Assured Guaranty Ltd. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; balance-sheet comparisons are with December 31, 2014. Amounts are in U.S. dollars unless stated otherwise. The company provides financial-guaranty insurance and related credit protection. Q3 figures include Radian Asset from its April 1, 2015 acquisition.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $368 million | $525 million | $1.432 billion | $1.073 billion |
| Net income | $129 million | $355 million | $627 million | $556 million |
| Diluted EPS | $0.88 | $2.09 | $4.13 | $3.13 |
| Operating income (non-GAAP) | $164 million | $177 million | $582 million | $410 million |
| Net earned premiums | $213 million | $144 million | $574 million | $412 million |
| Net investment income | $112 million | $102 million | $311 million | $301 million |
- Losses and claims: Loss and loss-adjustment expense was $112 million in Q3, compared with a $44 million benefit a year earlier; nine-month expense was $318 million versus $54 million. Net expected loss to be paid rose to $1.307 billion from $1.169 billion at year-end 2014.
- Cash flow: Operating cash flow was negative $39 million for nine months, versus positive $347 million in 2014. Investing activities provided $634 million, including the $800 million net cash acquisition outlay for Radian Asset; financing activities used $602 million. Cash ended the period at $66 million.
- Assets, debt and equity: Total assets were $15.034 billion and total liabilities $9.215 billion. Shareholders’ equity was $5.819 billion. Long-term debt had a $1.306 billion carrying value ($1.593 billion principal amount), little changed from year-end.
- Investments and liquidity: The investment portfolio totaled $11.343 billion, including $10.640 billion of fixed-maturity securities and $522 million of short-term investments. Management said it expected sufficient liquidity for the next 12 months; parent-company liquidity and access to subsidiary dividends are subject to regulatory and other restrictions. No conventional operating margin guidance is provided.
- Capital returns: The company repurchased 16.0 million shares for $420 million and paid $55 million in dividends during the first nine months. Shares outstanding declined to 142.9 million from 158.3 million at year-end.
Material changes and significant items
- AGC acquired Radian Asset for approximately $804.5 million on April 1. The deal added about $13.6 billion of net par at closing and generated a $214 million pretax bargain-purchase and settlement gain, including $55 million of bargain-purchase gain and $159 million from settling pre-existing relationships. Radian contributed approximately $348 million of revenue and $228 million of net income from acquisition through September.
- Q3 net income declined sharply year over year, principally because Q3 2014 included a large credit-derivative fair-value gain and higher gains on financial-guaranty variable-interest entities (VIEs). Q3 2015 also had higher Puerto Rico-related loss expense. Non-GAAP operating income decreased more modestly.
- Nine-month net income and operating income increased year over year, reflecting the acquisition gain and higher earned premiums, partly offset by increased losses, primarily related to Puerto Rico. Nine-month results also included $300 million of net fair-value gains on credit derivatives.
- Premium acceleration was a notable contributor: accelerated net earned premiums were $105 million in Q3 2015 versus $36 million, and $242 million for nine months versus $79 million. These largely reflect refundings or contract terminations and may vary by period.
- Net par outstanding was $372.4 billion versus $403.7 billion at year-end, while the acquired Radian portfolio increased exposure. Below-investment-grade (“BIG”) net par was $17.6 billion, or 4.7% of total net par, versus $18.2 billion, or 4.5%.
Outlook, risks and contingencies
- Puerto Rico: Net insured par exposure was $5.1 billion, all rated BIG internally. The company reported worsening fiscal and liquidity conditions, missed payments by the Puerto Rico Public Finance Corporation (which it does not insure), suspended Commonwealth deposits to its general-obligation redemption fund, and uncertainty about restructuring proposals. PREPA exposure was $744 million; the July 2015 debt-service payment was made after the insurers agreed to purchase $74 million of PREPA bonds. Negotiations with insurers remained unresolved, and PREPA had suspended deposits to its debt-service fund.
- Other credit and refinancing risks: Approximately $3.0 billion of infrastructure exposure carries refinancing risk; the company estimated gross claims on its two largest such transactions could reach $2.0 billion if refinancing were unavailable, with potential claims in 2017–2022. Expected recovery could take 10–35 years. Net direct exposure to selected European countries was $2.234 billion, including $866 million rated BIG.
- Loss estimates and valuation: Expected losses depend on long-dated, judgmental assumptions about defaults, recoveries, housing markets, interest rates and issuer behavior. Credit derivatives and all fair-value liabilities were Level 3; management noted that illiquid markets and unobservable model inputs can make estimates materially different from realized results. Credit-derivative fair-value changes can produce significant earnings volatility without indicating an equivalent change in cash claims.
- Post-quarter developments: The company said October terminations of five Alt-A CDS transactions and one CMBS transaction were expected to produce approximately $327 million of net fair-value gains in Q4 2015. It also reported that early-October agreements completed its pursuit of mortgage representations-and-warranties claims; the September 30 expected net benefit from existing agreements was $198 million.
- Ratings, collateral and contingencies: S&P had affirmed AA financial-strength ratings with stable outlook; Moody’s had maintained ratings but assigned negative outlooks to AGC and AGUK. The company had posted $333 million of collateral under CDS arrangements. Litigation includes a Lehman-related dispute for which the company said it could not reasonably estimate a possible loss, and other legal and reinsurance matters. Management stated ordinary-course litigation was not expected to materially affect financial position or liquidity, while acknowledging possible effects on period results.
- Guidance: The filing provides no quantified earnings or revenue forecast. Management cited modestly slower U.S. growth, global economic weakness, low interest rates and uncertain demand for financial-guaranty products; it expects future results to remain sensitive to credit conditions, rating actions, claims and market valuations.
Key facts for investors to verify
- How much of reported earnings and book-value growth reflects recurring underwriting and investment performance versus the Radian acquisition gain, premium accelerations and fair-value movements?
- Whether Puerto Rico and other public-finance deterioration increases expected losses, liquidity needs or collateral requirements, especially for PREPA and PRHTA.
- Whether Radian’s acquired premiums, loss estimates and portfolio performance develop in line with purchase-accounting assumptions.
- Whether the $198 million expected net R&W recovery is collected as projected, and how the October CDS terminations affect Q4 results and future exposure.
- How operating cash flow, claims paid, restricted assets, subsidiary dividend capacity and share repurchases affect holding-company liquidity and capital strength.
- Whether Level 3 credit-derivative and VIE valuation assumptions, reinsurer recoverability and disclosed legal contingencies change materially.