Assured Guaranty Ltd. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; balance-sheet comparisons are with December 31, 2012. Assured Guaranty provides credit protection for public finance, infrastructure and structured finance obligations.
Financial performance and position
| Metric | Q1 2013 / March 31, 2013 | Comparable period / prior year-end |
|---|---|---|
| Net earned premiums | $248 million | $194 million in Q1 2012 |
| Net investment income | $94 million | $98 million in Q1 2012 |
| Total revenues | $(176) million | $(362) million in Q1 2012 |
| Net loss; diluted loss per share | $(144) million; $(0.74) | $(483) million; $(2.65) in Q1 2012 |
| Non-GAAP operating income | $260 million; $1.34 per share | $71 million; $0.38 per share in Q1 2012 |
| Operating cash flow | $(14) million | $75 million in Q1 2012 |
| Cash and investment portfolio | $125 million cash; $10.862 billion portfolio | $138 million cash; $11.085 billion portfolio at year-end |
| Total assets; shareholders’ equity | $17.299 billion; $4.724 billion | $17.242 billion; $4.994 billion at year-end |
| Long-term debt, carrying value | $832 million | $836 million at year-end |
| Net insured par outstanding | $501.817 billion | $519.893 billion at year-end |
| Below-investment-grade exposure | $22.354 billion, or 4.5% of net par | $23.392 billion, or 4.5%, at year-end |
GAAP revenue and earnings were heavily affected by a $592 million net loss from credit-derivative fair-value changes, including $610 million of unrealized losses. Management says such market-driven changes can be volatile and generally reverse over contract lives, except for expected credit impairments. The filing does not provide a conventional operating margin measure.
Premium acceleration contributed $113 million of Q1 2013 earned premiums, versus $37 million a year earlier; scheduled net earned premiums were $128 million versus $152 million. Investment portfolio pretax book yield was 3.85%, compared with 3.96% at March 31, 2012. Net expected loss to be paid, after estimated representations-and-warranties recoveries, was $487 million, down from $677 million at year-end.
Material changes and significant items
- Net loss improved from $483 million to $144 million year over year, while non-GAAP operating income rose from $71 million to $260 million. Management attributed the improvement principally to higher earned premiums, lower loss and LAE expense, and the favorable effect of RMBS settlements; the prior-year period included Greek sovereign losses and reinsurance commutation gains that did not recur.
- Q1 2013 loss and LAE was a benefit of $48 million, compared with expense of $242 million in Q1 2012. Favorable U.S. RMBS economic loss development was driven mainly by representations-and-warranties recoveries; public-finance developments partly offset the benefit.
- Shareholders’ equity fell by $270 million during the quarter, reflecting the net loss, investment-related other comprehensive loss, repurchases and dividends. Adjusted book value, a non-GAAP measure, increased to $47.92 per share from $47.17 at year-end.
- The company repurchased 1.9 million shares for $39 million in Q1, at an average $20.46 per share. By May 6, it had repurchased 5.6 million shares for about $115 million; the board subsequently increased 2013 repurchase authorization to $315 million.
- Net insured par declined about $18.1 billion from year-end. Below-investment-grade exposure declined about $1.0 billion; BIG exposure remained concentrated in structured finance, particularly U.S. RMBS.
- Moody’s downgraded AGM, AGC and AG Re on January 17, 2013 to A2, A3 and Baa1, respectively, and downgraded AGUS and AGMH senior unsecured debt to Baa2. The filing reports stable outlooks from Moody’s and S&P at the time.
Outlook, risks and contingencies
- Management said low interest rates and tight credit spreads constrained bond-insurance demand and new business. Q1 present value of new business production was $18 million versus $56 million in Q1 2012; management could not say when market conditions or demand might improve. It identified a planned launch of MAC, focused on U.S. public finance, as a business initiative.
- Management expected liquidity to be adequate for the next 12 months, including common dividends. Holding-company liquidity depends substantially on operating-subsidiary dividends, which are subject to regulatory and rating-agency constraints. Consolidated operating cash flow was negative in Q1.
- Credit-derivative liabilities were $2.518 billion, up from $1.934 billion at year-end; valuations rely substantially on Level 3 inputs and hypothetical-market models. A 25% widening in modeled credit spreads was estimated to reduce net fair value by $617 million before tax.
- Approximately $709 million of collateral was posted by insurance subsidiaries under derivative contracts. Certain contracts contain collateral or termination provisions tied to insurer ratings. The Moody’s downgrade also triggered ratings provisions on leveraged-lease strip policies, creating possible gross liquidity claims of about $1.7 billion if leases terminate and obligors fail to pay; no related claims had occurred as of the filing.
- Three large infrastructure transactions carry refinancing risk. Potential claims could reach $1.4 billion, with most anticipated between 2014 and 2018; recoveries could take 10 to 35 years and are uncertain. Potential liabilities on the transactions may total as much as $3.8 billion over 13 years.
- The company reported $4.184 billion of net economic exposure to selected European countries, including $615 million to Hungary and $2.039 billion to Italy. It reported no direct sovereign-bond guarantees for those countries. Deteriorating views of Hungary contributed to higher estimated losses on Spanish and Hungarian credits.
- Municipal credit risks include Jefferson County and Stockton bankruptcies and Harrisburg fiscal distress. RMBS loss estimates depend on uncertain loan-performance, housing-market and recovery assumptions. The company included a $1.4 billion estimated net benefit from R&W recoveries, including amounts dependent on future counterparties’ payments and loss-sharing arrangements.
- Subsequent events: On May 6, 2013, Assured Guaranty agreed to a UBS settlement, including a $358 million cash payment and 85% reimbursement of future losses on specified RMBS transactions. The filing says the agreement provided a $142 million favorable Q1 economic loss-development effect. AGM also obtained a $106.5 million Flagstar judgment, which Flagstar appealed.
- Management stated that litigation against the company was not expected to materially affect financial position or liquidity, but an adverse outcome could materially affect results in a particular period. The company could not reasonably estimate possible losses for several proceedings, including certain municipal, reinsurance and Lehman-related matters.
Important facts for investors to verify
- Reconcile GAAP net loss with non-GAAP operating income and assess how much of the improvement depends on settlements, premium accelerations and fair-value adjustments.
- Track credit-derivative fair values, Level 3 assumptions, collateral requirements and any further rating actions or termination triggers.
- Assess the realization, timing and counterparty creditworthiness of the $1.4 billion estimated net R&W recovery benefit, including the UBS and Flagstar outcomes.
- Monitor RMBS loss assumptions and exposures, especially the $10.027 billion of BIG U.S. RMBS net par and the estimated $487 million net expected loss to be paid across the portfolio.
- Review liquidity and capital at the holding-company and regulated-insurer levels, including subsidiary dividend limits, infrastructure refinancing claims and leveraged-lease exposure.
- Follow municipal bankruptcy proceedings, European exposures, and the potential effect of further insurer downgrades on claims, collateral postings and new-business production.