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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 June 30, 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 ý    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 July 31, 2010 was 183,743,594 (excludes 192,390 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 June 30, 2010 and December 31, 2009

    1  

 

Consolidated Statements of Operations (unaudited) for the Three and Six Months Ended June 30, 2010 and 2009

    2  

 

Consolidated Statements of Comprehensive Income (unaudited) for the Three and Six Months Ended June 30, 2010 and 2009

    3  

 

Consolidated Statements of Shareholders' Equity (unaudited) for the Six Months ended June 30, 2010

    4  

 

Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2010

    5  

 

Notes to Consolidated Financial Statements (unaudited)

    6  

Item 2.

 

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

    105  

 

Forward-Looking Statements

    105  

 

Website Information

    106  

 

Executive Summary

    106  

 

Importance of Financial Strength Ratings

    113  

 

AGMH Acquisition

    115  

 

Insured Portfolio Profile

    118  

 

Results of Operations

    121  

 

Exposure to Residential Mortgage Backed Securities

    148  

 

Summary of Relationships with Monolines

    154  

 

Non-GAAP Financial Measures

    155  

 

Liquidity and Capital Resources

    158  

Item 3.

 

Market Risk

    179  

Item 4.

 

Controls and Procedures

    182  

PART II. OTHER INFORMATION

 

Item 1.

 

Legal Proceedings

    183  

Item 1A.

 

Risk Factors

    186  

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

    191  

Item 6.

 

Exhibits

    191  

Table of Contents


Assured Guaranty Ltd.

Consolidated Balance Sheets (Unaudited)

(dollars in thousands except per share and share amounts)

 
  June 30,
2010
  December 31,
2009
 

Assets

             

Investment portfolio:

             
 

Fixed maturity securities, available-for-sale, at fair value (amortized cost of $8,861,683 and $8,943,909)

  $ 9,113,803   $ 9,139,900  
 

Short term investments, at fair value

    1,391,183     1,668,279  
           
   

Total investment portfolio

    10,504,986     10,808,179  

Assets acquired in refinancing transactions

    138,306     152,411  

Cash

    97,212     44,133  

Premiums receivable, net of ceding commissions payable

    1,311,254     1,418,232  

Ceded unearned premium reserve

    929,475     1,080,466  

Deferred acquisition costs

    250,635     241,961  

Reinsurance recoverable on unpaid losses

    19,044     14,122  

Credit derivative assets

    491,122     492,531  

Committed capital securities, at fair value

    20,855     9,537  

Deferred tax asset, net

    1,072,260     1,158,205  

Salvage and subrogation recoverable

    686,039     420,238  

Financial guaranty variable interest entities' assets

    1,844,673     762,303  

Other assets

    222,729     200,375  
           
 

Total assets

  $ 17,588,590   $ 16,802,693  
           

Liabilities and shareholders' equity

             

Unearned premium reserves

  $ 7,661,289   $ 8,400,152  

Loss and loss adjustment expense reserve

    403,471     289,470  

Long-term debt

    921,628     917,362  

Notes payable

    137,632     149,051  

Credit derivative liabilities

    1,765,966     2,034,634  

Reinsurance balances payable, net

    243,039     215,239  

Financial guaranty variable interest entities' liabilities with recourse

    2,049,253     762,652  

Financial guaranty variable interest entities' liabilities without recourse

    184,890      

Other liabilities

    352,857     513,974  
           
 

Total liabilities

    13,720,025     13,282,534  
           

Commitments and contingencies

             

Common stock ($0.01 par value, 500,000,000 shares authorized; 183,743,517 and 184,162,896 shares issued and outstanding in 2010 and 2009)

    1,837     1,842  

Additional paid-in capital

    2,581,269     2,584,983  

Retained earnings

    1,092,129     789,869  

Accumulated other comprehensive income, net of deferred tax provision (benefit) of $55,425 and $58,551

    191,330     141,814  

Deferred equity compensation (181,818 shares)

    2,000     2,000  
           
 

Total shareholders' equity attributable to Assured Guaranty Ltd. 

    3,868,565     3,520,508  

Noncontrolling interest of financial guaranty variable interest entities

        (349 )
           
 

Total shareholders' equity

    3,868,565     3,520,159  
           
 

Total liabilities and shareholders' equity

  $ 17,588,590   $ 16,802,693  
           

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
June 30,
  Six Months Ended
June 30,
 
 
  2010   2009   2010   2009  

Revenues

                         
 

Net earned premiums

  $ 292,110   $ 78,634   $ 611,670   $ 227,080  
 

Net investment income

    90,871     43,300     175,173     86,901  
 

Net realized investment gains (losses):

                         
   

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

    (17,412 )   (36,466 )   (18,529 )   (54,912 )
   

Less: portion of OTTI loss recognized in other comprehensive income

        (21,633 )   (661 )   (21,633 )
   

Other net realized investment gains (losses)

    8,974     9,945     18,843     11,281  
                   
     

Net realized investment gains (losses)

    (8,438 )   (4,888 )   975     (21,998 )
 

Net change in fair value of credit derivatives:

                         
   

Realized gains and other settlements

    38,353     27,816     65,056     48,395  
   

Net unrealized gains (losses)

    35,115     (254,284 )   287,213     (227,302 )
                   
     

Net change in fair value of credit derivatives

    73,468     (226,468 )   352,269     (178,907 )
 

Fair value gain (loss) on committed capital securities

    12,593     (60,570 )   11,318     (40,904 )
 

Financial guaranty variable interest entities' revenues

    (19,133 )       (14,945 )    
 

Other income

    (13,396 )   492     (26,325 )   1,394  
                   
   

Total Revenues

    428,075     (169,500 )   1,110,135     73,566  
                   

Expenses

                         
 

Loss and loss adjustment expenses

    71,156     38,030     201,657     117,784  
 

Amortization of deferred acquisition costs

    6,936     16,548     15,109     39,969  
 

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

    2,751     24,225     6,772     28,846  
 

Interest expense

    24,831     6,484     49,965     12,305  
 

Financial guaranty variable interest entities' expenses

    (19,610 )       (4,832 )    
 

Other operating expenses

    47,507     26,533     110,040     55,885  
                   
   

Total expenses

    133,571     111,820     378,711     254,789  
                   

Income (loss) before income taxes

    294,504     (281,320 )   731,424     (181,223 )

Provision (benefit) for income taxes

                         
 

Current

    44,822     (9,874 )   5,869     1,701  
 

Deferred

    46,144     (101,442 )   200,042     (98,409 )
                   
   

Total provision (benefit) for income taxes

    90,966     (111,316 )   205,911     (96,708 )
                   

Net income (loss)

    203,538     (170,004 )   525,513     (84,515 )

Less: Noncontrolling interest of variable interest entities

                 
                   

Net income (loss) attributable to Assured Guaranty Ltd

  $ 203,538   $ (170,004 ) $ 525,513   $ (84,515 )
                   

Earnings per share:

                         
   

Basic

  $ 1.10   $ (1.82 ) $ 2.85   $ (0.91 )
   

Diluted

  $ 1.08   $ (1.82 ) $ 2.77   $ (0.91 )

Dividends per share

  $ 0.045   $ 0.045   $ 0.090   $ 0.090  

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
June 30,
  Six Months Ended
June 30,
 
 
  2010   2009   2010   2009  

Net income (loss)

  $ 203,538   $ (170,004 ) $ 525,513   $ (84,515 )

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

                         
 

Investments with no OTTI, net of deferred income tax provision (benefit) of $3,785, $10,415, $(1,597) and $14,930

    48,183     59,667     58,058     49,965  
 

Investments with OTTI, net of deferred income tax provision (benefit) of $0, $(1,665), $0 and $(1,665)

        (19,968 )   (661 )   (19,968 )
                   

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

    48,183     39,699     57,397     29,997  

Less: reclassification adjustment for gains (losses) included in net income (loss), net of deferred income tax provision (benefit) of $(4,206), $2,226, $(1,438) and $2,191

    (4,232 )   (7,114 )   2,413     (24,189 )
                   

Change in net unrealized gains on investments

    52,415     46,813     54,984     54,186  

Change in cumulative translation adjustment

    (1,375 )   6,384     (5,259 )   (2,003 )

Change in cash flow hedge

    (104 )   (104 )   (209 )   (209 )
                   

Other comprehensive income (loss)

    50,936     53,093     49,516     51,974  
                   

Comprehensive income (loss)

    254,474     (116,911 )   575,029     (32,541 )

Less: Comprehensive income (loss) attributable to noncontrolling interest of variable interest entities

                 
                   

Comprehensive income (loss) of Assured Guaranty Ltd.

  $ 254,474   $ (116,911 ) $ 575,029   $ (32,541 )
                   

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

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Assured Guaranty Ltd.

Consolidated Statement of Shareholders' Equity (Unaudited)

For the Six Months Ended June 30, 2010

(dollars in thousands, except share data)

 
   
   
   
   
   
   
   
  Noncontrolling
Interest of
Financial
Guaranty
Consolidated
Variable
Interest
Entities
   
 
 
   
   
   
   
   
   
  Total
Shareholders'
Equity
Attributable
to Assured
Guaranty Ltd.
   
 
 
  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 8)

                (206,540 )           (206,540 )   349     (206,191 )
                                       

Balance, January 1, 2010

    184,162,896     1,842     2,584,983     583,329     141,814     2,000     3,313,968         3,313,968  

Net income

                525,513             525,513         525,513  

Dividends on common stock ($0.09 per share)

                (16,613 )           (16,613 )       (16,613 )

Dividends on restricted stock units

            100     (100 )                      

Common stock repurchases

    (707,350 )   (7 )   (10,450 )               (10,457 )       (10,457 )

Share-based compensation and other

    287,971     2     6,636                 6,638         6,638  

Change in cash flow hedge, net of tax of $(113)

                    (209 )       (209 )       (209 )

Change in cumulative translation adjustment, net of tax of $(2,854)

                    (5,259 )       (5,259 )       (5,259 )

Unrealized gain on investments, net of tax of $(159)

                    54,984         54,984         54,984  
                                       

Balance, June 30, 2010

    183,743,517   $ 1,837   $ 2,581,269   $ 1,092,129   $ 191,330   $ 2,000   $ 3,868,565   $   $ 3,868,565  
                                       

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)

 
  Six Months Ended
June 30,
 
 
  2010   2009  

Net cash flows provided by (used in) operating activities

  $ (249,589 ) $ 202,780  
           

Investing activities

             
 

Fixed maturity securities:

             
   

Purchases

    (1,166,379 )   (827,862 )
   

Sales

    780,818     705,004  
   

Maturities

    488,552     5,500  
 

Net sales (purchases) of short-term investments

    276,641     (693,637 )
 

Proceeds from financial guaranty variable interest entities' assets

    217,329      
 

Other

    8,317      
           

Net cash flows provided by (used in) investing activities

    605,278     (810,995 )
           

Financing activities

             
 

Net proceeds from issuance of common stock

        448,495  
 

Net proceeds from issuance of equity units

        167,972  
 

Dividends paid

    (16,613 )   (8,199 )
 

Repurchases of common stock

    (10,457 )   (3,676 )
 

Share activity under option and incentive plans

    (2,233 )   (778 )
 

Paydown of financial guaranty variable interest entities' liabilities

    (259,367 )    
 

Repayment of notes payable

    (10,850 )    
           

Net cash flows provided by (used in) financing activities

    (299,520 )   603,814  

Effect of exchange rate changes

    (3,090 )   603  
           

Increase in cash

    53,079     (3,798 )

Cash at beginning of period

    44,133     12,305  
           

Cash at end of period

  $ 97,212   $ 8,507  
           

Supplemental cash flow information

             

Cash paid (received) during the period for:

             
 

Income taxes

  $ 136,645   $ 6,836  
 

Interest

  $ 45,266   $ 11,800  

Claims paid, net of reinsurance

  $ 516,834   $ 210,818  

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)

June 30, 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 United States ("U.S.") and international public finance, infrastructure and structured finance markets. 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, from Dexia Holdings, Inc. ("Dexia Holdings"). AGMH's principal insurance subsidiary is Financial Security Assurance Inc. (renamed Assured Guaranty Municipal Corp., "AGM"). As discussed further in Note 2, the 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. AGM focuses exclusively on the U.S. public finance and global infrastructure business. AGM ceased underwriting structured finance business in September 2008. The second company, AGC, underwrites global structured finance obligations as well as U.S. public finance and global infrastructure obligations. Neither company currently underwrites U.S. residential mortgage backed securities ("RMBS").

Segments

        The Company's business includes two principal segments: financial guaranty direct and financial guaranty reinsurance. Financial guaranties of RMBS and commercial mortgage-backed securities ("CMBS") are included in both the financial guaranty direct and reinsurance segments. 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." Each segment is reported net of business ceded to

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

1. Business and Organization (Continued)


external reinsurers. The financial guaranty segments include contracts accounted for as both insurance and credit derivatives. These segments are further discussed in Note 19.

Importance of Financial Strength Ratings

        Debt obligations guaranteed by AGL's insurance company 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. Investors in products insured by AGC or AGM frequently rely on rating agency ratings because ratings influence the trading value of securities and form the basis for many institutions' investment guidelines as well as individuals' bond purchase decisions. Therefore, the Company manages its business with the goal of achieving high financial strength ratings, preferably the highest that an agency will assign. However, the models used by rating agencies differ, presenting conflicting goals that sometimes make it inefficient or impractical to reach the highest rating level. The models are not fully transparent, contain subjective data (such as assumptions about future market demand for the Company's products) and change frequently.

        Historically, insurance financial strength ratings are with respect to an insurer's ability to pay under its insurance policies and contracts in accordance with their terms. The rating is not specific to any particular policy or contract. Insurance financial strength ratings do not refer to an insurer's ability to meet non-insurance obligations and are not a recommendation to purchase any policy or contract issued by an insurer or to buy, hold, or sell any security insured by an insurer. More recently, the ratings also reflect qualitative factors with respect to such things as the insurer's business strategy and franchise value, the anticipated future demand for its product, the composition of its portfolio, and its capital adequacy, profitability and financial flexibility.

        The rating agencies have developed and published rating guidelines for rating financial guaranty and mortgage guaranty insurers and reinsurers. The insurance financial strength ratings assigned by the rating agencies are based upon factors relevant to policyholders and are not directed toward the protection of investors in AGL's common shares. The rating criteria used by the rating agencies in establishing these ratings include consideration of the sufficiency of capital resources to meet projected growth (as well as access to such additional capital as may be necessary to continue to meet applicable capital adequacy standards), a company's overall financial strength, and demonstrated management expertise in financial guaranty and traditional reinsurance, credit analysis, systems development, marketing, capital markets and investment operations. Ratings reflect only the views of the respective rating agencies and are subject to continuous review and revision or withdrawal at any time.

        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 have 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

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

2. AGMH Acquisition (Continued)


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 16, the liquidity risks associated with AGMH's former Financial Products Business.

        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") have 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 a financial guaranty direct contract 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

8


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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

2. AGMH Acquisition (Continued)


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 unearned premium and loss reserves (i.e. "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 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 8.

        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.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

2. AGMH Acquisition (Continued)

        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.


Pro Forma Unaudited Results of Operations

 
  Second Quarter 2009   Six Months 2009  
 
  Revenues   Net Income
(Loss)
Attributable
to
Assured
Guaranty Ltd.
  Net Income
per
Basic Share
  Revenues   Net Income
(Loss)
Attributable
to
Assured
Guaranty Ltd.
  Net Income
per
Basic Share
 
 
  (dollars in thousands, except per share amounts)
 

Assured Guaranty as reported

  $ (169,500 ) $ (170,004 ) $ (1.82 ) $ 73,566   $ (84,515 ) $ (0.91 )

Pro Forma Combined

    382,709     137,053     0.86     1,480,260     606,212     3.81  

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 year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. 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 June 30, 2010 ("Second Quarter 2010") and the three-month period ended June 30, 2009 ("Second Quarter 2009"), the six-month period ended June 30, 2010 ("Six Months 2010") and the six-month period ended June 30, 2009 ("Six Months 2009). Results of operations for the Second Quarter and Six Months ended June 30, 2010 and 2009 are not necessarily indicative of the results that may be expected for a full year. The Second Quarter 2010 and Six Months 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. In addition, 2010 financial statements include the effects of consolidating certain financial guaranty VIEs (See Note 8).

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

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

3. Summary of Significant Accounting Policies (Continued)

        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 global financial markets experienced volatility and disruption over the past several years 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 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. Outstanding Exposure

        The Company's insurance policies and credit derivative contracts which, although written in different forms, collectively are considered financial guaranty contracts and 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 $1,058.0 billion at June 30, 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 reinsurers, was $942.6 billion at June 30, 2010 and $958.3 billion at December 31, 2009.

        The Company seeks to limit its exposure to losses 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.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

4. 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
  June 30,
2010
  December 31,
2009
  June 30,
2010
  December 31,
2009
  June 30,
2010
  December 31,
2009
 
 
  (in millions)
 

U.S.:

                                     
 

General obligation

  $ 199,969   $ 201,264   $ 18,001   $ 22,880   $ 181,968   $ 178,384  
 

Tax backed

    94,440     94,825     9,785     11,796     84,655     83,029  
 

Municipal utilities

    77,307     77,872     6,320     8,294     70,987     69,578  
 

Transportation

    42,862     42,540     6,106     7,243     36,756     35,297  
 

Healthcare

    27,351     28,214     5,194     6,205     22,157     22,009  
 

Higher education

    15,796     16,399     1,025     1,267     14,771     15,132  
 

Housing

    7,470     9,623     808     1,099     6,662     8,524  
 

Infrastructure finance

    4,894     4,530     895     977     3,999     3,553  
 

Investor-owned utilities

    1,677     1,694     3     4     1,674     1,690  
 

Other public finance—U.S. 

    6,318     6,002     73     120     6,245     5,882  
                           
   

Total public finance—U.S. 

    478,084     482,963     48,210     59,885     429,874     423,078  

Non-U.S.:

                                     
 

Infrastructure finance

    17,738     19,404     2,790     3,060     14,948     16,344  
 

Regulated utilities

    17,716     18,979     4,771     5,128     12,945     13,851  
 

Pooled infrastructure

    4,267     4,684     259     280     4,008     4,404  
 

Other public finance—non-U.S. 

    9,857     10,485     2,185     2,309     7,672     8,176  
                           
   

Total public finance—non-U.S. 

    49,578     53,552     10,005     10,777     39,573     42,775  
                           

Total public finance obligations

  $ 527,662   $ 536,515   $ 58,215   $ 70,662   $ 469,447   $ 465,853  
                           

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

4. 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
  June 30,
2010
  December 31,
2009
  June 30,
2010
  December 31,
2009
  June 30,
2010
  December 31,
2009
 
 
  (in millions)
 

U.S.:

                                     
 

Pooled corporate obligations

  $ 76,840   $ 82,622   $ 7,997   $ 8,289   $ 68,843   $ 74,333  
 

RMBS and home equity

    28,720     31,033     1,708     1,857     27,012     29,176  
 

Financial products(1)

    8,394     10,251             8,394     10,251  
 

CMBS

    7,347     7,463     53     53     7,294     7,410  
 

Consumer receivables

    7,410     9,314     356     441     7,054     8,873  
 

Structured credit

    2,602     2,738     126     131     2,476     2,607  
 

Commercial receivables

    2,364     2,485     3     3     2,361     2,482  
 

Insurance securitizations

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

Other structured finance—U.S. 

    2,056     2,754     1,186     1,236     870     1,518  
                           
   

Total structured finance—U.S. 

    137,464     150,391     11,509     12,090     125,955     138,301  

Non-U.S.:

                                     
 

Pooled corporate obligations

    24,687     27,743     2,770     3,046     21,917     24,697  
 

RMBS and home equity

    4,824     5,623     359     396     4,465     5,227  
 

Structured credit

    1,951     2,285     142     216     1,809     2,069  
 

Commercial receivables

    1,742     1,908     36     36     1,706     1,872  
 

Insurance securitizations

    994     995     15     14     979     981  
 

CMBS

    674     752             674     752  
 

Other structured finance—non-U.S. 

    644     717     82     47     562     670  
                           
   

Total structured finance—non-U.S. 

    35,516     40,023     3,404     3,755     32,112     36,268  
                           

Total structured finance obligations

  $ 172,980   $ 190,414   $ 14,913   $ 15,845   $ 158,067   $ 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)

June 30, 2010

4. Outstanding Exposure (Continued)

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

 
  June 30, 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

  $ 30,593     4.9 % $ 43,353     6.8 %

AAA

    70,755     11.3     59,786     9.3  

AA

    187,846     29.9     196,859     30.7  

A

    235,446     37.5     233,200     36.4  

BBB

    77,399     12.3     82,059     12.8  

Below investment grade ("BIG") (See Note 5)(2)

    25,475     4.1     25,165     4.0  
                   
 

Total exposures

  $ 627,514     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; however, the ratings in the above table may not be the same as ratings assigned by any nationally recognized rating agency. 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 on its internal rating scale 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 incur 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.

(2)
Includes $747.3 million in gross par as of June 30, 2010 which the Company obtained for risk mitigation purposes.

        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 non-payment 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 June 30, 2010 and December 31, 2009 and included in the Company's financial guaranty exposure in the tables above was $112.2 billion and $119.0 billion, respectively. See Note 7.

        In addition to amounts shown in the tables above, the Company had outstanding commitments to provide guaranties of $6.0 billion for structured finance and $2.2 billion for public finance commitments at June 30, 2010. The structured finance commitments include the unfunded component of and delayed draws on pooled corporate transactions. Public finance commitments are typically short term and relate to primary and secondary public finance debt issuances. The commitments are contingent on the satisfaction of all conditions set forth in the them and may expire unused or be cancelled at the

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Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

4. Outstanding Exposure (Continued)


counterparty's request. Therefore the total commitment amount does not necessarily reflect actual future guaranteed amounts.

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

        In Second Quarter 2010, the Company filed lawsuits against two sponsors of U.S. RMBS transactions insured by the Company, alleging breaches of representations and warranties both in respect of the underlying loans in the transactions and the accuracy of the information provided to the Company, and failure to cure or repurchase defective loans identified by the Company to such sponsors.

        The Company segregates its insured portfolio into IG and BIG 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.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

5. Significant Risk Management Activities (Continued)

Below Investment Grade Surveillance Categories

        Within the BIG category, the Company assigns each credit to one of three surveillance categories. Intense monitoring and intervention is employed for all BIG categories, with internal credit ratings reviewed quarterly:


Financial Guaranty Exposures
(Insurance and Credit Derivative Form)

 
  June 30, 2010  
 
  BIG Net Par Outstanding    
 
 
  Total Net Par
Outstanding
 
 
  BIG 1   BIG 2   BIG 3   Total BIG  
 
  (in millions)
 

First Lien U.S. RMBS:

                               
 

Prime First Lien

  $ 28   $ 656   $   $ 684   $ 920  
 

Alt-A First Lien

    622     4,059     224     4,905     6,517  
 

Alt-A Options ARM

    551     2,069     545     3,165     3,579  
 

Subprime (including net interest margin ("NIMs")

    28     2,941     98     3,067     9,485  

Second Lien U.S. RMBS:

                               
 

Closed end second lien ("CES")

    114     519     545     1,178     1,218  
 

Home equity lines of credit ("HELOC")

    636     24     3,626     4,286     5,293  
                       
   

Total U.S. RMBS

    1,979     10,268     5,038     17,285     27,012  

Other structured finance

    1,229     980     2,246     4,455     131,055  

Public finance

    2,234     901     600     3,735     469,447  
                       
     

Total

  $ 5,442   $ 12,149   $ 7,884   $ 25,475   $ 627,514  
                       

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

5. Significant Risk Management Activities (Continued)

 

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

First Lien U.S. RMBS:

                               
 

Prime First Lien

  $ 564   $ 51   $   $ 615   $ 985  
 

Alt-A First Lien

    752     3,698     173     4,623     7,108  
 

Alt-A Options ARM

    629     2,811         3,440     3,882  
 

Subprime (including NIMs)

    985     1,648     55     2,688     9,956  

Second Lien U.S. RMBS:

                               
 

CES

    123     628     509     1,260     1,305  
 

HELOCs

    13     113     4,372     4,498     5,940  
                       
   

Total U.S. RMBS

    3,066     8,949     5,109     17,124     29,176  

Other structured finance

    1,211     967     2,093     4,271     145,393  

Public finance

    2,361     723     687     3,771     465,853  
                       
     

Total

  $ 6,638   $ 10,639   $ 7,889   $ 25,166   $ 640,422  
                       

6. Financial Guaranty Contracts Accounted for as Insurance

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


Expected Collections of Gross Premiums Receivable,
Net of Ceding Commissions Payable

 
  June 30, 2010(1)  
 
  (in thousands)
 

2010 (July 1 - September 30)

  $ 73,957  

2010 (October 1 - December 31)

    75,659  

2011

    135,614  

2012

    119,603  

2013

    108,322  

2014

    96,565  

2015 - 2019

    398,876  

2020 - 2024

    288,809  

2025 - 2029

    210,344  

After 2029

    251,474  
       
 

Total expected collections

  $ 1,759,223  
       

(1)
Represents nominal amounts expected to be collected.

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Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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

        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 Payable Roll Forward

 
  (in thousands)  

Premium receivable, net at December 31, 2009

  $ 1,418,222  
 

Cumulative effect of change in accounting principle

    (19,087 )
       
 

Premium receivable, net at January 1, 2010

    1,399,135  
 

Premium written, net

    178,734  
 

Premium payments received, net

    (234,271 )
 

Adjustments to the premium receivable:

       
   

Changes in the expected term of financial guaranty insurance contracts

    8,160  
   

Accretion of the premium receivable discount

    23,689  
   

Foreign exchange rate changes

    (65,886 )
   

Other adjustments

    1,693  
       

Premium receivable, net at June 30, 2010

  $ 1,311,254  
       

        The $65.9 million loss due to foreign exchange rate changes relates to installment premium receivable denominated in currencies other than the U.S. dollar. Approximately 40% of the Company's installment premiums at June 30, 2010 are denominated in currencies other than the U.S. dollar, primarily in Euros and British Pound Sterling ("GBP"). Premium receivable is revalued to the spot rate at the end of each reporting period with the change reflected in either (1) other income in the consolidated statements of operations for premium receivable recorded by subsidiaries using the U.S. dollar as its functional currency or (2) other comprehensive income ("OCI") as a cumulative translation adjustment for premium receivables recorded by subsidiaries using a functional currency other than the U.S. dollar.


Selected Information for Policies Paid in Installments

 
  June 30, 2010  
 
  (dollars in thousands)
 

Premiums receivable, net of ceding commission payable

  $ 1,311,254  

Deferred premium revenue

    3,583,915  

Weighted-average risk-free rate used to discount premiums

    3.4  

Weighted-average period of premiums receivable (in years)

    10.3  

18


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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

        The following table presents the components of net premiums earned.


Net Earned Premiums(1)

 
  Second Quarter   Six Months  
 
  2010   2009   2010   2009  
 
  (in thousands)
 

Scheduled net earned premiums

  $ 267,359   $ 52,156   $ 558,326   $ 104,247  

Acceleration of premium earnings(2)

    15,446     20,049     30,770     110,336  

Accretion of discount on premium receivable

    8,667     5,539     21,276     10,897  
                   
 

Total net earned premiums

  $ 291,472   $ 77,744   $ 610,372   $ 225,480  
                   

(1)
Excludes $0.6 million and $0.8 million in net earned premium related to the Other segment for the Second Quarter 2010 and 2009, respectively, and $1.3 million and $1.6 million for the Six Months 2010 and 2009, respectively.

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

        The unearned premium reserve is comprised of deferred premium revenue net of claim payments that are not expected to be recovered and have not yet been recorded through the consolidated statements of operations. Paid losses are expensed when total expected loss (i.e. claim payments plus future expected loss) exceed deferred premium revenue.

 
  As of June 30, 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

  $ 7,855,351   $ 954,682   $ 6,900,669   $ 8,536,682   $ 1,095,593   $ 7,441,089  

Claim payments

    (205,479 )   (25,207 )   (180,272 )   (149,223 )   (15,127 )   (134,096 )
                           
 

Total

  $ 7,649,872   $ 929,475   $ 6,720,397   $ 8,387,459   $ 1,080,466   $ 7,306,993  
                           

(1)
Excludes $11.4 million and $12.7 million in unearned premium reserve related to the Other segment as of June 30, 2010 and December 31, 2009, respectively.

19


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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

        The following table provides a schedule of how the Company's financial guaranty insurance net deferred premium revenue and PV of expected losses are expected to run off in the consolidated statement of operations, pre-tax. This table excludes amounts related to consolidated VIEs.


Expected Financial Guaranty Scheduled Net Earned Premiums and
Net Loss to be Expensed

 
  As of June 30, 2010  
 
  Scheduled
Net Earned
Premium
  Expected
Loss and
LAE(1)
  Net  
 
  (in thousands)
 

2010 (July 1 - September 30)

  $ 254,846   $ 82,264   $ 172,582  

2010 (October 1 - December 31)

    239,693     74,769     164,924  

2011

    762,231     186,283     575,948  

2012

    604,798     115,426     489,372  

2013

    522,378     92,925     429,453  

2014

    501,190     88,647     412,543  

2015 - 2019

    1,678,091     257,632     1,420,459  

2020 - 2024

    1,025,097     117,252     907,845  

2025 - 2029

    630,973     65,522     565,451  

After 2029

    681,372     64,580     616,792  
               
 

Total present value basis(2)(3)

  $ 6,900,669   $ 1,145,300     5,755,369  

Discount

    411,222     632,837     (221,615 )
               
 

Total future value

  $ 7,311,891   $ 1,778,137   $ 5,533,754  
               

(1)
These amounts reflect the Company's estimate as of June 30, 2010 of expected losses to be expensed and 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.

(2)
Balances represent discounted amounts.

(3)
The effect of consolidating VIEs resulted in a reduction of $174.7 million in future scheduled net earned premium and $90.6 million to expected loss and LAE.

20


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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

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


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

 
  Expected
Loss to be
Paid as of
January 1, 2010
  Loss
Development
and Accretion of
Discount
  Less:
Paid
Losses
  Expected
Loss to be
Paid as of
June 30, 2010
 
 
  (in thousands)
 

U.S. RMBS:

                         
 

First Lien:

                         
   

Prime First lien

  $   $ 394   $ 9   $ 385  
   

Alt-A First lien

    204,368     15,443     28,971     190,840  
   

Alt-A Options ARM

    545,238     75,003     49,068     571,173  
   

Subprime

    77,528     69,331     2,294     144,565  
                   
     

Total First Lien

    827,134     160,171     80,342     906,963  
 

Second Lien:

                         
   

CES

    199,254     (40,438 )   39,881     118,935  
   

HELOCs

    (232,913 )   55,069     315,844     (493,688 )
                   
     

Total Second Lien

    (33,659 )   14,631     355,725     (374,753 )
                   

Total U.S. RMBS

    793,475     174,802     436,067     532,210  

Other structured finance

    102,613     35,566     5,593     132,586  

Public Finance

    130,858     (8,155 )   34,191     88,512  
                   
     

Subtotal(1)

    1,026,946     202,213     475,851     753,308  

Effect of consolidating VIEs

    (40,045 )   (21,437 )   (58,851 )   (2,631 )
                   
     

Total

  $ 986,901   $ 180,776   $ 417,000   $ 750,677  
                   

(1)
Excludes $3.5 million and $5.2 million of expected losses related to the Other segment recorded in loss reserves on the consolidated balance sheet as of June 30, 2010 and December 31, 2009, respectively.

        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 "net expected PV losses to be expensed" due primarily to amounts paid that have not yet been expensed and amounts expensed not yet paid.

        Loss expense is recognized in the consolidated statements of operations when the sum of claim payments not yet expensed, plus the present value of future expected losses exceeds deferred premium revenue.

21


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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

        The Company's estimate 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.

        The following table provides information on financial guaranty insurance and reinsurance contracts categorized as BIG as of June 30, 2010 and December 31, 2009:


Financial Guaranty Insurance BIG Transaction Loss Summary
June 30, 2010

 
  BIG Categories  
 
  BIG 1   BIG 2   BIG 3   Total
BIG
  Effect
of
Consolidating
VIEs(2)
  Total  
 
  (dollars in millions)
 

Number of risks

    69     165     87     321         321  

Remaining weighted-average contract period (in years)

    9.12     9.16     9.61     9.31         9.31  

Gross insured contractual payments outstanding:

                                     
 

Principal

  $ 4,306.2   $ 7,810.6   $ 7,101.0   $ 19,217.8   $   $ 19,217.8  
 

Interest

    1,581.6     3,609.6     2,058.5     7,249.7         7,249.7  
                           
   

Total

  $ 5,887.8   $ 11,420.2   $ 9,159.5   $ 26,467.5   $   $ 26,467.5  
                           

Gross expected cash outflows for loss and LAE

  $ 475.8   $ 2,054.9   $ 2,246.0   $ 4,776.7   $ (170.4 ) $ 4,606.3  

Less:

                                     
 

Gross potential recoveries(1)

    492.4     584.5     2,305.3     3,382.2     (174.9 )   3,207.3  
 

Discount

    19.3     476.7     122.5     618.5     13.5     632.0  
                           

Present value of expected cash flows for loss and LAE

  $ (35.9 ) $ 993.7   $ (181.8 ) $ 776.0   $ (9.0 ) $ 767.0  
                           

Deferred premium revenue

  $ 97.1   $ 974.5   $ 978.6   $ 2,050.2   $ (161.4 ) $ 1,888.8  

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

  $ (39.9 ) $ 276.9   $ (545.8 ) $ (308.8 ) $ 22.8   $ (286.0 )

Reinsurance recoverable (payable)

  $ (10.4 ) $ 7.1   $ (62.6 ) $ (65.9 ) $   $ (65.9 )

(1)
Includes estimated future recoveries for breaches of representations and warranties as well as excess spread and draws on HELOCs.

22


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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

(2)
The Company does not eliminate principal and interest outstanding from its disclosures in order to reflect the full net par outstanding for all financial guaranty insurance contracts, regardless of the accounting model applied.


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   $ 2,569.8   $ 4,554.4  

Less:

                         
 

Gross potential recoveries(1)

    3.5     506.6     2,312.0     2,822.1  
 

Discount

   
18.3
   
419.8
   
161.4
   
599.5
 
                   

Present value of expected cash flows for loss and LAE

  $ 14.0   $ 1,022.4   $ 96.4   $ 1,132.8  
                   

Deferred premium revenue

  $ 49.3   $ 1,187.3   $ 1,274.2   $ 2,510.8  

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

  $ (0.1 ) $ 146.4   $ (282.3 ) $ (136.0 )

Reinsurance recoverable (payable)

  $   $ 4.6   $ (27.6 ) $ (23.0 )

(1)
Includes estimated future recoveries for breaches of representations and warranties as well as excess spread and draws on HELOCs.

        The Company used weighted-average risk free rates ranging from 0% to 4.81% and 0.07% to 5.21% to discount expected losses as of June 30, 2010 and December 31, 2009, respectively.

23


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

6. Financial Guaranty Contracts Accounted for as Insurance (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
June 30,
2010
  As of
December 31,
2009
 
 
  (in thousands)
 

U.S. RMBS:

             
 

First Lien:

             
   

Prime First lien

  $ 243   $  
   

Alt-A First lien

    31,618     25,463  
   

Alt-A Options ARM

    127,311     51,188  
   

Subprime

    60,881     21,816  
           
     

Total First Lien

    220,053     98,467  
 

Second Lien:

             
   

CES

    6,022     21,172  
   

HELOC

    15,068     18,204  
           
     

Total Second Lien

    21,090     39,376  
           

Total US RMBS

    241,143     137,843  

Other structured finance

    102,975     67,661  

Public Finance

    55,825     67,723  
           

Total financial guaranty

    399,943     273,227  

Other

    1,920     2,121  
           
   

Subtotal

    401,863     275,348  

Effect of consolidating VIEs

    (17,436 )    
           
   

Total

  $ 384,427   $ 275,348  
           

24


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

6. Financial Guaranty Contracts Accounted for as Insurance (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
June 30,
2010
  As of
December 31,
2009
 
 
  (in thousands)
 

U.S. RMBS:

             
 

First Lien:

             
   

Alt-A First Lien

  $ 1,378   $  
   

Alt-A Options ARM

    24,035      
   

Subprime

        76  
           
     

Total First Lien

    25,413     76  
 

Second Lien:

             
   

CES

    33,742     91  
   

HELOC

    650,317     416,651  
           
     

Total Second Lien

    684,059     416,742  
           

Total U.S. RMBS

    709,472     416,818  

Other structured finance

    824     995  

Public Finance

    15,968     2,425  
           

Total

    726,264     420,238  

Less: Ceded recoverable(1)

    83,489     42,100  
           
   

Net recoverable

    642,775     378,138  

Effect of consolidating VIEs

    (40,225 )    
           
   

Total net recoverable

  $ 602,550   $ 378,138  
           

(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)

June 30, 2010

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


Loss and Loss Adjustment Expenses (Recoveries)
By Type

 
  Second Quarter   Six Months  
 
  2010   2009   2010   2009  
 
  (in thousands)
 

Financial Guaranty:

                         
 

U.S. RMBS:

                         
   

First Lien:

                         
     

Prime First lien

  $ (32 ) $ (519 ) $ 30   $  
     

Alt-A First lien

    7,997     6,296     13,428     6,447  
     

Alt-A Options ARM

    56,595     8,237     101,029     8,163  
     

Subprime

    16,268     5,040     40,981     5,851  
                   
       

Total First Lien

    80,828     19,054     155,468     20,461  
   

Second Lien:

                         
     

CES

    (11,420 )   33,322     (7,075 )   35,320  
     

HELOC

    11,193     22,081     34,813     40,601  
                   
       

Total Second Lien

    (227 )   55,403     27,738     75,921  
                   
 

Total U.S. RMBS

    80,601     74,457     183,206     96,382  
 

Other structured finance

    31,661     (17,189 )   41,829     (12,367 )
 

Public Finance

    (16,756 )   306     10,935     22,013  
                   

Total Financial Guaranty

    95,506     57,574     235,970     106,028  

Other

        (19,544 )   18     11,756  
                   
   

Subtotal

    95,506     38,030     235,988     117,784  

Effect of consolidating VIEs

    (24,350 )       (34,331 )    
                   
   

Total loss and LAE

  $ 71,156   $ 38,030   $ 201,657   $ 117,784  
                   

26


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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


Net Losses Paid on Financial Guaranty Insurance and Reinsurance Contracts

 
  Second Quarter   Six Months  
 
  2010   2009   2010   2009  
 
  (in thousands)
 

U.S. RMBS:

                         
 

First Lien:

                         
   

Prime First lien

  $ 9   $   $ 9   $  
   

Alt-A First lien

    14,986         28,971      
   

Alt-A Options ARM

    32,655     4     49,068     4  
   

Subprime

    1,425     338     2,294     790  
                   
     

Total First Lien

    49,075     342     80,342     794  
 

Second Lien:

                         
   

CES

    19,406     23,967     39,881     34,232  
   

HELOC

    166,865     63,250     315,844     114,907  
                   
     

Total Second Lien

    186,271     87,217     355,725     149,139  
                   

Total US RMBS

    235,346     87,559     436,067     149,933  

Other structured finance

    1,878     27,384     5,593     21,379  

Public Finance

    9,736     10,572     34,191     18,090  
                   
     

Subtotal

    246,960     125,515     475,851     189,402  

Effect of consolidating VIEs

    (40,868 )       (58,851 )    
                   
     

Total

  $ 206,092   $ 125,515   $ 417,000   $ 189,402  
                   

Loss Reserving

        In accordance with the Company's standard practices, the Company evaluated the most current available information as part of its loss estimation 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. Most of the Company's expected loss and loss adjustment expense reserves and paid losses relate to U.S. RMBS. As has been widely reported in the press, unprecedented levels of delinquencies and defaults have negatively impacted the mortgage market, especially U.S. RMBS issued in the period from 2005 through 2007. Based on information observed during the quarter (particularly early stage delinquencies), the Company determined that it may be witnessing the beginning of an improvement in the housing and mortgage markets. The Company also formed a view that any improvement in the second lien loan markets may be more gradual than it had assumed in its prior projection scenarios for second liens. As a result, the Company adjusted from prior quarters the assumptions and probability weightings of its loss projection scenarios to reflect those views. These changes were made with respect to how scenarios were run in the first quarter of 2010. The scenarios used in the first quarter of 2010, with the exception of an adjustment to the subprime severity, were the same as those employed at year-end 2009.

27


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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

U.S. Second Lien RMBS: HELOCs and CES

        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, a subsidiary of Bank of America.

        The performance of the Company's HELOC and CES exposures began to deteriorate in 2007, and transactions, particularly those originated in the period from 2005 through 2007, continue to perform below the Company's original underwriting expectations. While insured securities benefitted from structural protections within the transactions designed to absorb collateral losses in excess of previous historical high levels, in many second lien RMBS projected losses now exceed those structural protections.

        The Company believes the primary variables impacting its expected losses in second lien RMBS transactions are the amount and timing of future losses in the collateral pool supporting the transaction and the amount of loans repurchased for breaches of representations and warranties. Expected losses are also a function of the structure of the transaction, the voluntary prepayment rate, typically also referred as conditional prepayment rate ("CPR") of the collateral, the interest rate environment assumptions about the draw rate and loss severity. These variables are: interrelated, difficult to predict and subject to considerable volatility. If actual experience differs from 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.

28


Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

6. Financial Guaranty Contracts Accounted for as Insurance (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 June 30, 2010, March 31, 2010 and December 31, 2009:


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

HELOC Key Variables
  June 30,
2010
  March 31,
2010
  December 31,
2009

Plateau conditional default rate ("CDR")

  8.3 - 27.5%   11.5 - 38.0%   10.7 - 40.0%

Final CDR trended down to

  0.5 - 3.2%   0.5 - 3.2%   0.5 - 3.2%

Expected Period until Final CDR

  24 months   21 months   21 months

Initial CPR

  0.9 - 20.1%   0.4 - 13.4%   1.9 - 14.9%

Final CPR

  10%   10%   10%

Loss Severity

  95%   95%   95%

Future Repurchase of Ineligible Loans

  $875 million   $849 million   $828 million

Initial Draw Rate

  0.2 - 6.9%   0.2 - 4.8%   0.1 - 2.0%

 

CES Key Variables
  June 30,
2010
  March 31,
2010
  December 31,
2009

Plateau CDR

  8.0 - 28.0%   7.4 - 32.7%   21.5 - 44.2%

Final CDR Rate trended down to

  2.9 - 8.1%   2.9 - 8.1%   3.3 - 8.1%

Expected Period until Final CDR achieved

  24 months   21 months   21 months

Initial CPR

  0.8 - 10.1%   1.6 - 8.4%   0.8 - 3.6%

Final CPR

  10%   10%   10%

Loss Severity

  95%   95%   95%

Future Repurchase of Ineligible Loans

  $123 million   $137 million   $77 million

(1)
Represents assumptions for most heavily weighted scenario (the "base case").

        For second lien transactions the Company calculates expected losses in the following fashion. A loan is generally "charged off" by the securitization's servicer once the loan is 180 days past due and therefore the Company's projections assume that a loss is charged off once it is 180 days past due. Most second lien transactions report the amount of loans in five monthly delinquency categories (i.e., 30-59 days past due, 60-89 days past due, 90-119 days past due, 120-149 days past due and 150-179 days past due). The Company estimates the amount of loans that will default over the next five months by calculating current representative liquidation rates (the percent of loans in a given delinquency status that are assumed to ultimately default) from selected transactions and then applying those liquidation rates to the amount of loans in the delinquency categories. The amount of loans projected to default in the third, fourth and fifth month are then expressed as conditional default rates ("CDR"), and the average of those CDRs is then used as the basis for calculating defaults after the fifth month. In the base scenario, this CDR (the "plateau CDR") is held constant for one month. Last quarter, the base scenario's plateau was 4 months, the change this quarter reflects an improvement in the mortgage and real estate markets. Once the plateau period has ended, the CDR is assumed to gradually trend down in uniform increments to its final long-term steady state CDR. In the base scenario, the time over which the CDR trends down to its final CDR is eighteen months. Last quarter,

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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


the base scenario's ramp was 12 months, the change this quarter was implemented to reflect that the recovery may take longer than the Company had previously anticipated. Therefore, in the base case scenario, the total time from the current period to the end of the ramp (when the long-term steady CDR is reached) is 24 months. The long-term steady state CDRs are calculated as the constant conditional default rates that would have yielded the amount of losses originally expected at underwriting.

        Breaches of Representations and Warranties—Second Lien U.S. RMBS:    As mentioned above, performance of the collateral underlying certain securitizations has substantially differed from the Company's original expectations. The Company has employed several loan file diligence firms and law firms as well as devoting internal resources to review the mortgage files surrounding many of the defaulted loans. As of June 30, 2010 the Company had performed a detailed review of approximately 24,800 files, representing nearly $1.9 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 non- compliance with underwriting guidelines at loan origination. The Company continues to review new files as new loans default and as new loan files are made available to it. As of June 30, 2010 following negotiation with the sellers and originators of the breaching loans, the Company had reached agreement to have $227 million of the second lien loans repurchased and has included in its net expected loss estimates for second liens as of June 30, 2010 an estimated benefit from repurchases of $998.0 million of second lien loans, of which $875.0 million relates to HELOCs and the remainder to CES. 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 rate at which the principal amount of loan is prepaid may impact both the amount of losses projected (which is a function of the CDR and the loan balance over time) as well as the amount of excess spread (which is the excess of the interest paid by the borrowers on the underlying loan over the amount of interest and expenses owed on the insured obligations). In the base case, the current CPR is assumed to continue until the end of the plateau before gradually increasing to the final CPR over the same period the CDR decreases. The final CPR 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. This pattern is consistent with how the Company modeled the CPR in both the first quarter and year-end.

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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

        The Company uses a number of other variables in its second lien loss projections, including the spread between relevant interest rate indices, loss severities (assumed to be 95%) and HELOC draw rates (the amount of new advances provided on existing HELOCs expressed as a percent of current outstanding advances). 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 range from 0.1% to 3.5%.

        In estimating expected losses, the Company modeled and probability weighted three possible CDR curves applicable to the period preceding the return to the long-term steady state CDR. Given that draw rates 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 the assumptions affecting its modeling results.

        In the most recent prior quarters, the Company's base case assumed a 4 month CDR plateau and a 12 month CDR assumed the date of commencement ramp down. Reflecting the Company's belief that the primary variable relating to the Company's assumption was when an improvement in the mortgage markets would begin, in recent prior quarters it also modeled a 1 month CDR plateau and a 7 month CDR plateau. Consistent with the Company's current belief that an improvement in the mortgage market may be beginning but that any recovery may be more gradual that had previously been anticipated, this quarter's base case assumed a 1 month plateau and an 18 month ramp down. Increasing the CDR plateau to 4 months and keeping the ramp down at 18 months would increase the expected loss by approximately $106.0 million for HELOC transactions and $10.1 million for CES transactions. On the other hand, keeping the CDR plateau at 1 month but decreasing the length of the CDR ramp down back to last quarter's 12 month assumption would decrease the expected loss from those taken by approximately $110.5 million for HELOC transactions and $10.0 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 ARM." Finally, transactions may be primarily composed of loans made to prime borrowers.

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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

        The performance of the Company's first lien RMBS exposures began to deteriorate in 2007 and transactions, particularly those originated in the period from 2005 through 2007 and continue to perform below the Company's original underwriting expectations. The Company currently projects first lien collateral losses many times those expected at the time of underwriting. While insured securities benefitted from structural protections within the transaction designed to absorb some of the collateral losses, in many first lien RMBS projected losses exceed those structural protections.

        The majority of projected losses in first lien RMBS transactions are expected to come from mortgage loans that are delinquent or in foreclosure, an increase in delinquent and foreclosed loans beyond those delinquent and foreclosed last quarter is one of the primary drivers of loss development in this portfolio. In order to determine the number of defaults resulting from these delinquent and foreclosed loans, the Company applies a liquidation rate assumption to loans in each of various delinquency categories. The following table shows the Company's liquidation assumptions for various delinquency categories as of June 30 and March 31, 2010. The liquidation rate is a standard industry 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.

 
  June 30,
2010
  March 31,
2010
 

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  

        Losses are also projected on first lien RMBS that are presently current loans. The Company projects these losses by applying a CDR trend. The start of that CDR trend is based on the defaults the Company projected would emerge from currently delinquent and foreclosed loans. The total amount of expected defaults from these loans is then translated into a constant CDR (i.e., the CDR plateau), which, if applied for each of the next 24 months, would be sufficient to produce

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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


approximately the amount of losses that were calculated to emerge from the various delinquency categories. In the base case, each transaction's CDR is projected to improve over 12 months to an intermediate CDR (calculated as 15% of its CDR plateau); that intermediate CDR is held constant for 36 months then trails off in steps to a final CDR of 5% of the CDR plateau. In the First Quarter 2010, the CDR plateau was held constant for 3 months before it was assumed to begin improving, which reflects the Company's view that an improvement in the real estate and mortgage market may be beginning. Under the Company's methodology, defaults projected to occur in the first 24 months represent defaults that can be attributed to loans that are currently delinquent or in foreclosure, while the defaults projected to occur using the projected CDR trend after the first 24 month period represent defaults attributable to borrowers that are currently performing.

        Another important driver of loss projections is loss severity, 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 is assuming that these historical highs continue for another year. The Company determines its initial loss severity based on actual recent experience. The Company then assumes that loss severities begin returning to levels consistent with underwriting assumptions beginning in June 2011, and in the base scenario decline over two years to 40%.

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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

        The following table shows the Company's key assumptions used in its calculation of expected losses for these types of policies as of June 30, 2010, March 31, 2010 and December 31, 2009:


Key Assumptions in Base Case Expected Loss Estimates of First Lien RMBS Transactions

 
  June 30,
2010
  March 31,
2010
  December 31,
2009

Alt A First Lien

           
 

Plateau CDR

  2.2% - 40.6%   2.0% - 34.4%   1.5% - 35.7%
 

Intermediate CDR

  0.3% - 6.1%   0.3% - 5.2%   0.2% - 5.4%
 

Final CDR

  0.1% - 2.0%   0.1% - 1.7%   0.1% - 1.8%
 

Initial Loss Severity

  60%   60%   60%
 

Future Repurchases of Ineligible Loans

  $79.2 million   $75.8 million   $64.2 million
 

Initial CPR

  0.0% - 16.2%   0.0% - 27.9%   0.0% - 20.5%
 

Final CPR

  10%   10%   10%

Alt A Option ARM

           
 

Plateau CDR

  12.5% - 29.9%   15.1% - 27.4%   13.5% - 27.0%
 

Intermediate CDR

  1.9% - 4.5%   2.3% - 4.1%   2.0% - 4.1%
 

Final CDR

  0.6% - 1.5%   0.8% - 1.4%   0.7% - 1.4%
 

Initial Loss Severity

  60%   60%   60%
 

Future Repurchases of Ineligible Loans

  $242.8 million   $236.0 million   $203.7 million
 

Initial CPR

  0.0% - 9.3%   0.0% - 12.3%   0.0% - 3.5%
 

Final CPR

  10%   10%   10%

Subprime

           
 

Plateau CDR

  8.4% - 34.4%   7.8% - 30.4%   7.1% - 29.5%
 

Intermediate CDR

  1.3% - 5.2%   1.2% - 4.6%   1.1% - 4.4%
 

Final CDR

  0.4% - 1.7%   0.4% - 1.5%   0.4% - 1.5%
 

Initial Loss Severity

  75%   75%   70%
 

Future Repurchases of Ineligible Loans

  $0   $0   $0
 

Initial CPR

  0.0% - 12.0%   0.0% - 12.5%   0.0% - 12.0%
 

Final CPR

  10%   10%   10%

        The rate at which the principal amount of loan is prepaid may impact both the amount of losses projected (since that amount is a function of the CDR and the loan balance over time) as well as the amount of excess spread (the amount by which the interest paid by the borrowers on the underlying loan exceeds the amount of interest owed on the insured obligations). 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 plateau 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.

        Breaches of Representations and Warranties—First Lien U.S. RMBS:    As mentioned above, performance of the collateral underlying certain securitizations has substantially differed from the Company's original expectations. The Company has employed several loan file diligence firms and law firms as well as devoting internal resources to review the mortgage files surrounding many of the defaulted loans. As of June 30, 2010 the Company had performed a detailed review of approximately

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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


5,200 files representing nearly $2.3 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 June 30, 2010, the Company had reached agreement to have $50.5 million of first lien loans repurchased. The Company has included in its net expected loss estimates for first liens as of June 30, 2010 an estimated benefit from repurchases of $322.8 million, of which $242.8 million relates to Option ARMs, $79.2 million to Alt A first liens and $0.8 million to prime transactions. The amount the Company will ultimately recover 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 recoveries. 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 in 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 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.

        In establishing its reserves, the Company modeled and probability weighted sensitivities for first lien transactions by varying its assumptions of how fast an economic recovery is expected to occur. The primary variable when modeling sensitivities was how quickly the CDR returned to its modeled equilibrium, which was defined as 5% of the current CDR. The Company also stressed CPRs and the speed of recovery of loss severity rates. In a somewhat more stressful environment than that of the base case, where the CDR recovery was more gradual and the final CPR was 15% rather than 10%, the Company's expected losses would increase by approximately $11.3 million for Alt A first liens, $89.9 million for Option ARMs, $16.3 million for subprime and $0.1 million for prime transactions. In an even more stressful scenario where the CDR plateau was extended 3 months (so was 27 months long) before the same more gradual CDR recovery and loss severities were assumed to recover over 4 rather than 2 years (and subprime loss severities were assumed to recover only to 55%), the Company's expected losses would increase by approximately $39.5 million for Alt A first liens, $196.7 million for Option ARMs, $106.3 million for subprime and $0.6 million for prime transactions. The Company also considered a scenario where the recovery was faster than in its base case. In this scenario, where the CDR plateau was 3 months shorter (21 months, effectively assuming that liquidation rates would

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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


improve) and the CDR recovery was more pronounced, the Company's expected losses would decrease by approximately $21.4 million for Alt A first liens, $83.0 million for Option ARMs, $29.5 million for subprime and $0.3 million for prime 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. In particular, such credit losses in the investment portfolio could be realized in the event that circumstances arise resulting in the early liquidation of assets at a time when their market value is less than their intrinsic value.

        The Company's $2.1 billion in net par of XXX Life Insurance transactions include $882.5 million rated BIG by the Company as of June 30, 2010, and corresponded to three transactions. These two of the three XXX transactions had material amounts of their assets invested in US RMBS transactions. 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 June 30, 2010, the Company's gross expected loss, prior to reinsurance or netting of unearned premium, for its two BIG XXX insurance transactions was $63.3 million and its net reserve was $51.1 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. Oral argument on the Company's appeal was heard before the Appellate Division on May 26, 2010.

Public Finance Transactions

        Within the public finance category, $3.5 billion was rated BIG, with the largest BIG exposure being a public finance transaction for sewer service in Jefferson County, Alabama. The Company's total exposure to this transaction is approximately $512 million of net par. 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. In addition, during the Second Quarter 2010, the Company sued JPMorgan Chase Bank, N.A. and JPMorgan Securities, Inc. (together, "JPMorgan"), the underwriter of debt issued by Jefferson County, in New York Supreme Court alleging that JPMorgan induced the Company to issue its insurance policies in respect of such debt through material and fraudulent misrepresentation and omissions, including concealing that it had secured its

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

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


position as underwriter and swap provider through bribes to Jefferson County commissioners and others.

Other Sectors and Transactions

        The Company continues to closely monitor other sectors and individual financial guaranty insurance transactions it feels warrant the additional attention, including, as of June 30, 2010, its commercial mortgage exposure of $912.5 million of net par, its trust preferred securities ("TruPS") collateralized debt obligations ("CDOs") exposure of $1.1 billion, its student loan exposure of $4.1 billion net par and its U.S. health care exposure of $21.9 billion of net par.

7. 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 as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value with changes in fair value recorded in the consolidated statements of operations. 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 are similar to those 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 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 June 30, 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 $5.9 billion and $6.0 billion par insured, respectively. As of the date of this filing, none of AG Re,

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Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

7. Credit Derivatives (Continued)


AGRO or AGM had any 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 June 30, 2010, without giving effect to thresholds that apply under current ratings, the amount of par that is subject to collateral posting is approximately $18.9 billion. Counterparties have agreed that for approximately $17.6 billion of that $18.9 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 Standard & Poor's Rating Services ("S&P") or A3 by Moody's Investors Service, Inc. ("Moody's"), that maximum amount would be $485 million. As of June 30, 2010, the Company had posted approximately $637.7 million of collateral in respect of approximately $18.8 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, contractual claims paid and payable and received and receivable related to insured credit events under these 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 Second Quarter 2010 and 2009 and Six Months 2010 and 2009:


Realized Gains and Other Settlements on Credit Derivatives

 
  Second Quarter   Six Months  
 
  2010   2009   2010   2009  
 
  (in thousands)
 

Net credit derivative premiums received and receivable

  $ 50,679   $ 27,953   $ 104,372   $ 57,468  

Net Ceding commissions (paid and payable) received and receivable

    1,044     (152 )   2,049     (30 )
                   
 

Realized gains on credit derivatives

    51,723     27,801     106,421     57,438  

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

    (13,370 )   15     (41,365 )   (9,043 )
                   
 

Total realized gains and other settlements on credit derivatives

  $ 38,353   $ 27,816   $ 65,056   $ 48,395  
                   

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

7. Credit Derivatives (Continued)

        Net unrealized gains (losses) on credit derivatives represent the adjustments for changes in fair value in excess of realized gains and other settlements that are recorded in each reporting period. Changes in unrealized gains and losses on credit derivatives are reflected in the consolidated statements of operations. Fair value of credit derivatives is reflected as either net assets or net liabilities determined on a contract by contract basis 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, 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. 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.

        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. The Company determines its own credit risk based on quoted CDS prices traded on the Company at each balance sheet date. 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 the Company's Credit Spread on Credit Derivatives Fair Value

 
  As of June 30,
2010
  As of
December 31,
2009
 
 
  (dollars in millions)
 

Quoted price of CDS contract (in basis points):

             
 

AGC

    1,010     634  
 

AGM

    802     541  

Fair value of CDS contracts:

             
 

Before considering implication of the Company's credit spreads

  $ (5,636.3 ) $ (5,830.8 )
 

After considering implication of the Company's credit spreads

  $ (1,274.9 ) $ (1,542.1 )

39


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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

7. Credit Derivatives (Continued)

        As of June 30, 2010, AGC's and AGM's credit spreads remained relatively wide compared to pre-2007 levels, as did general market spreads. The $5.6 billion liability as of June 30, 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 June 30, 2010 compared to December 31, 2009, there was tightening of general market spreads as well as a run-off in net par outstanding and the effect of extending estimated remaining lives, resulting in a gain of approximately $194.5 million before taking into account AGC or AGM's credit spreads.

        Management believes that the trading level 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 volume as well as the overall lack of liquidity in the CDS market. Offsetting the benefit attributable to 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. 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 CMBS.

        The estimated remaining weighted average life of credit derivatives was 5.6 years at June 30, 2010 and 6.0 years at December 31, 2009.

40


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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

7. Credit Derivatives (Continued)

        The components of the Company's net par outstanding as of June 30, 2010 and December 31, 2009 are:


Net Par Outstanding on Credit Derivatives

 
  As of June 30, 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

    31.7 %   28.9 % $ 46,761     AAA     31.1 %   27.4 % $ 49,447     AAA  
   

Synthetic investment grade pooled corporate

    18.2     16.4     12,673     AAA     19.2     17.7     14,652     AAA  
   

Synthetic high yield pooled corporate

    38.0     33.1     8,439     AA+     36.7     34.4     11,040     AAA  
   

TruPS CDOs

    46.8     34.1     5,793     BB+     46.6     37.3     6,041     BBB-  
   

Market value CDOs of corporate obligations

    32.2     44.4     5,566     AAA     32.1     36.9     5,401     AAA  
                                   
 

Total pooled corporate obligations

    31.4     28.9     79,232     AAA     30.9     27.9     86,581     AAA  
 

U.S. RMBS:

                                                 
   

Alt-A Option ARMs and Alt-A First Lien

    20.1     19.7     5,076     B+     20.3     22.0     5,662     BB  
   

Subprime First lien (including NIMs)

    27.5     57.6     4,733     A+     27.6     52.4     4,970     A+  
   

Prime first lien

    10.9     10.4     524     B     10.9     11.1     560     BB  
   

CES and HELOCs

        18.9     92     B         19.2     111     B  
                                       
 

Total U.S. RMBS

    22.8     36.1     10,425     BBB-     22.9     34.6     11,303     BBB  
 

CMBS

    28.7     29.2     7,055     AAA     28.5     30.9     7,191     AAA  
 

Other

            13,806     AA-             15,700     AA-  
                                               

Total Financial Guaranty Direct

                110,518     AA+                 120,775     AA+  

Financial Guaranty Reinsurance

                1,648     AA-                 1,642     AA-  
                                               

Total

              $ 112,166     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. The Company's rating scale is similar to that used by the nationally recognized rating agencies; however, the ratings in the above table may not be the same as ratings assigned by any nationally recognized rating agency.

41


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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

7. Credit Derivatives (Continued)

        The components of the Company's change in unrealized gains (losses) on credit derivatives are as follows:


Change in Unrealized Gains (Losess) on Credit Derivatives

 
  Second Quarter   Six Months  
Asset Type
  2010   2009   2010   2009  
 
  (in millions)
 

Financial Guaranty Direct:

                         
 

Pooled corporate obligations:

                         
   

CLOs/CBOs

  $ 1.8   $ 1.6   $ 3.3   $ (75.8 )
   

Synthetic investment grade pooled corporate

    3.6     1.3     (4.0 )   2.9  
   

Synthetic high yield pooled corporate

    (5.9 )       14.5      
   

TruPS CDOs

    35.5     (75.7 )   65.2     (0.4 )
   

Market value CDOs of corporate obligations

    (0.1 )   (0.3 )   0.3     (7.3 )
   

Commercial Real Estate

        0.1         (2.1 )
   

CDO of CDOs (corporate)

        0.6         (0.2 )
                   
 

Total pooled corporate obligations

    34.9     (72.4 )   79.3     (82.9 )
 

U.S. RMBS:

                         
   

Alt-A Option ARMs and Alt-A First Lien

    9.6     (201.8 )   160.5     (245.9 )
   

Subprime First lien (Including NIMs)

    0.3     0.7     0.9     3.7  
   

Prime first lien

    5.2     (21.7 )   19.4     (70.7 )
   

CES and HELOCs

    (14.3 )       (5.9 )    
                   
 

Total U.S. RMBS

    0.8     (222.8 )   174.9     (312.9 )
 

CMBS

    0.3     1.0     9.8     (30.2 )
 

Other(1)

    (0.8 )   44.2     23.4     186.8  
                   

Total Financial Guaranty Direct

    35.2     (250.0 )   287.4     (239.2 )

Financial Guaranty Reinsurance

    (0.1 )   (4.3 )   (0.2 )   11.9  
                   

Total

  $ 35.1   $ (254.3 ) $ 287.2   $ (227.3 )
                   

(1)
"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 and, except in the case of TruPS CDOs, 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 consists of CLOs or synthetic pooled corporate obligations. Most of these 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 level of losses in the underlying collateral, further insulating the Company from industry specific concentrations of credit risk on these deals.

42


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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

7. Credit Derivatives (Continued)

        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 CDOs 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 $3.9 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 $9.9 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.

        The unrealized gain for Six Months 2010 on "Other" CDS contracts is primarily attributable to implied spreads narrowing on several different transactions, none of which represent material amounts. The unrealized gain for Second Quarter and Six Months 2009 on "Other" CDS contracts is primarily attributable to implied spreads narrowing on several UK public finance infrastructure transactions and a film securitization transaction.

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

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

7. Credit Derivatives (Continued)

        The following tables present additional details about the Company's unrealized gain or loss on credit derivatives associated with U.S. RMBS by vintage for the Second Quarter 2010 and Six Months 2010:


U.S. Residential Mortgage-Backed Securities

Vintage
  Original
Subordination(1)
  Current
Subordination(1)
  Net Par
Outstanding
(in millions)
  Weighted
Average
Credit
Rating(2)
  Second Quarter
2010
Unrealized
Gain (Loss)
(in millions)
  Six Months
2010 Unrealized
Gain (Loss)
(in millions)
 

2004 and Prior

    6.1 %   19.4 % $ 178   A   $ (0.1 ) $ 0.3  

2005

    26.8     58.9     3,273   AA-     (0.1 )   1.7  

2006

    28.5     50.5     1,705   BBB     (4.3 )   1.1  

2007

    19.1     17.1     5,269   B     5.3     171.8  

2008

                       

2009

                       

2010

                       
                               
 

Total

    22.8 %   36.1 % $ 10,425   BBB-   $ 0.8   $ 174.9  
                               

(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. The Company's rating scale is similar to that used by the nationally recognized rating agencies; however, the ratings in the above table may not be the same as ratings assigned by any nationally recognized rating agency.

44


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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

7. Credit Derivatives (Continued)

        The following table presents additional details about the Company's unrealized gain or loss on credit derivatives associated with CMBS transactions by vintage for the Second Quarter 2010 and Six Months 2010:


Commercial Mortgage-Backed Securities

Vintage
  Original
Subordination(1)
  Current
Subordination(1)
  Net Par
Outstanding
(in millions)
  Weighted
Average
Credit
Rating(2)
  Second Quarter
2010
Unrealized
Gain (Loss)
(in millions)
  Six Months 2010
Unrealized
Gain (Loss)
(in millions)
 

2004 and Prior

    28.5 %   43.8 % $ 579   AAA   $   $ 0.3  

2005

    17.6     25.0     684   AAA     (0.1 )   0.3  

2006

    26.4     25.3     4,377   AAA     0.5     5.0  

2007

    41.1     37.5     1,415   AAA     (0.1 )   4.2  

2008

                       

2009

                       

2010

                       
                               
 

Total

    28.7 %   29.2 % $ 7,055   AAA   $ 0.3   $ 9.8  
                               

(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. The Company's rating scale is similar to that used by the nationally recognized rating agencies; however, the ratings in the above table may not be the same as ratings assigned by any nationally recognized rating agency.

45


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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

7. 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 June 30, 2010  
Credit Spreads(1)
  Estimated Net
Fair Value (Pre-Tax)
  Estimated Pre-Tax
Change in
Gain/(Loss)
 
 
  (in millions)
 

100% widening in spreads

  $ (3,099.1 ) $ (1,824.3 )

50% widening in spreads

    (2,264.1 )   (989.3 )

25% widening in spreads

    (1,737.9 )   (463.1 )

10% widening in spreads

    (1,462.9 )   (188.1 )

Base Scenario

    (1,274.9 )    

10% narrowing in spreads

    (1,151.9 )   122.9  

25% narrowing in spreads

    (988.6 )   286.2  

50% narrowing in spreads

    (662.4 )   612.4  

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

8. Consolidation of VIEs

        The Company has exposure to VIEs through the issuance of financial guaranty insurance contracts that typically ensure the timely payment of principal and interest to the holders of VIE debt. As part of the terms of its insurance contracts, at the outset of a contract the Company obtains certain protective rights over the control of a VIE based upon the occurrence of certain trigger events, such as deal performance or servicer or collateral manager financial health. At deal inception, the Company typically is not deemed to be have control of a VIE, however, once a trigger event occurs the Company's control of the VIE typically increases.

        Under accounting rules previously in effect, the Company determined whether it was the primary beneficiary (i.e., the variable interest holder required to consolidate a VIE) of a VIE by first performing a qualitative analysis of the VIE that includes, among other factors, its capital structure, contractual terms, which variable interests create or absorb variability, related party relationships and the design of the VIE. The Company performed a quantitative analysis when qualitative analysis was not conclusive.

        The accounting guidance effective January 1, 2010, requires the Company to perform an analysis to determine whether its variable interests give it a controlling financial interest in a VIE. This analysis identifies the primary beneficiary of a VIE as the enterprise that has both 1) the power to direct the activities of a VIE that most significantly impact the entity's economic performance; and 2) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. Additionally, this guidance requires an ongoing reassessment of whether the Company is the primary beneficiary of a VIE.

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Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

8. Consolidation of VIEs (Continued)

        Pursuant to the new accounting guidance, the Company evaluated its power to direct the significant activities that most significantly impact the economic performance of VIEs that have debt obligations insured by the Company and, accordingly, where the Company is obligated to absorb VIE losses that could potentially be significant to the VIE. The Company determined that it is the primary beneficiary of 20 VIEs at June 30, 2010 based on the assessment of its control rights over servicer or collateral manager replacement, given that servicing/managing collateral were deemed to be the VIEs' most significant activities. The Company consolidated 21 VIEs at March 31, 2010. As a result of changes in control rights during the quarter ended June 30, 2010, two VIEs were deconsolidated and one additional VIE was consolidated during the quarter resulting in an increase in financial guaranty variable interest entities' assets of $51.0 million, an increase in financial guaranty variable interest entities' liabilities of $71.5 million and a net gain on deconsolidation/consolidation of $2.2 million, which was included in "financial guaranty variable interest entities' revenues" in the consolidated statement of operations. The Company is not primarily liable for the debt obligations issued by the VIEs and would only be required to make payments on these debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due. The Company's creditors do not have any rights with regard to the assets of the VIEs.

        The table below shows the carrying value of the consolidated VIE assets and liabilities in the Company's unaudited interim consolidated financial statements, segregated by the types of assets held by VIEs that collateralize their respective debt obligations:


Consolidated VIEs

 
  As of June 30, 2010   As of December 31, 2009  
 
  Assets   Liabilities   Assets   Liabilities  
 
  (in thousands)
 

HELOCs

  $ 436,454   $ 669,950   $   $  

First liens

    314,585     417,040          

Alt-A Second liens

    98,552     152,071          

Automobile loans

    589,431     589,431          

Life insurance

    293,805     293,805          

Credit card loans

    111,846     111,846     233,419     233,129  

Health care receivables

            211,808     212,484  

Consumer loans

            199,189     199,178  

Gas pipeline tariffs

            117,887     117,861  
                   
 

Total

  $ 1,844,673   $ 2,234,143   $ 762,303   $ 762,652  
                   

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Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

8. Consolidation of VIEs (Continued)

        The table below shows the revenues and expenses of the consolidated VIEs:

 
  Second Quarter
2010
  Six Months
2010
 
 
  (in thousands)
 

Revenues:

             

Financial guaranty variable interest entities' revenues:

             
 

Interest income

  $ 54,412   $ 115,290  
 

Net realized and unrealized gains (losses) on assets

    (73,545 )   (130,235 )
           
   

Financial guaranty variable interest entities' revenues

  $ (19,133 ) $ (14,945 )
           

Expenses:

             

Financial guaranty variable interest entities' expenses:

             
 

Interest expense

  $ 20,657   $ 44,710  
 

Net realized and unrealized (gains) losses on liabilities with recourse

    (50,209 )   (75,863 )
 

Net realized and unrealized (gains) losses on liabilities without recourse

    (8,686 )   (14,440 )
 

Other expenses

    18,628     40,761  
           
   

Financial guaranty variable interest entities' expenses

  $ (19,610 ) $ (4,832 )
           

        The financial reports of the consolidated VIEs are prepared by outside parties and are not available within the time constraints that the Company requires to ensure the financial accuracy of the operating results. As such, the financial results of the 20 VIEs are consolidated on a one quarter lag.

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Table of Contents


Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (Unaudited) (Continued)

June 30, 2010

8. Consolidation of VIEs (Continued)

        The new accounting guidance mandates the accounting changes prescribed by the statement to be recognized by the Company as a cumulative effect adjustment to retained earnings as of January 1, 2010. The cumulative effect of adopting the new accounting guidance was a $206.5 million after-tax decrease to the opening retained earnings balance due to the consolidation of 21 VIEs at fair value on January 1, 2010. The impact of adopting the new accounting guidance on the Company's balance sheet was as follows:

 
  As of
December 31,
2009
  Transition
Adjustment
  As of
January 1,
2010
 
 
  (in thousands)
 

Assets:

                   

Premiums receivable, net of ceding commissions payable

  $ 1,418,232   $ (19,087 ) $ 1,399,145  

Deferred tax asset, net

    1,158,205     111,213     1,269,418  

Financial guaranty variable interest entities' assets

    762,303     1,162,983     1,925,286  

Total assets

    16,802,693     1,255,109     18,057,802  

Liabilities and shareholders' equity:

                   

Unearned premium reserves

    8,400,152     (129,875 )   8,270,277  

Loss and loss adjustment expense reserve

    289,470     16,999     306,469  

Financial guaranty variable interest entities' liabilities with recourse

    762,652     1,348,200     2,110,852  

Financial guaranty variable interest entities' liabilities without recourse

        225,976     225,976  

Total liabilities

    13,282,534     1,461,300     14,743,834  

Retained earnings

    789,869     (206,540 )   583,329  

Total shareholders' equity attributable to Assured Guaranty Ltd. 

    3,520,508     (206,540 )   3,313,968  

Noncontrolling interest of financial guaranty variable interest entities

    (349 )   349      

Total shareholders' equity

    3,520,159     (206,191 )   3