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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)    

ý

 

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2010

or

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition Period from                  to                

Commission File No. 001-32141

ASSURED GUARANTY LTD.
(Exact name of registrant as specified in its charter)

Bermuda
(State or other jurisdiction of incorporation)
  98-0429991
(I.R.S. employer identification no.)

30 Woodbourne Avenue
Hamilton HM 08
Bermuda
(Address of principal executive offices)

(441) 279-5700
(Registrant's telephone number, including area code)

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o    No o

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer ý   Accelerated filer o   Non-accelerated filer o
(Do not check if a
smaller reporting company)
  Smaller reporting company o

        Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý

        The number of registrant's Common Shares ($0.01 par value) outstanding as of April 30, 2010 was 184,361,050 (excludes 217,269 unvested restricted shares).


Table of Contents

ASSURED GUARANTY LTD.

INDEX TO FORM 10-Q

 
   
  Page  

PART I. FINANCIAL INFORMATION

       
 

Item 1.

 

Financial Statements:

       

 

Consolidated Balance Sheets (unaudited) as of March 31, 2010 and December 31, 2009

    1  

 

Consolidated Statements of Operations (unaudited) for the Three Months Ended March 31, 2010 and 2009

    2  

 

Consolidated Statements of Comprehensive Income (unaudited) for the Three Months Ended March 31, 2010 and 2009

    3  

 

Consolidated Statements of Shareholders' Equity (unaudited) for the Three Months ended March 31, 2010

    4  

 

Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2010 and 2009

    5  

 

Notes to Consolidated Financial Statements (unaudited)

    6  
 

Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

    101  

 

Forward-Looking Statements

    101  

 

Website Information

    102  

 

Executive Summary

    102  

 

Financial Strength Ratings

    110  

 

AGMH Acquisition

    112  

 

Insured Portfolio Profile

    115  

 

Results of Operations

    118  

 

Exposure to Residential Mortgage Backed Securities

    144  

 

Summary of relationships with Monolines

    151  

 

Non-GAAP Measures

    152  

 

Liquidity and Capital Resources

    154  
 

Item 3.

 

Market Risk

    173  
 

Item 4.

 

Controls and Procedures

    176  

PART II. OTHER INFORMATION

       
 

Item 1.

 

Legal Proceedings

    176  
 

Item 1A.

 

Risk Factors

    180  
 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

    183  
 

Item 6.

 

Exhibits

    183  

Table of Contents


Assured Guaranty Ltd.

Consolidated Balance Sheets (Unaudited)

(dollars in thousands except per share and share amounts)

 
  March 31,
2010
  December 31,
2009
 

ASSETS

             

Investment portfolio:

             
 

Fixed maturity securities, available-for-sale, at fair value (amortized cost of $8,865,859 and $8,943,909)

  $ 9,057,230   $ 9,139,900  
 

Short term investments, at fair value

    1,421,421     1,668,279  
           
   

Total investment portfolio

    10,478,651     10,808,179  

Assets acquired in refinancing transactions

    143,488     152,411  

Cash

    90,472     44,133  

Premiums receivable, net of ceding commissions payable

    1,371,582     1,418,232  

Ceded unearned premium reserve

    926,227     1,051,971  

Deferred acquisition costs

    244,024     241,961  

Reinsurance recoverable on unpaid losses

    17,834     14,122  

Credit derivative assets

    537,050     492,531  

Committed capital securities, at fair value

    8,262     9,537  

Deferred tax asset, net

    1,132,059     1,158,205  

Salvage and subrogation recoverable

    261,774     239,476  

Financial guaranty variable interest entities' assets

    1,868,596     762,303  

Other assets

    308,435     200,375  
           
 

TOTAL ASSETS

  $ 17,388,454   $ 16,593,436  
           

LIABILITIES AND SHAREHOLDERS' EQUITY

             

Unearned premium reserves

  $ 7,720,942   $ 8,219,390  

Loss and loss adjustment expense reserve

    361,272     289,470  

Long-term debt

    919,493     917,362  

Notes payable

    142,403     149,051  

Credit derivative liabilities

    1,821,961     2,034,634  

Reinsurance balances payable, net

    185,398     186,744  

Financial guaranty variable interest entities' liabilities with recourse

    2,067,215     762,652  

Financial guaranty variable interest entities' liabilities without recourse

    205,724      

Other liabilities

    345,011     513,974  
           
 

TOTAL LIABILITIES

    13,769,419     13,073,277  
           

COMMITMENTS AND CONTINGENCIES

             

Common stock ($0.01 par value, 500,000,000 shares authorized; 184,345,013 and 184,162,896 shares issued and outstanding in 2010 and 2009)

    1,843     1,842  

Additional paid-in capital

    2,589,454     2,584,983  

Retained earnings

    885,344     789,869  

Accumulated other comprehensive income, net of deferred tax provision (benefit) of $47,982 and $58,551

    140,394     141,814  

Deferred equity compensation (181,818 shares)

    2,000     2,000  
           
 

TOTAL SHAREHOLDERS' EQUITY ATTRIBUTABLE TO ASSURED GUARANTY LTD

    3,619,035     3,520,508  

Noncontrolling interest of financial guaranty variable interest entities

        (349 )
           
 

TOTAL SHAREHOLDERS' EQUITY

    3,619,035     3,520,159  
           
 

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY

  $ 17,388,454   $ 16,593,436  
           

The accompanying notes are an integral part of these consolidated financial statements.

1


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Assured Guaranty Ltd.

Consolidated Statements of Operations (Unaudited)

(dollars in thousands except per share amounts)

 
  Three Months Ended
March 31,
 
 
  2010   2009  

Revenues

             

Net earned premiums

  $ 319,560   $ 148,446  

Net investment income

    84,302     43,601  

Net realized investment gains (losses):

             
 

Other-than-temporary impairment ("OTTI") losses

    (1,117 )   (18,446 )
 

Less: portion of OTTI loss recognized in other comprehensive income

    (661 )    
 

Other net realized investment gains (losses)

    9,869     1,336  
           
   

Net realized investment gains (losses)

    9,413     (17,110 )

Net change in fair value of credit derivatives:

             
 

Realized gains and other settlements

    26,703     20,579  
 

Net unrealized gains (losses)

    252,098     26,982  
           
   

Net change in fair value of credit derivatives

    278,801     47,561  

Fair value gain (loss) on committed capital securities

    (1,275 )   19,666  

Financial guaranty variable interest entities revenues

    4,188      

Other income

    (11,104 )   902  
           
 

Total Revenues

    683,885     243,066  
           

Expenses

             

Loss and loss adjustment expenses

    130,501     79,754  

Amortization of deferred acquisition costs

    8,173     23,421  

Assured Guaranty Municipal Holdings Inc. ("AGMH") acquisition-related expenses

    4,021     4,621  

Interest expense

    25,134     5,821  

Financial guaranty variable interest entities expenses

    14,778      

Other operating expenses

    64,358     29,352  
           
 

Total expenses

    246,965     142,969  
           

Income before income taxes

    436,920     100,097  

Provision (benefit) for income taxes

             

Current

    (38,953 )   11,575  

Deferred

    153,898     3,033  
           

Total provision (benefit) for income taxes

    114,945     14,608  
           
 

Net income

    321,975     85,489  

Less: Noncontrolling interest of variable interest entities

         
           

Net income attributable to Assured Guaranty Ltd

  $ 321,975   $ 85,489  
           

Earnings per share:

             
 

Basic

  $ 1.74   $ 0.94  
 

Diluted

  $ 1.69   $ 0.93  

Dividends per share

  $ 0.045   $ 0.045  

The accompanying notes are an integral part of these consolidated financial statements.

2


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Assured Guaranty Ltd.

Consolidated Statements of Comprehensive Income (Unaudited)

(in thousands)

 
  Three Months Ended
March 31,
 
 
  2010   2009  

Net income

  $ 321,975   $ 85,489  

Unrealized holding gains (losses) arising during the period on:

             

Investments with no OTTI, net of deferred income tax provision (benefit) of $(5,382) and $4,585

    9,875     (9,702 )

Investments with OTTI, net of deferred income tax provision (benefit) of $0 and $0

    (661 )    
           

Unrealized holding gains (losses) during the period, net of tax

    9,214     (9,702 )

Less: reclassification adjustment for gains (losses) included in net income (loss), net of deferred income tax provision (benefit) of $2,768 and $(35)

    6,645     (17,075 )
           

Change in net unrealized gains on investments

    2,569     7,373  

Change in cumulative translation adjustment

    (3,884 )   (8,387 )

Cash flow hedge

    (105 )   (105 )
           

Other comprehensive income (loss)

    (1,420 )   (1,119 )
           

Comprehensive income

  $ 320,555   $ 84,370  
           

The accompanying notes are an integral part of these consolidated financial statements.

3


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Assured Guaranty Ltd.

Consolidated Statements of Shareholders' Equity (Unaudited)

For the Three Months Ended March 31, 2010

(dollars in thousands, except share data)

 
   
   
   
   
   
   
  Total
Shareholders'
Equity
Attributable
to Assured
Guaranty Ltd.
  Noncontrolling
Interest of
Financial
Guaranty
Consolidated
Variable
Interest Entities
   
 
 
  Common Stock    
   
  Accumulated
Other
Comprehensive
Income (Loss)
   
   
 
 
  Additional
Paid-in
Capital
  Retained
Earnings
  Deferred Equity
Compensation
  Total
Shareholders'
Equity
 
 
  Shares   Amount  

Balance, December 31, 2009

    184,162,896   $ 1,842   $ 2,584,983   $ 789,869   $ 141,814   $ 2,000   $ 3,520,508   $ (349 ) $ 3,520,159  

Cumulative effect of accounting change—consolidation of variable interest entities effective January 1, 2010 (Note 23)

                (218,144 )           (218,144 )   349     (217,795 )
                                       

Balance at the beginning of the year, adjusted

    184,162,896     1,842     2,584,983     571,725     141,814     2,000     3,302,364         3,302,364  

Net income

                321,975             321,975         321,975  

Dividends on common stock ($0.045 per share)

                (8,305 )           (8,305 )       (8,305 )

Dividends on restricted stock units

            51     (51 )                    

Shares cancelled to pay withholding taxes

    (62,748 )   (1 )   (2,695 )               (2,696 )       (2,696 )

Stock options exercises

    10,658         113                     113         113  

Share-based compensation and other

    234,207     2     7,002                 7,004         7,004  

Change in cash flow hedge, net of tax of $(56)

                    (105 )       (105 )       (105 )

Change in cumulative translation adjustment

                    (3,884 )       (3,884 )       (3,884 )

Unrealized gain on investments, net of tax of $(8,150)

                    2,569         2,569         2,569  
                                       

Balance, March 31, 2010

    184,345,013   $ 1,843   $ 2,589,454   $ 885,344   $ 140,394   $ 2,000   $ 3,619,035   $   $ 3,619,035  
                                       

The accompanying notes are an integral part of these consolidated financial statements.

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Assured Guaranty Ltd.

Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

 
  Three Months Ended
March 31,
 
 
  2010   2009  

Operating activities

             

Net income

  $ 321,975   $ 85,489  

Adjustments to reconcile net income to net cash flows provided by operating activities:

             
 

Non-cash interest and operating expenses

    10,124     4,795  
 

Net amortization of premium on fixed maturity securities

    17,680     (1,819 )
 

Accretion of discount on net premium receivable

    (12,609 )   (5,287 )
 

Provision for deferred income taxes

    153,898     3,033  
 

Net realized investment losses (gains)

    (9,413 )   17,110  
 

Unrealized (gains) on credit derivatives

    (252,098 )   (26,982 )
 

Fair value loss (gain) on committed capital securities

    1,275     (19,666 )
 

Other income

    32,162      
 

Change in deferred acquisition costs

    (2,063 )   7,927  
 

Change in premiums receivable, net of ceding commissions

    13,269     (5,946 )
 

Change in ceded unearned premium reserves

    125,744     1,826  
 

Change in unearned premium reserves

    (432,905 )   91,945  
 

Change in reserves for losses and loss adjustment expenses, net

    55,878     13,870  
 

Change in current income taxes

    (203,132 )   26,005  
 

Other changes in credit derivatives assets and liabilities, net

    (5,094 )   (2,856 )
 

Change in financial guaranty variable interest entities assets and liabilities, net

    (10,230 )    
 

Other

    (41,051 )   (22,427 )
           

Net cash flows provided by (used by) operating activities

    (236,590 )   167,017  
           

Investing activities

             
 

Fixed maturity securities:

             
   

Purchases

    (418,032 )   (289,219 )
   

Sales

    187,800     274,260  
   

Maturities

    265,268     3,500  
 

Net (purchases) sales of short-term investments

    246,001     (139,622 )
 

Proceeds from financial guaranty variable interest entities assets

    60,687      
 

Other

    4,867      
           

Net cash flows provided by (used for) investing activities

    346,591     (151,081 )
           

Financing activities

             
 

Dividends paid

    (8,305 )   (4,122 )
 

Repurchases of common stock

        (3,676 )
 

Share activity under option and incentive plans

    (2,583 )   (942 )
 

Paydown of financial guaranty variable interest entities liabilities

    (46,157 )    
 

Repayment of notes payable

    (6,363 )    
           

Net cash flows provided by (used for) financing activities

    (63,408 )   (8,740 )

Effect of exchange rate changes

    (254 )   (173 )
           

Increase in cash

    46,339     7,023  

Cash at beginning of period

    44,133     12,305  
           

Cash at end of period

  $ 90,472   $ 19,328  
           

Supplemental cash flow information

             

Cash paid (received) during the period for:

             
 

Income taxes

  $ 136,645   $ (14,514 )
 

Interest

  $ 11,963   $  

Claims paid, net of reinsurance

  $ 256,809   $ 74,807  

The accompanying notes are an integral part of these consolidated financial statements.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2010

1. Business and Organization

        Assured Guaranty Ltd. ("AGL" and, together with its subsidiaries, "Assured Guaranty" or the "Company") is a Bermuda-based holding company that provides, through its operating subsidiaries, credit protection products to the public finance, infrastructure and structured finance markets in the United States ("U.S.") as well as internationally. The Company applies its credit underwriting expertise, risk management skills and capital markets experience to develop insurance, reinsurance and credit derivative products. The Company's primary product is a guaranty of principal and interest payments on debt securities. These securities include municipal finance obligations issued by U.S. state or municipal governmental authorities, utility districts or facilities; notes or bonds issued for international infrastructure projects; and asset-backed securities ("ABS") issued by special purpose entities ("SPEs"). 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 debt obligations. The Company guarantees debt obligations issued in many countries, although its principal focus is on the U.S. and European markets.

        On July 1, 2009 (the "Acquisition Date"), the Company acquired Financial Security Assurance Holdings Ltd. (renamed Assured Guaranty Municipal Holdings Inc., "AGMH"), and AGMH's subsidiaries, including Financial Security Assurance Inc. (renamed Assured Guaranty Municipal Corp., "AGM"), from Dexia Holdings, Inc. ("Dexia Holdings"). As discussed further in Note 2, Assured Guaranty's acquisition of AGMH (the "AGMH Acquisition") did not include the acquisition of AGMH's former financial products business, which was comprised of its guaranteed investment contracts ("GICs") business, its medium term notes ("MTNs") business and the equity payment agreements associated with AGMH's leveraged lease business (the "Financial Products Business").

        AGL's principal operating subsidiaries are Assured Guaranty Corp. ("AGC"), AGM and Assured Guaranty Re Ltd. ("AG Re").

        The Company is a leading provider of financial guaranty credit protection products. This achievement resulted from a combination of factors, including AGL's acquisition of AGMH in 2009, the Company's ability to achieve and maintain high investment-grade financial strength ratings, and the significant financial distress faced by many of the Company's competitors since 2007, which has impaired their ability to underwrite new business.

        Since July 1, 2009, when the AGMH Acquisition closed, the Company has conducted its financial guaranty business on a direct basis from two distinct platforms: (1) AGM, focusing exclusively on the U.S. public finance and global infrastructure business and (2) AGC, underwriting global structured finance transactions as well as U.S. public finance and global infrastructure obligations.

Segments

        The Company's business includes two principal segments: financial guaranty direct and financial guaranty reinsurance. The financial guaranty direct and reinsurance segments include financial guaranties of residential mortgage-backed securities ("RMBS") and commercial mortgage-backed securities ("CMBS"). The Company's mortgage guaranty insurance business, which used to be a segment and has had no new activity in recent years, and other lines of business that were 100% ceded upon Assured Guaranty's initial public offering ("IPO") in 2004, are shown as "other". The direct segment is reported net of business ceded to external reinsurers. The financial guaranty segments

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

1. Business and Organization (Continued)


include contracts accounted for as both insurance and credit derivatives. These segments are further discussed in Note 21.

Current Status of Ratings

        Debt obligations guaranteed by AGL's insurance subsidiaries are generally awarded debt credit ratings that are the same rating as the financial strength rating of the AGL subsidiary that has guaranteed that obligation.

        As of April 30, 2010, the following insurance subsidiaries of AGL were rated AAA (negative outlook) by Standard & Poor's Ratings Services ("S&P") and Aa3 (negative outlook) by Moody's Investors Service, Inc. ("Moody's"):

        AG Re and its subsidiaries Assured Guaranty Re Overseas Ltd. ("AGRO") and Assured Guaranty Mortgage Insurance Company ("AGMIC") were each rated AA (stable) by S&P and A1 (negative outlook) by Moody's.

        All of these ratings are subject to continuous review and there can be no assurance that rating agencies will not take action on the Company's ratings, including downgrading such ratings. The Company's business and its financial condition has been and will continue to be subject to risk of the global financial and economic conditions that could materially and negatively affect the demand for its products, the amount of losses incurred on transactions it guarantees, and its financial strength ratings.

2. AGMH Acquisition

        On the Acquisition Date, AGL, through its wholly owned subsidiary Assured Guaranty US Holdings Inc. ("AGUS"), purchased AGMH and, indirectly, its subsidiaries (excluding those involved in AGMH's former Financial Products Business) from Dexia Holdings. The acquired companies are collectively referred to as the "Acquired Companies." The AGMH subsidiaries that conducted AGMH's former Financial Products Business (the "Financial Products Companies") were sold to Dexia Holdings prior to the AGMH Acquisition. In connection with the AGMH Acquisition, Dexia Holdings agreed to assume the risks in respect of the Financial Products Business and AGM agreed to retain the risks relating to the debt and strip policy portions of such business. Accordingly, the Company has entered into various agreements with Dexia SA and certain of its affiliates (together, "Dexia") in order to transfer to Dexia the credit risks and, as discussed further in Note 17, the liquidity risks associated with AGMH's former Financial Products Business.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

2. AGMH Acquisition (Continued)

        The Company is indemnified against exposure to AGMH's former financial products segment through guaranties issued by Dexia SA and certain of its affiliates. In addition, the Company is protected from exposure to such GIC business through guaranties issued by the French and Belgian governments. Furthermore, to support the payment obligations of the Financial Products Companies, Dexia SA and its affiliate Dexia Crédit Local S.A. ("DCL") has entered into two separate ISDA Master Agreements, each with its associated schedule, confirmation and credit support annex (the "Guaranteed Put Contract" and the "Non-Guaranteed Put Contract" respectively, and collectively, the "Dexia Put Contracts"), pursuant to which Dexia SA and DCL jointly and severally guarantee the scheduled payments of interest and principal in relation to each asset of FSA Asset Management LLC ("FSAM"), which is one of the Financial Products Companies, as well as any failure of Dexia to provide liquidity or liquid collateral under certain liquidity facilities.

        AGMH is now a wholly owned subsidiary of AGUS and the Company's financial statements subsequent to the Acquisition Date include the activities of the Acquired Companies.

        The purchase price paid by the Company was $546.0 million in cash and 22.3 million common shares of AGL with an Acquisition Date fair value of $275.9 million, for a total purchase price of $821.9 million.

        At the closing of the AGMH Acquisition, Dexia Holdings owned approximately 14.0% of AGL's issued common shares. Effective August 13, 2009, Dexia Holdings transferred such AGL common shares to Dexia SA, acting through its French branch. On March 16, 2010, Dexia SA sold all of such AGL common shares in a secondary public offering.

        The AGMH Acquisition was accounted for under the purchase method of accounting in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Accordingly, the purchase price was allocated to assets acquired and liabilities assumed based on their estimated fair value at the Acquisition Date. In many cases, determining the fair value of acquired assets and assumed liabilities required the Company to exercise significant judgment. The most significant of these determinations related to the valuation of the acquired financial guaranty direct and ceded contracts.

        The fair value of the deferred premium revenue (which is a component of unearned premium reserve, as described below) is the estimated premium that a similarly rated hypothetical financial guarantor would demand to assume each policy. The methodology for determining such value takes into account the rating of the insured obligation, expectation of loss, sector and term. On January 1, 2009, new accounting guidance became effective for financial guaranty insurance which requires a Company to recognize loss reserves only to the extent expected losses exceed deferred premium revenue. As the fair value of the deferred premium revenue exceeded the Company's estimate of expected loss for each contract, no loss reserves were recorded at July 1, 2009 for the Acquired Companies' contracts.

        Based on the Company's assumptions, the fair value of the Acquired Companies' deferred premium revenue on its insurance contracts was $7.3 billion at July 1, 2009, an amount approximately $1.7 billion greater than the Acquired Companies' gross stand ready obligations at June 30, 2009. This indicates that the amounts of the Acquired Companies' contractual premiums were less than the premiums a market participant of similar credit quality would demand to acquire those contracts at the

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

2. AGMH Acquisition (Continued)


Acquisition Date. The fair value of the Acquired Companies' ceded contracts at July 1, 2009 was an asset of $1.7 billion and recorded in ceded unearned premium reserve. The fair value of the ceded contracts is in part derived from the fair value of the related insurance contracts with an adjustment for the credit quality of each reinsurer applied.

        For AGMH's long-term debt, the fair value was based upon quoted market prices available from third-party brokers as of the Acquisition Date. The fair value of this debt was approximately $0.3 billion lower than its carrying value immediately prior to the AGMH Acquisition. This discount is being amortized into interest expense over the estimated remaining life of the debt.

        Additionally, other purchase accounting adjustments included (1) the write off of the Acquired Companies' deferred acquisition cost ("DAC") and (2) the consolidation of certain financial guaranty variable interest entities ("VIEs") in which the combined variable interest of the Acquired Companies and AG Re was determined to be the primary beneficiary. Effective January 1, 2010, the Company deconsolidated these financial guaranty VIEs in accordance with new GAAP guidance as discussed in Note 23.

        The bargain purchase gain was recorded within "Goodwill and settlement of pre-existing relationship" in the Company's consolidated statements of operations at the Acquisition Date. The bargain purchase resulted from the unprecedented credit crisis, which resulted in a significant decline in AGMH's franchise value due to material insured losses, ratings downgrades and significant losses at Dexia. Dexia required government intervention in its affairs, resulting in motivation to sell AGMH, and with the absence of potential purchasers of AGMH due to the financial crisis, the Company was able to negotiate a bargain purchase price. The initial difference between the purchase price of $822 million and AGMH's recorded net assets of $2.1 billion was reduced significantly by the recognition of additional liabilities related to AGMH's insured portfolio on a fair value basis as required by purchase accounting.

        The Company and the Acquired Companies had a pre-existing reinsurance relationship. Under GAAP, this pre-existing relationship must be effectively settled at fair value. The loss relating to this pre-existing relationship resulted from the effective settlement of reinsurance contracts at fair value and the write-off of previously recorded assets and liabilities relating to this relationship recorded in the Company's historical accounts. The loss related to the contract settlement results from contractual premiums that were less than the Company's estimate of what a market participant would demand currently, estimated in a manner similar to how the value of the Acquired Companies insurance policies were valued, as well as related acquisition costs as described above.

Pro Forma Condensed Combined Statement of Operations

        The following unaudited pro forma information presents the combined results of operations of Assured Guaranty and the Acquired Companies. The unaudited pro forma combined financial information is presented for illustrative purposes only and does not indicate the financial results of the combined company had the companies actually been combined as of January 1, 2009, nor is it indicative of the results of operations in future periods.

9


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

2. AGMH Acquisition (Continued)


Pro Forma Unaudited Results of Operations
As of March 31, 2009

 
  Revenues   Net Income
Attributable to
Assured
Guaranty Ltd.
  Net Income per
Basic Share
 
 
  (dollars in thousands, except per share amounts)
 

Assured Guaranty as reported

  $ 243,066   $ 85,489   $ 0.94  

Pro Forma Combined

    1,097,551     469,159     3.04  

3. Summary of Significant Accounting Policies

Basis of Presentation

        The unaudited interim consolidated financial statements have been prepared in conformity with GAAP and, in the opinion of management, reflect all adjustments which are of a normal recurring nature, necessary for a fair statement of the Company's financial condition, results of operations and cash flows for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These unaudited interim consolidated financial statements cover the three-month period ended March 31, 2010 ("First Quarter 2010") and the three-month period ended March 31, 2009 ("First Quarter 2009"). Results of operations for the three-month period ended March 31, 2010 are not necessarily indicative of the results that may be expected for a full year. The First Quarter 2010 financial statements include the effects of the Company's common share and equity units offerings that took place in 2009 and the effects of the AGMH Acquisition, which was effective July 1, 2009.

        Intercompany accounts and transactions have been eliminated. Certain prior year balances have been reclassified to conform to the current year's presentation.

        These unaudited interim consolidated financial statements should be read in conjunction with the Company's consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2009, filed with the U.S. Securities and Exchange Commission (the "SEC").

        Certain of AGL's subsidiaries are subject to U.S. and U.K. income tax. The Company's provision for income taxes for interim financial periods is not based on an estimated annual effective rate due to the variability in changes in fair value of its credit derivatives, which prevents the Company from projecting a reliable estimated annual effective tax rate and pre-tax income for the full year of 2010. A discrete calculation of the provision is calculated for each interim period.

        The past couple of years saw volatility and disruption in the global financial markets including depressed home prices and increased foreclosures, falling equity market values, rising unemployment, declining business and consumer confidence and the risk of increased inflation, which have precipitated an economic slowdown. While there have been signs of a recovery as seen by stabilizing unemployment

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

3. Summary of Significant Accounting Policies (Continued)


and home prices as well as rising equity markets, there can be no assurance that volatility and disruption will not return to these markets in the near term. These conditions may adversely affect the Company's future profitability, financial position, investment portfolio, cash flow, statutory capital, financial strength ratings and stock price. Additionally, future legislative, regulatory or judicial changes in the jurisdictions regulating the Company may adversely affect its ability to pursue its current mix of business, materially impacting its financial results.

4. Recent Accounting Pronouncements

        On January 1, 2010, the Company adopted new accounting guidance as required by the Financial Accounting Standards Board ("FASB") that changed how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. See Note 23.

        Effective March 31, 2010, the Company adopted new accounting guidance as required by the FASB that clarifies existing disclosure requirements for fair value measurements. This new guidance requires the disclosure of (1) the amounts and nature of transfers in and out of Level 1 and Level 2 measurements; (2) purchase, sale, issuance and settlement activity for Level 3 measurements presented on a gross rather than a net basis; (3) fair value measurements by Level presented on a more disaggregated basis, by asset or liability class; and (4) more detailed disclosures about inputs and valuation techniques for Level 2 and Level 3 measurements for interim and annual reporting periods. The adoption of this disclosure guidance did not have a significant impact on the Company's fair value disclosures for the period ended March 31, 2010. See Note 9.

5. Outstanding Exposure

        The Company's insurance policies and credit derivative contracts typically guarantee the scheduled payments of principal and interest on public finance and structured finance obligations. The gross amount of in force exposure (principal and interest) was $1,078.7 billion at March 31, 2010 and $1,095.0 billion at December 31, 2009. The net amount of in force exposure (principal and interest), which deducts amounts ceded to third party insurers, was $958.2 billion at March 31, 2010 and $958.3 billion at December 31, 2009.

        The Company seeks to limit its exposure to losses from writing financial guaranty insurance and credit derivatives by underwriting obligations that are investment grade ("IG") at inception, diversifying its portfolio and maintaining rigorous subordination or collateralization requirements on structured finance obligations, as well as through reinsurance.

11


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

5. Outstanding Exposure (Continued)

        The par outstanding of insured obligations in the public finance insured portfolio includes the following amounts by type of issue:


Summary of Public Finance Insured Portfolio

 
  Gross Par Outstanding   Ceded Par Outstanding   Net Par Outstanding  
Types of Issues
  March 31,
2010
  December 31,
2009
  March 31,
2010
  December 31,
2009
  March 31,
2010
  December 31,
2009
 
 
  (in millions)
 

U.S.:

                                     
 

General obligation

  $ 200,139   $ 201,264   $ 18,877   $ 22,880   $ 181,262   $ 178,384  
 

Tax backed

    94,484     94,825     10,073     11,796     84,411     83,029  
 

Municipal utilities

    78,039     77,872     6,713     8,294     71,326     69,578  
 

Transportation

    42,575     42,540     6,204     7,243     36,371     35,297  
 

Healthcare

    28,097     28,214     5,555     6,205     22,542     22,009  
 

Higher education

    16,297     16,399     1,088     1,267     15,209     15,132  
 

Housing

    8,393     9,623     887     1,099     7,506     8,524  
 

Infrastructure finance

    5,190     4,530     975     977     4,215     3,553  
 

Investor-owned utilities

    1,734     1,694     2     4     1,732     1,690  
 

Other public finance—U.S. 

    5,615     6,002     77     120     5,538     5,882  
                           
   

Total public finance—U.S. 

    480,563     482,963     50,451     59,885     430,112     423,078  

Non-U.S.:

                                     
 

Infrastructure finance

    18,691     19,404     2,944     3,060     15,747     16,344  
 

Regulated utilities

    18,411     18,979     4,946     5,128     13,465     13,851  
 

Pooled infrastructure

    4,403     4,684     263     280     4,140     4,404  
 

Other public finance—non-U.S. 

    10,321     10,485     2,267     2,309     8,054     8,176  
                           
   

Total public finance—non-U.S. 

    51,826     53,552     10,420     10,777     41,406     42,775  
                           

Total public finance obligations

  $ 532,389   $ 536,515   $ 60,871   $ 70,662   $ 471,518   $ 465,853  
                           

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

5. Outstanding Exposure (Continued)

        The par outstanding of insured obligations in the structured finance insured portfolio includes the following amounts by type of collateral:


Summary of Structured Finance Insured Portfolio

 
  Gross Par Outstanding   Ceded Par Outstanding   Net Par Outstanding  
Types of Collateral
  March 31,
2010
  December 31,
2009
  March 31,
2010
  December 31,
2009
  March 31,
2010
  December 31,
2009
 
 
  (in millions)
 

U.S.:

                                     
 

Pooled corporate obligations

  $ 81,045   $ 82,622   $ 8,159   $ 8,289   $ 72,886   $ 74,333  
 

Residential mortgage-backed and home equity

    30,081     31,033     1,791     1,857     28,290     29,176  
 

Financial products(1)

    9,653     10,251             9,653     10,251  
 

Consumer receivables

    7,762     9,314     395     441     7,367     8,873  
 

Commercial mortgage-backed securities

    7,411     7,463     53     53     7,358     7,410  
 

Commercial receivables

    2,395     2,485     3     3     2,392     2,482  
 

Structured credit

    2,678     2,738     131     131     2,547     2,607  
 

Insurance securitizations

    1,731     1,731     80     80     1,651     1,651  
 

Other structured finance—U.S. 

    2,587     2,754     1,187     1,236     1,400     1,518  
                           
   

Total structured finance—U.S. 

    145,343     150,391     11,799     12,090     133,544     138,301  

Non-U.S.:

                                     
 

Pooled corporate obligations

    26,569     27,743     2,910     3,046     23,659     24,697  
 

Residential mortgage-backed and home equity

    5,277     5,623     379     396     4,898     5,227  
 

Structured credit

    2,067     2,285     146     216     1,921     2,069  
 

Commercial receivables

    1,659     1,908     36     36     1,623     1,872  
 

Insurance securitizations

    995     995     15     14     980     981  
 

Commercial mortgage-backed securities

    696     752             696     752  
 

Consumer receivables

    252         91         161      
 

Other structured finance—non-U.S. 

    489     717     24     47     465     670  
                           
   

Total structured finance—non-U.S. 

    38,004     40,023     3,601     3,755     34,403     36,268  
                           

Total structured finance obligations

  $ 183,347   $ 190,414   $ 15,400   $ 15,845   $ 167,947   $ 174,569  
                           

(1)
As discussed in Note 2, this represents the exposure to AGM's financial guaranties of GICs issued by AGMH's former financial products companies. This exposure is guaranteed by Dexia SA and certain of its affiliates. The Company is also protected by guaranties issued by the French and Belgian governments.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

5. Outstanding Exposure (Continued)

        The following table sets forth the net financial guaranty par outstanding by rating:

 
  March 31, 2010   December 31, 2009  
Ratings(1)
  Net Par
Outstanding
  % of Net Par
Outstanding
  Net Par
Outstanding
  % of Net Par
Outstanding
 
 
  (dollars in millions)
 

Super senior

  $ 34,830     5.4 % $ 43,353     6.8 %

AAA

    64,226     10.0     59,786     9.3  

AA

    198,699     31.1     196,859     30.7  

A

    236,950     37.1     233,200     36.4  

BBB

    79,222     12.4     82,059     12.8  

Below investment grade ("BIG") (See Note 6)

    25,538     4.0     25,165     4.0  
                   
 

Total exposures

  $ 639,465     100.0 % $ 640,422     100.0 %
                   

(1)
Represents the Company's internal rating. The Company's ratings scale is similar to that used by the nationally recognized rating agencies. The super senior category, which is not generally used by rating agencies, is used by the Company in instances where the Company's triple-A-rated exposure has additional credit enhancement due to either (1) the existence of another security rated triple-A that is subordinated to the Company's exposure or (2) the Company's exposure benefits 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 the Company's attachment point to be materially above the triple-A attachment point.

        As part of its financial guaranty business, the Company enters into credit derivative transactions. In such transactions, the buyer of protection pays the seller of protection a periodic fee in fixed basis points on a notional amount. In return, the seller makes a contingent payment to the buyer if one or more defined credit events occurs with respect to one or more third party referenced securities or loans. A credit event may be a nonpayment event such as a failure to pay, bankruptcy, or restructuring, as negotiated by the parties to the credit derivative transaction. The total notional amount of insured credit derivative exposure outstanding which is accounted for at fair value as of March 31, 2010 and December 31, 2009 and included in the Company's financial guaranty exposure in the tables above was $119.0 billion and $122.4 billion, respectively. See Note 8.

6. Significant Risk Management Activities

        Surveillance personnel are responsible for monitoring and reporting on all transactions in the insured portfolio, including exposures in both financial guaranty insurance and credit derivative form. The primary objective of the surveillance process is to monitor trends and changes in transaction credit quality, detect any deterioration in credit quality, and recommend to management such remedial actions as may be necessary or appropriate. All transactions in the insured portfolio are assigned internal credit ratings, and Surveillance personnel are responsible for recommending adjustments to those ratings to reflect changes in transaction credit quality.

        Work-out personnel are responsible for managing work-out and loss situations. They develop strategies designed to enhance the ability of the Company to enforce its contractual rights and

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

6. Significant Risk Management Activities (Continued)


remedies and to mitigate its losses, engage in negotiation discussions with transaction participants and, when necessary, manage the Company's litigation proceedings.

        The Company segregates its insured portfolio of IG and BIG risks into surveillance categories to facilitate the appropriate allocation of resources to monitoring and loss mitigation efforts and to aid in establishing the appropriate cycle for periodic review for each exposure. BIG credits include all credits internally rated lower than BBB-. The Company's internal credit ratings are based on the Company's internal assessment of the likelihood of default. The Company's internal credit ratings are expressed on a ratings scale similar to that used by the rating agencies and are generally reflective of an approach similar to that employed by the rating agencies.

        The Company monitors its IG credits to determine whether any new credits need to be internally downgraded to BIG. Quarterly procedures include qualitative and quantitative analysis of the Company's insured portfolio to identify potential new BIG credits. The Company refreshes its internal credit ratings on individual credits in cycles based on the Company's view of the credit's quality, loss potential, volatility and sector. Ratings on credits in sectors identified as under the most stress or with the most potential volatility are reviewed every quarter. Credits identified through this process as BIG are subjected to further review by Surveillance personnel to determine the various probabilities of a loss. Surveillance personnel present analysis related to potential loss scenarios to the reserve committee.

Below Investment Grade Surveillance Categories

        Within the BIG category, the Company assigns each credit to one of three surveillance categories:

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Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

6. Significant Risk Management Activities (Continued)

        The tables below present the U.S. RMBS portfolio and ratings within the BIG category.


Financial Guaranty Insurance Exposure on U.S. RMBS Policies

 
  March 31, 2010  
 
   
  BIG Net Par Outstanding  
 
  Total Net Par
Outstanding
 
 
  BIG 1   BIG 2   BIG 3   Total  
 
  (in millions)
 

First Lien U.S. RMBS:

                               
 

Prime First Lien

  $ 407   $ 53   $ 49   $   $ 102  
 

Alt-A First Lien

    2,426     237     1,469     163     1,869  
 

Alt-A Options ARM

    2,773     584     1,782     252     2,618  
 

Subprime (including net interest margin ("NIMs")

    4,882     930     1,524     45     2,499  

Second Lien U.S. RMBS:

                               
 

Closed end second lien ("CES")

    1,177     120     531     483     1,134  
 

Home equity lines of credit ("HELOC")

    5,623     29     104     4,114     4,247  
                       
   

Total

  $ 17,288   $ 1,953   $ 5,459   $ 5,057   $ 12,469  
                       


Financial Guaranty Insurance Exposure on U.S. RMBS Policies

 
  December 31, 2009  
 
   
  BIG Net Par Outstanding  
 
  Total Net Par
Outstanding
 
 
  BIG 1   BIG 2   BIG 3   Total  
 
  (in millions)
 

First Lien U.S. RMBS:

                               
 

Prime First Lien

  $ 426   $ 4   $ 50   $   $ 54  
 

Alt-A First Lien

    2,470     208     1,441     173     1,822  
 

Alt-A Options ARM

    2,858     596     2,096         2,692  
 

Subprime (including NIMs)

    4,985     924     1,272     47     2,243  

Second Lien U.S. RMBS:

                               
 

CES

    1,212     123     535     509     1,167  
 

HELOCs

    5,923     13     113     4,372     4,498  
                       
   

Total

  $ 17,874   $ 1,868   $ 5,507   $ 5,101   $ 12,476  
                       

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Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts

        Information in this note is only for contracts accounted for as financial guaranty insurance contracts.


Expected Collections of Gross Premiums Receivable, Net of Ceding Commissions(1)

 
  (in thousands)  

2010 (April 1 - June 30)

  $ 73,866  

2010 (July 1 - September 30)

    40,064  

2010 (October 1 - December 31)

    71,750  

2011

    137,650  

2012

    121,342  

2013

    110,983  

2014

    101,053  

2015 - 2019

    413,430  

2020 - 2024

    297,993  

2025 - 2029

    215,625  

After 2029

    261,889  
       
 

Total expected collections

  $ 1,845,645  
       

(1)
Represents nominal amounts expected to be collected for all Assured Guaranty insurance subsidiaries.

        The following table provides a reconciliation of the beginning and ending balances of gross premium receivable net of ceding commission payable:


Gross Premium Receivable, Net of Ceding Commissions Roll Forward(1)

 
  (in thousands)  

Premium receivable, net at December 31, 2009

  $ 1,418,222  
 

Cumulative effect of change in accounting principle

    (3,469 )
       
 

Premium receivable, net at January 1, 2010

    1,414,753  
 

Premium written, net

    83,662  
 

Premium payments received, net

    (114,824 )
 

Adjustments to the premium receivable:

       
   

Changes in the expected term of financial guaranty insurance contracts

    9,685  
   

Accretion of the premium receivable discount

    14,466  
   

Foreign exchange rate changes

    (38,624 )
   

Other adjustments

    2,443  
       

Premium receivable, net at March 31, 2010

  $ 1,371,561  
       

(1)
Excludes other segment.

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Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        The $(38.6) million foreign exchange rate change item above relates to future installment premiums due to the Company that are denominated in currencies other than the U.S. dollar. Approximately 45% of the Company's installment premiums are denominated in currencies other than the U.S. dollar, primarily in Euros and Great British pounds. Premium receivable are considered a monetary asset under U.S. GAAP and are therefore revalued each reporting period with the change reflected in other income in the statement of operations.


Selected Information for Policies Paid in Installments

 
  March 31, 2010  
 
  (dollars in
thousands)

 

Premiums receivable, net of ceding commission payable

  $ 1,371,561  

Deferred premium revenue

    3,846,166  

Weighted-average risk-free rate to discount premiums

    3.4  

Weighted-average period of premiums receivable (in years)

    10.2  

        The following table presents the components of net premiums earned.


Net Premiums Earned(1)

 
  Three Months Ended
March 31,
 
 
  2010   2009  
 
  (in thousands)
 

Scheduled net earned premiums

  $ 290,967   $ 50,162  

Acceleration of premium earnings(2)

    15,324     90,287  

Accretion of discount on premium receivable

    12,609     5,287  
           
 

Total net earned premium

  $ 318,900   $ 147,736  
           

(1)
Excludes $0.6 million and $0.7 million in net premium earned for other segment for the three months ended March 31, 2010 and December 31, 2009, respectively.

(2)
Reflects the unscheduled pre-payment or refundings of underlying insured obligations.

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Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        The unearned premium reserve, which is comprised of deferred premium revenues and claim payments made on policies where the payments are not in excess of the deferred premium revenue, is comprised of the following components:

 
  As of March 31, 2010   As of December 31, 2009  
 
  Gross
Unearned
Premium
Reserve(1)
  Ceded
Unearned
Premium
Reserve
  Net
Unearned
Premium
Reserve
  Gross
Unearned
Premium
Reserve(1)
  Ceded
Unearned
Premium
Reserve
  Net
Unearned
Premium
Reserve
 
 
  (in thousands)
 

Deferred premium revenue

  $ 8,150,989   $ 989,727   $ 7,161,262   $ 8,536,682   $ 1,095,593   $ 7,441,089  

Claim payments

    (442,081 )   (63,500 )   (378,581 )   (329,986 )   (43,622 )   (286,364 )
                           
 

Total

  $ 7,708,908   $ 926,227   $ 6,782,681   $ 8,206,696   $ 1,051,971   $ 7,154,725  
                           

(1)
Excludes $12.0 million and $12.7 million in unearned premium reserve for other segment as of March 31, 2010 and December 31, 2009, respectively.

        The following table provides a schedule of how the Company's financial guaranty net unearned premiums and expected losses are expected to run off in the consolidated statement of operations, pre-tax. This table excludes amounts related to consolidated VIEs that were eliminated beginning January 1, 2010 under new VIE consolidation rules, as discussed in Note 23.


Expected Financial Guaranty Net Present Value Earned Premium and
Present Value Net Loss to be Expensed.

 
  As of March 31, 2010  
 
  Expected PV
Net Earned
Premium(1)
  Expected PV Net
Loss to be
Expensed(2)
  Net  
 
  (in thousands)
 

2010 (April 1 - June 30)

  $ 270,330   $ 58,754   $ 211,576  

2010 (July 1 - September 30)

    259,996     63,058     196,938  

2010 (October 1 - December 31)

    242,135     61,921     180,214  

2011

    768,662     198,609     570,053  

2012

    608,121     122,219     485,902  

2013

    524,577     96,094     428,483  

2014

    468,635     90,574     378,061  

2015 - 2019

    1,687,658     269,339     1,418,319  

2020 - 2024

    1,023,456     126,177     897,279  

2025 - 2029

    628,621     70,295     558,326  

After 2029

    679,071     61,705     617,366  
               
 

Total

  $ 7,161,262   $ 1,218,745   $ 5,942,517  
               

(1)
Excludes $378.6 million related to contra account, (claim payments that have not exceeded the deferred premium revenue for the policy), and $12.0 million in unearned premium reserve for other segment.

19


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

(2)
Balances represent discounted amounts. These amounts reflect the Company's estimate as of March 31, 2010 of expected losses to be expensed, are not included in loss and loss adjustment expense ("LAE") reserve because these losses are less than deferred premium revenue determined on a contract-by-contract basis.

        The following table presents a rollforward of the net expected loss and LAE since December 31, 2009 by sector.


Financial Guaranty Insurance Net Expected Loss and Loss Adjustment
Expense Roll Forward by Sector(1)

 
  Expected
Loss to be
Paid as of
December 31,
2009
  Loss
Development
  Less:
Paid
Losses
  Expected
Loss to be
Paid as of
March 31,
2010
 
 
  (in thousands)
 

U.S. RMBS:

                         
 

First Lien:

                         
   

Prime First lien

  $   $ 396   $   $ 396  
   

Alt-A First lien

    204,368     9,016     13,985     199,399  
   

Alt-A Options ARM

    545,238     31,773     16,413     560,598  
   

Subprime

    77,528     49,954     869     126,613  
                   
     

Total First Lien

    827,134     91,139     31,267     887,006  
 

Second Lien:

                         
   

CES

    199,254     (42,300 )   20,475     136,479  
   

HELOCs

    (232,913 )   89,868     148,979     (292,024 )
                   
     

Total Second Lien

    (33,659 )   47,568     169,454     (155,545 )
                   

Total US RMBS

    793,475     138,707     200,721     731,461  

Other structured finance

    102,613     651     3,715     99,549  

Public Finance

    130,858     20,178     24,455     126,581  
                   
     

Subtotal(1)

    1,026,946     159,536     228,891     957,591  

Elimination of consolidated VIEs

    52,251     8,124     17,983     43,392  
                   
     

Total

  $ 974,695   $ 151,412   $ 210,908   $ 914,199  
                   

(1)
Excludes $5.0 million and $5.2 million of expected losses related to other segment recorded in loss reserves on the consolidated balance sheet as of March 31, 2010 and December 31, 2009, respectively. Excludes LAE reserves.

        Expected loss to be paid in the table above represents the present value of losses to be paid net of expected salvage and subrogation and reinsurance cessions. The amount of "expected loss to be paid" differs from "expected PV net loss to be expensed" due primarily to amounts paid that have not yet been expensed and salvage and subrogation not yet recognized in income.

20


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        Gross and ceded unearned premium reserve represents the stand ready obligation under GAAP. The carrying value of AGM's unearned premium reserve recorded on July 1, 2009 takes into account the total fair value of each financial guaranty contract on a contract by contract basis, less premiums receivable or premiums payable. Unearned premium reserve is comprised of deferred premium revenue (which represents future premium earnings) and a contra account representing claims paid (since July 1, for the AGM portfolio) that have not yet been expensed. Such claim payments reduce unearned premiums and therefore the unearned premium reserve represents the full stand-ready obligation to be reduced.

        Loss reserves are recorded at the time, and for the amount of, expected losses in excess of deferred premiums revenue on a contract by contract basis. Loss expense is recognized in the consolidated statements of operations only when the sum of claim payments recorded as a contra account plus the present value of future expected losses exceeds deferred premium revenue.

        In circumstances where total expected loss (sum of (a) accumulated claim payments since the Acquisition Date not yet expensed plus (b) present value of expected future loss or recovery) does not exceed deferred premium revenue, but accumulated claim payments since July 1, 2009 not yet expensed exceeded the deferred premium revenue, the amount of the accumulated claim payments equal to the deferred premium revenue amount on a contract by contract basis is offset in unearned premium reserve recorded on the consolidated balance sheet, and the excess of the accumulated claim payments since the Acquisition Date not yet expensed is recorded in salvage and subrogation recoverable (for the direct contracts) and salvage and subrogation payable (for any ceded portion) on the consolidated balance sheet. For the Company, this has occurred on several transactions because claim payments made prior to the Acquisition Date on AGMH transactions had not yet been recovered but are expected to be recovered in the future.

        The Company's estimates of ultimate losses on a policy is subject to significant uncertainty over the life of the insured transaction due to the potential for significant variability in credit performance due to changing economic, fiscal and financial market variability over the long duration of most contracts. The determination of expected loss is an inherently subjective process involving numerous estimates, assumptions and judgments by management. The Company's estimates of expected losses on RMBS transactions takes into account expected recoveries from sellers and originators, of the underlying residential mortgages due to breaches in the originator's representations and warranties regarding the loans transferred to the RMBS transaction.

21


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        The following table provides information on financial guaranty insurance and reinsurance contracts categorized as BIG as of March 31, 2010 and December 31, 2009:


Financial Guaranty BIG Transaction Loss Summary
March 31, 2010

 
  BIG Categories  
 
  BIG 1   BIG 2   BIG 3   Total
including
VIEs
  Elimination
of
Consolidated
VIEs
  Total  
 
  (dollars in millions)
 

Number of risks

    90     184     40     314         314  

Remaining weighted-average contract period (in years)

    8.9     8.7     9.4     9.0         9.0  

Gross insured contractual payments outstanding:

                                     
 

Principal

  $ 4,539   $ 7,047   $ 7,370   $ 18,956   $   $ 18,956  
 

Interest

    1,600     3,142     1,947     6,689         6,689  
                           
   

Total

  $ 6,139   $ 10,189   $ 9,317   $ 25,645   $   $ 25,645  
                           

Gross expected cash outflows for loss and LAE

  $ 385.1   $ 2,376.5   $ 1,797.5   $ 4,559.1   $ 89.1   $ 4,470.0  

Less:

                                     
 

Gross potential recoveries(1)

    411.1     811.5     1,629.3     2,851.9     54.7     2,797.2  
 

Discount

    (27.5 )   557.6     155.0     685.1     (8.0 )   693.1  
                           

Present value of expected cash flows for loss and LAE

  $ 1.5   $ 1,007.4   $ 13.2   $ 1,022.1   $ 42.4   $ 979.7  
                           

Deferred premium revenue

  $ 134.0   $ 1,011.9   $ 988.6   $ 2,134.5   $ 112.2   $ 2,022.3  

Gross reserves (salvage) for loss and LAE reported in the balance sheet

  $ (12.0 ) $ 203.9   $ (97.5 ) $ 94.4   $   $ 94.4  

Reinsurance recoverable (payable)

  $ (3.5 ) $ 4.2   $ (2.5 ) $ (1.8 ) $   $ (1.8 )

(1)
Includes estimated future recoveries for breaches of representations and warranties.

22


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)


Financial Guaranty BIG Transaction Loss Summary
December 31, 2009

 
  BIG Categories  
 
  BIG 1   BIG 2   BIG 3   Total  
 
  (dollars in millions)
 

Number of risks

    97     161     37     295  

Remaining weighted-average contract period (in years)

    8.79     7.63     9.24     8.52  

Gross insured contractual payments outstanding:

                         
 

Principal

  $ 4,230.9   $ 6,804.6   $ 6,671.6   $ 17,707.1  
 

Interest

    1,532.3     2,685.1     1,729.2     5,946.6  
                   
   

Total

  $ 5,763.2   $ 9,489.7   $ 8,400.8   $ 23,653.7  
                   

Gross expected cash outflows for loss and LAE

  $ 35.8   $ 1,948.8   $ 2,019.0   $ 4,003.6  

Less:

                         
 

Gross potential recoveries(1)

    3.5     506.6     1,528.6     2,038.7  
 

Discount

    18.3     419.8     213.3     651.4  
                   

Present value of expected cash flows for loss and LAE

  $ 14.0   $ 1,022.5   $ 277.1   $ 1,313.5  
                   

Deferred premium revenue

  $ 49.3   $ 1,187.3   $ 919.2   $ 2,155.8  

Gross reserves (salvage) for loss and LAE reported in the balance sheet

  $ (0.1 ) $ 146.4   $ (101.5 ) $ 44.8  

Reinsurance recoverable (payable)

  $   $ 4.6   $ 0.9   $ 5.5  

(1)
Includes estimated future recoveries for breaches of representations and warranties.

        The Company used weighted-average risk free rate ranging from 0% to 5.32% and 0.07% to 5.21% to discount expected losses as of March 31, 2010 and December 31, 2009, respectively.

23


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        The following table provides information on loss and LAE reserves net of reinsurance on the consolidated balance sheets.


Loss and Loss Adjustment Expense Reserves, Net of Reinsurance

 
  As of March 31,
2010
  As of December 31,
2009
 
 
  (in thousands)
 

U.S. RMBS:

             
 

First Lien:

             
   

Prime First lien

  $ 285   $  
   

Alt-A First lien

    26,489     25,463  
   

Alt-A Options ARM

    86,386     51,188  
   

Subprime

    46,812     21,816  
           
     

Total First Lien

    159,972     98,467  
 

Second Lien:

             
   

CES

    15,539     21,172  
   

HELOC

    15,010     18,204  
           
     

Total Second Lien

    30,549     39,376  
           

Total US RMBS

    190,521     137,843  

Other structured finance

    73,263     67,661  

Public Finance

    77,538     67,723  
           

Total financial guaranty

    341,322     273,227  

Other

    2,116     2,121  
           
       

Total

  $ 343,438   $ 275,348  
           

24


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        The following table provides information on financial guaranty insurance and reinsurance contracts recorded as an asset on the consolidated balance sheets.


Summary of Recoverables Recorded as Salvage and Subrogation

 
  As of March 31,
2010
  As of December 31,
2009
 
 
  (in thousands)
 

U.S. RMBS:

             
 

First Lien:

             
   

Alt-A Options ARM

  $ 9,283   $  
   

Subprime

    1,520     76  
           
     

Total First Lien

    10,803     76  
 

Second Lien:

             
   

CES

    226     91  
   

HELOC

    240,442     235,892  
           
     

Total Second Lien

    240,668     235,983  
           

Total US RMBS

    251,471     236,059  

Other structured finance

    992     992  

Public Finance

    9,311     2,425  
           

Total

    261,774     239,476  

Less: Ceded recoverable(1)

    16,881     13,605  
           
       

Net recoverable

  $ 244,893   $ 225,871  
           

(1)
Recorded in "reinsurance balances payable, net" on the consolidated balance sheets.

25


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)


Loss and Loss Adjustment Expenses (Recoveries)
By Type

 
  Three Months Ended
March 31,
 
 
  2010   2009  
 
  (in thousands)
 

Financial Guaranty:

             
 

U.S. RMBS:

             
   

First Lien:

             
     

Prime First lien

  $ 62   $ 519  
     

Alt-A First lien

    5,431     151  
     

Alt-A Options ARM

    44,434     (74 )
     

Subprime

    24,713     811  
           
       

Total First Lien

    74,640     1,407  
   

Second Lien:

             
     

CES

    4,345     1,998  
     

HELOC

    23,620     18,520  
           
       

Total Second Lien

    27,965     20,518  
           
 

Total U.S. RMBS

    102,605     21,925  
 

Other structured finance

    10,168     4,822  
 

Public Finance

    27,691     21,707  
           

Total Financial Guaranty

    140,464     48,454  

Other

    18     31,300  
           
   

Subtotal

    140,482     79,754  

Losses incurred on consolidated financial guaranty VIEs

    (9,981 )    
           
   

Total loss and LAE

  $ 130,501   $ 79,754  
           

26


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)


Net Losses Paid on Financial Guaranty Insurance Contracts

 
  Three Months Ended
March 31,
 
 
  2010   2009  
 
  (in thousands)
 

U.S. RMBS:

             
 

First Lien:

             
   

Prime First lien

  $   $  
   

Alt-A First lien

    13,985      
   

Alt-A Options ARM

    16,413      
   

Subprime

    869     452  
           
     

Total First Lien

    31,267     452  
 

Second Lien:

             
   

CES

    20,475     10,265  
   

HELOC

    148,979     51,657  
           
     

Total Second Lien

    169,454     61,922  
           

Total US RMBS

    200,721     62,374  

Other structured finance

    3,715     (6,005 )

Public Finance

    24,455     7,518  
           
     

Subtotal

    228,891     63,887  

Losses paid on consolidated financial guaranty VIEs

    (17,983 )    
           
     

Total

  $ 210,908   $ 63,887  
           

        In accordance with the Company's standard practices the Company evaluated the most current available information as part of its loss reserving process, including trends in delinquencies and charge-offs on the underlying loans and its experience in requiring providers of representations and warranties to purchase ineligible loans out of these transactions.

U.S. Second Lien RMBS: CES and HELOCs

        The Company insures two types of second lien RMBS, those secured by HELOCs and those secured by CES mortgages. HELOCs are revolving lines of credit generally secured by a second lien on a one to four family home. A mortgage for a fixed amount secured by a second lien on a one-to-four family home is generally referred to as a CES. The Company has material exposure to second lien mortgage loans originated and serviced by a number of parties, but the Company's most significant second lien exposure is to HELOCs originated and serviced by Countrywide.

        The performance of the Company's HELOC and CES exposures deteriorated beginning in 2007 and transactions, particularly those originated in the period from 2005 through 2007, continue to perform below the Company's original underwriting expectations.

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Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        The following table shows the Company's key assumptions used in its calculation of estimated expected losses for these types of policies as of March 31, 2010 and December 31, 2009:


Key Assumptions in Base Case Expected Loss Estimates
Second Lien RMBS(1)

HELOC Key Variables
  March 31,
2010
  December 31,
2009

Plateau conditional default rate ("CDR")

  11.5 - 38.0%   10.7 - 40.0%

Final CDR trended down to

  0.5 - 3.2%   0.5 - 3.2%

Expected Period until Final CDR(1)

  21 months   21 months

Initial conditional prepayment rate ("CPR")

  0.4 - 13.4%   1.9 - 14.9%

Final CPR

  10%   10%

Loss Severity

  95%   95%

Future Repurchase of Ineligible Loans

  $849 million   $828 million

Initial Draw Rate

  0.2 - 4.8%   0.1 - 2.0%

 

CES Key Variables
  March 31,
2010
  December 31,
2009

Plateau CDR

  21.5 - 44.2%   21.5 - 44.2%

Final CDR Rate trended down to

  2.9 - 8.1%   3.3 - 8.1%

Expected Period until Final CDR achieved

  21 months   21 months

Initial CPR

  0.8 - 3.6%   0.8 - 3.6%

Final CPR

  10%   10%

Loss Severity

  95%   95%

Future Repurchase of Ineligible Loans

  $137 million   $77 million

(1)
Represents assumptions for most heavily weighted scenario.

        The primary driver of the adverse development related to the HELOC and CES sector is significantly higher total pool delinquencies than had been experienced historically. In order to project future defaults in each pool, a CDR is applied each reporting period to various delinquency categories to calculate the projected losses to the pool. First, current representative liquidation rates (the percent of loans in a given delinquency status that are assumed to ultimately default) are used to estimate losses in the first five months from loans that are currently delinquent and then the CDR of the fifth month is held constant for a period of time. Taken together, the first five months of losses plus the period of time for which the CDR is held constant represent the stress period. Once the stress period has elapsed, the CDR is assumed to gradually trend down to its final CDR over twelve months. In the base case as of March 31, 2010, the total time between the current period's CDR and the long-term assumed CDR used to project losses was nine months. At the end of this period, the long-term steady CDRs modeled were between 0.5% and 3.2% for HELOC transactions and between 2.9% and 8.1% for CES transactions. The Company continued to assume an extended stress period based on transaction performance and the continued weakened overall economic environment.

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Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        The assumption for the CPR, which represents voluntary prepayments, follows a similar pattern to that of the CDR. The current CPR is assumed to continue for the stress period before gradually increasing to the final CPR, which is assumed to be 10% for both HELOC and CES transactions. This level is much higher than current rates but lower than the historical average, which reflects the Company's continued uncertainty about performance of the borrowers in these transactions. For HELOC transactions, the draw rate is assumed to decline from the current level to the final draw rate over a period of three months. The final draw rates were assumed to be between 0.1% and 2.4%.

        Performance of the collateral underlying certain securitizations has substantially differed from the Company's original expectations. Employing several loan file diligence firms and law firms as well as internal resources, as of March 31, 2010 the Company had performed a detailed review of approximately 23,000 files, representing nearly $1.8 billion in outstanding par of defaulted second lien loans underlying insured transactions, and identified a material number of defaulted loans that breach representations and warranties regarding the characteristics of the loans such as misrepresentation of income or occupation, undisclosed debt and the loan not underwritten in compliance with guidelines. The Company continues to review new files as new loans default and as new loan files are made available to it. Following negotiation with the sellers and originators of the breaching loans, as of March 31, 2010 the Company had reached agreement to have $175 million of the second lien loans repurchased. The Company has included in its net expected loss estimates for second liens as of March 31, 2010 an estimated benefit from repurchases of $986.0 million. The amount the Company ultimately recovers related to contractual representations and warranties is uncertain and subject to a number of factors including the counterparty's ability to pay, the number and amount of loans determined to have breached representations and warranties and, potentially, negotiated settlements or litigation. As such, the Company's estimate of recoveries is uncertain and actual amounts realized may differ significantly from these estimates. In arriving at the expected recovery from breaches of representations and warranties the Company considered: the credit worthiness of the provider of representations and warranties, the number of breaches found on defaulted loans, the success rate resolving these breaches with the provider of the representations and warranties and the potential amount of time until the recovery is realized. This calculation involved a variety of scenarios which ranged from the Company recovering substantially all of the losses it incurred due to violations of representations and warranties to the Company realizing very limited recoveries. These scenarios were probability weighted in order to determine the recovery incorporated into the Company's reserve estimate. This approach was used for both loans that had already defaulted and those assumed to default in the future. Recoveries were limited to amounts paid or expected to be paid out by the Company.

        The ultimate performance of the Company's HELOC and CES transactions will depend on many factors, such as the level and timing of loan defaults, interest proceeds generated by the securitized loans, prepayment speeds and changes in home prices, as well as the levels of credit support built into each transaction. The ability and willingness of providers of representations and warranties to repurchase ineligible loans from the transactions will also have a material effect on the Company's ultimate loss on these transactions. Finally, other factors also may have a material impact upon the ultimate performance of each transaction, including the ability of the seller and servicer to fulfill all of their contractual obligations including any obligation to fund future draws on lines of credit. The variables affecting transaction performance are interrelated, difficult to predict and subject to

29


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)


considerable volatility. If actual results differ materially from any of the Company's assumptions, the losses incurred could be materially different from the estimate. The Company continues to update its evaluation of these exposures as new information becomes available.

        The Company modeled and probability weighted three possible time periods over which an elevated CDR may potentially occur, one of which assumed a three month shorter period of elevated CDR and another of which assumed a three month longer period of elevated CDR than the most heavily weighted scenario described in the table above. Given that draw rates (the amount of new advances provided on existing HELOCs expressed as a percent of current outstanding advances) have been reduced to levels below the historical average and that loss severities in these products have been higher than anticipated at inception, the Company believes that the level of the elevated CDR and the length of time it will persist is the primary driver behind the likely amount of losses the collateral will suffer (before considering the effects of repurchases of ineligible loans). The Company continues to evaluate all of the assumptions affecting its modeling results.

        The primary drivers of the Company's approach to modeling potential loss outcomes for transactions backed by second lien collateral are to assume a stressed CDR for a selected period of time and a constant 95% severity rate for the duration of the transaction. Sensitivities around the results of these transactions were modeled by varying the length of the stressed CDR, which corresponds to how long the Company assumes the second lien sector remains stressed before a recovery begins and it returns to the long term equilibrium that was modeled when the deal was underwritten. For HELOC and CES, extending the expected period until the CDR begins returning to its long term equilibrium by three months would result in an increase to expected loss of approximately $144 million for HELOC transactions and $18.2 million for CES transactions. Conversely, shortening the time until the CDR begins to return to its long term equilibrium by three months decreases expected loss by approximately $151.1 million for HELOC transactions and $27.2 million for CES transactions.

U.S. First Lien RMBS: Alt-A, Option ARM, Subprime and Prime

        First lien RMBS are generally categorized in accordance with the characteristics of the first lien mortgage loans on one to four family homes supporting the transactions. The collateral supporting "Subprime RMBS" transactions is comprised of first-lien residential mortgage loans made to subprime borrowers. A "subprime borrower" is one considered to be a higher risk credit based on credit scores or other risk characteristics. Another type of RMBS transaction is generally referred to as "Alt-A RMBS." The collateral supporting such transactions is comprised of first-lien residential mortgage loans made to "prime" quality borrowers that lack certain ancillary characteristics that would make them prime. When more than 66% of the loans originally included in the pool are mortgage loans with an option to make a minimum payment that has the potential to negatively amortize the loan (i.e., increase the amount of principal owed), the transaction is referred to as an "Option ARMs." Finally, transactions may include loans made to prime borrowers.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        The performance of the Company's first lien RMBS exposures deteriorated during 2007 through First Quarter 2010 and transactions, particularly those originated in the period from 2005 through 2007, continue to perform below the Company's original underwriting expectations. The majority of the projected losses in the First Lien RMBS transactions are expected to come from mortgage loans that are currently delinquent, therefore an increase in delinquent loans beyond those expected last quarter is one of the primary drivers of loss development in this portfolio. Similar to many market participants, the Company applies a liquidation rate assumption to loans in various delinquency categories to determine what proportion of loans in those categories will eventually default.

        The problems affecting the subprime mortgage market have been widely reported, with rising delinquencies, defaults and foreclosures negatively impacting the performance of Subprime RMBS transactions. Those concerns relate primarily to Subprime RMBS issued in the period from 2005 through 2007. As of March 31, 2010, the Company had insured $4.8 billion in net par of Subprime RMBS transactions, of which $4.7 billion was in the financial guaranty direct segment. These transactions benefit from various structural protections, including credit enhancement that in the direct portfolio for the vintages 2005 through 2008 currently averages approximately 31.2% of the remaining insured balance.

        The factors affecting the subprime mortgage market are now affecting Alt-A RMBS transactions, with rising delinquencies, defaults and foreclosures negatively impacting their performance. Those concerns relate primarily to Alt-A RMBS issued in the period from 2005 through 2007. As of March 31, 2010, the Company had insured $2.4 billion in net par of Alt-A RMBS transactions, almost all of which was in the financial guaranty direct segment. These transactions benefit from various structural protections, including credit enhancement that in the direct portfolio for the vintages 2005 through 2007 currently averages approximately 5.5% of the remaining insured balance.

        As has been reported, the problems affecting the subprime mortgage market are affecting Option ARM RMBS transactions, with rising delinquencies, defaults and foreclosures negatively impacting their performance. Those concerns relate primarily to Option ARM RMBS issued in the period from 2005 through 2007. These transactions benefit from various structural protections, including credit enhancement that in the direct portfolio for the vintages 2005 through 2007 currently averages approximately 7.2% of the remaining insured balance.

        The Company also insures one direct prime RMBS transaction rated BIG with a net outstanding par at March 31, 2010 of $49.4 million, which it models as an Alt-A transaction and on which it had gross expected loss, prior to reinsurance or netting of unearned premium, of $0.4 million, and net reserves of $0.3 million. Finally, the Company insures NIM securities with a net par outstanding as of March 31, 2010 of $99.9 million. While these securities are backed by First Lien RMBS, the Company no longer expects to receive any cash flow on the underlying First Lien RMBS and has, therefore, fully reserved for these transactions, with the exception of expected payments of $92.1 million from third parties to cover principal and interest on the NIMs.

        The following table shows the Company's liquidation assumptions for various delinquency categories as of March 31, 2010 and December 31, 2009. The liquidation rate is a standard industry

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)


measure that is used to estimate the number of loans in a given aging category that will default within a specified time period. The Company projects these liquidations over two years.

 
  March 31,
2010
  December 31,
2009
 

30 - 59 Days Delinquent

             
 

Alt-A First lien

    50 %   50 %
 

Alt-A Option ARM

    50     50  
 

Subprime

    45     45  

60 - 89 Days Delinquent

             
 

Alt-A First lien

    65     65  
 

Alt-A Option ARM

    65     65  
 

Subprime

    65     65  

90—Bankruptcy

             
 

Alt-A First lien

    75     75  
 

Alt-A Option ARM

    75     75  
 

Subprime

    70     70  

Foreclosure

             
 

Alt-A First lien

    85     85  
 

Alt-A Option ARM

    85     85  
 

Subprime

    85     85  

Real Estate Owned

             
 

Alt-A First lien

    100     100  
 

Alt-A Option ARM

    100     100  
 

Subprime

    100     100  


First Lien U.S. RMBS
Future Repurchase of Ineligible Loans

 
  As of
March 31, 2010
  As of
December 31, 2009
 
 
  (in millions)
 

Future Repurchase of Ineligible Loans

  $ 311.7   $ 268.0  

        Another important driver of loss projections in this area is loss severities, which is the amount of loss the transaction incurs on a loan after the application of net proceeds from the disposal of the underlying property. Loss severities experienced in first lien transactions have reached historical highs, and the Company has been revising its assumptions to match experience. The Company is assuming that loss severities begin returning to more normal levels beginning in March 2011, reducing over two or four years to either 40% or 20 points (e.g. from 60% to 40%) below their initial levels, depending on the scenario.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        The Company increased its initial loss severity assumption this quarter for subprime transactions based on actual loss severity experience in transactions it insures. The following table shows the Company's initial loss severity assumptions as of March 31, 2010 and December 31, 2009:

 
  March 31,
2010
  December 31,
2009
 

Alt-A First lien

    60 %   60 %

Alt-A Option ARM

    60 %   60 %

Subprime

    75 %   70 %

        The primary driver of the adverse development related to first lien exposure, as was the case with the Company's second lien transactions, is the result of the continued increase in delinquent mortgages. The Company predicts losses and delinquent loans using liquidation rates, while losses from current loans are determined by applying a CDR trend. For delinquent loans, a liquidation rate is applied to loans in various stages of delinquency to determine the portion of loans in each delinquency category that will eventually default. Then, for each transaction, management calculates the constant CDR that, over the next 24 months, would be sufficient to produce the amount of losses that were calculated to emerge from the various delinquency categories. That CDR plateau is extended another three months, for a total of 27 months, in some scenarios. Each transaction's CDR is calculated to improve over 12 months to an intermediate CDR based upon its CDR plateau, then trail off to its final CDR. The intermediate CDRs modeled were between 0.4% and 6.0% for Alt-A first lien transactions, between 2.6% to 4.8% for Option ARM transactions and between 1.4% and 5.3% for Subprime transactions. The defaults resulting from the CDR after the 24 month period represent the defaults that can be attributed to borrowers that are currently performing.

        The assumption for the CPR follows a similar pattern to that of the CDR. The current level of voluntary prepayments is assumed to continue for the stress period before gradually increasing over 12 months to the final CPR, which is assumed to be either 10% or 15% depending on the scenario run. In the first quarter of 2010, the Company modeled and probability weighted four different scenarios with differing CDR curve shapes, loss severity development assumptions and voluntary prepayment assumptions.

        The performance of the collateral underlying certain of these securitizations has substantially differed from the Company's original expectations. As with the second lien policies, as of March 31, 2010 the Company had performed a detailed review of approximately 4,700 files representing nearly $2.1 billion in outstanding par of defaulted first lien loans underlying insured transactions, and identified a material number of defaulted loans that breach representations and warranties regarding the characteristics of the loans. The Company continues to review new files as new loans default and as new loan files are made available to it. Following negotiation with the sellers and originators of the breaching loans, as of March 31, 2010, the Company had reached agreement to have $30.5 million of first lien loans repurchased. The amount the Company ultimately recovers related to contractual representations and warranties is uncertain and subject to a number of factors including the counterparty's ability to pay, the number and amount of loans determined to have breached representations and warranties and, potentially, negotiated settlements or litigation. As such, the Company's estimate of recoveries is uncertain and actual amounts realized may differ significantly from

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)


these estimates. In arriving at the expected recovery from breaches of representations and warranties the Company considered the credit worthiness of the provider of representations and warranties, the number of breaches found on defaulted loans, the success rate resolving these breaches with the provider of the representations and warranty and the potential amount of time until the recovery is realized. This calculation involved a variety of scenarios which ranged from the Company recovering substantially all of the losses it incurred due to violations of representations and warranties to the Company realizing very limited recoveries. These scenarios were probability weighted in order to determine the recovery incorporated into the Company's reserve estimate. This approach was used for both loans that had already defaulted and those assumed to default in the future. In all cases recoveries were limited to amounts paid or expected to be paid out by the Company.

        The ultimate performance of the Company's First Lien RMBS transactions remains highly uncertain and may be subject to considerable volatility due to the influence of many factors, including the level and timing of loan defaults, changes in housing prices and other variables. The Company will continue to monitor the performance of its RMBS exposures and will adjust the risk ratings of those transactions based on actual performance and management's estimates of future performance.

        The Company modeled sensitivities for first lien transactions by varying its assumptions of how fast an economic recovery was expected to occur. The primary variables that were varied when modeling sensitivities were the amount of time until the CDR returned to its modeled equilibrium, which was defined as 5% of the current CDR, and how quickly the stressed loss severity returned to its long term equilibrium, which was approximately a 20 point reduction in the current severity rate. In a stressed economic environment assuming a slow recovery rate in the performance of the CDR, whereby the CDR rate steps down in five increments over 11.3 years, and a five year period before severity rates return to their normalized rate, the reserves increase by $31.1 million for Alt-A transactions, $126.9 million for Option ARM transactions and $76.6 million for subprime transactions. Conversely, assuming a faster recovery in the performance of the CDR, where the CDR rate steps down in two increments over 8.1 years, and a three year period before severity rates return to their normalized rate, the reserves decrease by approximately $31.9 million for Alt-A transactions, $121.9 million for Option ARM transactions and $39.9 million for subprime transactions.

"XXX" Life Insurance Transactions

        The Company has insured $2.1 billion of net par in "XXX" life insurance reserve securitization transactions based on discrete blocks of individual life insurance business. In these transactions the monies raised by the sale of the bonds insured by the Company are used to capitalize a special purpose vehicle that provides reinsurance to a life insurer or reinsurer. The monies are invested at inception in accounts managed by third-party investment managers. In order for the Company to incur an ultimate net loss on these transactions, adverse experience on the underlying block of life insurance policies and/or credit losses in the investment portfolio would need to exceed the level of credit enhancement built into the transaction structures.

        The Company's $2.1billion in net par of XXX Life Insurance transactions includes $1.8 billion in the financial guaranty direct segment. Of the total, $882.5 million was rated BIG by the Company as of March 31, 2010, and corresponded to two transactions. These two XXX transactions had material amounts of their assets invested in US RMBS transactions.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

7. Financial Guaranty Contracts Accounted for as Insurance Contracts (Continued)

        Based on its analysis of the information currently available, including estimates of future investment performance provided by the current investment manager, projected credit impairments on the invested assets and performance of the blocks of life insurance business at March 31, 2010, the Company's gross expected loss, prior to reinsurance or netting of unearned premium, for its two BIG XXX insurance transactions was $56.2 million and its net reserve was $45.5 million.

        On December 19, 2008, the Company sued J.P. Morgan Investment Management Inc. ("JPMIM"), the investment manager in one of the transactions, which relates to Orkney Re II p.l.c. ("Orkney Re II") in New York Supreme Court ("Court") alleging that JPMIM engaged in breaches of fiduciary duty, gross negligence and breaches of contract based upon its handling of the investments of Orkney Re II. On January 28, 2010 the Court ruled against the Company on a motion to dismiss filed by JPMIM. The Company has filed an appeal.

Public Finance Transactions

        Public finance net par outstanding represents 74% of total net par outstanding. Within the public finance category, $3.6 billion was rated BIG with the largest BIG exposure described below. The Company has exposure to a public finance transaction for sewer service in Jefferson County, Alabama. The Company's total exposure to this transaction is approximately $583 million of net par, of which $231 million is in the financial guaranty direct segment. The Company has made debt service payments during the year and expects to make additional payments in the near term. The Company is continuing its risk remediation efforts for this exposure.

Other Sectors and Transactions

        The Company continues to closely monitor other sectors and individual transactions it feels warrant the additional attention, including, as of March 31, 2010, its commercial mortgage exposure of $936.2 million of net par, of which $257.8 million was in the financial guaranty direct segment, its trust preferred securities ("TruPS") collateralized debt obligations ("CDOs") exposure of $1.1 billion, most of which was in the financial guaranty direct segment, its student loan exposure of $3.7 billion net par, of which $1.3 billion was in the direct segment, and its U.S. health care exposure of $22.4 billion of net par, of which $20.6 billion was in the financial guaranty direct segment.

8. Credit Derivatives

        Certain financial guaranty contracts written in credit derivative form, principally in the form of insured CDS contracts, have been deemed to meet the definition of a derivative under GAAP, which requires that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value. GAAP requires companies to recognize freestanding or embedded derivatives relating to beneficial interests in securitized financial instruments.

        In general, the Company structures credit derivative transactions such that the circumstances giving rise to the Company's obligation to make loss payments is similar to that for financial guaranty contracts written in insurance form and only occurs as losses are realized on the underlying reference obligation. Nonetheless, credit derivative transactions are governed by International Swaps and Derivatives Association, Inc. ("ISDA") documentation and operate differently from financial guaranty

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

8. Credit Derivatives (Continued)


contracts written in insurance form. For example, the Company's control rights with respect to a reference obligation under a credit derivative may be more limited than when the Company issues a financial guaranty contract written in insurance form. In addition, while the Company's exposure under credit derivatives, like the Company's exposure under financial guaranty contracts written in insurance form, has been generally for as long as the reference obligation remains outstanding, unlike financial guaranty contracts, a credit derivative may be terminated for a breach of the ISDA documentation or other specific events. If events of default or termination events specified in the credit derivative documentation were to occur, the non-defaulting or the non-affected party, which may be either the Company or the counterparty, depending upon the circumstances, may decide to terminate a credit derivative prior to maturity. The Company may be required to make a termination payment to its swap counterparty upon such termination.

        Some of the Company's CDS have rating triggers that allow certain CDS counterparties to terminate in the case of downgrades. If certain of its credit derivative contracts were terminated the Company could be required to make a termination payment as determined under the relevant documentation, although under certain documents, the Company may have the right to cure the termination event by posting collateral, assigning its rights and obligations in respect of the transactions to a third party or seeking a third party guaranty of the obligations of the Company. As of March 31, 2010 and December 31, 2009, if AGC's ratings were downgraded to levels between BBB or Baa2 and BB+ or Ba1, certain CDS counterparties could terminate certain CDS contracts covering approximately $6.0 billion par insured. As of the date of this filing, none of AG Re, AGRO or AGM has material CDS exposure subject to termination based on its rating. The Company does not believe that it can accurately estimate the termination payments it could be required to make if, as a result of any such downgrade, a CDS counterparty terminated its CDS contracts with the Company. These payments could have a material adverse effect on the Company's liquidity and financial condition.

        Under a limited number of other CDS contracts, the Company may be required to post eligible securities as collateral—generally cash or U.S. government or agency securities. For certain of such contracts, this requirement is based on a mark-to-market valuation, as determined under the relevant documentation, in excess of contractual thresholds that decline or are eliminated if the Company's ratings decline. Under other contracts, the Company has negotiated caps such that the posting requirement cannot exceed a certain amount. As of March 31, 2010, without giving effect to thresholds that apply under current ratings, the amount of par that is subject to collateral posting is approximately $19.6 billion. Counterparties have agreed that for approximately $18.2 billion of that $19.6 billion, the maximum amount that the Company could be required to post at current ratings is $435 million; if AGC were downgraded to A- by S&P or A3 by Moody's, that maximum amount would be $485 million. As of March 31, 2010, the Company had posted approximately $649.3 million of collateral in respect of approximately $19.5 billion of par insured. The Company may be required to post additional collateral from time to time, depending on its ratings and on the market values of the transactions subject to the collateral posting.

        Realized gains and other settlements on credit derivatives include credit derivative premiums received and receivable for credit protection the Company has sold under its insured CDS contracts, premiums paid and payable for credit protection the Company has purchased as well as any contractual claim losses paid and payable and received and receivable related to insured credit events under these

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

8. Credit Derivatives (Continued)


contracts, ceding commissions (expense) income and realized gains or losses related to their early termination.

        The following table disaggregates realized gains and other settlements on credit derivatives into its component parts for the three months ended March 31, 2010 and 2009:


Realized Gains and Other Settlements on Credit Derivatives

 
  Three Months Ended
March 31,
 
 
  2010   2009  
 
  (in thousands)
 

Net credit derivative premiums received and receivable

  $ 53,693   $ 29,515  

Ceding commissions (paid and payable) received and receivable, net

    1,005     122  
           
 

Realized gains on credit derivatives

    54,698     29,637  

Net credit derivative losses (paid and payable) recovered and recoverable

    (27,995 )   (9,058 )
           
 

Total realized gains and other settlements on credit derivatives

  $ 26,703   $ 20,579  
           

        Net unrealized gains (losses) on credit derivatives represent the adjustments for changes in fair value that are recorded in each reporting period. Changes in unrealized gains and losses on credit derivatives are reflected in the consolidated statements of operations in "net unrealized gains (losses) on credit derivatives." Cumulative unrealized losses, determined on a contract by contract basis, are reflected as either net assets or net liabilities in the Company's consolidated balance sheets. Unrealized gains and losses resulting from changes in the fair value of credit derivatives occur primarily because of changes in interest rates, credit spreads, and credit ratings of the referenced entities, claim payments, and the issuing company's own credit rating, credit spreads and other market factors. Except for estimated credit impairments, the unrealized gains and losses on credit derivatives will reduce to zero as the exposure approaches its maturity date.

        The Company determines the fair value of its credit derivative contracts primarily through modeling that uses various inputs to derive an estimate of the value of the Company's contracts in principal markets. See Note 9. Inputs include expected contractual life and credit spreads, based on observable market indices and on recent pricing for similar contracts. Credit spreads capture the impact of recovery rates and performance of underlying assets, among other factors, on these contracts. The Company's pricing model takes into account not only how credit spreads on risks that it assumes affect pricing, but also how the Company's own credit spread affects the pricing of its deals. If credit spreads of the underlying obligations change, the fair value of the related credit derivative changes. Market liquidity could also impact valuations of the underlying obligations.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

8. Credit Derivatives (Continued)

        The impact of changes in credit spreads will vary based upon the volume, tenor, interest rates, and other market conditions at the time these fair values are determined. In addition, since each transaction has unique collateral and structure terms, the underlying change in fair value of each transaction may vary considerably. The fair value of credit derivative contracts also reflects the change in the Company's own credit cost based on the price to purchase credit protection on AGC and AGM. As of March 31, 2010 the net credit liability included a reduction in the liability of $4.0 billion representing the Company's credit value adjustment. The Company determines its own credit risk based on quoted CDS prices traded on the Company at each balance sheet date. Historically, the price of CDS traded on AGC and AGM moves directionally the same as general market spreads, however in the first quarter of 2010, AGC's CDS widened while the general market tightened. Generally, a widening of the CDS prices traded on AGC and AGM has an effect of offsetting unrealized losses that result from widening general market credit spreads, while a narrowing of the CDS prices traded on AGC and AGM has an effect of offsetting unrealized gains that result from narrowing general market credit spreads. An overall narrowing of spreads generally results in an unrealized gain on credit derivatives for the Company and an overall widening of spreads generally results in an unrealized loss for the Company.


Effect of Company's Credit Spread on Credit Derivatives Fair Value

 
  As of March 31,
2010
  As of December 31,
2009
 
 
  (dollars in millions)
 

Quoted price of CDS contract (in basis points):

             
 

AGC

    734     634  
 

AGM

    468     541  

Fair value of CDS contracts:

             
 

Before considering implication of the Company's credit spreads

  $ (5,253.5 ) $ (5,830.8 )
 

After considering implication of the Company's credit spreads

  $ (1,284.9 ) $ (1,542.1 )

        As of March 31, 2010, AGC's and AGM's credit spreads remained relatively wide compared to pre-2007 levels, as did general market spreads. The $5.3 billion liability in First Quarter 2010, which represents the fair value of CDS contracts before considering the implications of AGC's and AGM's credit spreads, is a direct result of continued wide credit spreads in the fixed income security markets, and ratings downgrades. The asset classes that remain most affected, are recent vintages of Subprime RMBS and Alt-A deals, as well as trust-preferred securities. When looking at the First Quarter 2010 compared to the First Quarter 2009, there was tightening of general market spreads as well as a run-off in net par outstanding, resulting in a gain of approximately $577.3 million before taking into account AGC or AGM's credit spreads.

        During First Quarter 2009, the Company incurred net pre-tax unrealized gains on credit derivative contracts of $27.0 million. Of this amount, $2,291.5 million was due to the widening of AGC's own credit spread from 1,775 basis points at December 31, 2008 to 3,847 basis points at March 31, 2009. Management believes that the widening of AGC's credit spread is due to the correlation between AGC's risk profile and that experienced currently by the broader financial markets and increased demand for credit protection against AGC as the result of its direct segment financial guarantee

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

8. Credit Derivatives (Continued)


volume as well as the overall lack of liquidity in the CDS market. Offsetting the gain attributable to the significant increase in AGC's credit spread were declines in fixed income security market prices primarily attributable to widening spreads in certain markets as a result of the continued deterioration in credit markets and some credit rating downgrades, rather than from delinquencies or defaults on securities guaranteed by the Company. The higher credit spreads in the fixed income security market are due to the recent lack of liquidity in the high yield CDO and collateralized loan obligation ("CLO") markets as well as continuing market concerns over the most recent vintages of subprime RMBS and commercial mortgage backed securities.

        The tables below show net par outstanding and change in unrealized gain (losses) of credit derivatives. The estimated remaining weighted average life of credit derivatives was 5.7 years at March 31, 2010 and 6.0 years at December 31, 2009.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

8. Credit Derivatives (Continued)


Net Par Outstanding on Credit Derivatives

 
  As of March 31, 2010   As of December 31, 2009
Asset Type
  Original
Subordination(1)
  Current
Subordination(1)
  Net Par
Outstanding
  Weighted
Average
Credit
Rating(2)
  Original
Subordination(1)
  Current
Subordination(1)
  Net Par
Outstanding
  Weighted
Average
Credit
Rating(2)
 
  (dollars in millions)

Financial Guaranty Direct:

                                           
 

Pooled corporate obligations:

                                           
   

CLOs/CBOs

    31.5 %   28.3 % $ 48,392   AAA     31.1 %   27.4 % $ 49,447   AAA
   

Synthetic investment grade pooled corporate

    19.2     17.8     14,380   AAA     19.2     17.7     14,652   AAA
   

Synthetic high yield pooled corporate

    37.2     32.1     10,236   AAA     36.7     34.4     11,040   AAA
   

TruPS

    46.2     34.1     5,920   BB+     46.6     37.3     6,041   BBB-
   

Market value CDOs of corporate obligations

    31.0     36.9     5,535   AAA     32.1     36.9     5,401   AAA
                                 
 

Total pooled corporate obligations

    31.1     27.9     84,463   AAA     30.9     27.9     86,581   AAA
 

U.S. RMBS:

                                           
   

Alt-A Option ARMs and Alt-A First Lien

    20.3     21.0     5,505   B+     20.3     22.0     5,662   BB
   

Subprime First lien (including NIMs)

    27.5     57.6     4,859   A+     27.6     52.4     4,970   A+
   

Prime first lien

    10.9     10.5     541   B     10.9     11.1     560   BB
   

CES and HELOCs

        19.1     97   B         19.2     111   B
                                 
 

Total U.S. RMBS

    22.9     36.3     11,002   BBB-     22.9     34.6     11,303   BBB
 

Commercial mortgage-backed securities

    28.6     31.2     7,118   AAA     28.5     30.9     7,191   AAA
 

Other

            14,744   AA-             15,700   AA-
                                         

Total Financial Guaranty Direct

                117,327   AA+                 120,775   AA+

Financial Guaranty Reinsurance

                1,654   AA-                 1,642   AA-
                                         

Total

              $ 118,981   AA+               $ 122,417   AA+
                                         

(1)
Represents the sum of subordinate tranches and over-collateralization and does not include any benefit from excess interest collections that may be used to absorb losses.

(2)
Based on the Company's internal rating, which is on a ratings scale similar to that used by the nationally recognized rating agencies.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

8. Credit Derivatives (Continued)

Change in Unrealized Gain (Loss) on Credit Derivatives

 
  Three Months Ended
March 31,
 
Asset Type
  2010   2009  
 
  (in millions)
 

Financial Guaranty Direct:

             
 

Pooled corporate obligations:

             
   

CLOs/CBOs

  $ 1.5   $ (77.4 )
   

Synthetic investment grade pooled corporate

    (7.6 )   1.6  
   

Synthetic high yield pooled corporate

    20.4      
   

TruPS

    29.7     75.3  
   

Market value CDOs of corporate obligations

    0.4     (7.0 )
   

Commercial Real Estate

        (2.2 )
   

CDO of CDOs (corporate)

        (0.8 )
           
 

Total pooled corporate obligations

    44.4     (10.5 )
 

U.S. RMBS:

             
   

Alt-A Option ARMs and Alt-A First Lien

    150.9     (44.1 )
   

Subprime First lien (Including NIMs)

    0.6     3.0  
   

Prime first lien

    14.2     (49.0 )
   

CES and HELOCs

    8.4      
           
 

Total U.S. RMBS

    174.1     (90.1 )
 

Commercial mortgage-backed securities

    9.5     (31.2 )
 

Other

    24.2     142.6  
           

Total Financial Guaranty Direct

    252.2     10.8  

Financial Guaranty Reinsurance

    (0.1 )   16.2  
           

Total

  $ 252.1   $ 27.0  
           

        Corporate CLOs, synthetic pooled corporate obligations, market value CDOs, and TruPS, which comprise the Company's pooled corporate exposures, include all U.S. structured finance pooled corporate obligations and international pooled corporate obligations. U.S. RMBS are comprised of prime and subprime U.S. mortgage-backed and home equity securities. CMBS are comprised of commercial U.S. structured finance and commercial international mortgage backed securities. "Other" includes all other U.S. and international asset classes, such as commercial receivables, international infrastructure, international RMBS and home equity securities, and pooled infrastructure securities.

        The Company's exposure to pooled corporate obligations is highly diversified in terms of obligors, except in the case of TruPS, industries. Most pooled corporate transactions are structured to limit exposure to any given obligor and industry. The majority of the Company's pooled corporate exposure in the financial guaranty direct segment consists of CLOs or synthetic pooled corporate obligations. Most of these direct CLOs have an average obligor size of less than 1% and typically restrict the maximum exposure to any one industry to approximately 10%. The Company's exposure also benefits from embedded credit enhancement in the transactions which allows a transaction to sustain a certain

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

8. Credit Derivatives (Continued)


level of losses in the underlying collateral, further insulating the Company from industry specific concentrations of credit risk on these deals.

        The Company's TruPS CDO asset pools are generally less diversified by obligors and industries than the typical CLO asset pool. Also, the underlying collateral in TruPS CDOs consists primarily of subordinated debt instruments such as TruPS issued by banks, real estate investment trusts ("REITs") and insurance companies, while CLOs typically contain primarily senior secured obligations. Finally, TruPS CDOs typically contain interest rate hedges that may complicate the cash flows. However, to mitigate these risks TruPS CDOs were typically structured with higher levels of embedded credit enhancement than typical CLOs.

        The Company's exposure to "Other" CDS contracts is also highly diversified. It includes $4.0 billion of exposure to four pooled infrastructure transactions comprised of diversified pools of international infrastructure project transactions and loans to regulated utilities. These pools were all structured with underlying credit enhancement sufficient for the Company to attach at super senior AAA levels. The remaining $10.7 billion of exposure in "Other" CDS contracts is comprised of numerous deals typically structured with significant underlying credit enhancement and spread across various asset classes, such as commercial receivables, international RMBS and home equity securities, infrastructure, regulated utilities and consumer receivables. Substantially all of this of exposure is rated IG and the weighted average credit rating is AA-.

        The unrealized gain for the three months ended March 31, 2010 on "Other" CDS contracts is primarily attributable to implied spreads narrowing on a film securitization transaction.

        With considerable volatility continuing in the market, unrealized gains (losses) on credit derivatives may fluctuate significantly in future periods.

        The following tables present additional details about the Company's unrealized gain or loss on credit derivatives associated with U.S. RMBS by vintage as of March 31, 2010:


U. S. Residential Mortgage-Backed Securities

Vintage
  Original
Subordination(1)
  Current
Subordination(1)
  Net Par
Outstanding
(in millions)
  Weighted
Average
Credit
Rating(2)
  Three Months Ended
March 31, 2010
Unrealized
Gain (Loss)
(in millions)
 

2004 and Prior

    6.1 %   20.3 % $ 184   A   $ 0.4  

2005

    26.8     58.9     3,401   AA-     1.8  

2006

    28.5     50.6     1,738   BBB     5.4  

2007

    19.2     18.2     5,679   B+     166.5  

2008

                   

2009

                   

2010

                   
                           
 

Total

    22.9 %   36.3 % $ 11,002   BBB-   $ 174.1  
                           

(1)
Represents the sum of subordinate tranches and over-collateralization and does not include any benefit from excess interest collections that may be used to absorb losses.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

8. Credit Derivatives (Continued)

(2)
Based on the Company's internal rating, which is on a ratings scale similar to that used by the nationally recognized rating agencies.

        The following table presents additional details about the Company's unrealized gain or loss on credit derivatives associated with CMBS transactions by vintage as of March 31, 2010:


Commercial Mortgage-Backed Securities

Vintage
  Original
Subordination(1)
  Current
Subordination(1)
  Net Par
Outstanding
(in millions)
  Weighted
Average
Credit
Rating(2)
  Three Months Ended
March 31, 2010
Unrealized
Gain (Loss)
(in millions)
 

2004 and Prior

    28.2 %   43.0 % $ 614   AAA   $ 0.3  

2005

    17.6     24.9     685   AAA     0.4  

2006

    26.4     27.2     4,404   AAA     4.5  

2007

    41.1     41.4     1,415   AAA     4.3  

2008

                   

2009

                   

2010

                   
                           
 

Total

    28.6 %   31.2 % $ 7,118   AAA   $ 9.5  
                           

(1)
Represents the sum of subordinate tranches and over-collateralization and does not include any benefit from excess interest collections that may be used to absorb losses.

(2)
Based on the Company's internal rating, which is on a ratings scale similar to that used by the nationally recognized rating agencies.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

8. Credit Derivatives (Continued)

        The following table summarizes the estimated change in fair values on the net balance of the Company's credit derivative positions assuming immediate parallel shifts in credit spreads on AGC and AGM and on the risks that they both assume:

 
  As of March 31, 2010  
Credit Spreads(1)
  Estimated Net
Fair Value (Pre-Tax)
  Estimated Pre-Tax
Change in Gain/(Loss)
 
 
  (in millions)
 

100% widening in spreads

  $ (3,128.1 ) $ (1,843.2 )

50% widening in spreads

    (2,208.7 )   (923.8 )

25% widening in spreads

    (1,748.9 )   (464.0 )

10% widening in spreads

    (1,473.0 )   (188.1 )

Base Scenario

    (1,284.9 )    

10% narrowing in spreads

    (1,162.9 )   122.0  

25% narrowing in spreads

    (976.9 )   308.0  

50% narrowing in spreads

    (667.3 )   617.6  

(1)
Includes the effects of spreads on both the underlying asset classes and the Company's own credit spread.

        During First Quarter 2010 due to technical factors such as mismatched supply and demand for buyers and sellers of protection on AGC's credit spread, AGC's credit spread did not move in correlation with asset price changes experienced in the broader market. However, based upon historical data, and price shifts experienced as of the date of this filing, the Company believes that AGC's and AGM's credit spreads continue to remain correlated with asset price changes experienced throughout the financial markets.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments

        The carrying amount and estimated fair value of financial instruments are presented in the following table:


Fair Value of Financial Instruments

 
  As of March 31, 2010   As of December 31, 2009  
 
  Carrying
Amount
  Estimated
Fair Value
  Carrying
Amount
  Estimated
Fair Value
 
 
  (in thousands)
 

Assets:

                         
 

Fixed maturity securities

  $ 9,057,230   $ 9,057,230   $ 9,139,900   $ 9,139,900  
 

Short-term investments

    1,421,421     1,421,421     1,668,279     1,668,279  
 

Assets acquired in refinancing transactions

    143,488     151,160     152,411     160,143  
 

Credit derivative assets

    537,050     537,050     492,531     492,531  
 

Committed capital securities, at fair value

    8,262     8,262     9,537     9,537  
 

Financial guaranty VIE assets

    1,868,596     1,868,596          
 

Other assets

    24,295     24,295     18,473     18,473  

Liabilities:

                         
 

Financial guaranty insurance contracts(1)

    5,690,195     6,981,575     5,971,803     7,020,474  
 

Long-term debt

    919,493     981,275     917,362     927,823  
 

Notes payable

    142,403     147,147     149,051     148,477  
 

Credit derivative liabilities

    1,821,961     1,821,961     2,034,634     2,034,634  
 

Financial guaranty VIE liabilities with recourse

    2,067,215     2,067,215     762,652     762,652  
 

Financial guaranty VIE liabilities without recourse

    205,724     205,724          
 

Other liabilities

    68     68     66     66  

(1)
Includes the balance sheet amounts related to financial guaranty insurance contract premiums and losses, net of reinsurance.

Background

        Fair value framework defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The price represents the price available in the principal market for the asset or liability. If there is no principal market, then the price is based on the market that maximizes the value received for an asset or minimizes the amount paid for a liability (i.e. the most advantageous market).

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)

        A fair value hierarchy was also established based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Company estimates of market assumptions. In accordance with GAAP, the fair value hierarchy prioritizes model inputs into three broad levels as follows:

        An asset or liability's categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation.

Financial Instruments Carried at Fair Value

        The measurement provision of the fair value framework applies to both amounts recorded in the Company's financial statements and to disclosures. Amounts recorded at fair value in the Company's financial statements are included in the tables below.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)


Fair Value Hierarchy of Financial Instruments
As of March 31, 2010

 
   
  Fair Value Measurements Using  
 
  Fair Value   Level 1   Level 2   Level 3  
 
  (in millions)
 

Assets:

                         

Investment portfolio, available-for-sale:

                         
 

Fixed maturity securities

                         
   

U.S. government and agencies

  $ 1,048.7   $   $ 1,048.7   $  
   

Obligations of state and political subdivisions

    4,814.2         4,814.2      
   

Corporate securities

    642.6         642.6      
   

Mortgage-backed securities:

                         
     

Residential mortgage-backed securities

    1,466.6         1,387.3     79.3  
     

Commercial mortgage-backed securities

    247.6         247.6      
   

Asset-backed securities

    501.9         279.2     222.7  
   

Foreign government securities

    335.7         335.7      
                   
     

Total fixed maturity securities

    9,057.3         8,755.3     302.0  
 

Short-term investments

   
1,421.4
   
722.4
   
699.0
   
 
 

Assets acquired in refinancing transactions(1)

    31.9         21.3     10.6  
 

Credit derivative assets

    537.1             537.1  
 

Committed capital securities, at fair value

    8.3         8.3      
 

Financial guaranty VIE assets

    1,868.6             1,868.6  
 

Other assets

    24.2     19.8         4.4  
                   
   

Total assets

  $ 12,948.8   $ 742.2   $ 9,483.9   $ 2,722.7  
                   

Liabilities:

                         
 

Credit derivative liabilities

  $ 1,822.0   $   $   $ 1,822.0  
 

Financial guaranty VIE liabilities with recourse

    2,067.2             2,067.2  
 

Financial guaranty VIE liabilities without recourse

    205.7             205.7  
 

Other liabilities

    0.1         0.1      
                   
   

Total liabilities

  $ 4,095.0   $   $ 0.1   $ 4,094.9  
                   

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)


Fair Value Hierarchy of Financial Instruments
As of December 31, 2009

 
   
  Fair Value Measurements Using  
 
  Fair Value   Level 1   Level 2   Level 3  
 
  (in millions)
 

Assets:

                         

Investment portfolio, available-for-sale:

                         
 

Fixed maturity securities

                         
   

U.S. government and agencies

  $ 1,037.6   $   $ 1,037.6   $  
   

Obligations of state and political subdivisions

    5,039.5         5,039.5      
   

Corporate securities

    625.5         625.5        
   

Mortgage-backed securities:

                       
     

Residential mortgage-backed securities

    1,464.6         1,464.6      
     

Commercial mortgage-backed securities

    227.2         227.2      
   

Asset-backed securities

    388.9         185.0     203.9  
   

Foreign government securities

    356.6         356.6      
                   
     

Total fixed maturity securities

    9,139.9         8,936.0     203.9  
 

Short-term investments

   
1,668.3
   
437.2
   
1,231.1
   
 
 

Assets acquired in refinancing transactions(1)

    32.4         21.3     11.1  
 

Credit derivative assets

    492.5             492.5  
 

Committed capital securities, at fair value

    9.5         9.5      
 

Other assets

    18.5     18.3         0.2  
                   
   

Total assets

  $ 11,361.1   $ 455.5   $ 10,197.9   $ 707.7  
                   

Liabilities:

                         
 

Credit derivative liabilities

  $ 2,034.6   $   $   $ 2,034.6  
 

Other liabilities

    0.1         0.1      
                   
   

Total liabilities

  $ 2,034.7   $   $ 0.1   $ 2,034.6  
                   

(1)
Includes mortgage loans that are fair valued on a non-recurring basis. At March 31, 2010 and December 31, 2009, such investments were carried at their market value of $10.6 million and $11.1 million, respectively. The mortgage loans are classified as Level 3 of the fair value hierarchy as there are significant unobservable inputs used in the valuation of such loans. An indicative dealer quote is used to price the non-performing portion of these mortgage loans. The performing loans are valued using management's determination of future cash flows arising from these loans, discounted at the rate of return that would be required by a market participant. This rate of return is based on indicative dealer quotes.

Fixed Maturity Securities and Short-term Investments

        The fair value of bonds in the Investment Portfolio is generally based on quoted market prices received from third party pricing services or alternative pricing sources with reasonable levels of price

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)


transparency. Such quotes generally consider a variety of factors, including recent trades of the same and similar securities. If quoted market prices are not available, the valuation is based on pricing models that use dealer price quotations, price activity for traded securities with similar attributes and other relevant market factors as inputs, including security type, rating, vintage, tenor and its position in the capital structure of the issuer. The Company considers securities prices from pricing services, index providers or broker-dealers to be Level 2 in the fair value hierarchy. Prices determined based upon model processes are considered to be Level 3 in the fair value hierarchy. The Company used model processes to price 21 fixed maturity securities as of March 31, 2010 and these securities were classified as Level 3.

        Broker-dealer quotations obtained to price securities are generally considered to be indicative and are nonactionable (i.e. non-binding).

        The Company did not make any internal adjustments to prices provided by its third party pricing service.

Committed Capital Securities

        The fair value of committed capital securities ("CCS") represents the difference between the present value of remaining expected put option premium payments under the AGC's CCS (the "AGC CCS Securities") and AGM Committed Preferred Trust Securities (the "AGM CPS Securities") agreements and the value of such estimated payments based upon the quoted price for such premium payments as of the reporting dates (see Note 17). Changes in fair value of the AGM CPS and AGC CCS securities are included in the consolidated statement of operations. The significant market inputs used are observable, therefore, the Company classified this fair value measurement as Level 2.

Financial Guaranty Credit Derivatives Accounted for as Derivatives

        The Company's credit derivatives consist primarily of insured CDS contracts, and also include NIM securitizations and interest rate swaps (see Note 8) most of which fall under derivative accounting guidance requiring fair value accounting through the statement of operations. The Company does not typically exit its credit derivative contracts, and there are no quoted prices for its instruments or for similar instruments. Observable inputs other than quoted market prices exist; however, these inputs reflect contracts that do not contain terms and conditions similar to the credit derivative contracts issued by the Company. Therefore, the valuation of credit derivative contracts requires the use of models that contain significant, unobservable inputs. The Company accordingly believes the credit derivative valuations are in Level 3 in the fair value hierarchy discussed above.

        The fair value of the Company's credit derivative contracts represents the difference between the present value of remaining expected net premiums the Company receives for the credit protection and the estimated present value of premiums that a comparable credit-worthy financial guarantor would hypothetically charge the Company for the same protection at the balance sheet date. The fair value of the Company's credit derivatives depends on a number of factors, including notional amount of the contract, expected term, credit spreads, changes in interest rates, the credit ratings of referenced entities, the Company's own credit risk and remaining contractual cash flows.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)

        Market conditions at March 31, 2010 were such that market prices of the Company's CDS contracts were not generally available. Where market prices were not available, the Company used proprietary valuation models that used both unobservable and observable market data inputs such as various market indices, credit spreads, the Company's own credit spread, and estimated contractual payments to estimate the portion of the fair value of its credit derivatives. These models are primarily developed internally based on market conventions for similar transactions.

        Management considers the non-standard terms of its credit derivative contracts in determining the fair value of these contracts. These terms differ from more standardized credit derivative contracts sold by companies outside the financial guaranty industry. The non-standard terms include the absence of collateral support agreements or immediate settlement provisions. In addition, the Company employs relatively high attachment points and does not exit derivatives it sells for credit protection purposes, except under specific circumstances such as novations upon exiting a line of business. Because of these terms and conditions, the fair value of the Company's credit derivatives may not reflect the same prices observed in an actively traded market of credit derivatives that do not contain terms and conditions similar to those observed in the financial guaranty market. The Company's models and the related assumptions are continuously reevaluated by management and enhanced, as appropriate, based upon improvements in modeling techniques and availability of more timely and relevant market information.

        Remaining contractual cash flows are the most readily observable variables since they are based on the CDS contractual terms. These variables include i) net premiums received and receivable on written credit derivative contracts, ii) net premiums paid and payable on purchased contracts, iii) losses paid and payable to credit derivative contract counterparties and iv) losses recovered and recoverable on purchased contracts.

        Valuation models include management estimates and current market information. Management is also required to make assumptions on how the fair value of credit derivative instruments is affected by current market conditions. Management considers factors such as current prices charged for similar agreements, performance of underlying assets, life of the instrument, and the nature and extent of activity in the financial guaranty credit derivative marketplace. The assumptions that management uses to determine its fair value may change in the future due to market conditions. Due to the inherent uncertainties of the assumptions used in the valuation models to determine the fair value of these credit derivative products, actual experience may differ from the estimates reflected in the Company's unaudited interim consolidated financial statements and the differences may be material.

Assumptions and Inputs

        Listed below are various inputs and assumptions that are key to the establishment of the Company's fair value for CDS contracts.

        The key assumptions of the Company's internally developed model include the following:

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)

        The premium the Company receives is referred to as the "net spread." The Company's own credit risk is factored into the determination of net spread based on the impact of changes in the quoted market price for credit protection bought on the Company, as reflected by quoted market prices on CDS referencing AGC or AGM. The cost to acquire CDS protection referencing AGC or AGM affects the amount of spread on CDS deals that the Company retains and, hence, their fair value. As the cost to acquire CDS protection referencing AGC or AGM increases, the amount of premium the Company retains on a deal generally decreases. As the cost to acquire CDS protection referencing AGC or AGM decreases, the amount of premium the Company retains on a deal generally increases. In the Company's valuation model, the premium the Company captures is not permitted to go below the minimum rate that the Company would currently charge to assume similar risks. This assumption can have the effect of mitigating the amount of unrealized gains that are recognized on certain CDS contracts.

        The Company determines the fair value of its CDS contracts by applying the net spread for the remaining duration of each contract to the notional value of its CDS contracts. To the extent available actual transactions executed in the accounting period are used to validate the model results and to explain the correlation between various market indices and indicative CDS market prices.

        The Company's fair value model inputs are gross spread, credit spreads on risks assumed and credit spreads on the Company's name.

        Gross spread is an input into the Company's fair value model that is used to ultimately determine the net spread a comparable financial guarantor would charge the Company to transfer risk at the reporting date. The Company's estimate of the fair value adjustment represents the difference between the estimated present value of premiums that a comparable financial guarantor would accept to assume the risk from the Company on the current reporting date, on terms identical to the original contracts written by the Company and at the contractual premium for each individual credit derivative contract. This is an observable input that the Company obtains for deals it has closed or bid on in the market place.

        The Company obtains credit spreads on risks assumed from market data sources published by third parties (e.g. dealer spread tables for the collateral similar to assets within the Company's transactions) as well as collateral-specific spreads provided by trustees or obtained from market sources. If observable market credit spreads are not available or reliable for the underlying reference obligations,

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)


then market indices are used that most closely resembles the underlying reference obligations, considering asset class, credit quality rating and maturity of the underlying reference obligations. As discussed previously, these indices are adjusted to reflect the non-standard terms of the Company's CDS contracts. Market sources determine credit spreads by reviewing new issuance pricing for specific asset classes and receiving price quotes from their trading desks for the specific asset in question. Management validates these quotes by cross-referencing quotes received from one market source against quotes received from another market source to ensure reasonableness. In addition, the Company compares the relative change in price quotes received from one quarter to another, with the relative change experienced by published market indices for a specific asset class. Collateral specific spreads obtained from third-party, independent market sources are un-published spread quotes from market participants and or market traders whom are not trustees. Management obtains this information as the result of direct communication with these sources as part of the valuation process.

        For credit spreads on the Company's name the Company obtains the quoted price of CDS contracts traded on AGC and AGM from market data sources published by third parties.

Example

        The following is an example of how changes in gross spreads, the Company's own credit spread and the cost to buy protection on the Company affect the amount of premium the Company can demand for its credit protection. Scenario 1 represents the market conditions in effect on the transaction date and Scenario 2 represents market conditions at a subsequent reporting date.

 
  Scenario 1   Scenario 2  
 
  bps   % of Total   bps   % of Total  

Original gross spread/cash bond price (in bps)

    185           500        

Bank profit (in bps)

    115     62 %   50     10 %

Hedge cost (in bps)

    30     16     440     88  

The Company premium received per annum (in bps)

    40     22     10     2  

        In Scenario 1, the gross spread is 185 basis points. The bank or deal originator captures 115 basis points of the original gross spread and hedges 10% of its exposure to AGC, when the CDS spread on AGC was 300 basis points (300 basis points × 10% = 30 basis points). Under this scenario the Company received premium of 40 basis points, or 22% of the gross spread.

        In Scenario 2, the gross spread is 500 basis points. The bank or deal originator captures 50 basis points of the original gross spread and hedges 25% of its exposure to AGC, when the CDS spread on AGC was 1,760 basis points (1,760 basis points × 25% = 440 basis points). Under this scenario the Company would receive premium of 10 basis points, or 2% of the gross spread.

        In this example, the contractual cash flows (the Company premium received per annum above) exceed the amount a market participant would require the Company to pay in today's market to accept its obligations under the CDS contract, thus resulting in an asset. This credit derivative asset is equal to the difference in premium rate discounted at the corresponding LIBOR over the weighted average remaining life of the contract. The expected future cash flows for the Company's credit derivatives were

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)


discounted at rates ranging from 0.25% to 4.6% at March 31, 2010. The expected future cash flows for the Company's credit derivatives were discounted at rates ranging from 0.25% to 4.5% at December 31, 2009.

        The Company corroborates the assumptions in its fair value model, including the amount of exposure to AGC and AGM hedged by its counterparties, with independent third parties each reporting period. The current level of AGC's and AGM's own credit spread has resulted in the bank or deal originator hedging a significant portion of its exposure to AGC and AGM. This reduces the amount of contractual cash flows AGC and AGM can capture for selling its protection.

        The amount of premium a financial guaranty insurance market participant can demand is inversely related to the cost of credit protection on the insurance company as measured by market credit spreads. This is because the buyers of credit protection typically hedge a portion of their risk to the financial guarantor, due to the fact that contractual terms of financial guaranty insurance contracts typically do not require the posting of collateral by the guarantor. The widening of a financial guarantor's own credit spread increases the cost to buy credit protection on the guarantor, thereby reducing the amount of premium the guarantor can capture out of the gross spread on the deal. The extent of the hedge depends on the types of instruments insured and the current market conditions.

        A credit derivative asset on protection sold is the result of contractual cash flows on in-force deals in excess of what a hypothetical financial guarantor could receive if it sold protection on the same risk as of the current reporting date. If the Company were able to freely exchange these contracts (i.e., assuming its contracts did not contain proscriptions on transfer and there was a viable exchange market), it would be able to realize an asset representing the difference between the higher contractual premiums to which it is entitled and the current market premiums for a similar contract.

        Management does not believe there is an established market where financial guaranty insured credit derivatives are actively traded. The terms of the protection under an insured financial guaranty credit derivative do not, except for certain rare circumstances, allow the Company to exit its contracts. Management has determined that the exit market for the Company's credit derivatives is a hypothetical one based on its entry market. Management has tracked the historical pricing of the Company's deals to establish historical price points in the hypothetical market that are used in the fair value calculation.

        The following spread hierarchy is utilized in determining which source of spread to use, with the rule being to use CDS spreads where available. If not available, the Company either interpolates or extrapolates CDS spreads based on similar transactions or market indices.

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)

        Over time the data inputs can change as new sources become available or existing sources are discontinued or are no longer considered to be the most appropriate. It is the Company's objective to move to higher levels on the hierarchy whenever possible, but it is sometimes necessary to move to lower priority inputs because of discontinued data sources or management's assessment that the higher priority inputs are no longer considered to be representative of market spreads for a given type of collateral. This can happen, for example, if transaction volume changes such that a previously used spread index is no longer viewed as being reflective of current market levels.


Information by Credit Spread Type

 
  As of
March 31, 2010
  As of
December 31, 2009
 

Based on actual collateral specific spreads

    5 %   5 %

Based on market indices

    91 %   90 %

Provided by the CDS counterparty

    4 %   5 %
           
 

Total

    100 %   100 %
           

        The Company interpolates a curve based on the historical relationship between premium the Company receives when a financial guaranty contract written in CDS form is closed to the daily closing price of the market index related to the specific asset class and rating of the deal. This curve indicates expected credit spreads at each indicative level on the related market index. For specific transactions where no price quotes are available and credit spreads need to be extrapolated, an alternative transaction for which the Company has received a spread quote from one of the first three sources within the Company's spread hierarchy is chosen. This alternative transaction will be within the same asset class, have similar underlying assets, similar credit ratings, and similar time to maturity. The Company then calculates the percentage of relative spread change quarter over quarter for the alternative transaction. This percentage change is then applied to the historical credit spread of the transaction for which no price quote was received in order to calculate the transactions current spread. Counterparties determine credit spreads by reviewing new issuance pricing for specific asset classes and receiving price quotes from their trading desks for the specific asset in question. These quotes are validated by cross-referencing quotes received from one market source with those quotes received from another market source to ensure reasonableness. In addition, management compares the relative change experienced on published market indices for a specific asset class for reasonableness and accuracy.

Strengths and Weaknesses of Model

        The Company's credit derivative valuation model, like any financial model, has certain strengths and weaknesses.

        The primary strengths of the Company's CDS modeling techniques are:

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)

        The primary weaknesses of the Company's CDS modeling techniques are:

        Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. As of March 31, 2010 and December 31, 2009 these contracts are classified as Level 3 in the fair value hierarchy since there is reliance on at least one unobservable input deemed significant to the valuation model, most significantly the Company's estimate of the value of the non-standard terms and conditions of its credit derivative contracts and of the Company's current credit standing.

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

March 31, 2010

9. Fair Value of Financial Instruments (Continued)

Fair Value Option on Financial Guaranty VIE Assets and Liabilities

        The Company elected the Fair Value Option for financial guaranty VIE assets and liabilities upon adopting the new accounting guidance on accounting for VIEs (see Note 23).

        The Company's financial guaranty VIEs issued securities collateralized by HELOCs, first lien RMBS, Alt-A first and second lien RMBS, subprime automobile loans, and other loans and receivables. As the lowest level input that is significant to the fair value measurement of these securities in its entirety was a Level 3 input, we classified all such securities as Level 3 in the fair value hierarchy. The securities were priced with the assistance of an independent third-party using a discounted cash flow approach and the third-party's proprietary pricing models. The models to price the VIEs liabilities used, where appropriate, inputs such as estimated prepayment speeds; losses; recoveries; market values of the assets that collateralize the securities; estimated default rates (determined on the basis of an analysis of collateral attributes, historical collateral performance, borrower profiles and other features relevant to the evaluation of collateral credit quality); discount rates implied by market prices for similar securities; house price depreciation/appreciation rates based on macroeconomic forecasts and benefit from the Company's insurance policy guaranteeing the timely payment of principal and interest for the VIE tranches insured by the Company. Those VIE liabilities insured by the Company are considered to be with recourse, since the Company guarantees the payment of principal and interest regardless of the performance of the related VIE assets. Those VIE liabilities not insured by the Company are considered to be non-recourse, since the payment of principal and interest of these liabilities is wholly dependent on the performance of the VIE asset