Assured Guaranty Ltd. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; balance-sheet comparisons are to December 31, 2011. Amounts below are U.S. dollars unless noted. The company provides financial guaranty insurance and related credit protection for public finance, infrastructure and structured finance obligations.
Financial results and position
| Metric | Q1 2012 / March 31, 2012 | Comparable period / prior year-end |
|---|---|---|
| Total revenue | $(357.4) million | $278.9 million in Q1 2011 |
| Net earned premiums | $193.7 million | $254.0 million in Q1 2011, down 23.7% |
| Net investment income | $97.8 million; pretax book yield 3.96% | $97.4 million; 3.89% in Q1 2011 |
| Net income (loss) | $(483.0) million; diluted EPS $(2.65) | $139.3 million; diluted EPS $0.74 in Q1 2011 |
| Non-GAAP operating income | $71.2 million; $0.38 per share | $247.4 million; $1.32 per share in Q1 2011 |
| Operating cash flow | $75.3 million provided | $122.1 million used in Q1 2011 |
| Cash | $182.0 million | $214.5 million at December 31, 2011 |
| Investment portfolio | $11.31 billion, including $10.20 billion of fixed maturities and $903.4 million of short-term investments | $11.10 billion at December 31, 2011 |
| Total assets / liabilities | $18.50 billion / $14.32 billion | $18.02 billion / $13.37 billion at December 31, 2011 |
| Shareholders’ equity | $4.18 billion | $4.65 billion at December 31, 2011 |
| Long-term debt | $1.035 billion carrying value; $1.344 billion principal | $1.038 billion carrying value at December 31, 2011 |
| Dividends per share | $0.09 | $0.045 in Q1 2011 |
The filing does not report a conventional operating margin, and such a measure is not presented as a key performance indicator for this insurer.
Material changes and drivers
- The large GAAP loss reflected a $690.7 million net fair-value loss on credit derivatives, including $633.8 million of unrealized losses; $246.8 million of loss and loss adjustment expense; and a $36.6 million fair-value loss on consolidated financial guaranty variable interest entities (FG VIEs). Derivative marks are sensitive to market spreads and Assured Guaranty’s own credit spreads and do not necessarily equal ultimate claims.
- Management cited $189.3 million of Q1 loss expense related to insured Greek sovereign debt. Net economic loss development across the insured portfolio was $211.8 million, primarily reflecting Greece and other structured-finance changes.
- Non-GAAP operating income fell to $71.2 million from $247.4 million. Management attributed the decline principally to Greek exposure, lower earned premiums and lower credit-derivative revenue, partly offset by $83.3 million of commutation gains on reassumed reinsurance business.
- Net earned premiums declined as structured-finance premiums ran off; refundings and accelerations partly offset the decline. The company said premiums are expected to decrease each year from runoff unless replaced by new business.
- Loss and LAE reserves rose to $954.5 million from $679.0 million. Shareholders’ equity fell by $469.0 million, mainly due to the net loss, partly offset by $30.9 million of other comprehensive income.
- Net par outstanding across the insured portfolio was $567.1 billion, versus $558.0 billion at year-end. Below-investment-grade exposure was $26.0 billion, or 4.6% of net par; this presentation reflects a rating reclassification related to Bank of America collateral arrangements.
Liquidity, capital and portfolio
- Q1 operating cash flow was positive, while investing activities provided $106.7 million and financing activities used $217.2 million, including $192.9 million of FG VIE liability paydowns. Cash ended the quarter at $182.0 million.
- Management said holding-company liquidity was sufficient for the next 12 months, including common dividends. Its liquidity policy targets liquid assets equal to 1.5 times projected operating-company cash needs over the next four quarters and stress-tests to one times stressed net cash flows. Insurance subsidiaries rely on cash, short-term investments, operating cash flow and portfolio maturities/paydowns.
- At March 31, $678.2 million of securities were pledged under derivative arrangements. The company also reported $35.4 billion of ceded par outstanding and $182.7 million of ceded expected losses and LAE; collection depends on reinsurer performance.
- In January, AGC and AGM established a public-finance excess-of-loss reinsurance facility: it attaches after $2.0 billion of aggregate net losses and covers part of the next $600 million, with reinsurers assuming up to $435 million.
- The company reassumed $12.9 billion of par from Radian and commuted/reassumed about $6.2 billion from Tokio Marine, receiving payments that contributed to the quarter’s commutation gains. A separate $1.8 billion of Radian public-finance par was reinsured.
- Adjusted book value, a non-GAAP measure, was $9.01 billion, or $49.37 per share, compared with $8.99 billion, or $49.32, at year-end. It includes estimated future premium value and is dependent on assumptions about losses, runoff, foreign exchange and recoveries.
Outlook, commentary and notable risks
- Ratings: Moody’s placed AGL and its subsidiaries, including the insurance subsidiaries, on review for possible downgrade on March 20, 2012. A downgrade could impair new-business demand and pricing, trigger collateral or termination requirements, accelerate claims, permit GIC withdrawals, or allow reinsurers to recapture assumed business. S&P had assigned AA- ratings with stable outlook to key insurers in November 2011.
- Deutsche Bank settlement after quarter-end: On May 8, 2012, the company agreed to receive $165.6 million in cash and entered into loss-sharing arrangements covering specified RMBS exposures. Deutsche Bank’s reinsurance affiliate is to provide collateral, initially about $282.7 million. Most settlement terms were already reflected in 2011 expected-loss estimates; certain CDS-related claims remain unresolved.
- Mortgage and recovery uncertainty: Management retained assumptions reflecting a slower housing-market recovery because early-stage delinquencies remained elevated. Expected losses depend on loan defaults, severity, prepayments, servicing and representation-and-warranty recoveries. The company included estimated R&W benefits in loss estimates, but acknowledged actual recoveries may differ materially.
- Europe and public finance: Net economic exposure to selected European countries was $5.13 billion, including $291 million of net Greek sovereign exposure. The Greek debt exchanges drove substantial loss development. The company also had $710.4 million net exposure to Jefferson County, Alabama, which is in Chapter 9 bankruptcy.
- Other contingencies: Possible AGM liquidity claims under leveraged-lease strip policies were approximately $1.0 billion for transactions already subject to rating triggers, with a further approximately $991 million potentially affected by specified additional downgrades. No such lease-default claims had occurred to date. The company also disclosed RMBS, municipal derivatives, reinsurance and other litigation and investigations; some potential losses could not be reasonably estimated.
- Business environment: Management described weak demand and limited issuance in structured finance and international infrastructure, municipal budget pressures, and continuing negative industry perceptions. It reported $56.3 million of Q1 present value of new business production (PVP), including $21.9 million from assumed Radian public-finance business; PVP is non-GAAP and is not a forecast.
- The company stopped selling new CDS protection in early 2009 and said it does not expect to resume in the foreseeable future. There is no quantified company-wide earnings or revenue guidance in the provided filing text.
Most important facts for investors to verify
- How much of the GAAP loss is market-driven derivative and FG VIE valuation volatility versus expected credit claims, and how sensitive valuations are to spread assumptions.
- Whether Moody’s review results in a downgrade and the related effects on collateral, termination rights, claims, reinsurance recapture and new business.
- Actual Greek-related cash claims and recoveries, and the development of Jefferson County and other material public-finance exposures.
- Whether Bank of America and Deutsche Bank reimbursements and other R&W recoveries are realized as estimated, including collateral adequacy and the unresolved CDS claims.
- Liquidity availability after pledged/restricted assets, reinsurance recoverable collectability, and the company’s reliance on subsidiary dividends and Dexia-related support for legacy GIC exposures.
- Progress in replacing runoff premium income with new business, and the assumptions underlying non-GAAP operating income and adjusted book value.