Business context and reporting period
Assured Guaranty Ltd. (AGL) is a Bermuda-based financial guaranty insurer serving U.S. and international public finance, infrastructure and structured finance markets. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2012; comparisons are with the corresponding 2011 periods unless noted. AGL’s results include substantial fair-value effects from credit derivatives and consolidated financial guaranty variable-interest entities (FG VIEs).
Key financial metrics
Amounts below are in millions of dollars except per-share data and where indicated.
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | 759.5 | 116.3 | 402.1 | 395.2 |
| Net earned premiums | 219.3 | 230.1 | 413.0 | 484.0 |
| Net investment income | 101.6 | 102.6 | 199.4 | 200.0 |
| Loss and loss adjustment expenses | 122.5 | 123.9 | 369.3 | 98.4 |
| Net income (loss) | 376.5 | (43.1) | (106.5) | 96.2 |
| Diluted EPS | $2.01 | $(0.23) | $(0.58) | $0.51 |
| Non-GAAP operating income | 114.0 | 143.4 | 185.2 | 390.8 |
Balance sheet at June 30: total assets were $18.07 billion, total liabilities $13.35 billion and shareholders’ equity $4.72 billion. Cash was $175.3 million and short-term investments $919.8 million. Long-term debt had a carrying value of $846.4 million, down from $1.04 billion at December 31, 2011; principal outstanding was $1.15 billion.
Cash flow, six months: operating activities provided $162.1 million, compared with $631.9 million in 2011; investing activities provided $273.4 million versus $44.8 million; financing activities used $471.1 million versus $622.8 million. Cash ended the period at $175.3 million, down from $214.5 million at year-end. The filing does not present a conventional operating margin as a key measure; non-GAAP operating income was $0.61 per diluted share for Q2 and $0.99 for the six-month period.
Material changes versus the prior comparable period
- Q2 GAAP net income improved sharply, but was highly affected by valuation movements: credit derivatives recorded a $260.7 million fair-value gain versus a $64.8 million loss in Q2 2011, while FG VIEs recorded a $172.4 million gain versus a $174.3 million loss. Management attributed significant portions of the Q2 2012 gains to the Deutsche Bank settlement. These marks can be volatile and are not equivalent to operating cash earnings.
- For the first half, AGL reported a $106.5 million net loss versus $96.2 million net income in 2011. The $430.0 million net credit-derivative fair-value loss and higher loss expenses were major factors. Non-GAAP operating income fell to $185.2 million from $390.8 million.
- Premium revenue declined: six-month net earned premiums fell 15% to $413.0 million, mainly as structured-finance exposures ran off. Q2 premiums included $68.2 million of refunding and other accelerated earnings, versus $21.0 million a year earlier.
- Net expected loss to be paid across the insured portfolio, after estimated representations-and-warranties (R&W) recoveries, was $1.20 billion at June 30, up from $1.11 billion at year-end. Below-investment-grade (BIG) net par was $24.8 billion, or 4.5% of net par outstanding, versus $26.8 billion, or 4.8%, at year-end.
- Shareholders’ equity increased to $4.72 billion from $4.65 billion. AGL issued 13.43 million shares when its equity units settled and repurchased 2.07 million shares for $24.3 million during the half-year.
Outlook, management commentary, risks and unusual items
- Business and outlook: Management said it remained the most active financial guaranty provider, but described industry conditions and demand as difficult. U.S. municipal issuance increased in Q2, while low interest rates can reduce demand for insurance. No numerical earnings guidance was provided. Management expects earned premiums to decline over time as the existing book runs off unless replaced by new business, and said recovery in structured finance and international infrastructure opportunities is possible but not assured. Six-month U.S. municipal market penetration by par was 4.0%, down from 5.6% in 2011.
- Ratings: Moody’s placed AGL and most existing subsidiaries on review for possible downgrade in March 2012. Management warned that further downgrades could weaken new-business opportunities and premiums, prompt collateral posting or claims, and affect reinsurance, GICs and other contracts.
- Mortgage and recovery exposure: A May 2012 Deutsche Bank agreement provided $165.6 million in cash and loss-sharing protections for specified RMBS exposures; approximately $282.7 million of eligible assets was placed in trust as collateral. The company’s estimated R&W benefit in loss estimates is material and uncertain; actual recoveries depend on counterparties, loan-file access, future losses and agreements or litigation.
- Public finance and Europe: Expected net losses on troubled U.S. public finance credits rose to $58.4 million from $32.7 million at March 31, primarily reflecting Jefferson County and Stockton. AGL’s net economic exposure to six selected European countries was $4.78 billion; its Greece exposure had a full-limit loss established. Greece-related exchanges produced $216.2 million of inception-to-date net economic loss development, and the company accelerated or planned to accelerate claims on the affected bonds.
- Other notable transactions: AGL acquired MIAC for $91.1 million in cash in May. Reassumptions and reinsurance transactions with Radian and Tokio involved approximately $19.1 billion of par and generated $83.3 million of first-half commutation gains. A new $435 million excess-of-loss reinsurance facility was arranged for certain public-finance losses.
- Liquidity and contingent demands: Management stated that holding-company liquidity should be sufficient for the next 12 months, including common dividends, and that operating subsidiaries could meet near-term needs from cash, investments and operating cash flow. However, $687.9 million of collateral was pledged under derivative contracts. Rating triggers can create further demands: specified AGM swap guarantees could involve up to $370.1 million of termination claims if stated conditions are met; AGM downgrade scenarios could require GIC withdrawals and collateral posting. The former GIC business also depends on Dexia-related guarantees and liquidity facilities.
- Legal matters: An adverse ruling concerning reimbursement priority in an RMBS transaction could result in up to approximately $144 million of gross discounted unreimbursed claims over the life of the transaction, excluding a separate $7.2 million repayment, if not changed on appeal. The filing also describes RMBS recovery suits, municipal and former financial-products investigations and litigation; certain potential losses could not be reasonably estimated.
- Estimation and valuation risk: Expected losses, R&W recoveries, credit-derivative marks and FG VIE valuations depend on assumptions and significant unobservable inputs. Management noted continued mortgage-market uncertainty, elevated early-stage delinquencies and the possibility that actual losses and recoveries differ materially from estimates.
Most important facts an investor should verify
- Separate recurring underwriting performance from volatile GAAP fair-value results; review the reconciliation of net income to non-GAAP operating income and the assumptions behind derivative and FG VIE marks.
- Track updates to expected losses, especially Greece, RMBS collateral performance, R&W recoveries, Jefferson County and Stockton; compare subsequent claims and recoveries with management’s estimates.
- Review Moody’s and S&P rating actions and the related triggers for collateral, CDS termination payments, GIC withdrawals, leveraged leases and reinsurance recapture.
- Assess liquidity available at the holding company versus regulated insurance subsidiaries, including pledged collateral, dividend restrictions and reliance on Dexia-related support for the former GIC business.
- Confirm the outcome and financial effect of the RMBS reimbursement appeal, recovery litigation and former financial-products investigations, including matters for which the company could not estimate a loss range.