Assured Guaranty Ltd. — Q2 2015 Form 10-Q
Business and period: Bermuda-based financial guaranty insurer covering public finance and structured finance obligations. This unaudited filing covers the quarter and six months ended June 30, 2015; balance-sheet comparisons are with December 31, 2014. Assured Guaranty completed its acquisition of Radian Asset on April 1, 2015.
Key financial results
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $695 million | $353 million | $1,064 million | $548 million |
| Net earned premiums | $219 million | $136 million | $361 million | $268 million |
| Net investment income | $98 million | $96 million | $199 million | $199 million |
| Loss and loss adjustment expenses | $188 million | $57 million | $206 million | $98 million |
| Net income | $297 million | $159 million | $498 million | $201 million |
| Diluted EPS | $1.96 | $0.89 | $3.23 | $1.11 |
| Non-GAAP operating income | $278 million | $101 million | $418 million | $233 million |
Q2 and six-month earnings included a $214 million pretax bargain-purchase and settlement gain from Radian, as well as higher premium accelerations and commutation gains. Q2 included $12 million of acquisition-related costs. Six-month fair-value gains on credit derivatives were $214 million, versus losses of $108 million in the prior-year period; these market-driven marks can materially affect GAAP earnings and are excluded in part from operating income.
Financial position, cash flow and capital
- At June 30, total assets were $15.479 billion, liabilities $9.673 billion, and shareholders’ equity $5.806 billion. The investment portfolio was $11.631 billion; consolidated cash was $75 million.
- Long-term debt had a $1.305 billion carrying value. Six-month interest expense was $51 million. The filing reports no amounts outstanding under the $495 million Strip Coverage Facility, and the company was in compliance with its covenants.
- Six-month operating cash flow was $105 million, down from $222 million. Investing activities provided $299 million, including security sales and purchases and the $800 million net cash acquisition outflow for Radian. Financing activities used $404 million, including $285 million of share repurchases and $37 million of dividends.
- Assured Guaranty repurchased 10.6 million shares for $285 million in the first half. As of August 5, $280 million remained under share-repurchase authorizations. The company declared dividends of $0.24 per share for the first half.
- Management stated that AGL should have sufficient liquidity for the next 12 months. Holding-company liquidity depends substantially on subsidiary distributions, which are restricted by insurance regulation. AGL reported $145 million of cash and short-term investments; some investment assets are restricted or pledged.
Material changes and portfolio developments
- Radian added approximately $13.6 billion of net par at acquisition and increased scale, premiums and exposures. The acquisition was funded with $804.5 million cash consideration; a temporary $200 million parent loan was repaid in April.
- Total net par outstanding was $390.4 billion, down from $403.7 billion at year-end despite the acquisition. Below-investment-grade (BIG) net par rose to $20.4 billion from $18.2 billion; 5.3% of total net par was BIG.
- Net expected loss to be paid increased to $1.510 billion from $1.169 billion at year-end. Q2 economic loss development was $192 million, primarily driven by Puerto Rico, partly offset by higher discount rates. The company’s estimated net expected loss on troubled U.S. public finance exposures rose to $613 million from $310 million at March 31.
- Puerto Rico net exposure was $5.43 billion, all rated BIG internally, up from $4.94 billion at year-end. The company also reported $32.3 billion of net par in credit derivatives, compared with $35.0 billion at year-end.
- Net earned premiums increased chiefly because of accelerated recognition associated with refundings and the acquired Radian portfolio. The filing notes that scheduled premiums generally decline over time unless replenished by new business, reassumed business or acquisitions.
Outlook, commentary and principal risks
- No quantified earnings or operating guidance is provided. Management expected continued demand for municipal bond insurance, citing increased issuance and market penetration, but noted low interest rates, competition and rating perceptions could constrain demand. U.S. municipal issuance and insured penetration increased year over year in the first half.
- Puerto Rico’s fiscal and liquidity difficulties were a major risk. PREPA’s creditor forbearance agreements ran through September 15, 2015; a consensual recovery plan was not assured. PREPA paid $416 million of scheduled principal and interest on July 1, but the payment was facilitated by insurer purchases of PREPA bonds; Assured Guaranty purchased $74 million on July 31. Puerto Rico’s Public Finance Corporation missed most of a debt-service payment on August 3; Assured Guaranty said it did not insure those obligations.
- Approximately $3.1 billion of infrastructure exposure carried refinancing risk. For the two largest transactions, assumed claims could total $1.9 billion gross if refinancing failed, with payments potentially due during 2017–2022; recoveries could take 10–35 years and are uncertain.
- Management highlighted uncertainty in expected-loss estimates, recoveries from representations-and-warranties claims, reinsurer performance, credit markets, interest rates and Level 3 fair values. The company estimated a $225 million net future benefit from R&W recoveries, which may differ materially from realized amounts.
- Material contingencies include the Lehman Brothers International (Europe) litigation, for which the company could not estimate possible loss, and a disputed Spanish surety-reinsurance arbitration. Management said litigation outcomes were not expected to materially affect financial position or liquidity, while adverse outcomes could affect results in a particular period.
- Rating actions could affect new business, collateral demands and claims. S&P affirmed insurer ratings of AA with stable outlook in June 2015; rating agencies continue to review ratings. Management also cited potential downgrade-related claims and liquidity demands, including under certain swaps, variable-rate obligations and legacy GIC exposures.
Important facts for investors to verify
- Separate recurring operating performance from the $214 million Radian-related gain, premium accelerations, commutations and volatile credit-derivative marks.
- Track Puerto Rico exposure, PREPA negotiations and payments, and changes in expected losses and reserve estimates.
- Assess whether cash flow, restricted assets, subsidiary dividend capacity and collateral requirements support holding-company liquidity and planned repurchases.
- Review Radian integration, acquired portfolio credit quality, and the ongoing development of BIG exposures and net expected losses.
- Monitor refinancing risks in infrastructure, R&W recovery assumptions, reinsurer collectability, ratings and unresolved legal matters.