AGO

Business Context and Reporting Period

Company: Assured Guaranty Ltd. (AGL)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2010
Business Overview: AGL is a Bermuda-based holding company providing credit protection products (insurance, reinsurance, and credit derivatives) for public finance, infrastructure, and structured finance markets. The company operates primarily through two platforms: Assured Guaranty Municipal Corp. (AGM), focusing on U.S. public finance and global infrastructure, and Assured Guaranty Corp. (AGC), underwriting global structured finance and public finance obligations. The reporting period includes the full impact of the July 2009 acquisition of Assured Guaranty Municipal Holdings Inc. (AGMH) and the adoption of new accounting guidance (FASB) requiring the consolidation of certain Variable Interest Entities (VIEs) effective January 1, 2010.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 181% year-over-year, driven primarily by the inclusion of AGMH premiums and a significant unrealized gain on credit derivatives ($252.1 million in Q1 2010 vs. $27.0 million in Q1 2009). Net earned premiums more than doubled due to the AGMH acquisition.
• Profitability: Net income increased 277% to $322.0 million. This surge is largely attributable to non-cash unrealized gains on credit derivatives resulting from tightening market credit spreads and the impact of the company's own credit spread widening.
• Losses: Loss and LAE expenses increased 64% to $130.5 million. The increase is primarily due to adverse development in U.S. Residential Mortgage-Backed Securities (RMBS) portfolios, specifically First Lien (Alt-A, Option ARM, Subprime) and Second Lien (HELOC, CES) transactions.
• Accounting Changes: The adoption of new VIE consolidation rules on January 1, 2010, resulted in a cumulative effect adjustment that reduced opening retained earnings by $218.1 million. This change consolidated 21 VIEs that were previously not consolidated.
• Investment Portfolio: Net investment income increased 93% due to the addition of AGMH's investment assets ($5.8 billion), despite a decrease in pre-tax yields to maturity (3.52% in 2010 vs. 5.0% in 2009).

Guidance, Outlook, Risks, and Unusual Items

Management Commentary and Outlook

• Market Environment: Management notes that while the U.S. public finance market remains robust, demand for financial guaranties in structured finance and international infrastructure markets remains limited due to the ongoing economic recovery. The company has ceased underwriting new U.S. RMBS transactions and AGM has withdrawn from the structured finance market.
• Non-GAAP Measures: Management utilizes "Operating Income" to exclude volatile fair value adjustments. Operating income for Q1 2010 was $89.6 million, compared to $63.4 million in Q1 2009. Adjusted Book Value (ABV) per share was $48.00 as of March 31, 2010.
• Capital: The company maintains high financial strength ratings (AAA/Aa3 negative outlook for AGC and AGM). A December 2009 capital raise of approximately $574 million was utilized to meet rating agency capital requirements.

Risks and Contingencies

• RMBS Exposure: Significant exposure remains in U.S. RMBS (First and Second Lien). The company estimates expected losses based on conditional default rates (CDR) and loss severities. Sensitivity analysis indicates that extending the stress period for CDR by three months could increase expected losses by approximately $144 million for HELOCs and $18.2 million for CES.
• Reinsurance Counterparty Risk: The company has significant ceded exposure to reinsurers that have faced financial distress or regulatory intervention (e.g., Syncora, Ambac, RAM Re). While collateral is posted for unauthorized reinsurers, the company remains exposed if reinsurers fail to meet obligations.
• Legal Proceedings: The company is involved in litigation regarding the AGMH former financial products business (antitrust/bid-rigging investigations) and has sued J.P. Morgan Investment Management regarding the Orkney Re II transaction. The company cannot reasonably estimate potential losses from these proceedings.
• Rating Sensitivity: A downgrade of the company's financial strength ratings could trigger termination clauses in credit derivative contracts, requiring significant termination payments and collateral posting, potentially impacting liquidity.

Unusual Items

• Foreign Exchange Loss: Other income included a $31.1 million loss due to the revaluation of premium receivables denominated in foreign currencies (primarily Euros and British Pounds).
• OTTI Losses: Other-than-temporary impairment losses on investments were $1.2 million in Q1 2010, a significant decrease from $18.4 million in Q1 2009.

Key Facts for Investor Verification

• Unrealized Gains Volatility: Verify the sustainability of the $252.1 million unrealized gain on credit derivatives, which is highly sensitive to market credit spreads and the company's own credit spread (CDS prices).
• RMBS Loss Development: Monitor the "Below Investment Grade" (BIG) portfolio, which represents 4.0% of net par outstanding ($25.5 billion). Specifically, track the performance of HELOC and Alt-A Option ARM transactions, which drive the majority of loss reserves.
• Reinsurance Recoveries: Assess the collectability of reinsurance recoverables ($17.8 million) and the financial stability of key reinsurers (Radian, Tokio, RAM Re, Syncora) to whom significant risk has been ceded.
• Accounting Adjustments: Understand the impact of the $218.1 million reduction in retained earnings due to the new VIE consolidation rules and how this affects the comparability of equity balances.
• Liquidity and Collateral: Review the $649.3 million in collateral posted for credit derivatives and the availability of the $300 million 2006 Credit Facility and $1 billion Strip Coverage Facility.