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AGO > SEC Filings for AGO > Form 10-Q/A on 14-Nov-2011All Recent SEC Filings

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Form 10-Q/A for ASSURED GUARANTY LTD


14-Nov-2011

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Form 10-Q/A contains information that includes or is based upon forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements give the expectations or forecasts of future events of Assured Guaranty Ltd. ("AGL" and, together with its subsidiaries, "Assured Guaranty" or the "Company"). These statements can be identified by the fact that they do not relate strictly to historical or current facts and relate to future operating or financial performance.

Any or all of Assured Guaranty's forward-looking statements herein are based on current expectations and the current economic environment and may turn out to be incorrect. Assured Guaranty's actual results may vary materially. Among factors that could cause actual results to differ materially are:

rating agency action, including a ratings downgrade, a change in outlook, the placement of ratings on watch for downgrade, or a change in rating criteria, at any time, of AGL or any of its subsidiaries and/or of transactions that AGL's subsidiaries have insured, all of which have occurred in the past;

developments in the world's financial and capital markets that adversely affect issuers' payment rates, the Company's loss experience, its ability to cede exposure to reinsurers, its access to capital, its unrealized (losses) gains on derivative financial instruments or its investment returns;

changes in the world's credit markets, segments thereof or general economic conditions;

more severe or frequent losses implicating the adequacy of the Company's expected loss estimates;

the impact of market volatility on the mark-to-market of the Company's contracts written in credit default swap ("CDS") form;

reduction in the amount of insurance and reinsurance opportunities available to the Company;

deterioration in the financial condition of our reinsurers, the amount and timing of reinsurance recoverables actually received and the risk that reinsurers may dispute amounts owed to us under our reinsurance agreements;

the possibility that the Company will not realize insurance loss recoveries or damages from originators, sellers, sponsors, underwriters or servicers of residential mortgage-backed securities transactions;

increased competition;

          changes in applicable accounting policies or practices;



          changes in applicable laws or regulations, including insurance and
tax laws;

other governmental actions;

difficulties with the execution of the Company's business strategy;

contract cancellations;

the Company's dependence on customers;

loss of key personnel;

adverse technological developments;


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the effects of mergers, acquisitions and divestitures;

          natural or man-made catastrophes;



          other risks and uncertainties that have not been identified at this
time;

management's response to these factors; and

other risk factors identified in the Company's filings with the U.S. Securities and Exchange Commission (the "SEC").

The foregoing review of important factors should not be construed as exhaustive, and should be read in conjunction with the other cautionary statements that are included in this Quarterly Report. The Company undertakes no obligation to update publicly or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by law. Investors are advised, however, to consult any further disclosures the Company makes on related subjects in the Company's periodic reports filed with the SEC.

If one or more of these or other risks or uncertainties materialize, or if the Company's underlying assumptions prove to be incorrect, actual results may vary materially from what the Company projected. Any forward looking statements in this Form 10-Q/A reflect the Company's current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to its operations, results of operations, growth strategy and liquidity.

For these statements, the Company claims the protection of the safe harbor for forward-looking statements contained in Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act").

Convention

Unless otherwise noted, ratings disclosed in this Management's Discussion and Analysis of Assured Guaranty's insured portfolio reflect internal ratings. Although Assured Guaranty's rating scale is similar to that used by the nationally recognized statistical rating organizations, the ratings may not be the same as ratings assigned by any such rating agency. The super senior category, which is not generally used by rating agencies, is used by Assured Guaranty in instances where its AAA-rated exposure has additional credit enhancement due to either (1) the existence of another security rated AAA that is subordinated to Assured Guaranty's exposure or (2) Assured Guaranty's exposure benefitting from a different form of credit enhancement that would pay any claims first in the event that any of the exposures incurs a loss, and such credit enhancement, in management's opinion, causes Assured Guaranty's attachment point to be materially above the AAA attachment point.

Website Information

The Company routinely posts important information for investors on its website (www.assuredguaranty.com), under the "Investor Information" (particularly under the "By Company," "Assured Guaranty Ltd." tabs) and "Press Room" tabs. The Company uses this website as a means of disclosing material, non-public information and for complying with its disclosure obligations under SEC Regulation FD (Fair Disclosure). Accordingly, investors should monitor the Investor Information and Press Room portions of the Company's website, in addition to following the Company's press releases, SEC filings, public conference calls, presentations and webcasts. The information contained on, or that may be accessed through, the Company's website is not incorporated by reference into, and is not a part of, this Quarterly Report.


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Executive Summary

This executive summary of management's discussion and analysis highlights selected information and may not contain all of the information that is important to readers of the Quarterly Report. For a complete description of events, trends and uncertainties, as well as the capital, liquidity, credit, operational and market risks and the critical accounting policies and estimates affecting the Company, the Original Form 10-Q and this Form 10-Q/A should be read together in their entirety. Financial information in Management's Discussion and Analysis has been restated as described in Note 2 of "Item 1. Financial Statements." The restatement related primarily to the correction of errors in the elimination of intercompany transactions between the Company's insurance subsidiaries and the consolidated financial guaranty variable interest entities ("FG VIEs"). The total effect of this restatement was a decrease to equity of $36.1 million and $65.3 million as of June 30, 2011 and December 31, 2010, respectively, an increase to net income of $15.1 million and $30.3 million for the three months and six months ended June 30, 2011, respectively, and a decrease to net income of $24.4 million and $12.9 million for the three months and six months ended June 30, 2010, respectively, from amounts previously reported in the Original Form 10-Q.

Business Overview

Assured Guaranty provides, through its operating subsidiaries, credit protection products to the United States ("U.S.") and international public finance, infrastructure and structured finance markets. The Company has applied its credit underwriting judgment, risk management skills and capital markets experience to develop insurance, reinsurance and credit derivative products that protect holders of debt instruments and other monetary obligations from defaults in scheduled payments, including scheduled interest and principal payments. Financial guaranty contracts written in insurance form provide an unconditional and irrevocable guaranty that protects the holder of a financial obligation against non-payment of principal and interest when due. Financial guaranty contracts written in credit derivative form (typically CDS) are generally structured such that the circumstances giving rise to the Company's obligation to make loss payments are similar to those for financial guaranty contracts accounted for as insurance and only occurs upon one or more defined credit events with respect to one or more third party referenced securities or loans.

Public finance obligations insured or assumed through reinsurance by the Company consist primarily of general obligation bonds supported by the issuers' taxing powers, tax-supported bonds and revenue bonds and other obligations of states, their political subdivisions and other municipal issuers supported by the issuers' or obligors' covenant to impose and collect fees and charges for public services or specific projects. Public finance obligations include obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including government office buildings, toll roads, health care facilities and utilities.

Structured finance obligations insured or assumed through reinsurance by the Company are backed by pools of assets such as residential mortgage loans, consumer or trade receivables, securities or other assets having an ascertainable cash flow or market value and issued by special purpose entities. The Company currently does not underwrite U.S. residential mortgage-backed securities ("RMBS").

Debt obligations guaranteed by the Company's insurance subsidiaries are generally awarded ratings that are the same rating as the financial strength rating of the Assured Guaranty subsidiary that has guaranteed that obligation. Investors in products insured by Assured Guaranty Municipal Corp. ("AGM") or Assured Guaranty Corp. ("AGC") frequently rely on rating agency ratings. Therefore, low financial strength ratings or uncertainty over AGM's or AGC's abilities to maintain their financial strength ratings would have a negative impact on the demand for their insurance product.

As of August 9, 2011, AGM and AGC and their respective insurance-company subsidiaries had financial strength ratings of Aa3 (negative outlook) by Moody's Investors Service, Inc. ("Moody's") and AA+ (negative outlook) by Standard and Poor's Ratings Services ("S&P"). In connection with S&P's downgrade on August 5, 2011 of the long-term sovereign credit rating of the United States of America to AA+ (negative outlook), on August 8, 2011, S&P affirmed the rating of AGL and the financial strength ratings of AGM and AGC and their respective insurance company subsidiaries, and revised the outlooks of those entities from stable to negative. S&P noted in its Research Update that the rating action did not reflect a change in S&P's view of Assured Guaranty's fundamental credit characteristics, but rather was a result of the application of its criteria that the sovereign local-currency credit


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rating constrains its financial strength ratings on insurers whose businesses and assets are highly concentrated in the U.S. and which have significant holdings in U.S. Treasury and agency securities.

A downgrade by Moody's or S&P of the financial strength ratings of the Company's insurance subsidiaries may have a negative impact on the Company's liquidity. A downgrade may trigger (1) increased claims on some of the Company's insurance policies, in certain cases, on a more accelerated basis than when the original transaction closed; or (2) termination payments or collateral posting under CDS contracts. A downgrade in the financial strength ratings may also enable beneficiaries of the Company's policies to cancel the credit protection offered by the Company and cease paying premium. A downgrade may also enable primary insurance companies that had ceded business to the Company to recapture a significant portion of its in-force financial guaranty reinsurance business.

In 2011, the Company is focusing on three principal areas that are critical to Assured Guaranty's future growth and business potential. Those areas are:

S&P's proposal to change its bond insurance rating criteria.

Loss mitigation, including the pursuit of recoveries for breaches of representations and warranties and efforts to improve servicing.

New business development.

Standard and Poor's Ratings Services Bond Insurer Criteria

On September 27, 2011, S&P published a Research Update in which it placed its ratings of Assured Guaranty on CreditWatch Negative. This action included changing the financial strength ratings of AGC and AGM from AA+ (Negative Outlook) to AA+ (CreditWatch Negative), and the AA (Negative Outlook) rating of Assured Guaranty Re Ltd. ("AG Re") to AA (CreditWatch Negative), signifying that S&P may downgrade such financial strength ratings in the near future. In the Research Update, S&P stated that the CreditWatch placement is due to significant concentration risk in Assured Guaranty's consolidated insured portfolio; the portfolio contains exposures that are not consistent with S&P's new bond insurance rating criteria and breach the "largest obligor test" in such new criteria. The largest obligor test appears to have the effect of significantly reducing Assured Guaranty's allowed single risk limits and limiting its financial strength rating level. S&P published updated criteria in Bond Insurance Rating Methodology and Assumptions on August 25, 2011, subsequent to its publication of Request for Comment: Bond Insurance Criteria on January 24, 2011. According to S&P, based on statements from Assured Guaranty's management that Assured Guaranty intends to take action such as create capital or utilize additional forms of reinsurance to mitigate these concentration risks, it is likely such actions, if taken, would support financial strength ratings in the "AA" category. S&P noted that it expects to resolve this CreditWatch placement no later than November 30, 2011. The Company is considering transactions that are designed to create capital and/or mitigate its concentration risks but can give no assurance that it will be able to complete the transactions at all or on terms that are acceptable. If it cannot do so, S&P may downgrade the financial strength ratings of AGL and its subsidiaries, including the financial strength ratings of AGC, AGM and AG Re, which downgrade may have an adverse impact on the Company's financial condition, results of operation, liquidity, business prospects or other aspects of the Company's business and on its insured portfolio. See Notes 5, 7 and 12 of the Financial Statements for the potential impact of a financial strength rating downgrade on the Company and on the insured portfolio. Since S&P's January 2011 announcement that it planned to change its rating criteria, the Company has been pursuing strategies to improve its rating agency capital position. Such strategies include:

Negotiating comprehensive agreements with representations and warranties ("R&W") providers, such as the Bank of America Agreement consummated on April 14, 2011. See "Recoveries for Breaches of R&W" below.

Agreeing to terminate contracts under which the Company sells credit protection. Through June 30, 2011, the Company agreed to terminate CDS with net par of $7.7 billion, resulting in net gains of $15.5 million in the three-month period ended March 31, 2011 ("First Quarter 2011") and $16.4 million in losses in the three-month period ended June 30, 2011 ("Second Quarter 2011").


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Commuting reinsurance contracts. In 2011, the Company cancelled an assumed reinsurance contract for a gain of $8.1 million and cancelled a ceded reinsurance contract for a gain of $24.1 million. In 2010, the Company reassumed previously ceded business resulting in gains of $16.7 million.

Purchasing securities insured by the Company. In 2011, the Company purchased additional insured securities bringing the June 30, 2011 carrying value of assets purchased for loss mitigation purposes to $244.3 million, with a par of $1,029.3 million.

Recoveries for Breaches of R&W

On April 14, 2011, Assured Guaranty reached a comprehensive agreement with Bank of America Corporation and its subsidiaries, including Countrywide Financial Corporation and its subsidiaries (collectively, "Bank of America"), regarding their liabilities with respect to 29 RMBS transactions insured by Assured Guaranty, including claims relating to reimbursement for breaches of R&W and historical loan servicing issues ("Bank of America Agreement"). Of the 29 RMBS transactions, eight are second lien transactions and 21 are first lien transactions. The Bank of America Agreement covers Bank of America-sponsored securitizations that AGM or AGC has insured, as well as certain other securitizations containing concentrations of Countrywide-originated loans that AGM or AGC has insured. The transactions covered by the Bank of America Agreement have a gross par outstanding of $4.7 billion ($4.4 billion net par outstanding) as of June 30, 2011, or 28% of Assured Guaranty's total below-investment-grade ("BIG") RMBS net par outstanding.

Bank of America paid $928.1 million in Second Quarter 2011 in respect of covered second lien transactions and is obligated to pay another $171.9 million by March 2012. In consideration of the $1.1 billion, the Company has agreed to release its claims for the repurchase of mortgage loans underlying the eight second lien transactions (i.e. Assured Guaranty will retain the risk of future insured losses without further offset for R&W claims against Bank of America).

In addition, Bank of America will reimburse Assured Guaranty 80% of claims Assured Guaranty pays on the 21 first lien transactions, until aggregate collateral losses on such RMBS transactions reach $6.6 billion. The Company accounts for the 80% loss sharing agreement with Bank of America as subrogation. As the Company calculates expected losses for these 21 first lien transactions, such expected losses will be offset by an R&W benefit from Bank of America for 80% of these amounts. As of June 30, 2011, Bank of America had placed $1.0 billion of eligible assets in trust in order to collateralize the reimbursement obligation relating to the first lien transactions. The amount of assets required to be posted may increase or decrease from time to time, as determined by rating agency requirements.

As of June 30, 2011, cumulative collateral losses on the 21 first lien RMBS transactions were approximately $1.6 billion. The Company estimates that cumulative projected collateral losses for these first lien transactions will reach $4.84 billion, which will result in estimated gross expected losses to the Company of $630.9 million before considering R&W recoveries from Bank of America, and $126.8 million after considering such R&W recoveries. As of June 30, 2011, the Company had been reimbursed $14.9 million in respect of the covered first lien transactions under the Bank of America Agreement.

Although the Bank of America Agreement was executed in Second Quarter 2011, it provided additional evidence about the estimates inherent in the loss estimation process at March 31, 2011 and, therefore, the March 31, 2011 loss estimates incorporated updated assumptions and estimates reflecting the terms of the Bank of America Agreement. The benefit for R&W in 2011 reflects higher expected recoveries across all transactions as a result of the Bank of America Agreement. For transactions covered under the Bank of America Agreement, the R&W benefit has been updated to reflect amounts collected and expected to be collected under the terms of the Bank of America Agreement. For transactions with other sponsors of U.S. RMBS, against which the Company is pursuing R&W claims, the Company has increased the benefit for R&W in 2011 to reflect the probability that actual recovery rates may be higher than originally expected in First Quarter 2011. For transactions involving R&W providers other than Bank of America, the Company has continued to review additional loan files and has found breach rates consistent with those in the Bank of America transactions.


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As a result of the 80% loss sharing arrangement, the Company increased its estimate of expected R&W recoveries during First Quarter 2011 for the transactions covered under the Bank of America Agreement by $411.2 million, resulting in an increase to pre-tax income of approximately $220 million. Changes in gross expected loss on these first lien transactions will result in a corresponding benefit for R&W equal to 80% of such development, up to $6.6 billion of collateral losses.

The Company believes the Bank of America Agreement was a significant step in the effort to recover U.S. RMBS losses the Company experienced resulting from breaches of R&W. The Company is continuing to pursue other representation and warranty providers for U.S. RMBS transactions it has insured.

New Business Development

Management believes that the Company is able to provide value not only by insuring the timely payment of scheduled interest and principal amounts when due, but also through its underwriting skills and surveillance capabilities, particularly with regard to the U.S. public finance market. Few individual or even institutional investors have the analytic resources to cover all the varied municipal credits in that market, which are estimated to number more than 30,000. Through its financial guaranty, the Company undertakes the tasks of credit selection, analysis, negotiation of terms, monitoring and, if necessary, remediation. Management believes this allows retail investors to participate more widely, institutional investors to operate more efficiently and smaller, less well-known issuers to gain market access on a more cost-effective basis. In fact, in Second Quarter 2011, based on par, the Company insured approximately 15% of new U.S. municipal issues that were $25 million or less in size across all rating categories.

Economic Environment

Early-stage mortgage delinquencies have slowly improved in 2011, but severities on first lien transactions have increased. New issuance in the U.S. and international public finance sectors has not returned to historic levels, and the market for financial guaranty insurance has been hampered by ratings actions and municipal rating recalibrations, as well as reduced new issuance volume. In particular, in the U.S. public finance market, new issue volume for the first half of 2011 was only $115.0 billion, down 44% from the same period in 2010. The factors contributing to this decline include:

Strong volume in December 2010, as issuers seeking to take advantage of the expiring Build America Bonds program issued $15.4 billion of new bonds.

Reduction in capital spending due to municipal budget constraints, resulting in less need for increased debt.

Reluctance to increase taxes to service principal and interest costs under new debt.

Financial Performance

The table below presents selected financial data in accordance with accounting principles generally accepted in the United States of America ("GAAP").

                           Reported Financial Results



                                                    Second Quarter                     Six Months
                                                 2011             2010            2011            2010
                                                   (dollars in millions, except per share amounts)
                                              (restated)       (restated)      (restated)      (restated)
Net earned premiums                         $        230.0    $      297.0    $      484.0    $      611.7
Net investment income                                101.1            90.9           197.2           175.2
Realized gains and other settlements on
credit derivatives                                   (10.8 )          38.4            24.6            65.1
Net unrealized gains (losses) on credit
derivatives                                          (54.0 )          35.1          (325.6 )         287.2
Net change in fair value of financial
guaranty variable interest entities                 (174.3 )         (27.4 )         (54.7 )         (36.3 )
Loss and loss adjustment expenses                   (123.9 )         (85.7 )         (98.4 )        (196.6 )
Other operating expenses                             (48.5 )         (47.4 )        (105.3 )        (110.0 )
Net income (loss)                                    (42.6 )         179.1            98.0           512.6
Diluted earnings per share                           (0.23 )          0.95            0.52            2.70


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Second Quarter 2011 net loss was driven primarily by fair value losses on credit derivatives FG VIEs. Fair value losses on credit derivatives resulted primarily from the narrowing of AGC and AGM credit spreads. Fair value losses on FG VIEs resulted primarily from losses on consolidation of eight new VIEs of $95.3 million, pretax, and declines in fair value of the underlying collateral on two consolidated VIEs. Second Quarter 2011 also includes a gain on commutation of a financial guaranty assumed reinsurance contract of $8.1 million, pretax, as the Company actively seeks to reduce exposure to BIG monolines. Net investment income increased due to the shift towards longer duration assets and increased invested assets largely due to cash received under the Bank of America Agreement in Second Quarter 2011. As expected, net earned premiums and credit derivative fees in Second Quarter 2011 declined compared with the three-months period ended June 30, 2010 ("Second Quarter 2010") as the structured in-force book of business declines. Loss and loss adjustment expenses ("LAE") increased compared with Second Quarter 2010 and was higher than expected due primarily to the decline in the risk-free rates used to discount cash flows in the loss models.

For the six-month period ended June 30, 2011 ("Six Months 2011"), net income also includes fair value losses on credit derivatives and FG VIEs. In addition to the effect of AGC and AGM credit spread narrowing since year end 2010, Six Month 2011 also includes fair value losses due to a refinement in assumptions in the First Quarter 2011. Six Months 2011 commutation gains on financial guaranty . . .

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