Business context and reporting period
Assured Guaranty Ltd. (AGL) is a Bermuda-based holding company whose subsidiaries provide financial guaranty and related insurance, principally for public finance and structured finance obligations. This unaudited Form 10-Q covers the three and six months ended June 30, 2017; financial amounts below are in millions of dollars unless otherwise indicated.
Key financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $308 | $396 | $835 | $641 |
| Net income | $153 | $146 | $470 | $205 |
| Diluted EPS | $1.24 | $1.09 | $3.76 | $1.51 |
| Operating income (non-GAAP) | $141 | $136 | $414 | $259 |
| Net earned premiums | $162 | $214 | $326 | $397 |
| Net investment income | $101 | $98 | $223 | $197 |
| Loss and LAE expenses | $72 | $102 | $131 | $192 |
- Q2 pretax income was $150 versus $201; the tax benefit was $3 versus a $55 provision. Six-month pretax income was $522 versus $266, with tax provisions of $52 and $61, respectively.
- No conventional operating margin is reported. The filing reports non-GAAP operating income; it should not be treated as a GAAP measure.
- At June 30, total assets were $14,655, total liabilities $7,905 and shareholders’ equity $6,750. The investment portfolio was $11,271, including fixed-maturity securities of $10,505.
- Cash and restricted cash totaled $201 at June 30, compared with $127 at December 31, 2016. Six-month operating cash flow was $198, versus cash used of $47 in the prior-year period; investing cash flow was $361 and financing cash flow was negative $488.
- Long-term debt carrying value was $1,294, down from $1,306 at year-end. Six-month interest expense was $49; cash interest paid was $45.
Material changes and notable items
- Q2 revenue declined 22% year over year, mainly due to lower earned premiums and less favorable credit-derivative fair-value activity. Net income and non-GAAP operating income rose modestly, supported by lower loss expenses and lower taxes.
- Six-month net income included the MBIA UK acquisition’s $58 pretax bargain-purchase and pre-existing-relationship gain, as well as a $73 commutation gain from reassuming previously ceded business. The IRS closure of the 2009–2012 audit led to a roughly $37 release of uncertain-tax-position reserves and accrued interest in Q2. These items materially affect comparability.
- The January 2017 MBIA UK acquisition added approximately $12.7 billion of net par insured exposure. The acquired business contributed approximately $149 revenue and $112 net income from acquisition through June 30, including the acquisition gain and other transaction-related effects.
- Net expected loss to be paid increased to $1,297 from $1,198 at year-end. Public finance expected losses were $1,086, including $1,044 for troubled U.S. public finance credits; the six-month public-finance loss development was primarily driven by Puerto Rico.
- Net insured par outstanding was $290.6 billion, versus $296.3 billion at year-end. $13.0 billion, or 4.5%, was internally rated below investment grade (BIG). Shareholders’ equity increased from $6,504, while 8.9 million shares were repurchased for $351 during the first half; dividends paid were $36.
Outlook, management commentary and risks
- No specific earnings or revenue guidance is provided. Management expects AGL to have sufficient liquidity for its needs over the next 12 months, relying substantially on subsidiary distributions, investment cash flows and premium collections. Those distributions are subject to regulatory, rating-agency and statutory-capital constraints.
- Puerto Rico is the principal disclosed credit risk: AGL had $4.937 billion net par exposure at June 30, all BIG. Puerto Rico and several related issuers defaulted on payments; the filing reports claim payments and Title III PROMESA proceedings, including developments after quarter-end. The Commonwealth’s and authorities’ fiscal plans, pledged-revenue disputes and recovery litigation remain uncertain.
- Other disclosed risks include the long duration and estimation uncertainty of insured credit exposure; RMBS default, severity and prepayment assumptions; Level 3 fair-value inputs and illiquid credit-derivative markets; reinsurer collectability and recapture rights; ratings downgrades and potential collateral or claims; and Brexit-related uncertainty.
- Management noted that lower interest rates have dampened demand for bond insurance, while municipal market penetration and new-business production improved. Six-month gross written premiums were $190 versus $55, and present value of new business production (non-GAAP) was $169 versus $79.
- Controls and procedures were assessed as effective at June 30, 2017. The filing states there were no material changes to the risk factors from the 2016 Form 10-K.
Important facts for investors to verify
- How much of first-half earnings reflects recurring underwriting and investment results versus acquisition, commutation and tax-reserve-release gains.
- Developments in Puerto Rico defaults, Title III proceedings, pledged-revenue litigation, claim payments and expected-loss assumptions.
- Whether the $1.297 billion expected-loss estimate, particularly the U.S. public-finance component, changes as credit conditions and recoveries develop.
- Subsidiary dividend capacity, restricted or encumbered assets, and the availability of parent-company liquidity to fund buybacks and obligations.
- Assumptions and sensitivity in Level 3 valuations, credit derivatives, RMBS loss estimates, and reinsurance recoverables.
- Progress and required approvals for the planned European subsidiary combination, and the integration and performance of the MBIA UK portfolio.