Assured Guaranty Ltd. — FY 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; filed February 26, 2015. Assured Guaranty provides financial guarantees on public finance, infrastructure and structured finance obligations. Comparisons below are with FY 2013 unless noted.
Financial performance and position
| Metric | FY 2014 / year-end | FY 2013 / comparison |
|---|---|---|
| Total revenue | $1.994 billion | $1.608 billion |
| Net income; diluted EPS | $1.088 billion; $6.26 | $808 million; $4.30 |
| Operating income (non-GAAP); per diluted share | $491 million; $2.83 | $609 million; $3.25 |
| Net earned premiums | $570 million | $752 million |
| Net investment income | $403 million | $393 million |
| Net change in fair value of credit derivatives | Gain of $823 million | Gain of $65 million |
| Loss and loss adjustment expenses | $126 million | $154 million |
| Cash from operating activities; ending cash | $577 million; $75 million | $244 million; $184 million |
| Investments and cash; total assets | $11.459 billion; $14.925 billion | $10.969 billion; $16.287 billion |
| Long-term debt (carrying value); principal outstanding | $1.303 billion; $1.596 billion | $816 million; $1.114 billion |
| Shareholders’ equity; book value per share | $5.758 billion; $36.37 | $5.115 billion; $28.07 |
Operating income is a company-defined non-GAAP measure. The filing does not provide a conventional operating-margin measure. Cash from investing activities was a $96 million outflow and financing activities were a $585 million outflow; cash decreased by $109 million during the year.
Material changes versus the prior period
- GAAP net income rose 35%, largely reflecting the increase in credit-derivative fair-value gains and lower loss expense. These market-sensitive marks do not necessarily indicate corresponding realized gains or improvement in credit performance.
- Operating income fell 19%, principally because of lower earned premiums and credit-derivative revenues, partly offset by lower loss expense and higher commutation gains.
- Net earned premiums declined 24%, reflecting lower premium accelerations and the run-off of structured finance exposure. Net deferred premium revenue was $3.8 billion at year-end.
- Net expected loss to be paid increased to $1.169 billion from $982 million. Favorable RMBS and representations-and-warranties developments were offset by deterioration in public finance and other structured finance.
- Net par outstanding declined to $403.729 billion from $459.107 billion. Below-investment-grade (“BIG”) net par fell to $18.247 billion from $22.538 billion.
- Shareholders’ equity increased, while operating shareholders’ equity and adjusted book value declined, reflecting repurchases and dividends; per-share non-GAAP measures rose as the share count fell.
Business, outlook and notable items
- New business production improved: present value of new business production (PVP, non-GAAP) was $168 million versus $141 million; gross par written was $13.171 billion versus $9.350 billion. U.S. municipal insurance penetration rose to 5.9% from 3.9%, although low interest rates, modest issuance and competition remain constraints.
- Management expected U.S. municipal issuance to remain low in 2015 and cited potential longer-term demand for guarantees if rates rise, credit spreads widen and infrastructure financing expands. The filing provides no numerical earnings guidance.
- Puerto Rico exposure was $4.939 billion net par, of which $4.7 billion was internally rated BIG. The filing describes fiscal and liquidity pressures, creditor forbearance for PREPA through March 31, 2015, and uncertainty following the court’s invalidation of Puerto Rico’s Recovery Act and the Commonwealth’s appeal.
- The Company had approximately $3.0 billion of infrastructure exposure with refinancing risk. For its two largest such transactions, it estimated potential gross claims of $1.8 billion absent refinancing, potentially payable during 2017–2022; reimbursement could take 10–35 years and is uncertain.
- AGC agreed to buy Radian Asset for $810 million cash, with closing and merger expected in the first half of 2015, subject to approvals. Management expected to fund the purchase mainly by liquidating AGC investments and using accumulated cash. Radian Asset reported $1.139 billion of statutory policyholders’ surplus and $189 million of contingency reserve at year-end.
- Capital actions included $590 million of share repurchases (24.4 million shares) and issuance by AGUS of $500 million of 5.0% senior notes due 2024. The annual dividend was $0.44 per share. Management stated that AGL had sufficient liquidity for the next 12 months, while noting reliance on subsidiary distributions, financing and investment liquidity.
- Insurer ratings included S&P AA with stable outlook for AGM, AGC and MAC; KBRA AA+ with stable outlook for AGM and MAC. Moody’s ratings included AGM A2 with stable outlook and AGC A3 with negative outlook. Ratings are material to demand, pricing, collateral requirements and capital access.
- Other notable items: 2014 contingency-reserve releases of approximately $588 million at AGM and $540 million at AGC; a $268 million positive RMBS representations-and-warranties development; and $376 million of collateral posted for CDS obligations, down from $677 million.
Risks, contingencies and unusual items
- GAAP results were materially influenced by Level 3 fair-value estimates for credit derivatives and consolidated financial-guaranty variable-interest entities. In Q4 2014, revised market indices contributed about $346 million of unrealized credit-derivative gains; management noted that fair-value changes can reverse and are subject to significant estimation uncertainty.
- Loss estimates depend on long-term assumptions, including credit performance, recoveries, discount rates and litigation outcomes. The Company’s expected-loss estimates include a $317 million net benefit for future RMBS representations-and-warranties recoveries, some of which is not covered by existing agreements.
- Liquidity and capital risks include potential claims on Puerto Rico and refinancing-sensitive infrastructure, collateral calls on CDS, reinsurer credit risk, and restrictions on dividends from regulated subsidiaries. About 5% of principal outstanding had been ceded to third-party reinsurers.
- The Company reported a $1.4 billion claim asserted by Lehman Brothers International (Europe) in a CDS dispute; it could not reasonably estimate possible loss. A separate Wells Fargo interpleader case could increase transaction losses by an estimated $10–$20 million, net of expected settlements and reinsurance.
- The filing states ordinary-course litigation was not expected to materially affect financial position or liquidity, but adverse outcomes could materially affect a particular period’s results. Certain municipal derivatives investigations and lawsuits relating to the former Financial Products Business remained unresolved; Dexia indemnities may not cover all consequences.
- PricewaterhouseCoopers issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded disclosure controls and internal control were effective at year-end.
Important facts for investors to verify
- How much of the $1.088 billion net income increase came from unrealized credit-derivative and VIE valuation changes, and how sustainable are operating income and premium earnings?
- Whether Puerto Rico’s fiscal position, PREPA negotiations and related legal developments change expected claims, recoveries or liquidity needs.
- Whether the infrastructure refinancing exposure produces near-term claims, and whether modeled long-dated recoveries are achieved.
- Whether the Radian Asset acquisition closes as expected, its final purchase economics and loss assumptions, and the effect on AGC’s capital and ratings.
- Whether the $317 million expected RMBS recovery benefit and other loss reserves prove supportable as claims, collateral performance and settlements develop.
- Available parent-company liquidity after repurchases, debt service and the Radian purchase, including regulatory limits on subsidiary dividends and potential CDS collateral demands.