Assured Guaranty Ltd. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016; comparisons are to the corresponding 2015 periods unless stated otherwise. Amounts are in U.S. dollars. Assured Guaranty provides financial guaranty insurance and related credit protection, principally for public finance and structured finance obligations.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $396 million | $695 million | $641 million | $1.064 billion |
| Net income | $146 million | $297 million | $205 million | $498 million |
| Diluted EPS | $1.09 | $1.96 | $1.51 | $3.23 |
| Non-GAAP operating income | $139 million | $278 million | $252 million | $418 million |
| Net earned premiums | $214 million | $219 million | $397 million | $361 million |
| Net investment income | $98 million | $98 million | $197 million | $199 million |
| Loss and loss-adjustment expenses | $102 million | $188 million | $192 million | $206 million |
- Q2 and first-half net income and operating income were lower year over year. The 2015 comparison included $214 million of Radian Asset-related bargain purchase and settlement gains. Lower loss expenses partly offset that comparison effect.
- First-half 2016 revenue also reflected substantially lower credit-derivative fair-value gains: $3 million versus $214 million in first-half 2015. Q2 2016 included a $63 million credit-derivative fair-value gain, compared with $90 million in Q2 2015. These marks can be volatile and are not necessarily indicative of underlying credit performance.
- Balance sheet at June 30: total assets $14.092 billion, total liabilities $7.842 billion, and shareholders’ equity $6.250 billion. Long-term debt carried at $1.303 billion; principal outstanding was $1.591 billion.
- Cash was $190 million, with $585 million in short-term investments. First-half operating cash flow was negative $47 million, versus positive $105 million a year earlier; investing cash flow was positive $777 million and financing cash flow negative $703 million. Financing outflows included $135 million of share repurchases, $35 million of dividends, and $531 million of paydowns on financial-guaranty VIE liabilities.
- Net financial-guaranty par outstanding was $329.9 billion, down from $358.6 billion at year-end 2015. Below-investment-grade (“BIG”) net par was $14.8 billion, or 4.5% of the portfolio, versus $15.2 billion, or 4.2%, at year-end. Net expected losses to be paid were $1.326 billion, compared with $1.391 billion at year-end.
Material changes and business developments
- U.S. public-finance net expected loss increased to $1.000 billion from $809 million at year-end; the U.S. public-finance component was $963 million versus $771 million. First-half public-finance economic loss development was $208 million, primarily related to Puerto Rico.
- Puerto Rico exposure totaled $5.054 billion net par at June 30, all BIG and internally rated triple-C or below. On July 1, Puerto Rico and the Public Buildings Authority defaulted on most scheduled payments, and Assured Guaranty made initial claim payments. The company subsequently moved $1.803 billion of exposure across two risks from BIG Category 1 to Category 3.
- AGC acquired CIFG on July 1, after transferring $450.6 million to a paying agent on June 30; the restricted funds are included on the quarter-end balance sheet. The acquisition added $4.4 billion of net par insured. Purchase-price allocation was not complete; management expected to provide it in the third-quarter 2016 filing.
- First-half gross written premiums were $55 million versus $54 million; present value of new business production (PVP, non-GAAP) was $79 million versus $62 million. Gross par written declined to $7.524 billion from $8.289 billion. Management cited stronger U.S. public-finance PVP, while low interest rates continued to dampen bond-insurance demand.
- The company repurchased 5.37 million shares for $135 million during the first half and paid $35 million in dividends. The remaining repurchase authorization was $170 million at June 30 and approximately $150 million as of August 3.
Outlook, risks, contingencies and unusual items
- No specific earnings or revenue guidance is provided. Management stated it expects sufficient holding-company liquidity for the next 12 months and believes subsidiary liquidity needs over that period can be met from cash, investments, operating cash flow and portfolio maturities. Access to subsidiary dividends remains subject to regulatory, rating-agency and statutory restrictions.
- PROMESA created a federal oversight board and a framework for potential Puerto Rico debt restructuring; the effects on insured obligations, liens, litigation and recoveries remained uncertain. The company challenged Puerto Rico actions affecting pledged revenues and sought relief from the PROMESA litigation stay. PREPA restructuring discussions also remained conditional; PREPA had suspended debt-service-fund deposits.
- Other exposures include $546 million of gross potential claims on one infrastructure transaction with refinancing risk; recovery, if claims are paid, could take 10–35 years. The filing also describes possible liquidity claims of approximately $1.1 billion on leveraged-lease strip policies if all leases terminate early and obligors fail to make required payments; no such claim had occurred.
- CDS collateral posted was approximately $216 million at June 30. The filing warns that additional collateral demands could impair liquidity. CDS and certain VIE valuations rely on Level 3 models and significant unobservable inputs; management notes limited market liquidity and validation for these estimates.
- Brexit could affect insured credits, currencies, interest rates, U.K. regulation and AGE’s ability to write new business in other EU/EEA countries. Q2 foreign-exchange impacts included approximately $9 million of net-of-tax losses in earnings and $18 million of net-of-tax losses in other comprehensive income, primarily related to sterling.
- Rating agencies had affirmed key ratings in recent actions, including S&P’s AA (stable) ratings for insurance subsidiaries on July 27, 2016. Management cautions that downgrades could reduce business opportunities and premiums and could trigger collateral, liquidity or policy-payment consequences.
- Material litigation includes the LBIE dispute, for which the company could not reasonably estimate any potential loss; the other party’s expert estimated damages of $200–$500 million, excluding interest. The filing also describes Puerto Rico litigation and other recovery actions. Management stated expected litigation outcomes against the company were not expected to materially affect financial position or liquidity, while adverse outcomes in a period could affect results.
Important facts for investors to verify
- Subsequent Puerto Rico claim payments, revised loss estimates, restructuring terms, and the effect of PROMESA on liens, recoveries and litigation.
- CIFG acquisition accounting, purchase-price allocation, integration and realized contribution to earnings and capital.
- Operating cash flow, holding-company liquidity and dividend capacity under insurance-subsidiary restrictions, particularly after claims and collateral requirements.
- Sensitivity of expected losses and Level 3 fair values to credit, discount-rate, mortgage-performance and recovery assumptions.
- Developments in the LBIE case, PREPA restructuring, infrastructure refinancing exposure, ratings and Brexit-related regulation or currency movements.