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AGO > SEC Filings for AGO > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for ASSURED GUARANTY LTD



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:

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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, all of which have occurred in the past;

developments in the world's financial and capital markets that adversely affect issuers' payment rates, Assured Guaranty's loss experience, 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 possibility that Assured Guaranty will not realize insurance loss recoveries or damages expected from originators, sellers, sponsors, underwriters or servicers of residential mortgage-backed securities transactions;

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

          contract cancellations;

          Assured Guaranty's dependence on customers;

          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

          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").

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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 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").


Unless otherwise noted, ratings disclosed herein on Assured Guaranty's insured portfolio reflect its internal rating. 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. For example 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 benefiting 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.


AGL provides, through its operating subsidiaries, credit protection products in the United States ("U.S.") and international public finance (including infrastructure) and structured finance markets. The Company has applied 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 Company markets its credit protection products directly to issuers and underwriters of public finance 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., Europe and Australia.

Financial guaranty contracts provide an unconditional and irrevocable guaranty that protects the holder of a financial obligation against non-payment of principal and interest when due. The Company has issued financial guaranty insurance policies on both public finance obligations and structured finance obligations. Public finance obligations insured by the Company consist primarily of general obligation bonds supported by the taxing powers of U.S. state or municipal governmental authorities, as well as tax-supported bonds, revenue bonds and other obligations supported by covenants from state or municipal governmental authorities or other municipal obligors to impose and collect fees and charges for public services or specific infrastructure 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 generally issued by special purpose entities.

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 insurance 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.

A downgrade by Moody's Investors Service, Inc. ("Moody's") or Standard and Poor's Ratings Services ("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 credit default swap ("CDS") contracts. A downgrade in the financial strength ratings may also enable beneficiaries of the Company's

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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. On March 20, 2012, Moody's placed the ratings of AGL and of those subsidiaries that it rates, including the financial strength ratings of the insurance subsidiaries, on review for possible downgrade. On October 30, 2012, Moody's indicated that it anticipates resolving its review during the first half of November 2012. There can be no assurance as to the actions that Moody's may take on the Company's ratings.

Available Information

The Company maintains an Internet web site at The Company makes available, free of charge, on its web site (at 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 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 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.

Executive Summary

The following discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with the Company's consolidated financial statements and accompanying notes which appear elsewhere in this Form 10-Q. It contains forward looking statements that involve risks and uncertainties. Please see "Forward Looking Statements" for more information.

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 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, this Quarterly Report should be read in its entirety and in addition to Assured Guaranty's Annual Report on Form 10-K.

Economic Environment

The Company continued to be the most active provider of financial guaranty insurance for the three months ended September 30, 2012 ("Third Quarter 2012") and nine months ended September 30, 2012 ("Nine Months 2012") as a result of its financial strength and its ability to maintain financial strength ratings in the double-A ratings category throughout the financial crisis. All of the Company's former financial guaranty competitors, except AGM, which the Company acquired in 2009, have had their financial strength ratings downgraded by rating agencies to below investment grade levels or are no longer rated, severely impacting their ability to underwrite new business. Only two other industry participants have investment grade financial strength ratings today, but they are not underwriting material new business. National Public Finance Guarantee Corporation has been involved in litigation challenging its separation from MBIA Insurance Corp. and appears not to have financial strength ratings adequate to issue new financial guaranty policies on public finance obligations. Build America Mutual Assurance Company is a new entrant to the industry that commenced operations during Third Quarter 2012. 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 Company expects Build American Mutual will compete against the Company for smaller transactions. However, the presence of a new financial guaranty insurer may lead to higher overall insurance penetration of the U.S. municipal bond market.

The overall economic environment in the U.S. in Third Quarter 2012 was stronger than in the three months ended September 30, 2011 ("Third Quarter 2011"), and indicators such as lower delinquency rates and more stable housing prices point toward recovery in the housing market. However, unemployment rates remain too high for a robust general economic

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recovery to have taken hold.

Municipal credits have experienced budgetary stress since the recent credit crisis and the ensuing recession, compounded in many cases by significant unfunded pension and retiree health care liabilities. While revenues at the state level have been rebounding in general, many local governments have continued to face structural deficits as a result of the decline in property taxes. Although the vast majority of municipalities have been taking steps to address their fiscal challenges, a small number have sought bankruptcy protection. The Company is closely monitoring legal proceedings in municipal bankruptcy cases in various states as this is an area of law that has not been tested due to the relatively low frequency of such cases. The publicity surrounding high-profile defaults, especially those few where bond insurers are paying claims, provides evidence of the value of bond insurance and may therefore stimulate demand, especially at the retail level.

In 2012, new issuance volume in the U.S. public finance market increased as interest rates fell to historic lows. Such low rates tend to 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.

In the international arena, troubled Eurozone countries are a source of stress in global equity and debt markets following the execution of the debt restructuring in Greece. Debt costs in Portugal, Spain and Italy remain elevated, and 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 may cause recession. The rating agencies have downgraded many European sovereign credits within the past year. 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 current economic environment 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-economic crisis level. In particular, there has been limited new issue activity and also limited demand for financial guaranties in 2012 and 2011 in both the global structured finance and international infrastructure finance markets compared with pre-economic crisis levels. 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, although the Company cannot assure that this will occur.

In 2012, the Company continues 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. S&P revised its criteria for rating financial guarantors in August 2011 and, in November 2011, assigned AGM and AGC financial strength ratings of AA- (Stable Outlook) under those criteria. AGM's and AGC's financial strength ratings have been rated Aa3 (Negative Outlook) by Moody's since December 2009. Furthermore, on March 20, 2012, Moody's placed the ratings of AGL and of those subsidiaries that it rates, including the financial strength ratings of insurers AGM, AGC, Assured Guaranty Re Ltd. ("AG Re") and Assured Guaranty (Europe) Ltd. ("AGE"), on review for possible downgrade. On October 30, 2012, Moody's indicated that it anticipates resolving its review during the first half of November 2012. There can be no assurance as to the actions that Moody's may take on the Company's ratings. Because the financial strength ratings of Assured Guaranty were under review for possible downgrade by Moody's throughout Second and Third Quarters 2012, the Company believes the demand for the Company's insurance product was negatively impacted.

The demand for the Company's insurance has also been negatively affected by its credit spread, which is a reflection of the risk that investors perceive with the Company. The higher the Company's credit spread, the lower the benefit of the Company's guaranty. 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. While AGC's and AGM's credit spreads were lower at September 30, 2012 compared with December 31, 2011, they remained high compared with their pre-2007 credit spreads.

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Financial Performance of Assured Guaranty

                               Financial Results
                                                 Third Quarter                      Nine Months
                                             2012             2011             2012             2011
                                                 (dollars in millions, except per share amounts)
Selected income statement data
Net earned premiums                      $      222       $      211       $      635       $      695
Net investment income                           102               95              301              295
Realized gains (losses) and other
settlements on credit derivatives                 2                0              (78 )             25
Net unrealized gains (losses) on credit
derivatives                                     (38 )          1,156             (388 )            830
Fair value gains (losses) on financial
guaranty variable interest entities              38              (99 )            174             (154 )
Loss and loss adjustment expenses                90              215              459              313
Other operating expenses                         48               46              163              163
Net income (loss)                               142              761               36              857
Diluted earnings per share               $     0.73       $     4.13       $     0.19       $     4.60
Selected non-GAAP measures(1)
Operating income                         $      166       $       38       $      351       $      429
Operating income per share                     0.85             0.21             1.85             2.30
Present value of new business production
("PVP")                                          35               51              141              155


(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 underlying insured obligations and FG VIE 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 financial guaranty variable interest entities' ("FG VIEs") assets and liabilities. In addition to these factors, changes in expected losses, the timing of refundings, accelerations and terminations of financial guaranty insurance contracts, 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. Third quarter 2012 net income declined to $142 million from $761 million in third quarter 2011 due primarily to the effects of changes in credit spreads on the fair value of credit derivatives, offset in part by a decline in loss expense, which was significantly higher in the prior year due mainly to the effects of declining discount rates in the third quarter of 2011.
Net earned premiums have increased in Third Quarter 2012 compared with Third Quarter 2011 despite the scheduled decline in net par of the structured finance insured portfolio, due to higher than expected refundings, accelerations and terminations of insured transactions. Refundings are sensitive to movements in interest rates, and the current low interest rate environment has encouraged refinancings of debt obligations. The total acceleration of premiums related to these refundings and terminations was $73 million in Third Quarter 2012 compared to $27 million in Third Quarter 2011.
Realized gains and other settlements on credit derivatives include both premiums and losses that have been received or paid, or are receivable or payable. Realized gains from credit derivative revenues have declined due to the lower inforce book of business as the Company no longer enters into new CDS in order to sell credit protection. Third quarter 2012 credit derivative premiums were $33 million, offset by $31 million in losses paid or payable. In third quarter 2011, credit derivative premiums were $40 million, offset by $41 million in losses paid or payable.
Loss and LAE includes a component related to changes in risk-free rates used to discount expected losses. Any increase or decrease in loss expense due to changes in risk free rates does not reflect additional credit impairment or improvement. Loss and LAE in third quarter 2012 was lower than third quarter 2011 primarily due to the effect of declining

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interest rates in third quarter 2011, which comprised a significant portion of loss and LAE in Third Quarter 2011. In Third Quarter 2012 risk-free rates were relatively flat.
Operating income (non-GAAP)
Non-GAAP operating income in Third Quarter 2012 was $166 million, an increase from operating income in Third Quarter 2011, due primarily to higher net earned premiums due to refundings, accelerations and terminations, lower loss expense, and a lower effective tax rate on operating income.
Due primarily to the low interest rate environment and ratings uncertainty, the Company's new business originations in the U.S. public finance sector decreased in Third Quarter 2012, compared with Third Quarter 2011.

Key Business Strategies

The Company has been focused on various strategies to create value: loss mitigation, including the pursuit of recoveries for breaches of representations and warranties (" R&W"), servicing improvements and the purchase of insured obligations; new business development and commutations, and other rating agency capital improvement strategies.

Loss Mitigation

The Company continued its risk remediation strategies which lowered losses and also created additional rating agency capital. The following are examples of the strategies employed by the Company.

Pursuit of R&W Breaches

On May 8, 2012, Assured Guaranty reached a settlement with Deutsche Bank AG and certain of its affiliates (collectively, "Deutsche Bank"), resolving claims related to certain RMBS transactions issued, underwritten or sponsored by Deutsche Bank that were insured by Assured Guaranty under financial guaranty insurance policies and to certain RMBS exposures in re-securitization transactions as to which Assured Guaranty provides credit protection through CDS.

Assured Guaranty received a cash payment of $166 million from Deutsche Bank upon signing of the Deutsche Bank Agreement, a portion of which partially reimbursed Assured Guaranty for past losses on certain transactions. Assured Guaranty and Deutsche Bank also entered into loss sharing arrangements covering future RMBS related losses, which are described below. Under the Deutsche Bank Agreement, Deutsche Bank AG placed eligible assets in trust in order to collateralize the obligations of a reinsurance affiliate under the loss-sharing arrangements. The Deutsche Bank reinsurance affiliate may be required to post additional collateral in the future to satisfy rating agency requirements. As of September 30, 2012 the balance of the assets held in trust of $282 million was sufficient to fully collateralize Deutsche Bank's obligations, based on the Company's estimate of expected loss for the transactions covered under the agreement.

The settlement includes eight RMBS transactions ("Covered Transactions") that Assured Guaranty has insured through financial guaranty insurance policies and . . .

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