U.S. RMBS was $67 million as of March 31, 2018 and total expected recovery on all second lien U.S. RMBS was $50 million as of December 31, 2017, respectively. This change was due primarily to cash received in 2018 from a favorable settlement of R&W litigation reached in late December 2017.

The following table shows the range as well as the average, weighted by outstanding net insured par, for key assumptions for the calculation of expected loss to be paid for individual transactions for direct vintage 2004 - 2008 HELOCs.

Key Assumptions in Base Case Expected Loss Estimates
HELOCs

 
As of
March 31, 2018
 
As of
December 31, 2017
 
Range
 
Weighted Average
 
Range
 
Weighted Average
Plateau CDR
2.5
%
-
18.4%
 
10.6%
 
2.7
%
-
19.9%
 
11.4%
Final CDR trended down to
2.5
%
-
3.2%
 
2.5%
 
2.5
%
-
3.2%
 
2.5%
Liquidation rates:
 
 
 
 
 
 
 
 
 
 
 
Delinquent/Modified in the Previous 12 Months
20%
 
 
 
20%
 
 
30 – 59 Days Delinquent
40
 
 
 
45
 
 
60 – 89 Days Delinquent
60
 
 
 
60
 
 
90+ Days Delinquent
75
 
 
 
75
 
 
Bankruptcy
55
 
 
 
55
 
 
Foreclosure
65
 
 
 
70
 
 
Real Estate Owned
100
 
 
 
100
 
 
Loss severity
98%
 
 
 
98%
 
 


The Company’s base case assumed a six month CDR plateau and a 28 month ramp-down (for a total stress period of 34 months). The Company also modeled a scenario with a longer period of elevated defaults and another with a shorter period of elevated defaults. Increasing the CDR plateau to eight months and increasing the ramp-down by three months to 31 months (for a total stress period of 39 months) would increase the expected loss by approximately $11 million for HELOC transactions. On the other hand, reducing the CDR plateau to four months and decreasing the length of the CDR ramp-down to 25 months (for a total stress period of 29 months), and lowering the ultimate prepayment rate to 10% would decrease the expected loss by approximately $12 million for HELOC transactions.

Breaches of Representations and Warranties

As of March 31, 2018, the Company had a net R&W receivable of $19 million from R&W counterparties, compared to a net R&W receivable of $117 million as of December 31, 2017. The decrease was due primarily to cash received in 2018 from a favorable settlement of R&W litigation reached in late December 2017.

Other Structured Finance
 
The Company had $1.2 billion of net par exposure to financial guaranty triple-X life insurance transactions as of March 31, 2018, of which $85 million in net par was rated BIG. The triple-X life insurance transactions are based on discrete blocks of individual life insurance business. In older vintage triple-X life insurance transactions, which include the BIG-rated

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transactions, the amounts raised by the sale of the notes insured by the Company were used to capitalize a special purpose vehicle that provides reinsurance to a life insurer or reinsurer. The amounts have been invested since inception in accounts managed by third-party investment managers. In the case of the BIG-rated transactions, material amounts of their assets were invested in U.S. RMBS.

The Company has insured or reinsured $1.2 billion net par of student loan securitizations issued by private issuers that are classified as structured finance. Of this amount, $113 million is rated BIG. In general, the projected losses are due to: (i) the poor credit performance of private student loan collateral and high loss severities, or (ii) high interest rates on auction rate securities with respect to which the auctions have failed.

The Company projected that its total net expected loss across its troubled non-RMBS structured finance exposures as of March 31, 2018 including those mentioned above was $29 million and is primarily attributable to structured student loans. The economic loss development in First Quarter 2018 was $2 million.

Recovery Litigation

In the ordinary course of their respective businesses, certain of AGL's subsidiaries assert claims in legal proceedings against third parties to recover losses paid in prior periods or prevent losses in the future.
 
Public Finance Transactions

The Company has asserted claims in a number of legal proceedings in connection with its exposure to Puerto Rico. See Note 4, Outstanding Exposure, for a discussion of the Company's exposure to Puerto Rico and related recovery litigation being pursued by the Company.

On November 1, 2013, Radian Asset Assurance Inc. (Radian Asset) commenced a declaratory judgment action in the U.S. District Court for the Southern District of Mississippi against Madison County, Mississippi (County) and the Parkway East Public Improvement District (District) to establish its rights under a contribution agreement from the County supporting certain special assessment bonds issued by the District and insured by Radian Asset (now AGC). As of March 31, 2018, $19 million of such bonds were outstanding. The County maintained that its payment obligation is limited to two years of annual debt service, while AGC contended the County’s obligations under the contribution agreement continue so long as the bonds remain outstanding. On April 27, 2016, the Court granted AGC's motion for summary judgment, agreeing with AGC's interpretation of the County's obligations. The County appealed the District Court’s summary judgment ruling to the United States Court of Appeals for the Fifth Circuit, and on May 31, 2017, the appellate court reversed the District Court’s ruling and remanded the matter to the District Court. In March 2018, the County, the District, and AGC executed a settlement agreement which formalizes the procedures related to the disposition of assessments and of the properties that have defaulted. The agreement also provides for the County-owned property to be conveyed to the District, which, to the extent practicable, is obligated to lease, sell or otherwise dispose of the property to maximize pledged revenues. Any such actions will require AGC’s consent.

RMBS Transactions

On November 26, 2012, CIFG Assurance North America Inc. (CIFGNA) filed a complaint in the Supreme Court of the State of New York against JP Morgan Securities LLC (JP Morgan) for material misrepresentation in the inducement of insurance and common law fraud, alleging that JP Morgan fraudulently induced CIFGNA to insure $400 million of securities issued by ACA ABS CDO 2006-2 Ltd. and $325 million of securities issued by Libertas Preferred Funding II, Ltd. On June 26, 2015, the Court dismissed with prejudice CIFGNA’s material misrepresentation in the inducement of insurance claim and dismissed without prejudice CIFGNA’s common law fraud claim. On September 24, 2015, the Court denied CIFGNA’s motion to amend but allowed CIFGNA to re-plead a cause of action for common law fraud. On November 20, 2015, CIFGNA filed a motion for leave to amend its complaint to re-plead common law fraud. On April 29, 2016, CIFGNA filed an appeal to reverse the Court’s decision dismissing CIFGNA’s material misrepresentation in the inducement of insurance claim. On November 29, 2016, the Appellate Division of the Supreme Court of the State of New York ruled that the Court’s decision dismissing with prejudice CIFGNA’s material misrepresentation in the inducement of insurance claim should be modified to grant CIFGNA leave to re-plead such claim. On February 27, 2017, AGC (as successor to CIFGNA) filed an amended complaint which includes a claim for material misrepresentation in the inducement of insurance.


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6.
Contracts Accounted for as Insurance

Premiums

The portfolio of outstanding exposures discussed in Note 4, Outstanding Exposure, includes contracts that meet the definition of insurance contracts, contracts that meet the definition of a derivative, and contracts that are accounted for as consolidated FG VIEs. Amounts presented in this note relate to insurance contracts. See Note 8, Contracts Accounted for as Credit Derivatives for amounts that relate to CDS and Note 9, Consolidated Variable Interest Entities for amounts that relate to FG VIEs.

Net Earned Premiums
 
 
First Quarter
 
2018
 
2017
 
(in millions)
Scheduled net earned premiums
$
88

 
$
103

Accelerations:
 
 
 
Refundings
46

 
56

Terminations
6

 
2

Total Accelerations
52

 
58

Accretion of discount on net premiums receivable
4

 
3

  Financial guaranty insurance net earned premiums
144

 
164

Non-financial guaranty net earned premiums