Assured Guaranty Ltd. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods unless noted. Amounts are in millions of dollars except per-share data. Assured Guaranty provides financial guarantees on public-finance and structured-finance obligations.
Financial performance and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $353 | $465 | $548 | $289 |
| Net earned premiums | $136 | $163 | $268 | $411 |
| Net investment income | $96 | $93 | $199 | $187 |
| Loss and loss adjustment expenses | $57 | $62 | $98 | $14 |
| Net income | $159 | $219 | $201 | $75 |
| Diluted EPS | $0.89 | $1.16 | $1.11 | $0.39 |
| Non-GAAP operating income | $101 | $98 | $233 | $358 |
| Non-GAAP operating income per share | $0.56 | $0.52 | $1.28 | $1.87 |
The filing does not provide a single operating margin measure. Reported results include substantial fair-value movements in credit derivatives and consolidated financial-guaranty VIEs, which can make GAAP revenue and earnings volatile.
- Balance sheet at June 30: Total assets were $15.69 billion, total liabilities $10.45 billion and shareholders’ equity $5.24 billion. The investment portfolio was $11.64 billion and cash was $106 million.
- Debt: Long-term debt carrying value was $1.31 billion, up from $816 million at year-end 2013. AGUS issued $500 million of 5.0% senior notes due 2024, receiving net proceeds of $496 million; proceeds were held in short-term and other marketable securities.
- Cash flow, six months: Operating cash flow was $222 million versus $122 million. Investing activities used $229 million versus providing $472 million; financing activities used $73 million versus $585 million. Cash declined by $78 million to $106 million.
- Loss estimates and liquidity: Net expected loss to be paid was $1.035 billion, compared with $982 million at December 31, 2013. Loss and LAE reserves were $775 million, up from $592 million. Management said holding-company liquidity should be sufficient for the next 12 months and targets liquid assets at insurance subsidiaries equal to 1.5 times projected operating-company cash needs over the next four quarters.
- Capital returns: The company repurchased 8.4 million shares for $212 million during the first half and paid $40 million of dividends. A further $400 million repurchase authorization was approved August 6, 2014, after quarter-end.
Material changes versus comparable periods
- Q2 net income fell to $159 million from $219 million, chiefly because fair-value gains on FG VIEs were lower ($25 million versus $143 million) and premiums declined; gains on credit derivatives and lower U.S. RMBS losses partly offset the decline.
- First-half net income rose to $201 million from $75 million, principally reflecting much smaller credit-derivative fair-value losses and higher other income, including commutation gains. First-half operating income, however, fell to $233 million from $358 million, reflecting lower earned premiums and credit-derivative revenues and higher losses.
- Net earned premiums fell in both comparison periods, mainly from lower premium accelerations and runoff of the insured portfolio. Six-month loss and LAE increased to $98 million from $14 million, with higher U.S. public-finance and other structured-finance losses.
- Net par outstanding declined to $438.8 billion from $460.3 billion at year-end 2013. Below-investment-grade (“BIG”) net par declined slightly to $21.6 billion from $22.5 billion, or 4.9% of total net par at both dates.
- Shareholders’ equity increased to $5.24 billion from $5.12 billion; adjusted book value per share, a non-GAAP measure, increased to $50.82 from $49.58.
Outlook, commentary, risks and unusual items
- Business outlook: No formal earnings guidance was provided. Management described U.S. economic conditions as gradually improving, noted municipal-market insurance penetration improved, and reported $3.9 billion of insured new municipal issues in the first half, up from $3.4 billion a year earlier. Management cited low interest rates as a constraint on demand and viewed U.K. infrastructure and future structured-finance activity as potential opportunities.
- Puerto Rico: Net exposure was $5.2 billion, of which $5.0 billion was rated BIG. The filing describes fiscal deficits, constrained market access and near-term refinancing risk. Puerto Rico’s Recovery Act, enacted in June 2014, was being challenged in court; PREPA had drawn $42 million from reserves to make July 1 debt service. These developments drove much of Q2’s increase in expected U.S. public-finance losses.
- Other stressed exposures: The company had $2.1 billion net par exposure to Detroit and $119 million exposure to Stockton’s general fund, among other troubled credits. Settlements or proposed plans remained subject to court approval and other conditions. European direct net exposure to selected countries was $2.83 billion, with $1.12 billion rated BIG.
- Refinancing and claims risk: Approximately $3.1 billion of insured infrastructure exposure had refinancing risk. Under specified assumptions, claims on the two largest such transactions could total $1.8 billion gross from 2017–2022, with recoveries potentially taking 10–35 years. All AGM leveraged-lease strip transactions were breaching rating triggers; potential liquidity claims were approximately $1.3 billion gross if leases terminated and obligors failed to pay, though none had produced a claim to date.
- Recoveries and estimates: The company had received or agreed to receive approximately $3.8 billion gross from RMBS representations-and-warranties actions and included a $651 million net expected benefit in loss estimates. Recoveries not supported by agreements remain uncertain and may differ significantly from estimates. RMBS estimates depend on uncertain housing, default, severity and recovery assumptions.
- Fair-value and rating risks: Credit derivatives and FG VIEs rely substantially on Level 3 models and unobservable inputs; management cautioned that actual values may differ materially. S&P upgraded insurance subsidiaries to AA with stable outlook in March. Moody’s affirmed ratings in July but assigned negative outlooks to AGC and AGUK. Rating changes may affect business, collateral needs, claims and liquidity.
- Other developments: The company recorded a $120 million gain from deconsolidating seven FG VIEs during the first half and a further $37 million gain related to accelerating two VIEs. Reinsurance commutations reassumed approximately $856 million of par exposure. The filing also describes ongoing RMBS recovery litigation and other legal matters; management could not estimate possible losses for certain proceedings.
Important facts for investors to verify
- Whether Puerto Rico, Detroit and other stressed credits cause further increases in expected losses or actual claim payments.
- Whether projected RMBS and representations-and-warranties recoveries are realized, and how sensitive loss estimates are to changed assumptions.
- How much reported earnings depend on Level 3 fair-value movements, VIE consolidation and other nonrecurring items versus operating income.
- Whether insurer ratings, collateral requirements, reinsurance collectability and regulatory dividend limits affect subsidiary and parent liquidity.
- Whether refinancing-risk exposures or leveraged-lease triggers result in material claims, and whether recoveries arrive on the expected timetable.
- How the new debt issuance and expanded repurchase authorization affect leverage, liquidity and per-share value.