ASSURED GUARANTY LTD quarterly report, Q2 FY2010

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Assured Guaranty Ltd. — Form 10-Q Summary

Reporting period: Quarter and six months ended June 30, 2010. Assured Guaranty provides financial guaranty insurance, reinsurance and credit protection for public finance, infrastructure and structured finance obligations. Results include AGMH, acquired July 1, 2009, and reflect new VIE consolidation accounting; comparisons with 2009 are therefore not like-for-like.

Financial performance and position

  • Revenue and earnings: Q2 revenue was $428.1 million versus negative $169.5 million in Q2 2009; net income was $203.5 million versus a $170.0 million loss. For six months, revenue was $1.110 billion versus $73.6 million, and net income was $525.5 million versus an $84.5 million loss.
  • Premiums and investment income: Net earned premiums were $292.1 million for Q2 and $611.7 million for six months, up from $78.6 million and $227.1 million, respectively. Net investment income was $90.9 million for Q2 and $175.2 million for six months, versus $43.3 million and $86.9 million.
  • Profitability and earnings quality: Non-GAAP operating income was $172.0 million for Q2 and $284.6 million for six months, compared with $27.3 million and $90.8 million. GAAP results were materially affected by credit-derivative fair-value gains: $73.5 million in Q2 and $352.3 million for six months. Management cautions that these gains can be volatile and are not necessarily realized cash earnings. The filing does not present a conventional operating margin.
  • Losses: Loss and loss adjustment expense was $71.2 million in Q2 and $201.7 million for six months, up from $38.0 million and $117.8 million. The increase mainly reflects AGMH and continued RMBS and other structured-finance loss development. Net loss reserves were $403.5 million at June 30, versus $289.5 million at year-end 2009.
  • Cash flow and liquidity: Six-month operating cash flow was negative $249.6 million, compared with positive $202.8 million in 2009; net claims paid were $516.8 million versus $210.8 million. Cash was $97.2 million at June 30. Investments totaled $10.5 billion, including $1.4 billion in short-term investments. Management said liquidity should be adequate for the next 12 months, relying significantly on subsidiary dividends. A $300 million revolving facility was undrawn, and the company reported compliance with its financial covenants.
  • Debt and equity: Long-term debt principal was $1.253 billion and notes payable principal was $129.3 million; their combined carrying value was $1.059 billion. Shareholders’ equity was $3.869 billion, up from $3.520 billion at year-end, including a $206.5 million after-tax reduction to opening retained earnings from VIE accounting adoption. The quarterly dividend was $0.045 per share.
  • Exposure: Gross and net in-force exposure, including principal and interest, were $1.058 trillion and $942.6 billion. Net par outstanding was $627.5 billion, of which $25.5 billion, or 4.1%, was internally rated below investment grade. These exposure measures use different definitions and should not be conflated.

Material changes and business outlook

  • AGMH’s acquisition significantly increased premium revenue, investment income, expenses and insured exposure relative to the prior-year comparison. Management expects earned premiums to decline over time as the acquired portfolio runs off unless replaced by new business.
  • Six-month present value of new business production (a non-GAAP measure) fell to $168.7 million from $361.7 million; gross par written declined to $15.4 billion from $32.8 billion. Management cited weaker issuance and demand, including the Build America Bonds program, and reported no new non-affiliated quota-share reinsurance production in the period.
  • Management saw possible early improvement in housing and mortgage conditions but expected any second-lien recovery to be gradual. Loss estimates depend on uncertain default, severity, prepayment and loan-repurchase assumptions. The filing provides scenario sensitivities illustrating material potential changes in expected losses.
  • As of August 9, S&P had affirmed AAA ratings for AGC and AGM with negative outlooks and AA for AG Re with a stable outlook. Moody’s ratings were Aa3 for AGC, AGM and AGUK, and A1 for AG Re and certain affiliates, with negative outlooks. Downgrades could impair new business, trigger collateral postings or contract terminations, and affect liquidity.
  • The July 21, 2010 Dodd-Frank Act may impose capital, margin, clearing or trading requirements on derivatives; implementation and impact were uncertain pending regulatory rulemaking.

Risks, contingencies and unusual items

  • RMBS remains a major risk: first- and second-lien collateral has performed below original underwriting expectations, and projected losses in some transactions exceed structural protections. Estimated loan-repurchase recoveries are uncertain and depend on counterparties’ ability to pay and the outcome of negotiations or litigation.
  • Credit-derivative valuations rely substantially on Level 3 models and unobservable inputs. At June 30, the net credit-derivative liability was approximately $1.275 billion after reflecting the company’s own credit spread; a modeled 10% widening in spreads would reduce fair value by an estimated $188.1 million pre-tax.
  • Counterparty and reinsurance exposure includes distressed monolines. The company remained primarily liable for insured claims even where it had ceded risk; collateral posted by non-affiliated reinsurers exceeded $1.1 billion. A downgrade of AGC could permit termination of CDS covering about $5.9 billion of par, with termination payments not reliably estimable. Approximately $637.7 million of collateral was already posted.
  • Dexia and French and Belgian government support arrangements protect exposures related to AGMH’s former financial-products business, but the filing identifies residual credit and timing risk if support is delayed or not honored. Certain GIC downgrade scenarios could require collateral or withdrawals.
  • Material litigation and investigations include municipal-derivatives bid-rigging matters, municipal bond-rating methodology claims, RMBS repurchase disputes, and litigation concerning Jefferson County sewer debt and an investment manager. The company could not reasonably estimate potential losses for several proceedings.
  • VIE consolidation added substantial assets and liabilities to the balance sheet and reduced opening retained earnings by $206.5 million after tax. VIE results are consolidated on a one-quarter lag.

Key facts for investors to verify

  • How much of reported earnings and operating income reflects recurring premium and investment income versus fair-value movements and acquisition accounting.
  • Subsequent RMBS loss development, actual claims paid, reserve adequacy, and realized recoveries from loan repurchases and representations-and-warranties claims.
  • Rating-agency outlooks and any resulting effects on collateral requirements, CDS termination rights, reinsurance recapture or subsidiary dividend capacity.
  • Liquidity available at the holding company and regulated subsidiaries, including cash generation, claims needs, pledged collateral and reliance on Dexia-related support.
  • Implementation of Dodd-Frank requirements and developments in significant litigation, investigations and related contingencies.