Business context and reporting period
Assured Guaranty Ltd. filed this Form 10-K for the fiscal year ended December 31, 2017. The Bermuda-based holding company provides financial guaranty insurance and related credit protection, principally for U.S. and international public finance, infrastructure and structured finance obligations. Its results are consolidated across its subsidiaries and are reported in U.S. dollars.
Financial performance and position
| Metric | 2017 | 2016 |
|---|---|---|
| Total revenue | $1.739 billion | $1.677 billion |
| Net earned premiums | $690 million | $864 million |
| Net investment income | $418 million | $408 million |
| Loss and loss adjustment expense | $388 million | $295 million |
| Income before tax | $991 million | $1.017 billion |
| Net income | $730 million | $881 million |
| Diluted EPS | $5.96 | $6.56 |
| Non-GAAP operating income | $661 million | $895 million |
| Operating cash flow | $433 million | $(132) million |
Revenue increased about 4%, while net income declined about 17%. The implied net margin was approximately 42% versus 53%; reported earnings included significant acquisition, commutation and settlement gains, so this comparison is not a clean measure of underlying operating trends. Management’s non-GAAP operating income also declined. The filing does not provide a single comparable operating-margin measure.
At year-end, total assets were $14.433 billion, shareholders’ equity $6.839 billion and GAAP long-term debt carrying value $1.292 billion. Debt principal outstanding was $1.558 billion, including purchased debt; interest expense was $97 million. Cash was $144 million, short-term investments $627 million and total investments $11.395 billion. Net par insured declined to $264.952 billion from $296.318 billion. Net expected loss to be paid increased to $1.303 billion from $1.198 billion; $12.238 billion of net par was rated below investment grade (BIG), compared with $13.074 billion.
Operating cash flow improved, reflecting lower net claim payments, commutation premiums and increased new-business premium collections. Investing cash flow was $345 million and financing cash flow was $(766) million, including $501 million of share repurchases and $70 million of dividends. Claims paid, net of reinsurance, were $229 million. The holding company reported $36 million in cash and short-term investments; access to subsidiary funds depends on regulatory and rating-agency constraints. Management stated it expected sufficient holding-company liquidity for the following 12 months.
Material changes versus the prior comparable period
- Net earned premiums fell 20%, mainly because refundings and terminations generated lower accelerated premium recognition.
- Loss and LAE rose to $388 million. Net economic loss development was $313 million, primarily due to U.S. public finance, partly offset by structured-finance improvements.
- Puerto Rico-related expected losses increased: total net expected loss to be paid rose to $1.303 billion, while Puerto Rico net par exposure was $4.966 billion, all rated BIG.
- 2017 revenue and earnings included $328 million of pretax gains from commutations of previously ceded business and a $58 million pretax gain related to the MBIA UK acquisition. Management also cited $151 million of pretax litigation and representations-and-warranties settlement gains. The Tax Act resulted in a provisional $61 million tax expense.
- Assured Guaranty acquired MBIA UK in January 2017, adding approximately $12 billion of net par at acquisition. Net par outstanding overall fell, reflecting run-off, terminations and portfolio changes.
- The company repurchased 12.7 million shares for approximately $501 million. Shareholders’ equity rose to $6.839 billion from $6.504 billion, and book value per share rose to $58.95 from $50.82.
Outlook, commentary, risks and unusual items
The filing provides no formal quantitative earnings or revenue guidance. Management said higher interest rates could support bond-insurance demand, but noted that low rates and narrow credit spreads had constrained issuer savings and demand. U.S. public-finance insurance penetration by par fell to 5.6% in 2017 from 6.0% in 2016; Assured Guaranty insured an estimated 58% of insured U.S. public-finance issuance.
Puerto Rico is a central risk. Defaults, PROMESA restructuring proceedings and Hurricane Maria’s extensive damage have affected insured obligors and recovery prospects. The company is pursuing litigation to enforce its rights; the eventual restructuring outcomes and recoveries remain uncertain. A court ruling adverse to the company on special-revenue lien enforcement was appealed in February 2018.
Other material risks include changes in financial-strength ratings, municipal credit deterioration, the adequacy and timing of loss recoveries, reinsurer performance, market and interest-rate volatility, foreign-exchange exposure, and Brexit-related uncertainty over regulation and European passporting. Loss estimates rely on management assumptions and may change materially. Credit-derivative and other Level 3 valuations use significant unobservable inputs, and can create earnings volatility without corresponding current cash effects.
The 2017 Tax Act reduced the U.S. corporate tax rate and changed international tax rules; the company recorded provisional tax effects and said the ultimate impact was not yet clear. A February 2018 agreement to reinsure substantially all of Syncora Guarantee’s insured portfolio, involving approximately $14.5 billion of business and $360 million plus estimated $55 million present value of installment premiums, remained subject to approvals and closing conditions, with closing expected by the end of the second quarter of 2018.
PwC issued an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective as of year-end.
Important facts for investors to verify
- Puerto Rico loss assumptions, actual claim-payment needs, legal outcomes and expected recoveries, including the effects of Hurricane Maria and restructuring plans.
- Whether the 2017 commutation and settlement gains are repeatable, and how underlying operating earnings develop as premiums run off.
- The final tax consequences of the Tax Act and any subsequent adjustments to the provisional tax accounting.
- Completion terms and capital, collateral and risk effects of the proposed Syncora portfolio transaction.
- Subsidiary dividend capacity, holding-company liquidity, debt service needs and the availability of reinsurance or other capital support.
- Changes in insurer ratings, BIG exposure and key assumptions used to value Level 3 assets, credit derivatives and expected losses.