Assured Guaranty Ltd. — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. Assured Guaranty provides financial guaranty insurance, reinsurance and credit protection for public finance, infrastructure and structured finance obligations. The 2009 acquisition of AGMH and 2010 changes in VIE consolidation affect comparisons with prior periods.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenues | $244.2 million | $283.8 million | $1,354.4 million | $357.4 million |
| Net earned premiums | $288.7 million | $330.0 million | $900.4 million | $557.1 million |
| Net investment income | $85.6 million | $84.7 million | $260.8 million | $171.6 million |
| Net income (loss) attributable to AGL | $180.9 million | $(35.0) million | $706.4 million | $(119.5) million |
| Diluted EPS | $0.96 | $(0.22) | $3.73 | $(1.05) |
| Operating income (non-GAAP) | $222.8 million | $46.2 million | $507.4 million | $137.0 million |
- Q3 net income improved from a year-earlier loss, despite a $284.9 million unrealized loss on credit derivatives. A $55.8 million tax benefit from an amended return, lower loss expenses and lower acquisition-related costs contributed to the improvement.
- Nine-month 2010 results include substantial gains and changes from VIE consolidation; the filing cautions that the period is not directly comparable with 2009. Operating income is a company-defined non-GAAP measure.
- Q3 loss and loss-adjustment expenses were $109.1 million, versus $133.3 million. Nine-month expenses increased to $310.8 million from $251.1 million. Nine-month net claims paid were $756.3 million, including $95.9 million for consolidated VIEs.
- At September 30, assets were $18.37 billion, liabilities $14.18 billion and shareholders’ equity $4.19 billion. The investment portfolio was $10.68 billion, including $9.78 billion in fixed maturities and $907.7 million in short-term investments; cash was $87.4 million.
- Long-term debt had a carrying value of $923.8 million; notes payable were $132.1 million. No amounts were drawn under the disclosed revolving or loss-support credit facilities, and the company reported compliance with applicable financial covenants.
- For the first nine months, operating cash flow was negative $140.0 million, compared with positive $293.6 million in 2009. Investing activities provided $735.8 million and financing activities used $551.0 million; cash increased by $43.3 million.
Material changes and portfolio developments
- Net insured par outstanding declined to $628.1 billion from $640.4 billion at year-end 2009. Public finance accounted for $468.7 billion and structured finance $159.4 billion. Below-investment-grade exposure was $27.0 billion, or 4.3% of total net par.
- U.S. RMBS net par was $26.0 billion; 64.7% was internally rated below investment grade. Net loss and LAE reserves on the balance sheet were $448.9 million, compared with $275.4 million at year-end. Expected losses remain sensitive to mortgage performance and recovery assumptions.
- Management estimated $1.3 billion of net recoveries from mortgage-loan representation-and-warranty breaches in its loss estimates. Agreed repurchases to date totaled $390 million. Actual recoveries may differ materially; the estimate excludes possible litigation damages.
- New business production weakened: present value of new business production (non-GAAP) was $88.9 million in Q3 versus $158.1 million, and $257.6 million for nine months versus $519.8 million. Gross par written for nine months fell to $22.9 billion from $41.9 billion.
- Adopting new VIE consolidation guidance reduced opening retained earnings by $206.5 million after tax. At September 30, 23 VIEs were consolidated; their assets and liabilities were $2.30 billion and $2.46 billion, respectively. The company stated it is not primarily liable for VIE debt, and its creditors have no rights to VIE assets.
Outlook, risks and unusual items
- Outlook: No specific earnings or production guidance is provided. Management said it expected sufficient liquidity for the next 12 months, including common-share dividends, with subsidiary dividends a major anticipated funding source. It also noted that future financing may be needed and may not be available on acceptable terms.
- Ratings: On October 25, 2010, after quarter-end, S&P lowered AGC, AGM and their respective insurance subsidiaries from AAA to AA+, with a stable outlook; AGL was affirmed at A+. S&P cited strong capitalization and business position, while warning that meaningful statutory losses could prompt further negative action. Moody’s ratings remained Aa3 for AGC and AGM and A1 for AG Re and certain affiliates, with negative outlooks.
- Mortgage and recovery risk: Management reported some improvement in second-lien loan roll rates but said early delinquencies remained disappointing and assumed housing-market recovery would be delayed. It increased second-lien loss severity assumptions from 95% to 98%. Foreclosure-documentation issues could increase servicing costs, delay loss timing and affect ultimate losses.
- Market and valuation risk: Credit-derivative valuations rely substantially on Level 3 models and unobservable inputs in illiquid markets. Management cautioned that actual results could differ materially. A 25% widening in modeled credit spreads would reduce estimated net fair value by $512.5 million, before tax.
- Liquidity and counterparty risk: Downgrades could trigger CDS terminations or additional collateral posting. After a November 2010 amendment, the company reported approximately $753 million of agreed collateral posting requirements on about $19.0 billion of par exposure, subject to ratings and market values. Reinsurance recoveries also depend on counterparties, several of which were financially distressed.
- Other exposures: The company disclosed ongoing RMBS recovery lawsuits, municipal-finance and former financial-products investigations and litigation, and an RMBS reimbursement-priority case with potential unreimbursed claims of up to approximately $110 million over the transaction’s life. Management could not estimate potential losses for several proceedings. Dodd-Frank implementation could increase capital, margin or clearing requirements.
Most important facts for investors to verify
- How much of reported earnings reflects recurring underwriting and investment performance versus derivative fair-value changes, VIE consolidation and the $55.8 million tax benefit.
- Whether RMBS loss estimates and the $1.3 billion representation-and-warranty recovery assumption prove supportable as claims develop and recoveries are collected.
- The consequences of the S&P downgrade for new business, subsidiary statutory capital, reinsurance, collateral requirements and CDS termination exposure.
- Cash-flow and liquidity needs, including claims paid, collateral postings, reliance on subsidiary dividends and the collectability of Dexia and other counterparty support.
- Developments in foreclosure servicing, municipal and former financial-products litigation, and regulatory implementation of Dodd-Frank.