Assured Guaranty Ltd. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; balance-sheet comparisons are to December 31, 2012. Assured Guaranty is a Bermuda-based financial guarantor serving public finance, infrastructure and structured finance markets. Amounts below are in U.S. dollars; financial statement figures are generally in millions unless stated otherwise.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $465 | $755 | $289 | $393 |
| Net earned premiums | $163 | $219 | $411 | $413 |
| Net investment income | $93 | $101 | $187 | $199 |
| Net income (loss) | $219 | $377 | $75 | $(106) |
| Diluted EPS | $1.16 | $2.01 | $0.39 | $(0.58) |
| Non-GAAP operating income | $98 | $114 | $358 | $185 |
| Present value of new business production (PVP) | $16 | $50 | $34 | $106 |
Reported results were materially affected by credit-derivative and consolidated variable-interest-entity fair-value changes. Credit derivatives produced a net fair-value gain of $74 in Q2 but a loss of $518 for the first half; fair-value gains on financial guaranty VIEs were $143 and $213, respectively. No conventional operating margin is clearly provided; reported revenue and earnings include substantial volatile fair-value items.
At June 30, total assets were $16.608 billion, total liabilities $12.124 billion and shareholders’ equity $4.484 billion, down from $17.242 billion, $12.248 billion and $4.994 billion at year-end. Cash was $143; short-term investments were $943; the investment portfolio totaled $10.637 billion. Long-term debt had a carrying value of $827 million and principal outstanding of $1.128 billion. Six-month operating cash flow was $122 million, investing cash flow $472 million and financing cash flow negative $585 million; ending cash increased $5 million to $143 million. The company paid $38 million in dividends and repurchased $244 million of shares.
Net financial-guaranty par outstanding was $486.989 billion, down from $519.893 billion at year-end. Below-investment-grade exposure was $21.632 billion, or 4.4% of net par, versus $23.392 billion, or 4.5%. Net expected losses to be paid were $774 million, up from $677 million at year-end. Adjusted book value was $49.06 per share versus $47.17 at year-end; GAAP book value was $24.52 per share.
Changes versus comparable periods
- Q2 net income fell to $219 million from $377 million, principally reflecting lower premium revenue and smaller credit-derivative fair-value gains. Lower loss expense partly offset these declines.
- First-half net income improved to $75 million from a $106 million loss. Lower losses—particularly relative to the prior-year Greek sovereign exposure—and R&W settlement benefits were key factors. Credit-derivative fair-value losses remained substantial.
- First-half operating income rose to $358 million from $185 million, while PVP fell to $34 million from $106 million, reflecting weak production conditions and lower new-business volume.
- Shareholders’ equity declined by $510 million, mainly due to repurchases, dividends and lower unrealized investment gains, partly offset by net income. Adjusted book value per share rose, primarily reflecting fewer shares outstanding.
- Investment portfolio fair value declined to $10.637 billion from $11.085 billion. Accumulated other comprehensive income fell to $209 million from $515 million, with first-half other comprehensive loss of $306 million.
Outlook, commentary and significant items
- Management said low interest rates and tight credit spreads continued to constrain demand for bond insurance. It expected opportunities may improve if rates rise and spreads widen, but gave no assurance on timing. No specific earnings or revenue guidance is provided.
- Management reported improving performance in second-lien RMBS and shortened the assumed recovery period in certain scenarios; it saw no comparable improvement in first-lien RMBS and largely retained prior assumptions. Expected-loss estimates depend on uncertain mortgage, default, severity and recovery assumptions.
- R&W recoveries were an important loss-mitigation factor. The company reported $3.5 billion of gross payments, commitments and repurchases relating to R&W through June 30, and included an estimated net benefit of $964 million in expected-loss estimates. The amount and timing of future recoveries remain uncertain.
- AGM settled with Flagstar for $105 million and future reimbursement of covered claims. The May UBS settlement provided $358 million in cash plus 85% of future losses on specified transactions. Additional settlements and an agreement in principle were reported after quarter-end.
- Detroit filed for Chapter 9 bankruptcy on July 18, 2013, after quarter-end. Assured Guaranty reported $2.154 billion of net par exposure and projected that troubled U.S. public-finance credits would produce $71 million of future net losses, compared with a projected net recovery at March 31; Detroit was the principal driver of the deterioration.
- Three large infrastructure transactions carry potential liabilities of up to $3.8 billion over 13 years; management estimated potential claims of approximately $1.4 billion before reinsurance, with recoveries potentially delayed 10 to 35 years and subject to uncertainty.
- Moody’s downgraded AGM, AGC and AG Re in January 2013 to A2, A3 and Baa1, respectively; outlooks were stable. Management warned that further downgrades could impair new business, increase collateral or liquidity demands, or trigger claims. MAC was capitalized and began underwriting in 2013 after quarter-end; it received AA+ from KBRA and AA- from S&P.
- Key risks include volatile Level 3 credit-derivative valuations, reinsurer collectability, municipal defaults and bankruptcy outcomes, RMBS litigation and recovery uncertainty, refinancing-related liquidity demands, and potential collateral calls. A further downgrade could affect derivatives, swaps, variable-rate debt and reinsurance arrangements. Management said parent-company liquidity should be sufficient for the next 12 months, subject to insurance-subsidiary dividend and regulatory restrictions.
- Management reported effective disclosure controls as of June 30, 2013, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether reported earnings and adjusted book value assumptions remain supported by actual R&W receipts, settlement performance and claim experience.
- How Detroit’s bankruptcy and other stressed municipal credits affect claims, reserves, collateral requirements and statutory capital.
- The sensitivity of the $774 million expected-loss estimate to RMBS assumptions, infrastructure refinancing outcomes and discount rates.
- Credit-derivative fair-value exposure: $2.349 billion of reported liabilities and $2.248 billion net Level 3 liability position in the fair-value rollforward; verify valuation inputs and spread sensitivity.
- Whether collateral posting, rating actions or reinsurer disputes constrain liquidity or the ability of subsidiaries to pay dividends to the holding company.
- MAC’s post-quarter capitalization, transferred portfolio and underwriting launch, and the effect on affiliate capital and dividend capacity.
- The amount and timing of remaining 2013 share repurchases; approximately $71 million remained under the authorization at June 30.