Business context and reporting period
Assured Guaranty Ltd. is a Bermuda-based financial guaranty insurer serving public finance and structured finance markets. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods unless noted. Figures are in U.S. dollars.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $566 million | $368 million | $1.207 billion | $1.432 billion |
| Net income | $479 million | $129 million | $684 million | $627 million |
| Diluted EPS | $3.60 | $0.88 | $5.06 | $4.13 |
| Operating income, non-GAAP | $508 million | $164 million | $760 million | $582 million |
| Net earned premiums | $231 million | $213 million | $628 million | $574 million |
| Net investment income | $94 million | $112 million | $291 million | $311 million |
Balance sheet at September 30, 2016: Assets were $14.669 billion, liabilities $8.029 billion and shareholders’ equity $6.640 billion. Cash was $98 million; short-term investments were $528 million; the investment portfolio totaled $11.445 billion. Long-term debt had a $1.304 billion carrying value and $1.590 billion principal amount.
Cash flow and capital: Operating cash flow was negative $190 million for the nine months, versus negative $39 million in 2015. Investing cash flow was positive $933 million and financing cash flow was negative $807 million. The company paid $52 million of dividends and repurchased $190 million of shares during the period. The quarterly dividend was $0.13 per share.
Portfolio and loss measures: Net financial guaranty par outstanding was $315.325 billion, down from $358.571 billion at year-end 2015. Net expected loss to be paid was $1.090 billion, compared with $1.391 billion at year-end. The filing does not provide a single operating margin measure as a headline GAAP metric; its operating income measure is non-GAAP.
Material changes versus the prior comparable period
- Q3 net income rose to $479 million, primarily reflecting the CIFG acquisition and lower loss and loss adjustment expenses. Nine-month net income increased more modestly, to $684 million from $627 million.
- The July 2016 CIFG acquisition generated a reported $259 million pre-tax bargain purchase gain and settlement effect, including a $357 million bargain purchase gain offset by a $98 million loss on settlement of pre-existing relationships. The acquisition added $4.2 billion of net par insured.
- Nine-month revenue fell to $1.207 billion from $1.432 billion, despite higher premiums, mainly reflecting lower credit-derivative fair-value gains than in 2015. Q3 revenue increased, with the CIFG gain a major contributor.
- Net earned premiums increased, helped by higher premium accelerations from refundings and terminations. Net investment income decreased, partly because matured securities were reinvested at lower yields.
- Net economic loss development was a $44 million benefit in Q3, but a $37 million loss for the nine months, primarily because of U.S. public finance and Puerto Rico exposures. Claims paid, net of reinsurance, were $360 million for the nine months, compared with $238 million in 2015.
- The company repurchased 7.4 million shares for $190 million through September 30. Its board added a further $250 million authorization on November 2, leaving approximately $345 million authorized as of November 3.
Outlook, management commentary, risks and unusual items
- Management said it expects sufficient holding-company liquidity for the next 12 months and expects operating subsidiaries’ liquidity needs to be met by cash, investments, premiums, investment income and maturities. Access to subsidiary dividends is subject to regulatory and rating-agency restrictions.
- No specific earnings or revenue guidance was provided. Management cited low interest rates as a continuing headwind to bond-insurance demand, while noting continued demand and competition from two other active financial guarantors in one market.
- Puerto Rico: The company had $4.786 billion of net par exposure, all rated below investment grade and internally triple-C or lower. Payment defaults had occurred, including on Commonwealth general obligation bonds, and the company had paid claims on several credits. The outcome of PROMESA-related restructuring, litigation stays, pledged-revenue disputes and recovery efforts remained uncertain.
- Other credit and liquidity risks: The filing identifies a $562 million gross infrastructure exposure with refinancing risk; claims could arise from 2018–2022 and recovery, if required, could take 10–35 years. Downgrades could also increase claims, collateral needs or recapture of assumed reinsurance. Approximately $130 million was posted to secure CDS obligations at quarter-end.
- Acquisitions: Assured Guaranty agreed to acquire MBIA UK, with an expected early January 2017 closing subject to regulatory approvals and other conditions. Consideration included transferring Zohar II notes with approximately $347 million principal; MBIA UK had approximately $13 billion net par insured as of June 30, 2016.
- Valuation and estimates: Credit derivatives and other significant balances rely on Level 3 models and unobservable inputs. Management notes that changes in credit spreads, expected losses, discount rates and assumptions can materially affect reported results. The company recorded $259 million of CIFG-related pre-tax gain, a notable non-recurring item.
- Management reported effective disclosure controls and procedures as of September 30, 2016. It stated that there were no material changes to previously disclosed risk factors during the quarter.
Most important facts for investors to verify
- Separate recurring underwriting performance from the CIFG bargain purchase gain and other fair-value items; compare GAAP results with the company’s non-GAAP operating income and its reconciliation.
- Track Puerto Rico claim payments, expected losses, recoveries and the legal and restructuring developments under PROMESA, including the status of pledged revenues.
- Review the assumptions supporting the $1.090 billion expected-loss estimate and the sensitivity of mortgage and public-finance exposures to defaults, severities, recoveries and discount rates.
- Assess liquidity at the parent and regulated-insurer levels, including dividend capacity, collateral requirements, cash flows and the maturity and refinancing risks identified in the filing.
- Confirm the status, regulatory approvals, consideration and integration effects of the proposed MBIA UK acquisition, and monitor the execution and capital impact of share repurchases.