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AGO > SEC Filings for AGO > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for ASSURED GUARANTY LTD

Form 10-Q for ASSURED GUARANTY LTD


12-Nov-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


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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;

          contract cancellations;

          loss of key personnel;

          adverse technological developments;

          the effects of mergers, acquisitions and divestitures;

          natural or man-made catastrophes;

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          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 principally in the United States and the United Kingdom ("U.K."). The Company also guarantees obligations issued in other countries and regions, including Australia and Western Europe.

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 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.


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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 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 September 30, 2013.

Economic Environment

The Company continued to be the most active provider of financial guaranty insurance in the three months ended September 30, 2013 ("Third Quarter 2013") and nine months ended September 30, 2013 ("Nine 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 Nine Months 2013. Business conditions have been difficult for the entire financial guaranty insurance industry since mid-2007, and the industry continues to face challenges in maintaining its market penetration today. The industry's ability to generate new business has been constrained in the environment of low interest rates and tight credit spreads that has prevailed in recent years. 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 there is potential for growth in insured penetration once interest rates rise and credit spreads widen. For example, in Third Quarter 2013, interest rates were significantly higher than in the same period of 2012 and the insured penetration of the municipal new-issue market was also higher, despite lower overall new issuance. The Company cannot assure whether or for how long this pattern will be sustained.

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 elevated, 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, though not always obtained, bankruptcy protection. Municipal bankruptcy is an area of law that is relatively undeveloped due to the low frequency of such cases.

The Company, along with other creditors, has negotiated conditional agreements with certain distressed municipalities, including Jefferson County, Alabama, the City of Stockton, California, and the City of Harrisburg, Pennsylvania. The Company is also active with respect to the municipal bankruptcy case of the City of Detroit, Michigan and is closely monitoring legal proceedings in other municipal bankruptcy cases. 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 the Company believes may stimulate demand, especially at the retail level.

The Company is also closely following developments in the Commonwealth of Puerto Rico, which has significant economic challenges. The Company believes that recent announcements and actions by the current Governor and his administration demonstrate that officials of the Commonwealth are focused on making the necessary choices to help Puerto Rico operate within its financial resources and maintain its access to the capital markets, which is a critical source of funding for the Commonwealth. The Commonwealth has not defaulted on any of its debt, and neither Puerto Rico nor its instrumentalities are eligible debtors under Chapter 9 of the U.S. Bankruptcy Code. For additional information on the Company's exposure to Puerto Rico, please refer to "Puerto Rico" in Note 3, Outstanding Exposure, of the Financial Statements.


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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 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. During Third Quarter 2013, the Company guaranteed two bond issues for U.K. public-private partnership infrastructure financings, the first new-issue transactions since 2008, and it anticipates guaranteeing additional similar transactions. The Company cannot assure that this recent increase in U.K. infrastructure opportunities will continue or that the Company will be given the opportunity to participate in such financings if it does.

In Third 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 has been limited, AGC's and AGM's credit spreads were tighter at June 30, 2013 than at January 1, 2013 by 49% and 32%, respectively. In Third Quarter 2013, other factors, such as generally wider credit spreads, affected AGC's and AGM's credit spreads, which were 31% and 6% tighter at September 30, 2013 than at January 1, 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 borrowing. Although high compared with their pre-2007 levels, both AGC's and AGM's credit spreads were less than 16% of their March 2009 peaks as of September 30, 2013.


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Financial Performance of Assured Guaranty

                               Financial Results

                                              Third Quarter                      Nine Months
                                          2013              2012             2013            2012
                                                 (in millions, except per share amounts)
Selected income statement data
Net earned premiums                  $       159       $       222       $       570     $      635
Net investment income                         99               102               286            301
Realized gains (losses) and other
settlements on credit derivatives             24                 2               (44 )          (78 )
Net unrealized gains (losses) on
credit derivatives                           330               (38 )            (120 )         (388 )
Fair value gains (losses) on
financial guaranty variable interest
entities                                      40                34               253            161
Loss and loss adjustment (expenses)
benefit                                      (55 )             (86 )             (69 )         (446 )
Other operating expenses                     (54 )             (48 )            (166 )         (163 )
Net income (loss)                            384               142               459             36
Diluted income (loss) per share      $      2.09       $      0.73       $      2.43     $     0.19
Selected non-GAAP measures(1)
Operating income                     $       117       $       166       $       475     $      351
Operating income per share           $      0.64       $      0.85       $      2.51     $     1.85
Present value of new business
production ("PVP")                   $        40       $        35       $        74     $      141


____________________


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

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 Third Quarter 2013 was $384 million compared with net income of $142 million in the three-month period ended September 30, 2012 ("Third Quarter 2012"). The increase was primarily due to unrealized gains on credit derivatives that resulted from the increase in AGC's and AGM's credit spreads in the Third Quarter 2013 and lower loss and loss adjustment expenses due primarily to an increase in projected representations and warranties ("R&W") recoveries from U.S. residential mortgage-backed security ("RMBS") transactions. This was partially offset by the decline in net earned premiums due to lower scheduled earned premiums, and lower refundings and terminations.

Net income for Nine Months 2013 was $459 million compared with net income of $36 million in the nine-month period ended September 30, 2012 ("Nine Months 2012"). On a year to date basis, the increase in net income was primarily attributable to lower loss expense due to several factors including the resolution of Greek exposures in 2012 and the impact of various R&W settlements in 2013, lower unrealized losses on credit derivatives, and certain R&W settlements that benefited the fair value of FG VIEs in 2013. This was partially offset by lower net premium earned and lower other income due to the inclusion of commutation gains recognized on previously ceded reinsurance contracts from Radian Asset Assurance Inc. ("Radian") and Tokio Marine & Nichido Fire Insurance Co., Ltd. ("Tokio") in Nine Months 2012.


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Non-GAAP Financial Measures

Non-GAAP operating income in Third Quarter 2013 was $117 million, compared with $166 million in Third 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 Nine Months 2013 was $475 million, compared with $351 million in Nine Months 2012. The increase in operating income was driven primarily by lower losses, partially offset by the decrease in net earned premiums and other income, as indicated above. The increase in pretax operating income in U.S. taxable jurisdictions resulted in a higher effective tax rate in Nine Months 2013.

Adjusted book value per share was $49.55 as of September 30, 2013, as compared with $47.17 per share as of December 31, 2012. Adjusted book value value per share increased primarily due to share repurchases during Nine 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 strategies to manage capital more efficiently, 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 42 U.S. jurisdictions, including the District of Columbia. MAC is a new financial guaranty insurer that provides insurance only on investment grade debt obligations in select sectors of the U.S. public finance markets. In July 2013, it was capitalized with $700 million in equity and a $100 million surplus note issued to AGM. MAC was established in order to increase the Company's insurance penetration in the U.S. public finance sector and, unlike other new financial guarantors, began operations with a seasoned book of business totaling $111 billion in par, which was ceded from its affiliates AGC and AGM, a future stream of investment income and premiums earnings. 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"). Please refer to Note 11, Insurance Company Regulatory Requirements, of the Financial Statements for additional information.

Loss Mitigation

The Company continued its risk remediation strategies in 2013, which lowered losses and improved its rating agency capital position. The Company believes that, with its knowledge and resources and, in some instances, the remedies available to it as insurer, it is often in a better position than a single bond holder to avoid or mitigate losses from troubled credits.

In an effort to recover U.S. 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. See Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of R&W settlements. Most recently:

On May 6, 2013, the Company entered into an agreement with UBS Real Estate Securities Inc. and affiliates ("UBS") 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 entered into a settlement agreement pursuant to which Flagstar paid AGM $105 million and withdrew its appeal of the judgment in favor of AGM.

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. Separately, AGM entered into a settlement agreement with a servicer of certain RMBS transactions that AGM had insured.


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On October 10 2013, the Company entered into an agreement with Deutsche Bank to terminate a below investment grade transaction under which the Company had provided protection to Deutsche Bank through a credit default swap ("CDS").

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