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AGO > SEC Filings for AGO > Form 10-Q on 9-Aug-2013All Recent SEC Filings

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Form 10-Q for ASSURED GUARANTY LTD


9-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward Looking Statements

This Form 10-Q 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 Assured Guaranty or any of its subsidiaries and/or of transactions that Assured Guaranty's subsidiaries have insured;

developments in the world's financial and capital markets, including changes in interest and foreign exchange rates, that adversely affect the demand for the Company's insurance, issuers' payment rates, Assured Guaranty's loss experience, its exposure to refinancing risk in transactions (which could result in substantial liquidity claims on its guarantees), 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;

the impact of rating agency action with respect to sovereign debt and the resulting effect on the value of securities in the Company's investment portfolio and collateral posted by and to the Company;

more severe or frequent losses impacting the adequacy of Assured Guaranty's expected loss estimates;

the impact of market volatility on the mark-to-market of Assured Guaranty's contracts written in credit default swap form;

reduction in the amount of insurance opportunities available to Assured Guaranty;

deterioration in the financial condition of Assured Guaranty's reinsurers, the amount and timing of reinsurance recoverables actually received and the risk that reinsurers may dispute amounts owed to Assured Guaranty under its reinsurance agreements;

the failure of Assured Guaranty to realize insurance loss recoveries or damages expected from originators, sellers, sponsors, underwriters or servicers of residential mortgage-backed securities transactions through loan putbacks, settlement negotiations or litigation;

the possibility that budget shortfalls or other factors will result in credit losses or impairments on obligations of state and local governments that the Company insures or reinsures;

increased competition, including from new entrants into the financial guaranty industry;

          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 Assured Guaranty's business
strategy;


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          contract cancellations;

          loss of key personnel;

          adverse technological developments;

          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 Assured Guaranty'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 Form 10-Q. 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 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 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").

Introduction

The Company provides credit protection products in the United States ("U.S.") and international public finance (including infrastructure) and structured finance markets. The Company applies its credit underwriting judgment, risk management skills and capital markets experience to offer insurance that protects holders of debt instruments and other monetary obligations from defaults in scheduled payments, including scheduled interest and principal payments. The securities insured by the Company include taxable and tax-exempt obligations issued by U.S. state or municipal governmental authorities, utility districts or facilities; notes or bonds issued to finance international infrastructure projects; and asset-backed securities issued by special purpose entities. The Company markets its credit protection products directly to issuers and underwriters of public finance, infrastructure and structured finance securities as well as to investors in such obligations. The Company guarantees obligations issued in many countries, although its principal focus is on the U.S., as well as Europe and Australia.

Available Information

The Company maintains an Internet web site at www.assuredguaranty.com. The Company makes available, free of charge, on its web site (at www.assuredguaranty.com/investor-information/by-company/assured-guaranty-ltd/sec-filings) the Company's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13 (a) or 15 (d) of the Exchange Act as soon as reasonably practicable after the Company files such material with, or furnishes it to, the SEC. The Company also makes available, free of charge, through its web site (at www.assuredguaranty.com/governance) links to the Company's Corporate Governance Guidelines, its Code of Conduct and the charters for its Board Committees.

The Company routinely posts important information for investors on its web site (at www.assuredguaranty.com/about-us/company-statements). The Company uses this web site as a means of disclosing material, non-public information and for


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complying with its disclosure obligations under SEC Regulation FD. Accordingly, investors should monitor the Investor Information portion of the Company's web site, 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 web site is not incorporated by reference into, and is not a part of, this report.

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 this Quarterly Report. For a more detailed 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, this Quarterly Report should be read in its entirety and in addition to Assured Guaranty's 2012 Annual Report on Form 10-K and Assured Guaranty's Quarterly Report on 10-Q for the quarter ended March 31, 2013.

Economic Environment

The Company continued to be the most active provider of financial guaranty insurance in the three-months ended June 30, 2013 ("Second Quarter 2013") and six-months ended June 30, 2013 ("Six Months 2013") as a result of its financial strength and its ability to attract investors through its default protection, credit selection, underwriting and surveillance. All of the Company's pre-2008 financial guaranty competitors have had their financial strength ratings downgraded by rating agencies to below investment grade levels or are no longer rated, severely impairing their ability to underwrite new business. Only two other industry participants have investment grade financial strength ratings today: National Public Finance Guarantee Corporation, which recently resolved litigation challenging its separation from MBIA Insurance Corporation and appears not to have financial strength ratings adequate to issue new financial guaranty policies on public finance obligations at this time, and Build America Mutual Assurance Company, which is a new entrant to the industry that commenced operations during 2012 and significantly increased its business during Six Months 2013. Business conditions have been difficult for the entire financial guaranty insurance industry since mid-2007, and the Company continues to face challenges in maintaining its market penetration today. The industry's ability to generate new business in the current environment of sustained low interest rates and tight credit spreads is constrained. These conditions suppress demand for bond insurance as the potential savings for issuers are diminished and some investors prefer to forgo insurance in favor of greater yield. However, the Company believes this indicates potential for growth in insured penetration once interest rates rise and credit spreads widen. The Company cannot assure whether or when these changes will occur.

The overall economic environment in the U.S. has improved over the last few years and indicators such as lower mortgage delinquency rates, more stable housing prices and record stock market valuations point toward further improvement. However, unemployment rates remain high, and the economy is continuing to experience the economic impact of the Federal budget sequestration mandated by congressional legislation.

Although few municipalities have fully rebuilt reserves to pre-recession levels, the vast majority have been taking steps to address the ongoing fiscal challenges they have experienced since the recent credit crisis and the ensuing recession, including,in many cases, significant unfunded pension and retiree health care liabilities. Revenues at the state level have been rebounding in general, and while the strength of the housing recovery varies from region to region, property tax and other revenues have stabilized for most local governments. Although municipal defaults remain rare, a small number of municipal credits have sought bankruptcy protection. This is an area of law that has not been tested due to the relatively low frequency of such cases. The Company has been active with respect to the municipal bankruptcy cases involving Jefferson County, Alabama, the City of Stockton, California and the City of Detroit, Michigan. It has also been closely monitoring legal proceedings in other municipal bankruptcy cases. In addition, the Company has been involved with efforts of the city receiver for the City of Harrisburg, Pennsylvania to develop and implement a fiscal recovery plan for the city. The publicity surrounding high-profile defaults and bankruptcy filings, such as Detroit's, especially those few where bond insurers are paying claims, provides evidence of the value of bond insurance, which we believe may stimulate demand, especially at the retail level.

In the international arena, troubled Eurozone countries continue to be a source of stress in global equity and debt markets. Following the 2011 restructuring of the sovereign debt of Greece, debt costs in Portugal, Spain and Italy remain elevated, although they have declined substantially since the announcement on August 2, 2012 by the European Central Bank that it would undertake outright monetary transactions in support of Eurozone sovereign bonds. Successful execution of structural reforms is necessary to avert further fiscal stress in those and other European Union ("EU") countries. Fiscal austerity programs initiated to address the problems have constrained economic growth, and a number of countries are in or near


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recession. The rating agencies have downgraded many European sovereign credits. The Company's exposure to troubled Eurozone countries is described in "-Results of Operations-Consolidated Results of Operations-Losses in the Insured Portfolio" and "-Insured Portfolio-Selected European Exposures."

The economic environment since 2008 has had a significant negative impact on the demand by investors for financial guaranty policies, and it is uncertain when or if demand for financial guaranties will return to their pre-credit crisis level. In particular, there has been limited new issue activity and also limited demand for financial guaranties in both the global structured finance and international infrastructure finance markets for several years. The Company expects that global structured finance and international infrastructure opportunities will increase in the future as the global economy recovers, issuers return to the capital markets for financings and institutional investors again utilize financial guaranties. The Company has recently seen an increase in UK infrastructure opportunities, although the Company cannot assure that this will continue.

In Second Quarter 2013, the Company continued to be affected by a negative perception of financial guaranty insurers arising from the financial distress suffered by other companies in the industry during the financial crisis. On January 17, 2013, after a ten month review, Moody's Investors Service, Inc.
("Moody's") assigned the following lower financial strength ratings: A2 (Stable)
for Assured Guaranty Municipal Corp. ("AGM"), A3 (Stable) for Assured Guaranty Corp. ("AGC"), and Baa1 (Stable) for Assured Guaranty Re Ltd. ("AG Re"). The Company believes the Moody's rating action during first quarter 2013 caused an interruption in demand for its municipal bond insurance as the market evaluated the action's implications. Historically, production has decreased in the periods immediately before and after an unfavorable rating agency action but subsequently increased from those lower levels.

In a sign that the impact of the Moody's downgrade is limited, AGC's and AGM's credit spreads tightened 49% and 32%, respectively, during Six Months 2013. Credit spreads reflect the risk that investors perceive in the Company, among other factors. The higher the Company's credit spread, the lower the benefit of the Company's guaranty is to certain investors. If investors view the Company as being only marginally less risky, or perhaps even as risky, as the uninsured security, the coupon on a security insured by the Company may not be much lower, or may be the same as, an uninsured security offered by the same issuer. Accordingly, issuers may be unwilling to pay a premium for the Company to insure their securities if the insurance does not lower the costs of issuance. Although high compared with their pre-2007 levels, both AGC's and AGM's credit spreads were less than 12% of their March 2009 peaks as of June 30, 2013.

Financial Performance of Assured Guaranty

                               Financial Results

                                              Second Quarter                      Six Months
                                          2013               2012             2013           2012
                                                 (in millions, except per share amounts)
Selected income statement data
Net earned premiums                  $        163       $       219       $      411     $      413
Net investment income                          93               101              187            199
Realized gains (losses) and other
settlements on credit derivatives             (86 )             (23 )            (68 )          (80 )
Net unrealized gains (losses) on
credit derivatives                            160               284             (450 )         (350 )
Fair value gains (losses) on
financial guaranty variable interest
entities                                      143               168              213            127
Loss and loss adjustment (expenses)
benefit                                       (62 )            (118 )            (14 )         (360 )
Other operating expenses                      (52 )             (53 )           (112 )         (115 )
Net income (loss)                             219               377               75           (106 )
Diluted income (loss) per share      $       1.16       $      2.01       $     0.39     $    (0.58 )
Selected non-GAAP measures(1)
Operating income                     $         98       $       114       $      358     $      185
Operating income per share           $       0.52       $      0.61       $     1.87     $     0.99
Present value of new business
production ("PVP")                   $         16       $        50       $       34     $      106


____________________


(1) Please refer to "-Non-GAAP Financial Measures."


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Net Income (Loss)

There are several primary drivers of volatility in reported net income or loss that are not necessarily indicative of credit impairment or improvement, or ultimate economic gains or losses: changes in credit spreads of insured credit derivative obligations and financial guaranty variable interest entities' ("FG VIEs") assets and liabilities, changes in the Company's own credit spreads, and changes in risk-free rates used to discount expected losses. Changes in credit spreads have the most significant effect on changes in fair value of credit derivatives and FG VIE assets and liabilities. In addition to these factors, changes in expected losses, the timing of refundings and terminations, realized gains and losses on the investment portfolio (including other-than-temporary impairments), the effects of large settlements or transactions, and the effects of the Company's various loss mitigation strategies, among other factors, may also have a significant effect on reported net income or loss in a given reporting period.

Net income for Second Quarter 2013 was $219 million compared to net income of $377 million in the three-month period ended June 30, 2012 ("Second Quarter 2012"). Second Quarter 2013 net earned premiums were lower than Second Quarter 2012 due primarily to the scheduled amortization of the insurance portfolio, and fewer negotiated terminations and refundings, coupled with low new business originations. Credit spreads affecting the fair value of credit derivatives declined more significantly in Second Quarter 2012 than Second Quarter 2013, resulting in lower fair value gains in Second Quarter of 2013. Loss and loss adjustment expenses were lower in Second Quarter 2013 than Second Quarter 2012 due primarily to increased representations and warranties ("R&W") benefits, offset in part by higher losses in U.S. public finance primarily due to Detroit.

Net income for Six Months 2013 was $75 million compared to net loss of $106 million in the six-month period ended June 30, 2012 ("Six Months 2012"). Loss and loss adjustment expenses in Six Months 2013 were significantly lower than Six Months 2012 primarily due to the loss in the prior year related to Greek sovereign exposures, and the benefit taken in 2013 related to R&W settlement agreements, including the UBS settlement. Net change in fair value of FG VIEs was higher in Six Months 2013 due to the benefit of several R&W settlements related to such consolidated FG VIEs. Other income in Six Months 2012 included commutation gains recognized on previously ceded reinsurance contracts from Radian Asset Assurance Inc. ("Radian") and Tokio Marine & Nichido Fire Insurance Co., Ltd. ("Tokio"). This was offset in part by higher fair value losses in Six Months 2013 related to credit derivatives as a result of credit spread tightening, which was more significant in 2013 than 2012.

Non-GAAP Financial Measures

Non-GAAP operating income in Second Quarter 2013 was $98 million, compared with $114 million in Second Quarter 2012. The decrease in operating income was primarily driven by the scheduled amortization of the insurance portfolio and lower refundings and negotiated terminations, partially offset by lower loss expense. Non-GAAP operating income in Six Months 2013 was $358 million, compared with $185 million in Six Months 2012. The increase in operating income was primarily driven by lower losses, partially offset by the decrease in other income, as indicated above. The increase in pretax operating income in U.S. taxable jurisdictions resulted in a higher effective tax rate in Six Months 2013.

Adjusted book value per share was $49.06 as of June 30, 2013 as compared to $47.17 per share as of December 31, 2012. Adjusted book value value per share increased primarily due to the benefit of the settlement agreements, including the UBS Agreement, and the share repurchases in Six Months 2013.

See "-Non-GAAP Financial Measures" for a description of these non-GAAP financial measures.

Key Business Strategies

While continuing its focus on loss mitigation, commutations and capital improvement strategies, the Company has also devoted significant resources to launching its subsidiary, Municipal Assurance Corp. ("MAC"), formerly known as Municipal and Infrastructure Assurance Corporation.

Municipal Assurance Corp.

MAC was acquired by the Company in May 2012 and is licensed to provide financial guaranty insurance and reinsurance in 38 U.S. jurisdictions, including the District of Columbia. MAC is a new financial guaranty insurer that provides insurance only on high quality debt obligations in the U.S. public finance markets. In July, it was capitalized with $700 million in equity and a $100 million surplus note issued to AGM. MAC started operations in July 2013 with an assumed book of


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business totaling $111 billion in par, which was ceded to MAC from its affiliates, AGC and AGM. The Company was established in order to increase the Company's insurance penetration in the U.S. public finance sector and starts with a seasoned book of business and a future stream of investment income and premiums earnings which is unlike other start up financial guarantors. MAC received a AA+ (stable outlook) financial strength rating from Kroll Bond Rating Agency and a AA- (stable outlook) financial strength rating from Standard and Poor's Ratings Services ("S&P").

Loss Mitigation

The Company continued its risk remediation strategies in 2013, which lowered losses and improved rating agency capital. In an effort to recover U.S. residential mortgage-backed security ("RMBS") losses the Company experienced in its insured U.S. RMBS portfolio resulting from breaches of R&W, the Company has pursued R&W providers by enforcing R&W provisions in contracts, negotiating agreements with R&W providers relating to those provisions and, where indicated, initiating litigation against R&W providers.

On May 6, 2013, the Company entered into the UBS Agreement to settle R&W claims with UBS for a cash payment of $358 million plus 85% of future losses on certain transactions under a loss-sharing agreement. In the proceeding AGM brought against Flagstar Bank in the United States District Court for the Southern District of New York, the court granted judgment in favor of AGM awarding AGM damages of $90.7 million and pre-judgment interest of $15.9 million, for a total of $106.5 million. In Second Quarter 2013, Flagstar and AGM settled out of court for $105 million. See Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of R&W settlements.

In addition, in August 2013, AGC entered into a settlement agreement with an R&W provider that resolved AGC's claims relating to specified RMBS transactions that AGC had insured and AGM reached an agreement in principle with a servicer of certain RMBS transactions that AGM had insured.

All together these efforts have resulted in the Company causing R&W providers to pay or agree to pay $3.5 billion (gross of reinsurance) in respect of R&W. The Company believes these results, including settlement agreements and trial decisions, are significant and will help it as it continues to pursue R&W providers for U.S. RMBS transactions it has insured. The Company continues to enforce contractual provisions and pursue litigation and is in discussions with other R&W providers regarding potential agreements. See "Recovery Litigation" in Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of the litigation proceedings the Company has initiated against other R&W providers.

The Company is also continuing to purchase attractively priced below-investment-grade ("BIG") obligations that it insured. These purchases resulted in a reduction to net expected loss to be paid of $535 million as of June 30, 2013. As of June 30, 2013, the fair value of assets purchased or obtained for loss mitigation purposes (excluding the value of the Company's insurance) was $685 million, with a par of $1,905 million (including bonds related to FG VIEs of $92 million in fair value and $700 million in par).

The quality of servicing of the mortgage loans underlying an RMBS transaction influences collateral performance and ultimately the amount (if any) of the Company's insured losses. The Company has established a group to mitigate RMBS losses by influencing mortgage servicing, including, if possible, causing the transfer of servicing or establishing special servicing arrangements. "Special servicing" is an industry term referencing more intense servicing applied to delinquent loans aimed at mitigating losses. Special servicing arrangements provide incentives to a servicer to achieve better performance on the mortgage loans it services. As a result of the Company's efforts, as of June 30, 2013, the servicing of approximately $2.8 billion of mortgage loans had been transferred to a new servicer and another $1.7 billion of mortgage loans were subject to special servicing arrangements. The June 30, 2013 net insured par of the transactions subject to a servicing transfer was $2.4 billion and the net insured par of the transactions subject to a special servicing arrangement was $0.9 billion.

New Business Production and Commutations

Management believes that the Company is able to provide value not only by . . .

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