ASSURED GUARANTY LTD quarterly report, Q3 FY2013

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Assured Guaranty Ltd. — Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2013; comparative periods are the corresponding 2012 periods. Filed November 12, 2013. Amounts are in U.S. dollars unless noted.

Business context

Bermuda-based holding company providing financial guaranty insurance and credit protection, principally for U.S. and international public finance, infrastructure and structured finance obligations. Results include consolidated financial guaranty variable interest entities (FG VIEs). The company had stopped writing new credit-default-swap protection in early 2009.

Financial results and position

  • Third-quarter revenue: $670 million, versus $338 million; net income was $384 million, or $2.09 diluted per share, versus $142 million, or $0.73. A $330 million unrealized gain on credit derivatives was a major contributor to the quarter’s results.
  • Nine-month revenue: $959 million, versus $731 million; net income was $459 million, or $2.43 diluted per share, versus $36 million, or $0.19.
  • Non-GAAP operating income: $117 million for the quarter, down from $166 million; $475 million for nine months, up from $351 million. The quarter’s decline reflected scheduled premium amortization and fewer refundings and negotiated terminations, partly offset by lower loss expense. This measure excludes, among other items, non-credit fair-value changes.
  • Premiums and investment income: Net earned premiums were $159 million for the quarter and $570 million for nine months, down from $222 million and $635 million. Net investment income was $99 million and $286 million, versus $102 million and $301 million. Management cited portfolio runoff and lower reinvestment rates; no standard operating margin is stated.
  • Losses: Loss and loss-adjustment expense was $55 million for the quarter and $69 million for nine months, compared with $86 million and $446 million. Net expected loss to be paid was $806 million at September 30, versus $677 million at year-end 2012; the increase included deterioration in troubled U.S. public finance exposures.
  • Cash flow: Nine-month operating cash flow was $146 million, versus an outflow of $223 million. Investing activities provided $570 million and financing activities used $747 million. Cash ended the period at $106 million, down from $138 million at year-end.
  • Balance sheet and debt: Total assets were $16.354 billion, liabilities $11.520 billion and shareholders’ equity $4.834 billion, compared with $17.242 billion, $12.248 billion and $4.994 billion at December 31, 2012. Long-term debt had a carrying value of $819 million and principal of $1.118 billion.
  • Portfolio and capital: Net insured par outstanding, excluding loss-mitigation bonds, was $473.370 billion, down from $518.772 billion. Below-investment-grade (BIG) net par was $18.557 billion, or 3.9% of the portfolio, versus $22.297 billion, or 4.3%. The company changed its rating approach and excluded loss-mitigation securities from these disclosures, affecting comparability. Adjusted book value, a non-GAAP measure, was $49.55 per share versus $47.17; repurchases reduced shares outstanding.

Material changes and notable items

  • Credit-derivative fair-value results swung to a $354 million gain in the quarter from a $36 million loss a year earlier; for nine months, the change was a $164 million loss versus a $466 million loss. These marks are volatile, largely model-based and substantially affected by credit spreads, including the company’s own spreads.
  • Economic loss development was favorable by $22 million in the quarter and $33 million for nine months, chiefly reflecting higher projected RMBS representations-and-warranties recoveries. This contrasts with $64 million of adverse development in the 2012 quarter and $365 million for the 2012 nine-month period. Management cautioned that mortgage-market recovery was not showing up as quickly in first-lien transaction performance as previously anticipated.
  • The company reported approximately $3.5 billion of gross R&W payments received or agreed, and included an estimated $895 million net R&W benefit in expected-loss estimates. A portion remains dependent on future recoveries, litigation, counterparties’ ability to pay and assumptions about loan losses.
  • MAC was capitalized in July with $700 million of equity and a $100 million surplus note; it received ratings of AA+ from Kroll and AA- from S&P. Affiliates ceded approximately $111 billion of par exposure to MAC.
  • After quarter-end, AGL became U.K. tax resident effective November 6, 2013, while remaining Bermuda-based. Management expected no material change to the group’s overall tax charge; regulatory discussions with U.K. and New York authorities were continuing.
  • In November, the board authorized a new $400 million share-repurchase program, replacing the prior authorization. Through November 11, 2013, repurchases under the prior program totaled approximately $264 million.

Outlook, risks and contingencies

  • No formal earnings or revenue guidance is provided. Management expected operating subsidiaries’ cash, short-term investments and operating cash flow to meet liquidity needs over the next 12 months, and said AGL expected sufficient holding-company liquidity, including for common dividends. Availability of subsidiary dividends is subject to regulatory and rating-agency constraints.
  • Key credit risks include Puerto Rico exposure of $5.5 billion net par; Detroit exposure of $2.1 billion; refinancing risk on approximately $3.1 billion of infrastructure exposures; and municipal bankruptcy and fiscal stress. The company said Puerto Rico credits were current, with 92% of exposure internally and externally rated investment grade.
  • The remaining two largest infrastructure refinancing-risk transactions could generate estimated claims of $1.8 billion gross, or $1.3 billion net of reinsurance, from 2017–2022 if not refinanced; reimbursement could take years and is uncertain.
  • Ratings downgrades could reduce new business and premium capacity and trigger collateral, liquidity or claims consequences. At September 30, $681 million of collateral was posted by insurance subsidiaries. The company also identified possible additional liquidity claims on $1.6 billion gross leveraged-lease strip exposure if all leases terminated early and obligors failed to pay.
  • Reinsurance collectability, RMBS loss estimates and R&W recoveries are material uncertainties. Legal proceedings include RMBS recovery actions and municipal matters; the company said adverse outcomes in certain matters could affect results. A Wells Fargo interpleader case could add approximately $10 million of net losses if resolved adversely.
  • Reported GAAP income is sensitive to fair-value assumptions, discount rates, credit spreads and FG VIE valuations; much of the relevant exposure is Level 3 and lacks active-market pricing. Management reported no material change in market risk since year-end 2012 and effective disclosure controls.

Important facts for investors to verify

  • How much of reported earnings growth reflects recurring underwriting and investment performance versus volatile credit-derivative and FG VIE fair-value movements?
  • Whether projected $895 million net R&W recoveries are realized, and the sensitivity of expected losses to mortgage performance and recovery assumptions.
  • Progress and ultimate costs or recoveries for Detroit, Puerto Rico, Stockton, Jefferson County and infrastructure refinancing exposures.
  • Holding-company liquidity and the amount of cash and capital legally available for dividends and repurchases after insurance-company restrictions and collateral needs.
  • Effects of U.K. tax residency and evolving group-regulation arrangements, including whether anticipated tax and capital-management benefits are achieved.