Assured Guaranty Ltd. — FY2010 Form 10-K
Reporting period: Year ended December 31, 2010. The filing is an annual report, not a standalone fourth-quarter report. Assured Guaranty is a Bermuda-based financial guaranty insurer and reinsurer serving public finance, infrastructure and structured finance markets. Results include a full year of acquired AGMH operations in 2010 versus six months in 2009.
Financial performance and position
| Metric | FY2010 / Dec. 31, 2010 | Prior comparable period |
|---|---|---|
| Total revenue | $1.401 billion | $917.2 million in 2009 |
| Net earned premiums | $1.187 billion | $930.4 million in 2009 |
| Net investment income | $354.7 million | $259.2 million in 2009 |
| Net income attributable to AGL | $548.9 million; diluted EPS $2.90 | $97.2 million; diluted EPS $0.75 in 2009 |
| Income before tax | $635.5 million | $132.9 million in 2009 |
| Operating income (non-GAAP) | $660.3 million | $293.4 million in 2009 |
| Operating cash flow | $104.0 million | $279.2 million in 2009 |
| Claims paid, net | $931.7 million | $687.7 million in 2009 |
| Investments and cash | $10.837 billion | $11.013 billion at year-end 2009 |
| Long-term debt, carrying value | $1.053 billion | $1.066 billion at year-end 2009 |
| Shareholders’ equity | $3.799 billion; book value $20.67 per share | $3.520 billion; $19.12 per share at year-end 2009 |
| Net insured par outstanding | $617.1 billion; 4.3% internally rated below investment grade | $640.4 billion; 4.0% below investment grade |
Calculated from reported figures, net margin was approximately 39% and pre-tax margin approximately 45%; both are influenced by fair-value accounting, consolidation changes and other items described below. These are not company-reported margin measures.
Material changes and unusual items
- Net income rose substantially, but the comparison is affected by the full-year inclusion of AGMH, a $55.8 million tax benefit from an amended pre-acquisition tax return, and $49.8 million of commutation gains. The filing also reports $183.1 million of net losses from changes in financial-guaranty VIEs.
- Loss and loss-adjustment expense increased to $413.8 million from $377.8 million. U.S. RMBS losses were a key driver; management cited slower expected housing recovery and raised its initial subprime loss-severity assumption from 70% to 80%.
- Operating cash flow declined despite higher earnings. Cash outflows included $931.7 million of net claims paid, compared with $687.7 million in 2009.
- Adopting a revised VIE consolidation standard reduced opening retained earnings by $206.5 million after tax. The company consolidated 29 VIEs at year-end; the change reduced 2010 GAAP net income by $105.2 million, according to the filing’s reconciliation.
- U.S. public-finance and structured-finance new business production weakened: present value of new business production (PVP, non-GAAP) fell to $362.7 million from $640.2 million; gross par written declined to $30.8 billion from $49.9 billion. Management attributed the decline to the Build America Bonds program, rating recalibration and uncertainty over insurer ratings.
Liquidity, debt and capital
- Year-end cash was $107.2 million; investments and cash totaled approximately $10.8 billion. Management said it expected holding-company liquidity needs over the next 12 months, including common dividends, to be met, primarily through subsidiary dividends. Subsidiary dividends and other transfers are restricted by regulation, contracts and rating requirements.
- Carrying-value long-term debt was $1.053 billion; contractual obligations totaled $9.881 billion, including $3.877 billion of undiscounted expected financial-guaranty claim payments. These claim-payment estimates are not reduced for reinsurance or estimated representation-and-warranty recoveries.
- At year-end, $765.9 million of eligible securities were pledged as collateral. A $300 million revolving facility had no borrowings outstanding; the $991.9 million Dexia strip-coverage facility and other described credit facilities also had no amounts drawn.
- Reported statutory policyholders’ surplus was $2.627 billion and claims-paying resources were $12.630 billion. These statutory measures are not the same as GAAP equity or unrestricted holding-company liquidity.
Outlook, risks and contingencies
- Management sees longer-term demand for municipal and infrastructure guarantees, but near-term production depends on market issuance, spreads and the company’s financial-strength ratings. The filing provides no numerical earnings or revenue guidance.
- As of February 2011, AGM and AGC were rated Aa3 with negative outlook by Moody’s and AA+ with stable outlook by S&P; S&P had downgraded them from AAA in October 2010. S&P’s proposed criteria could require additional statutory capital to preserve an AA-level rating: the company estimated up to about $1.8 billion under one treatment of non-U.S. public finance exposures, or about $2.3 billion if that adjustment were not made. The criteria were proposals, not final requirements.
- U.S. RMBS remained a major risk: net par was $25.1 billion, and 65.1% of that exposure was internally rated below investment grade. Estimated future representation-and-warranty recoveries of $1.6 billion reduce estimated losses but depend on file access, successful enforcement and counterparties’ ability to pay; actual recoveries could differ materially.
- Reinsurance counterparties present collection and recapture risks. The company had ceded approximately 9.4% of principal outstanding; some reinsurers had weak or withdrawn ratings. Statutory unearned premiums subject to potential recapture included $133.3 million at AG Re and $162.0 million at AGC.
- AGM’s guarantees relating to AGMH’s former financial-products business remain, although that business was not acquired and Dexia and, for certain GIC exposures, the Belgian and French governments provided guarantees and liquidity arrangements. The company warned that delayed or failed performance could expose AGM to credit and liquidity claims.
- Litigation includes RMBS recovery actions, municipal-finance claims and investigations and lawsuits concerning AGMH’s former municipal GIC business. Management could not reasonably estimate losses for several proceedings. A separate reimbursement-priority dispute could involve up to approximately $144 million of gross, undiscounted claims if resolved adversely.
- Other risks include municipal budget stress, foreclosure delays, volatile Level 3 credit-derivative valuations, collateral calls or termination rights after rating downgrades, regulatory changes including Dodd-Frank, and tax uncertainty. The financial statements received an unqualified audit opinion; management and the auditor reported effective internal control over financial reporting at year-end.
Most important facts for investors to verify
- How much of reported earnings reflects recurring underwriting and investment performance versus AGMH acquisition accounting, the amended-return tax benefit, commutations and VIE fair-value movements.
- Whether RMBS loss assumptions and the $1.6 billion estimated representation-and-warranty recovery benefit are supported by realized recoveries and counterparty capacity.
- Final rating-agency criteria, any resulting capital requirements, and the effect of any downgrade on new business, collateral, claims and reinsurance recapture.
- Liquidity available at the holding company after considering insurance-subsidiary dividend restrictions, collateral needs and the reliability of Dexia and government support arrangements.
- Developments in material RMBS, municipal and former GIC-business litigation, and any resulting claims or recoveries.