Business Context and Reporting Period
Assured Guaranty Ltd. is a Bermuda-based financial guarantor serving public finance, infrastructure and structured finance markets. This unaudited Form 10-Q covers the three months ended March 31, 2011; comparisons are with the three months ended March 31, 2010 unless noted. The company no longer reports separate direct and reinsurance segments, reflecting management’s consolidated approach. It wrote no new CDS after 2009 and does not currently underwrite new U.S. RMBS.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 / prior balance |
|---|---|---|
| Total revenue | $254.1 million | $667.3 million |
| Net earned premiums | $254.0 million | $319.6 million |
| Net investment income | $96.4 million | $84.3 million |
| Net income; diluted EPS | $125.4 million; $0.67 | $322.0 million; $1.69 |
| Non-GAAP operating income | $248.9 million | $112.6 million |
| Operating cash flow | $(158.2) million | $(236.6) million |
| Investing / financing cash flow | $402.4 million / $(257.3) million | $346.6 million / $(63.4) million |
| Cash at period end | $95.9 million | $90.5 million |
| Total assets; shareholders’ equity | $19.51 billion; $3.89 billion | At Dec. 31, 2010: $19.79 billion; $3.80 billion |
| Long-term debt | $1.05 billion carrying value; $1.37 billion principal | At Dec. 31, 2010: $1.05 billion carrying value |
Investment portfolio was $10.51 billion at March 31, including $9.47 billion of fixed maturities and $768.5 million of short-term investments. The filing does not present a conventional operating margin. The company paid a $0.045-per-share dividend, unchanged from Q1 2010.
Material Changes Versus the Prior Comparable Period
- Net income fell $196.6 million, chiefly because credit derivatives generated $271.1 million of unrealized losses versus $252.1 million of unrealized gains in Q1 2010. Management attributes the change to market spreads, valuation assumptions and related factors; these fair-value movements do not necessarily represent ultimate claims.
- Net earned premiums declined $65.6 million, primarily as the structured finance book ran off. Net investment income rose $12.1 million, mainly from cash deployed during 2010 and improved accretion on certain investments.
- Reported loss and loss adjustment expenses were a $27.0 million recovery, compared with $130.5 million of expense. The result reflected updated loss estimates and higher expected recoveries, including from the Bank of America agreement; underlying RMBS assumptions also worsened.
- Non-GAAP operating income increased to $248.9 million from $112.6 million. This measure excludes specified items, including non-credit derivative fair-value changes and VIE consolidation effects; it is not a GAAP substitute.
- New-business production weakened: present value of new business production (PVP) was $52.5 million versus $78.8 million, and gross par written was $2.32 billion versus $7.19 billion. Management cited a 55% contraction in the U.S. municipal new-issue market.
- Net insured par outstanding declined to $602.3 billion from $617.1 billion. Below-investment-grade (BIG) exposure increased slightly to $26.8 billion, or 4.5% of net par, from $26.8 billion, or 4.3%.
Outlook, Commentary, Risks and Unusual Items
- Bank of America agreement: Signed April 14, 2011, after quarter-end but incorporated into March 31 loss estimates as a subsequent event. Bank of America paid $850 million and is to pay another $250 million by March 2012. It will reimburse 80% of claims on 21 first-lien RMBS transactions, subject to a $6.6 billion collateral-loss limit; $1 billion of eligible assets was placed in trust. Covered transactions had $4.8 billion net par outstanding at quarter-end. Management recorded a substantial increase in estimated R&W recoveries, but actual recoveries remain uncertain.
- Mortgage outlook and estimates: Management reported elevated early-stage delinquencies and higher first-lien loss severities, and extended the modeled recovery period for second-lien exposures. Initial Alt-A and Option ARM loss-severity assumptions rose from 60% to 65%; the modeled second-lien stress period lengthened by 12 months to 36 months. Loss estimates are sensitive to default, severity, prepayment, housing-market and recovery assumptions.
- Ratings: As of May 9, 2011, AGM and AGC had Moody’s Aa3 ratings with negative outlook and S&P AA+ ratings with stable outlook. S&P’s proposed criteria could result in one or more rating-category downgrades if adopted; final criteria and updated ratings were expected in Q3 2011. A downgrade could increase claims, trigger collateral or CDS termination payments, affect reinsurance and weaken demand for new guarantees.
- Liquidity and debt: Management said holding-company liquidity should be adequate for the next 12 months, with subsidiary dividends a major source; future external financing may be needed and may be costly or unavailable. The $300 million revolving facility had no borrowings, and the company reported covenant compliance. Cash and short-term investments totaled approximately $864 million, while some securities were pledged or held in trust.
- Credit and legal exposures: The portfolio includes $24.1 billion net par of U.S. RMBS, of which $16.2 billion was BIG. Net fair value of credit derivatives was a $2.14 billion liability, based on significant Level 3 inputs. A court ruling on one RMBS waterfall could require repayment of $7.2 million and, if not modified, lead to up to approximately $144 million of unreimbursed claims over the transaction’s life. Other RMBS, municipal derivatives and reinsurance disputes remain unresolved; management says some potential losses cannot be reasonably estimated.
- Additional risks and unusual items: The company reported $237.6 million of net claims paid in Q1. Foreclosure delays may affect RMBS loss timing and severity. Reinsurer financial distress, the ability to collect recoveries, and Dexia-related support for former financial-products exposures are material considerations. Dodd-Frank implementation and other regulatory changes could affect derivatives, capital needs and business opportunities.
- Premium runoff: Approximately $6.0 billion of remaining deferred premium revenue is expected to be earned over time. Management expects earned premiums to decline each year unless replaced by new business; no formal earnings guidance was provided.
Most Important Facts for Investors to Verify
- Whether Bank of America makes the scheduled payment and reimbursement obligations, and whether the collateral remains sufficient.
- How actual RMBS delinquencies, severities, foreclosure timing and loan repurchases compare with management’s assumptions, and whether the estimated R&W recoveries are realized.
- Whether S&P’s final criteria or other rating actions trigger insurer downgrades, accelerated claims, collateral calls or CDS terminations.
- Whether reinsurers, Dexia and related support providers meet their obligations, and how unresolved litigation or the RMBS waterfall appeal develops.
- Whether operating cash needs, claims, restricted assets and dividend limits leave adequate liquidity at the holding company and regulated subsidiaries.
- How much reported earnings and book value depend on Level 3 derivative/VIE valuations, tax assumptions and non-GAAP adjustments.