Assured Guaranty Ltd. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2017; balance-sheet comparisons are to December 31, 2016. Amounts are in U.S. dollars unless noted. Assured Guaranty is a Bermuda-based financial guaranty and insurance holding company. It filed this report on November 3, 2017.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $623 million | $566 million | $1.458 billion | $1.207 billion |
| Net earned premiums | $186 million | $231 million | $512 million | $628 million |
| Net investment income | $99 million | $94 million | $322 million | $291 million |
| Loss and loss adjustment expenses | $223 million | $(9) million | $354 million | $183 million |
| Income before taxes | $313 million | $480 million | $835 million | $746 million |
| Net income | $208 million | $479 million | $678 million | $684 million |
| Diluted EPS | $1.72 | $3.60 | $5.48 | $5.06 |
| Non-GAAP operating income | $156 million | $497 million | $570 million | $756 million |
Net income was lower year over year in Q3 and broadly stable for the nine-month period. Comparisons are materially affected by unusual gains: 2017 included $255 million of Q3 and $328 million of nine-month pretax reinsurance commutation gains, plus a $58 million nine-month MBIA UK acquisition gain; 2016 included a $259 million CIFG-related pretax gain in both comparative periods. Management says that, excluding these gains, lower earned premiums and increased U.S. public finance losses were key factors in the earnings decline. Non-GAAP operating income is management’s measure and is not a GAAP substitute.
The effective tax rate was 33.6% in Q3 2017 versus 0.3% in Q3 2016, and 18.8% for nine months 2017 versus 8.3% in 2016. The company uses discrete interim tax calculations; the 2017 nine-month result includes the release of approximately $37 million of tax reserves and accrued interest following closure of an IRS audit.
Balance sheet, cash flow and capital
| Metric | September 30, 2017 | December 31, 2016 |
|---|---|---|
| Total assets | $14.649 billion | $14.151 billion |
| Investment portfolio | $11.591 billion | $10.985 billion |
| Cash | $72 million | $118 million |
| Long-term debt, carrying value | $1.292 billion | $1.306 billion |
| Total shareholders’ equity | $6.878 billion | $6.504 billion |
| Loss and LAE reserve | $1.326 billion | $1.127 billion |
| Unearned premium reserve | $3.597 billion | $3.511 billion |
For the first nine months of 2017, operating activities generated $354 million of cash, versus $189 million used in the prior-year period. Investing activities provided $232 million and financing activities used $645 million. Financing outflows included $431 million of common-share repurchases and $53 million of dividends. The company repurchased 10.7 million shares during the nine months; its board authorized an additional $300 million of repurchases on November 1, with $398 million of authorization remaining as of November 2. Dividends were $0.4275 per share for the nine months.
Management stated it expects sufficient holding-company liquidity for the next 12 months and that insurance subsidiaries’ near-term liquidity needs can be met from cash, short-term investments and operating cash flow. Holding-company liquidity depends substantially on subsidiary distributions, which are subject to regulatory, statutory and rating-agency constraints. AGL reported $47 million of cash and short-term investments; AGUS and AGMH together reported $59 million.
Material changes and portfolio developments
- MBIA UK acquisition: Completed January 10, 2017, adding approximately $12 billion of net par insured at acquisition. The acquired business contributed approximately $176 million of revenue and $129 million of net income through September 30, including the acquisition gain and other related activity. The company is pursuing a European subsidiary combination, subject to further regulatory and court approvals; completion and timing are uncertain.
- Reinsurance commutations: Three 2017 commutations reassumed previously ceded business. They produced $328 million of nine-month pretax gains and increased net par outstanding by $4.628 billion. These gains are significant to reported results and are not necessarily recurring.
- Insured portfolio: Net financial guaranty par outstanding was $275.8 billion, compared with $296.3 billion at year-end 2016; the September balance includes $13.0 billion from MBIA UK. Below-investment-grade exposure was $13.226 billion, or 4.8% of net par.
- Expected losses: Present value of net expected loss to be paid rose to $1.292 billion from $1.198 billion at year-end. Nine-month economic loss development was $298 million, driven primarily by $427 million of public finance deterioration, largely Puerto Rico, partly offset by $129 million of structured-finance benefit. Q3 economic loss development was $204 million.
- Capital returns: Shareholders’ equity per share increased to $58.32 from $50.82, while non-GAAP adjusted book value per share rose to $74.78 from $66.46. Repurchases reduced shares outstanding; these non-GAAP measures include management estimates of future premiums and losses.
Outlook, risks and unusual items
- Puerto Rico and hurricanes: Net insured Puerto Rico exposure was $4.966 billion, all internally rated below investment grade. Multiple issuers had defaulted, the company had paid claims on most of the exposure, and Title III PROMESA proceedings and related litigation were ongoing. Hurricane Maria caused extensive damage in September; management expected near-term declines in economic activity, tourism and tax collections, while rebuilding and recovery were expected to take years. The ultimate effect of the storm, federal response, restructurings and legal challenges remained uncertain.
- Other stressed exposures: The company disclosed $498 million of U.S. Virgin Islands net par, of which $224 million was below investment grade; the territories had sustained hurricane damage but had made debt-service payments to date. Other risks include distressed public finance credits, RMBS performance, and European sovereign and sub-sovereign exposure.
- Loss estimates and fair value: Expected losses rely on subjective assumptions about defaults, recoveries, timing, economic conditions and governmental actions, and actual claims may differ materially. All fair-value liabilities and a portion of fair-value assets are Level 3; credit-derivative valuations rely on models and significant unobservable inputs. Credit-derivative fair-value changes can create substantial reported earnings volatility without corresponding current cash flows.
- Liquidity and contingent exposures: Claims, collateral posting, reinsurance recoveries and subsidiary dividend capacity may fluctuate. The company remains exposed to collection risk from financially stressed reinsurers. A $360 million excess-of-loss reinsurance facility covers specified U.S. public finance losses above an aggregate attachment point, but excludes Puerto Rico credits. Separate potential liquidity exposures include insured leveraged-lease obligations and GIC-related risks.
- Business outlook: Management cited increased bond-insurance penetration in the municipal market, but noted that persistently low rates dampen demand and a competitor is active. It expected structured-finance opportunities to improve with economic recovery and higher rates, but gave no specific earnings or revenue guidance. Management also identified Brexit, market volatility, rating actions, catastrophe events and access to capital as risks.
- Legal and governance matters: Puerto Rico recovery litigation continued, with certain complaints withdrawn without prejudice after Hurricane Maria and an appeal pending regarding a PREPA stay-relief motion. Management said litigation against the company was not expected to materially affect financial position or liquidity, though an adverse resolution could materially affect results in a period. The General Counsel’s planned departure effective December 31, 2017 and transition through 2018 were disclosed.
Investor facts to verify
- How Puerto Rico losses and claims evolve after Hurricane Maria, including recovery assumptions, restructuring outcomes and litigation results.
- How much of earnings and book-value growth depends on commutation and acquisition gains, versus recurring underwriting and investment performance.
- Whether the $1.292 billion expected-loss estimate, including its public-finance assumptions, changes materially in later filings.
- The sensitivity and reliability of Level 3 credit-derivative and other fair-value estimates.
- Actual subsidiary dividend capacity, holding-company liquidity, stressed claims and reinsurance recoverability, alongside continued share repurchases.