Business Context and Reporting Period
Company: Assured Guaranty Ltd.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: A Bermuda-based holding company providing credit enhancement products (financial guaranty insurance and credit derivatives) to public finance, structured finance, and mortgage markets. The company operates through four segments: Financial Guaranty Direct, Financial Guaranty Reinsurance, Mortgage Guaranty, and Other.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2008 | Nine Months Ended Sep 30, 2008 | Three Months Ended Sep 30, 2007 | Nine Months Ended Sep 30, 2007 |
|---|---|---|---|---|
| Net Written Premiums ($ millions) | $111.5 | $521.8 | $60.4 | $180.3 |
| Net Earned Premiums ($ millions) | $85.5 | $184.0 | $38.6 | $113.6 |
| Net Investment Income ($ millions) | $43.4 | $120.2 | $31.8 | $94.2 |
| Net Realized Investment Losses ($ millions) | $(20.0) | $(18.0) | $(0.1) | $(1.9) |
| Net Change in Fair Value of Credit Derivatives ($ millions) | $(86.3) | $422.0 | $(205.0) | $(198.8) |
| Loss and Loss Adjustment Expenses ($ millions) | $82.5 | $175.8 | $2.0 | $(11.8) |
| Net (Loss) Income ($ millions) | $(63.3) | $312.7 | $(115.0) | $(43.2) |
| Basic EPS ($) | $(0.70) | $3.59 | $(1.70) | $(0.64) |
| Total Assets ($ millions) | $4,442.7 | - | - | $3,762.9 (Dec 31, 2007) |
| Total Shareholders' Equity ($ millions) | $2,089.9 | - | - | $1,666.6 (Dec 31, 2007) |
Material Changes vs. Prior Period
- Revenue Growth: Net written premiums increased significantly (85% for the quarter, 190% for the nine months) driven by growth in the U.S. public finance business and a portfolio assumption from Ambac Assurance Corp.
- Profitability Volatility: The nine-month period showed a net income of $312.7 million, a stark contrast to the nine-month 2007 net loss of $43.2 million. This improvement was primarily due to a $422.0 million unrealized gain on credit derivatives in 2008, compared to a $198.8 million loss in 2007. The gain was largely offset by the widening of the company's own credit spreads.
- Quarterly Loss: The third quarter of 2008 reported a net loss of $63.3 million, improved from the $115.0 million loss in the same period in 2007. The improvement was driven by a smaller unrealized loss on credit derivatives ($116.2 million vs. $222.7 million) and higher investment income.
- Loss Reserves: Loss and loss adjustment expenses surged to $82.5 million in Q3 2008 from $2.0 million in Q3 2007. This increase was primarily due to $57.8 million in losses related to Home Equity Line of Credit (HELOC) exposures, specifically direct Countrywide transactions.
- Investment Portfolio: The company recognized $18.5 million in other-than-temporary impairment losses on corporate securities for the three and nine months ended September 30, 2008. Gross unrealized losses on the investment portfolio increased to $157.0 million from $50.5 million in the prior quarter.
Guidance, Outlook, Risks, and Unusual Items
- Rating Agency Review: On July 21, 2008, Moody's placed the company's Aaa and Aa2 insurance financial strength ratings under review for possible downgrade. Management believes this has adversely impacted new business production. A downgrade could trigger recapture of reinsurance business (up to $615 million in unearned premiums) and increased collateral posting requirements.
- Credit Derivative Volatility: The fair value of credit derivatives is highly sensitive to the company's own credit spread. In Q3 2008, the company's credit spread widened from 900 to 1,255 basis points, creating a significant mark-to-market gain that offset losses from widening spreads on underlying assets. Management notes that these fair value adjustments do not reflect actual credit losses.
- HELOC Exposure: Performance of HELOC transactions, particularly those originated between 2005 and 2007, continues to deteriorate. The company incurred $52.3 million in losses on direct Countrywide transactions in Q3 2008. Cumulative incurred losses on these transactions reached $94.5 million as of September 30, 2008.
- Capital Raise: In April 2008, the company raised $250.0 million through a private placement with WL Ross & Co. LLC. WL Ross has a remaining commitment to purchase up to $750.0 million, subject to price and rating conditions which were not met as of the filing date.
- Accounting Changes: The company adopted FAS 157 (Fair Value Measurements) effective January 1, 2008. Additionally, FAS 163 (Accounting for Financial Guarantee Insurance Contracts) will be adopted on January 1, 2009, which is expected to have a material effect on financial statements.
- Lehman Brothers Exposure: As of September 30, 2008, the company had CDS contracts with Lehman Brothers International (Europe) with future installment payments totaling $93.6 million. No payments have been received since Lehman's bankruptcy filing on September 15, 2008.
Key Facts for Investor Verification
- Moody's Rating Review: Verify the outcome of Moody's review and any subsequent rating actions by S&P or Fitch, as a downgrade could trigger significant reinsurance recaptures and collateral calls.
- HELOC Loss Development: Monitor the actual performance of HELOC exposures (specifically Countrywide 2005-J and 2007-D) against the company's modeling assumptions (CDR, CPR, draw rates) to assess the adequacy of the $94.5 million cumulative loss reserve.
- Credit Derivative Valuation: Scrutinize the sensitivity of the credit derivative portfolio to the company's own credit spread widening, as this drives significant volatility in reported earnings without reflecting actual claim payments.
- Investment Impairments: Review the status of the $157.0 million in gross unrealized losses on the investment portfolio and the potential for further other-than-temporary impairment write-downs.
- Lehman Brothers Counterparty Risk: Track the resolution of the $93.6 million exposure to Lehman Brothers International (Europe) and the potential for non-payment or settlement disputes.