Assured Guaranty Ltd. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparisons are with Q1 2013 unless otherwise stated. Assured Guaranty provides financial-guaranty insurance and related credit protection, primarily for U.S. and international public finance and structured finance obligations. Amounts below are U.S. dollars.
Financial performance and position
| Metric | Q1 2014 / March 31, 2014 | Comparable period / prior date |
|---|---|---|
| Total revenue | $195 million | $(176) million in Q1 2013 |
| Net income (loss) | $42 million; diluted EPS $0.23 | $(144) million; diluted EPS $(0.74) |
| Operating income (non-GAAP) | $132 million; $0.72 per share | $260 million; $1.34 per share |
| Net earned premiums | $132 million | $248 million |
| Net investment income | $103 million | $94 million |
| Loss and loss adjustment expenses | $41 million | $(48) million benefit |
| Operating cash flow | $101 million | $(14) million |
| Cash | $219 million | $184 million at December 31, 2013 |
| Total assets / liabilities / shareholders’ equity | $15.106 billion / $9.897 billion / $5.209 billion | $16.287 billion / $11.172 billion / $5.115 billion at December 31, 2013 |
| Long-term debt | $812 million carrying value; $1.109 billion principal | $816 million carrying value; $1.114 billion principal at December 31, 2013 |
Net income improved substantially year over year, but operating income declined. Management attributed the GAAP improvement chiefly to smaller unrealized credit-derivative losses, gains associated with FG VIEs, and commutation gains. The FG VIE gain was $157 million, including a $120 million gain from deconsolidating seven VIEs and $37 million from accelerating two VIEs. Credit-derivative fair-value changes remain a major source of reported earnings volatility. The filing does not provide a directly comparable operating margin measure.
Net earned premiums fell mainly because of lower premium accelerations and scheduled runoff. Premium accelerations were $19 million versus $113 million in Q1 2013. Net investment income increased, while reported loss and LAE shifted from a prior-year benefit to expense, primarily reflecting higher U.S. public finance losses and the prior-year R&W settlement comparison.
Net cash provided by investing activities was $275 million and financing activities used $342 million. Financing outflows included $281 million of FG VIE liability paydowns, $35 million of share repurchases and $20 million of dividends. The investment portfolio was $10.948 billion at quarter-end; fixed-maturity securities and short-term investments had a 4.9-year duration. Management said it expected holding-company and insurance-subsidiary liquidity needs over the next 12 months to be met, subject to subsidiary dividend restrictions and other conditions.
Portfolio, changes, and capital actions
- Net par outstanding, including loss-mitigation bonds, was $450.9 billion, down from $460.3 billion at year-end. Public finance accounted for $381.3 billion and structured finance for $69.6 billion. BIG net par was $21.9 billion, or 4.9% of net par excluding loss-mitigation bonds.
- Present value of net expected loss to be paid was $984 million, compared with $982 million at December 31, 2013. Q1 economic loss development was an adverse $12 million, including adverse U.S. public finance development partly offset by an RMBS benefit. Expected losses are estimates and depend on assumptions, recoveries, discount rates and credit performance.
- The estimated net benefit from RMBS representations-and-warranties recoveries was $721 million. Providers had paid or agreed to pay approximately $3.7 billion gross of reinsurance through March 31, 2014; the filing cautions that additional recoveries are uncertain.
- The company repurchased 1.35 million shares for $35 million in Q1 at an average $25.92 per share. It reported 3.0 million shares repurchased for $75 million year to date through May 7, 2014. The board authorization was $400 million.
- New-business production increased: gross par written was $1.869 billion versus $1.594 billion, and present value of production (PVP, non-GAAP) was $31 million versus $18 million. U.S. municipal market penetration by par was 4.6%, compared with 2.6%.
- S&P upgraded the financial strength ratings of the insurance subsidiaries to AA with stable outlook from AA-. Moody’s affirmed ratings for AGM, AGC and AG Re, but changed AG Re’s outlook to negative.
Outlook, risks, and contingencies
Management gave no specific numerical earnings or revenue guidance. It described municipal insurance demand as showing signs of improvement, while noting low interest rates, limited international activity and a competitive market. It expected potential growth in international infrastructure and structured-finance opportunities as markets recover, but timing and demand remain uncertain. The company intended to use the remaining share-repurchase authorization by the end of Q3 2014 and then seek a new authorization, subject to market, capital, liquidity and rating conditions.
- Puerto Rico: Net exposure was approximately $5.3 billion, of which $5.1 billion was rated BIG. All insured credits were current, but the Commonwealth faced high debt, recession, population decline, structural deficits and underfunded pensions. Rating agencies downgraded much of Puerto Rico’s debt below investment grade; the March 2014 $3.5 billion bond issue provided near-term liquidity, not assurance of longer-term performance.
- Municipal distress: Net Detroit exposure was $2.1 billion. A tentative settlement on certain unlimited-tax general-obligation bonds, announced after quarter-end, implied at least a 74% ultimate recovery, subject to conditions and plan confirmation. Stockton’s tentative settlement also remained subject to bankruptcy-court confirmation. Troubled U.S. public-finance expected losses rose to $281 million from $264 million, primarily due to Detroit developments.
- Refinancing and liquidity exposure: Approximately $3.0 billion of insured infrastructure exposure had refinancing risk. For the two largest transactions, estimated gross claims could reach $1.8 billion, payable from 2017 to 2022 if refinancing did not occur; recovery could take 10–35 years and is uncertain.
- Credit derivatives and valuation: Net credit-derivative fair value was a liability of $1.923 billion, versus $1.693 billion at year-end. Valuations rely substantially on Level 3 models and unobservable inputs; market illiquidity and changes in the company’s own credit spreads can materially affect reported results. Approximately $669 million of securities were pledged under credit-derivative contracts.
- Other exposures: Potential claims may arise from rating-triggered swap terminations, variable-rate demand obligations, legacy GIC guarantees and leveraged leases. Possible gross liquidity claims on leveraged-lease strip policies were approximately $1.4 billion, though no such claims had occurred. Reinsurer creditworthiness and collection timing are additional risks; ceded par was $27.5 billion.
- Legal matters: The company disclosed RMBS recovery litigation and other proceedings, including a Lehman-related claim in which the counterparty asserted approximately $1.4 billion against an affiliate, versus the affiliate’s calculation that approximately $25 million was owed. Management said it could not reasonably estimate potential loss for several matters. It judged litigation against the company not expected to materially affect financial position or liquidity, while adverse outcomes could materially affect results in a particular period.
Important facts for investors to verify
- Whether Puerto Rico, Detroit and other distressed municipal exposures remain current, and how settlements or restructurings affect expected losses and claim timing.
- Whether the $721 million estimated R&W recovery benefit is realized, particularly the $337 million projected from transactions without current agreements.
- How credit spreads, Level 3 assumptions, and changes in the company’s own credit spreads affect derivative fair values and reported earnings.
- Whether refinancing-risk infrastructure claims, rating triggers, collateral requirements, or GIC and leveraged-lease obligations create material liquidity needs.
- Whether operating-subsidiary dividends, regulatory capital limits, ratings and holding-company resources continue to support liquidity, repurchases and dividends.
- Progress on new-business production and municipal insurance penetration, and whether premium runoff can be offset by new business or reassumed ceded business.