UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

ý

 

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

 

For the Quarterly Period Ended March 31, 2004

 

OR

 

o

 

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

 

transition Period from                                  to                                 

 

Commission File No. 001-32141

 

ASSURED GUARANTY LTD.

(Exact name of registrant as specified in its charter)

 

Bermuda

 

Not Applicable

(State or other jurisdiction of incorporation)

 

(I.R.S. employer identification no.)

 

30 Woodbourne Avenue

Hamilton HM 08

Bermuda

(address of principal executive office)

 

(441) 296-4004

(Registrants 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   o        NO   ý

 

Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

YES   o        NO   ý

 

The number of registrant’s Common Shares ($0.01 value) outstanding as of May 15, 2004 was 75,969,792.

 

 



 

ASSURED GUARANTY LTD.

 

INDEX TO FORM 10-Q

 

PART I.

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements

 

 

 

 

 

 

 

 

 

Combined Balance Sheets as of March 31, 2004 (unaudited) and December 31, 2003

 

 

 

 

 

 

 

 

 

Combined Statements of Operations and Comprehensive Income (unaudited) for the Three Months Ended March 31, 2004 and 2003

 

 

 

 

 

 

 

 

 

Combined Statements of Shareholder’s Equity (unaudited) for the Three Months Ended March 31, 2004

 

 

 

 

 

 

 

 

 

Combined Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2004 and 2003

 

 

 

 

 

 

 

 

 

Notes to Combined Financial Statements (unaudited)

 

 

 

 

 

 

 

Item 2.

 

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

 

 

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosure about Market Risk

 

 

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

 

 

 

 

 

PART II.

 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

 

 

 

 

 

 

Item 6.

 

Exhibits and Reports on Form 8-K

 

 

 

 

 

 

 

Signatures

 

 



 

Assured Guaranty Ltd.

Combined Balance Sheets

(in thousands of U.S. dollars)

 

 

 

March 31,
2004

 

December 31,
2003

 

 

 

(unaudited)

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Fixed maturity securities, at fair value (amortized cost: $1,930,399 in 2004 and $1,937,743 in 2003)

 

$

2,065,948

 

$

2,052,217

 

Short-term investments, at cost which approximates fair value

 

154,355

 

137,517

 

Total investments

 

2,220,303

 

2,189,734

 

Cash and cash equivalents

 

36,254

 

32,365

 

Accrued investment income

 

24,302

 

23,758

 

Deferred acquisition costs

 

186,267

 

178,673

 

Prepaid reinsurance premiums

 

17,012

 

10,974

 

Reinsurance recoverable on ceded losses

 

106,131

 

122,124

 

Due from affiliate

 

 

115,000

 

Premiums receivable

 

35,133

 

63,997

 

Value of reinsurance business assumed

 

11,915

 

14,226

 

Goodwill

 

85,417

 

87,062

 

Other assets

 

26,490

 

19,954

 

Total assets

 

$

2,749,224

 

$

2,857,867

 

 

 

 

 

 

 

Liabilities and shareholder’s equity

 

 

 

 

 

Liabilities

 

 

 

 

 

Unearned premium reserves

 

$

537,930

 

$

625,429

 

Reserve for losses and loss adjustment expenses

 

431,297

 

522,593

 

Profit commissions payable

 

56,805

 

71,237

 

Deferred income taxes

 

73,865

 

55,637

 

Unrealized losses on derivative financial instruments

 

1,209

 

8,558

 

Funds held by Company under reinsurance contracts

 

9,289

 

9,635

 

Long-term debt

 

75,000

 

75,000

 

Other liabilities

 

53,756

 

52,154

 

Total liabilities

 

1,239,151

 

1,420,243

 

Commitments and contingencies

 

 

 

 

 

Shareholder’s equity

 

 

 

 

 

Common stock

 

16,403

 

16,403

 

Additional paid-in capital

 

961,852

 

955,490

 

Unearned stock grant compensation

 

(4,505

)

(5,479

)

Retained earnings

 

436,918

 

390,025

 

Accumulated other comprehensive income

 

99,405

 

81,185

 

Total shareholder’s equity

 

1,510,073

 

1,437,624

 

Total liabilities and shareholder’s equity

 

$

2,749,224

 

$

2,857,867

 

 

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

 

1



 

Assured Guaranty Ltd.

Combined Statements of Operations and Comprehensive Income

(in thousands of U.S. dollars except per share amounts)

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2004

 

2003

 

Revenues

 

 

 

 

 

Gross written premiums

 

$

(1,544

)

$

112,735

 

Ceded premiums

 

5,327

 

8,662

 

Net written premiums

 

(6,871

)

104,073

 

(Increase)/decrease in net unearned premium reserves

 

93,538

 

(40,485

)

Net earned premiums

 

86,667

 

63,588

 

Net investment income

 

24,385

 

24,101

 

Net realized investment gains

 

1,182

 

1,903

 

Unrealized gains (losses) on derivative financial instruments

 

7,349

 

(1,110

)

Other income

 

532

 

557

 

Total revenues

 

120,115

 

89,039

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

Loss and loss adjustment expenses

 

23,668

 

23,188

 

Profit commissions expense

 

5,486

 

2,969

 

Acquisition costs

 

13,108

 

11,843

 

Other operating expenses

 

12,621

 

11,635

 

Goodwill impairment

 

1,645

 

 

Interest expense

 

1,434

 

1,434

 

Total expenses

 

57,962

 

51,069

 

 

 

 

 

 

 

Income before provision for income taxes

 

62,153

 

37,970

 

Provision/(benefit) for income taxes

 

 

 

 

 

Current

 

2,179

 

(2,025

)

Deferred

 

13,081

 

8,244

 

Total provision for income taxes

 

15,260

 

6,219

 

Net income

 

46,893

 

31,751

 

Other comprehensive income, net of taxes

 

 

 

 

 

Unrealized holding gains on fixed maturity securities arising during the year

 

14,845

 

5,619

 

Reclassification adjustment for realized (gains)/losses included in net income

 

3,375

 

(4,075

)

Change in net unrealized gains on fixed maturity securities

 

18,220

 

1,544

 

Comprehensive income

 

$

65,113

 

$

33,295

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

Basic

 

$

0.63

 

$

0.42

 

Diluted

 

$

0.63

 

$

0.42

 

 

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

 

2



 

Assured Guaranty Ltd.

Combined Statements of Shareholder’s Equity
For the three months ended March 31, 2004

(in thousands of U.S. dollars)

(unaudited)

 

 

Common
Stock

 

Additional
Paid-in
capital

 

Unearned
Stock Grant
Compensation

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Income

 

Total
Shareholder’s
Equity

 

Balance, December 31, 2003

 

$

16,403

 

$

955,490

 

$

(5,479

)

$

390,025

 

$

81,185

 

$

1,437,624

 

Net income

 

 

 

 

46,893

 

 

46,893

 

Dividends

 

 

 

 

 

 

 

Capital contribution

 

 

932

 

 

 

 

932

 

Tax benefit for options exercised

 

 

5,430

 

 

 

 

5,430

 

Unrealized gain on fixed maturity securities, net of tax of ($4,991)

 

 

 

 

 

18,220

 

18,220

 

Unearned stock grant compensation, net

 

 

 

974

 

 

 

974

 

Balance, March 31, 2004

 

$

16,403

 

$

961,852

 

$

(4,505

)

$

436,918

 

$

99,405

 

$

1,510,073

 

 

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

 

3



 

Assured Guaranty Ltd.
Combined Statements of Cash Flows
(in thousands of U.S. dollars)

(unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2004

 

2003

 

Operating activities

 

 

 

 

 

Net income

 

$

46,893

 

$

31,751

 

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

 

 

 

 

 

Non-cash interest and operating expenses

 

932

 

1,010

 

Net amortization of premium/(discount) on fixed maturity securities

 

2,797

 

1,781

 

Goodwill impairment

 

1,645

 

 

Provision for deferred income taxes

 

13,081

 

8,244

 

Net realized investment gains

 

(1,182

)

(1,903

)

Change in unrealized (gains) losses on derivative financial instruments

 

(7,349

)

1,110

 

Change in deferred acquisition costs

 

(7,594

)

(4,751

)

Change in accrued investment income

 

(544

)

(112

)

Change in premiums receivable

 

28,864

 

5,232

 

Change in due from affiliate

 

115,000

 

 

Change in prepaid reinsurance premiums

 

(6,038

)

3,287

 

Change in unearned premium reserves

 

(87,499

)

37,198

 

Change in reserve for losses and loss adjustment expenses, net

 

(75,303

)

(49,287

)

Change in profit commissions payable

 

(14,432

)

(9,311

)

Change in value of reinsurance business assumed

 

2,311

 

1,524

 

Change in funds held by Company under reinsurance contracts

 

(346

)

(8,519

)

Other

 

1,168

 

5,106

 

Net cash provided by operating activities

 

12,404

 

22,360

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

Purchases

 

(172,821

)

(217,433

)

Sales

 

179,638

 

186,019

 

Maturities

 

160

 

3,180

 

(Purchases)/sales of short-term investments, net

 

(16,838

)

8,758

 

Net cash used in investing activities

 

(9,861

)

(19,476

)

 

 

 

 

 

 

Financing activities

 

 

 

 

 

Dividends paid

 

 

(2,000

)

Net cash used in financing activities

 

 

(2,000

)

 

 

 

 

 

 

Increase in cash and cash equivalents

 

2,543

 

884

 

Effect of exchange rate changes

 

1,346

 

2,017

 

Cash and cash equivalents at beginning of period

 

32,365

 

9,445

 

Cash and cash equivalents at end of period

 

$

36,254

 

$

12,346

 

 

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

 

4



 

ASSURED GUARANTY LTD.
NOTES TO COMBINED FINANCIAL STATEMENTS

March 31, 2004

(Expressed in thousands of U.S. dollars, except share amounts or as where otherwise described)

(Unaudited)

 

1.    Organization

 

On April 28, 2004, subsidiaries of ACE Limited (“ACE”), completed an initial public offering (“IPO”) of 49,000,000 common shares of their wholly-owned subsidiary, Assured Guaranty Ltd. (“Assured Guaranty” or the “Company”, formerly AGC Holdings Ltd.).  The Company’s common shares are traded on the New York Stock Exchange under the symbol AGO. This offering raised approximately $840.1 million in net proceeds, all of which went to the selling shareholders.  As part of the IPO, Assured Guaranty and ACE entered into a master agreement which governs various settlement issues.  As part of the master agreement all pre-IPO intercompany receivables and payables are expected to be settled with ACE by June 10, 2004.

 

Assured Guaranty is a Bermuda-based company providing credit enhancement products to the municipal finance, structured finance and mortgage markets. Credit enhancement products are financial guarantees or other types of support, including credit derivatives, that improve the credit of underlying debt obligations. The Company applies its credit expertise, risk management skills and capital markets experience to develop insurance, reinsurance and derivative products that meet the credit enhancement needs of its customers. Under a reinsurance agreement, the reinsurer, in consideration of a premium paid to it, agrees to indemnify another insurer, called the ceding company, for part or all of the liability of the ceding company under one or more insurance policies that the ceding company has issued.  A derivative is a financial instrument whose characteristics and value depend upon the characteristics and value of an underlying security or commodity. The Company markets its products directly to and through financial institutions, serving the U.S. and international markets.  The Company’s financial results include four principal business segments: financial guaranty direct, financial guaranty reinsurance, mortgage guaranty and other.  These segments are further discussed in Note 9.

 

2.    Basis of presentation

 

The historical combined financial statements include the assets, liabilities, operating results and cash flows of Assured Guaranty and combined entities and have been prepared using the historical bases for assets and liabilities and the historical results of operations of the aforementioned combined entities. The historical combined financial statements also include certain long-term debt used to fund the Company’s insurance operations and related interest expense. For all periods presented, certain expenses reflected in the financial statements include allocations of corporate expenses incurred by the Company’s former Parent, ACE, related to general and administrative services provided to the Company, including tax consulting and preparation services, internal audit services and liquidity facility costs. These expenses were allocated based on estimates of the cost incurred by ACE to provide these services to the Company. All intercompany accounts and transactions have been eliminated. Certain items in the prior year financial statements have been reclassified to conform with the current year presentation.

 

The interim unaudited financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company’s financial condition, results of operations and cash flows for the periods presented.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.  The results of the Company reported herein were consolidated into the results of ACE, as the Company was a wholly-owned subsidiary of ACE as of March 31, 2004.

 

5



 

Management believes that the foregoing adjustments and allocations were made on a basis that is a reasonable reflection of the historical results of the Company. However, these results do not necessarily represent what the historical combined financial position, results of operations and cash flows of the Company would have been if the Company had been a separate and stand-alone entity during the periods presented.

 

Certain of the Company’s subsidiaries are subject to U.S. income tax.  The provision for income taxes is calculated in accordance with FAS No. 109, “Accounting for Income Taxes”.  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 derivative financial instruments.  A discrete calculation of the provision is calculated for each interim period.

 

These interim unaudited combined financial statements should be read in conjunction with the 2003 audited combined financial statements and related notes thereto included in the Company’s Registration Statement on Form S-1 (Registration No. 333-111491).

 

3.    New accounting pronouncements

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), as an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” FIN 46 addresses consolidation of variable interest entities (“VIEs”) by business enterprises. An entity is considered a VIE subject to consolidation if the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support or if the equity investors lack one of three characteristics of a controlling financial interest. First, the equity investors lack the ability to make decisions about the entity’s activities through voting rights or similar rights. Second, they do not bear the obligation to absorb the expected losses of the entity if they occur. Lastly, they do not claim the right to receive expected returns of the entity if they occur, which are the compensation for the risk of absorbing the expected losses. FIN 46 requires that VIEs be consolidated by the entity that maintains the majority of the risks and rewards of ownership. This Interpretation applied immediately to VIEs created after January 31, 2003 and to VIEs in which an enterprise obtains an interest after that date. FASB deferred the effective date of FIN 46 until the end of the first interim or annual period ending after December 15, 2003 for VIEs created before February 1, 2003. The adoption of FIN 46 did not have a material impact on our results of operations or financial condition.

 

4.    Reinsurance

 

To limit its exposure on assumed risks, the Company entered into certain proportional and non-proportional retrocessional agreements with other insurance companies, primarily subsidiaries of ACE, that cede a portion of the risk underwritten by the Company. In the event that any or all of the reinsurers are unable to meet their obligations, the Company would be liable for such defaulted amounts. Direct, assumed, and ceded reinsurance amounts were as follows:

 

 

 

Three Months Ended
March 31,

 

 

 

2004

 

2003

 

 

 

(in thousands of U.S. dollars)

 

Premiums Written:

 

 

 

 

 

Direct

 

$

(91,043

)

$

7,346

 

Assumed

 

89,499

 

105,389

 

Ceded

 

5,327

 

8,662

 

Net

 

$

(6,871

)

$

104,073

 

 

 

 

 

 

 

Premiums Earned:

 

 

 

 

 

Direct

 

$

17,512

 

$

7,426

 

Assumed

 

71,674

 

65,142

 

Ceded

 

2,519

 

8,980

 

Net

 

$

86,667

 

$

63,588

 

 

 

 

 

 

 

Loss and Loss Adjustment Expenses:

 

 

 

 

 

Direct

 

$

(8,523

)

$

8,567

 

Assumed

 

33,211

 

18,937

 

Ceded

 

1,020

 

4,316

 

Net

 

$

23,668

 

$

23,188

 

 

6



 

Direct premiums written and direct loss and loss adjustment expenses (“LAE”) were impacted $(97.8) million and $(19.0) million, respectively, from the close out of transaction types the Company does not expect to underwrite in the future.  Reinsurance recoverable on ceded unpaid losses and LAE as of March 31, 2004 and December 31, 2003 is $105.9 million and $122.1 million, respectively. Of these amounts, $84.0 million and $100.1 million, respectively, relate to reinsurance agreements with affiliates.

 

5. Commitments and Contingencies

 

On January 18, 2002, World Omni Financial Corp. (“World Omni”) filed an action against AG Intermediary Inc., (“AGI”) subsidiary of the Company, in the United States District Court for the Southern District of New York entitled World Omni Financial Corp. v. ACE Capital Re Inc., Case no. 02 CV 0476 (RO).  On September 20, 2002, World Omni amended its complaint to add Assured Guaranty Re Overseas Ltd. (“AGRO”) as a defendant.  The dispute arises out of a quota share reinsurance agreement between AGRO and JCJ Insurance Company (“JCJ”), an affiliate of World Omni, and an underlying residual value insurance policy issued by JCJ to World Omni, which insured residual value losses of World Omni with respect to a portfolio of automobile leases. Subject to the terms and conditions of the policy, the residual value insurance policy insures World Omni against losses (as defined in the policy) resulting from the value of leased vehicles at the end of the applicable lease term being less than what such value was assumed to have been at the inception of the applicable lease term. In the District Court action, World Omni sought a declaratory judgment regarding AGRO’s coverage obligations, if any, for such alleged losses, as well as damages for breach of contract based upon AGRO’s refusal to pay claims asserted by World Omni.  World Omni sought $157.0 million, which is the limit of liability under the quota share reinsurance agreement, plus interest.

 

AGRO and AGI denied World Omni’s claims, and intend to contest them vigorously.  On February 24, 2004, the parties entered into a separate arbitration agreement that governs the parties’ disputes and provides for an arbitration hearing to occur in July 2005.  On March 1, 2004, the parties submitted a joint motion for a stay of proceedings in the District Court action so that they could pursue arbitration.  By Order dated March 5, 2004, the District Court granted the parties’ joint motion and stayed further proceedings in the District Court action.  No formal discovery had been taken in the District Court action by the time the proceedings were stayed.

 

At March 31, 2004 and December 31, 2003, the Company carried a reserve for losses and LAE, net of recoveries, of $32.2 million for the World Omni action.

 

On April 28, 2004, AGRO and ACE INA Overseas Insurance Company, a subsidiary of ACE, entered into a 100% quota share retrocession agreement under which AGRO will retrocede to ACE INA Overseas Insurance Company an auto residual value reinsurance transaction for a premium of $32.2 million.

 

Various other lawsuits have arisen in the ordinary course of the Company’s business. It is the opinion of the Company’s management, based upon the available information, that the expected outcome of these matters, individually and in the aggregate, will not have a material adverse effect on the Company’s financial position, results of operations or liquidity, although an adverse resolution of one or more of these items could

 

7



 

have a material adverse effect on the Company’s results of operations or liquidity in a particular quarter or fiscal year.

 

The Company is party to reinsurance agreements with other monoline primary financial guaranty insurance companies. The Company’s facultative and treaty agreements are generally subject to termination (i) upon written notice (ranging from 90 to 120 days) prior to the specified deadline for renewal, (ii) at the option of the primary insurer if the Company fails to maintain certain financial, regulatory and rating agency criteria which are equivalent to or more stringent than those the Company is otherwise required to maintain for its own compliance with state mandated insurance laws or (iii) upon certain changes of control of the Company. Upon termination under the conditions set forth in (ii) and (iii) above, the Company may be required (under some of its reinsurance agreements) to return to the primary insurer all statutory unearned premiums, less ceding commissions, attributable to reinsurance ceded pursuant to such agreements. Upon the occurrence of the conditions set forth in (ii) above, whether or not an agreement is terminated, the Company may be required to obtain a letter of credit or alternative form of security to collateralize its obligation to perform under such agreement or it may be obligated to increase the level of ceding commission paid.

 

6. Long-Term Debt and Credit Facility

 

The Company’s combined financial statements include long-term debt used to fund the Company’s insurance operations, and related interest expense, as described below.

 

As of March 31, 2004, the Company’s long-term debt included $75.0 million of cumulative monthly income preferred shares issued in 1994 through an affiliate of the Company, Capital Re LLC, a limited liability company organized under the laws of Turks and Caicos Islands. These securities pay monthly dividends at a rate of 7.65% and are mandatorily redeemable in January 2044. Since January 31, 1999, Capital Re LLC also has the option to redeem these shares in whole or in part at the redemption price of $25.00 per share plus accumulated and unpaid dividends. At March 31, 2004 none of the three million outstanding shares were redeemed. Capital Re LLC exists solely for the purpose of issuing preferred and common shares and lending the proceeds to ACE Financial Services, Inc. to fund its business operations. The amount paid to preferred shareholders for each of the periods ended March 31, 2004 and 2003 was approximately $1.4 million and is shown on the statement of operations as interest expense.  Upon completion of the IPO, Capital Re LLC and the obligation with respect to the $75.0 million cumulative monthly preferred shares remained with ACE.  See Note 11 for further information.

 

As of March 31, 2004 Company had entered into the following credit facilities, which were available for general corporate purposes:

 

(i)                                     The Company participated in a liquidity facility established for the benefit of ACE and certain of its subsidiaries. The overall facility was a 364-day credit agreement in the amount of $500.0 million with a syndicate of banks. The Company had a $50.0 million participation in the facility.  Due to the IPO, as of April 2, 2004, this facility was replaced.

 

(ii)                                  The Company also participated in a liquidity facility established for the benefit of Assured Guaranty Corp. (“AGC”), a Maryland domiciled insurance company and subsidiary of the Company. The overall facility was a 364-day credit agreement in the amount of $140.0 million with a syndicate of banks. Under the terms of this liquidity facility AGC would have been required to pledge collateral to one of the syndicate banks. If the amount of collateral posted for the benefit of AGC credit default swap counterparties exceeded 11% of AGC shareholders’ equity.  In such case an amount equal to that excess was to have been pledged

 

8



 

for the benefit of the syndicate banks. As of March 31, 2004, AGC had not posted any collateral under this covenant.  Due to the IPO, as of April 28, 2004, this facility was replaced.

 

(iii)                               The Company has a $75.0 million line of credit facility and a $50.0 million line of credit facility from subsidiaries of ACE.  Due to the IPO, as of April 28, 2004, this facility was replaced.

 

As of March 31, 2004, the Company had not drawn any amounts under these credit facilities.

 

To replace the general corporate purpose credit facilities,  the Company entered into a $250.0 million unsecured credit facility (“$250.0 million credit facility”) on April 29, 2004, with a syndicate of banks, for which ABN AMRO Incorporated and Bank of America (an affiliate of Banc of America Securities LLC) acted as co-arrangers to which each of the Company, AGC and Assured Guaranty (UK) Ltd., a subsidiary of the Company organized under the laws of the United Kingdom, is a party, as borrower. The $250.0 million credit facility is a 364-day facility and any amounts outstanding under the facility at its expiration will be due and payable one year following the facility’s expiry. Under the $250.0 million credit facility, AGC can borrow up to $250.0 million, Assured Guaranty Ltd. has a borrowing limit not to exceed $50.0 million, and Assured Guaranty (UK) Ltd. has a borrowing limit not to exceed $12.5 million.

 

As of March 31, 2004, the Company was party to a non-recourse credit facility with a syndicate of banks, which provided up to $175.0 million. This facility was specifically designed to provide rating agency qualified capital to further support the Company’s claim paying resources. This agreement is due to expire November 2010.  As of March 31, 2004, the Company had not drawn any amounts under this credit facility.

 

7. Employee Benefit Plans and Stock Based Compensation

 

Prior to the IPO, Assured Guaranty officers and employees participated in ACE’s long-term incentive plans providing options to purchase shares and restricted share unit awards. Our officers and employees have been covered under additional benefit plans, including retirement programs providing 401(k) plan benefits, health and life insurance benefits; medical, dental and vision benefits for active employees; disability and life insurance protection; and severance.  These additional benefits have been provided to our employees and officers who work in the United States by plans maintained by Assured Guaranty Corp. and to our employees and officers who work in Bermuda and the United Kingdom through plans maintained by ACE covering ACE employees in those locations.  Since the completion of the IPO, our officers and employees have been covered by benefit plans the Company has or is establishing; except that during a transition period following the IPO, employees located in the United Kingdom and Bermuda may continue to participate in some of the ACE benefit plans in which they participated prior to the IPO.

 

Upon completion of the IPO, any unvested options to purchase ACE ordinary shares held by our officers or employees immediately vested and any unvested restricted ACE ordinary shares were forfeited. Our officers and employees have 90 days from the date of the IPO to exercise any vested options to acquire ACE ordinary shares. The acceleration of vesting of options to purchase ordinary shares resulted in a pre-tax charge to us of approximately $3.0 million.  Based upon a price of $42.79 per ACE ordinary share, the Company incurred a pre-tax charge of $7.8 million and contributed cash in the same amount to fund a trust, with an independent trustee,  for the value of the restricted ACE ordinary shares forfeited by all of our officers and employees. These pre-tax charges took place during the second quarter of 2004.  The trust purchased common shares in the IPO and allocated to each such individual common shares having the approximate value of the ACE ordinary shares forfeited by such individual. Based on the initial public offering price of $18.00 per common share, the trust purchased approximately 436,000 common shares. The common shares will be deliverable to each individual on the 18-month anniversary of the IPO so long as during that 18-month period the individual was not employed, directly or indirectly, by any designated financial guaranty company. Any forfeited common shares will be delivered to us. The independent trustee will not have any beneficial interest in the trust. Since completion of the IPO, our officers and employees are no longer eligible to participate in the ACE long-term incentive plans.  In connection with these events, Assured Guaranty received $4.5 million from ACE, for the book value of unrestricted compensation, which it recorded in unearned stock grant compensation, which is included in shareholder’s equity.

 

9



 

As of April 27, 2004, the Company adopted the Assured Guaranty Ltd. 2004 Long-Term Incentive Plan (the “Incentive Plan”). The number of common shares that may be delivered under the Incentive Plan may not exceed 7,500,000. In the event of certain transactions affecting our common shares, the number or type of shares subject to the Incentive Plan, the number and type of shares subject to outstanding awards under the Incentive Plan, and the exercise price of awards under the Incentive Plan, may be adjusted.

 

The Incentive Plan authorizes the grant of incentive stock options, non-qualified stock options, stock appreciation rights, and full value awards that are based on our common shares. The grant of full value awards may be in return for a participant’s previously performed services, or in return for the participant surrendering other compensation that may be due, or may be contingent on the achievement of performance or other objectives during a specified period, or may be subject to a risk of forfeiture or other restrictions that will lapse upon the achievement of one or more goals relating to completion of service by the participant, or achievement of performance or other objectives. Awards under the Incentive Plan may accelerate and become vested upon a change in control of Assured Guaranty.

 

The Incentive Plan is administered by a committee of the board of directors. The compensation committee of the board serves as this committee except as otherwise determined by the board. The board may amend or terminate the Incentive Plan.

 

In connection with the IPO, awards of options and restricted common shares were made to our officers and employees. Each of the options will vest in equal annual installments over a three-year period and will expire on the tenth anniversary of the date of grant. The exercise price of the options is $18.00, the public offering price of the IPO. Restricted common shares will vest in equal annual installments over a four-year period. Options to purchase an aggregate of 1,873,300 common shares and an aggregate of 969,792 restricted common shares were issued in connection with the IPO.

 

Because the Company was a wholly-owned subsidiary of ACE during the reporting period, stock based compensation is based on ACE stock. The Company accounts for stock-based compensation plans in accordance with APB No. 25. No compensation expense for options is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of the grant. Pro forma information regarding net income and earnings per share is required by FAS No. 123, “Accounting for Stock-Based Compensation”. In December 2002, FASB issued FAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” FAS 148 amends the disclosure requirements of FAS 123 to require prominent disclosure in both annual and interim financial statements regarding the method of accounting for stock-based compensation and the effect of the method used on reported results.

 

For restricted stock awards, the Company records the market value of the shares awarded at the time of the grant as unearned stock grant compensation and includes it as a separate component of shareholder’s equity. The unearned stock grant compensation is amortized into expense ratably over the vesting period.

 

10



 

The following table outlines the Company’s net income, and basic and diluted earnings per share for the periods ended March 31, 2004 and 2003, had the compensation cost been determined in accordance with the fair value method recommended in FAS 123.

 

 

 

Three Months Ended
March 31,

 

(in thousands of U.S. dollars, except per share amounts)

 

2004

 

2003

 

Net income as reported

 

$

46,893

 

$

31,751

 

Add: Stock-based compensation expense included in reported net income, net of income tax

 

411

 

364

 

Deduct: Compensation expense, net of income tax

 

1,267

 

935

 

Pro Forma

 

$

46,037

 

$

31,180

 

 

 

 

 

 

 

Earnings Per Share:

 

 

 

 

 

Basic

 

$

0.61

 

$

0.42

 

Diluted

 

$

0.61

 

$

0.42

 

 

The fair value of the ACE options issued is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted-average assumptions used for grants for the three months ended March 31, 2004 and 2003, respectively: dividend yield of 1.74 percent and 2.46 percent, expected volatility of 26.72 percent and 32.71 percent, risk free interest rate of 2.69 percent and 2.35 percent. The expected life is four years and the forfeiture rate is 5 percent for 2004 and 2003.

 

8. Earnings Per Share

 

The following table sets forth the computation of basic and diluted earnings per share (“EPS”):

 

 

 

Three Months Ended
March 31,

 

(in thousands of U.S. dollars, except per share amounts)

 

2004

 

2003

 

Net income

 

$

46,893

 

$

31,751

 

 

 

 

 

 

 

Basic shares(1)

 

75,000,000

 

75,000,000

 

Diluted shares(1)

 

75,000,000

 

75,000,000

 

Basic EPS

 

$

0.63

 

$

0.42

 

Diluted EPS

 

$

0.63

 

$

0.42

 

 


(1) Based on shares outstanding immediately prior to the IPO.

 

9.  Segment Reporting

 

The Company has classified its business into four principal business segments, which is at the same level as that reviewed by senior management; (1) financial guaranty direct, which includes transactions whereby the Company provides an unconditional and irrevocable guaranty that indemnifies the holder of a financial obligation against non-payment of principal and interest when due, and includes credit support for credit default swaps; (2) financial guaranty reinsurance, which includes agreements whereby the Company is a reinsurer and agrees to indemnify a primary insurance company against part or all of the loss which the latter may sustain under a policy it has issued; (3) mortgage guaranty, which includes mortgage guaranty insurance and reinsurance whereby the Company provides protection against the default of borrowers on mortgage loans; and (4) other, which includes several lines of business in which the Company is no longer active, including trade credit reinsurance, title reinsurance, auto residual value reinsurance and the credit protection of equity layers of collateralized debt obligations, as well as life, accident and health reinsurance.

 

The Company’s reportable business segments are strategic business units that offer different products and services. They are managed separately since each business requires different marketing strategies and underwriting skill sets.

 

11



 

The Company does not segregate certain assets and liabilities at a segment level since management reviews and controls these assets and liabilities on a consolidated basis. The Company allocates certain operating expenses to each segment based on the proportion of net earned premium for each respective segment to the total net earned premium.  Management uses underwriting gains and losses as the primary measure of each segment’s financial performance.  There were no inter-segment transactions during the periods presented.  The following table summarizes the components of underwriting gain (loss) for each reporting segment:

 

 

 

Three Months Ended March 31, 2004

 

 

 

Financial
Guaranty
Direct

 

Financial
Guaranty
Reinsurance

 

Mortgage
Guaranty

 

Other

 

Total

 

 

 

(in millions of U.S. dollars)

 

Gross written premiums

 

$

25.6

 

$

52.4

 

$

14.0

 

(93.5

)

(1.5

)

Net written premiums

 

25.3

 

52.4

 

14.0

 

(98.6

)

(6.9

)

Net earned premiums

 

40.7

 

20.4

 

8.4

 

17.2

 

86.7

 

Loss and loss adjustment expenses

 

13.4

 

3.9

 

(1.2

)

7.6

 

23.7

 

Profit commission expense

 

 

0.1

 

5.0

 

0.4

 

5.5

 

Acquisition costs

 

1.4

 

7.1

 

0.9

 

3.7

 

13.1

 

Operating expenses

 

3.3

 

4.1

 

1.7

 

3.6

 

12.7

 

Underwriting gain

 

$

22.6

 

$

5.2

 

$

2.0

 

$

1.9

 

$

31.7

 

 

 

 

Three Months Ended March 31, 2003

 

 

 

Financial
Guaranty
Direct

 

Financial
Guaranty
Reinsurance

 

Mortgage
Guaranty

 

Other

 

Total

 

 

 

(in millions of U.S. dollars)

 

Gross written premiums

 

$

14.0

 

$

29.8

 

$

8.1

 

$

60.8

 

$

112.7

 

Net written premiums

 

13.8

 

29.1

 

8.1

 

53.1

 

104.1

 

Net earned premiums

 

14.7

 

16.9

 

9.6

 

22.4

 

63.6

 

Loss and loss adjustment expenses

 

2.0

 

1.8

 

1.2

 

18.2

 

23.2

 

Profit commission expense

 

 

0.1

 

3.2

 

(0.3

)

3.0

 

Acquisition costs

 

 

5.4

 

1.0

 

5.4

 

11.8

 

Operating expenses

 

2.7

 

3.1

 

1.8

 

4.1

 

11.7

 

Underwriting gain (loss)

 

$

10.0

 

$

6.5

 

$

2.4

 

$

(5.0

)

$

13.9

 

 

The following is a reconciliation of total underwriting gain to income before provision for income taxes for the periods ended:

 

 

 

Three Months Ended
March 31,

 

(in millions of U.S. dollars)

 

2004

 

2003

 

Total underwriting gain

 

$

31.7

 

$

13.9

 

Net investment income

 

24.4

 

24.1

 

Net realized investment gains

 

1.2

 

1.9

 

Unrealized gains (losses) on derivative financial instruments

 

7.4

 

(1.1

)

Other income

 

0.5

 

0.6

 

Goodwill impairment

 

(1.6

)

 

Interest expense

 

(1.4

)

(1.4

)

Income before provision for income taxes

 

$

62.2

 

$

38.0

 

 

Our other segment consists of certain non-core lines of business that the Company has stopped, or intends to stop, writing, including equity layer credit protection, trade credit reinsurance, title

 

12



 

reinsurance, LA&H reinsurance and auto residual value reinsurance. In connection with this plan, the Company wrote off $1.6 million of goodwill related to our trade credit reinsurance business which we exited as part of the IPO.  Also included in the other segment is the impact of the affiliate reinsurance transactions, that were purchased by management for the benefit of all of the Company’s reporting segments. The Company does not allocate the cost nor the related benefit of these transactions to the reporting segments but rather records the impact of these transactions in the other segment. The Company manages these exited lines of business by focusing on the net earned premiums and the underwriting gain/(loss).

 

The following table provides underwriting gain/(loss) by line of business for the other segment.

 

 

 

Three Months Ended
March 31,

 

(in millions of U.S. dollars)

 

2004

 

2003

 

Underwriting gain/(loss):

 

 

 

 

 

Equity layer credit protection

 

$

2.4

 

$

1.1

 

Trade credit reinsurance

 

1.3

 

(1.4

)

Title reinsurance

 

0.7

 

1.0

 

Life accident and health reinsurance

 

 

(0.5

)

Auto residual value reinsurance

 

(2.5

)

(2.5

)

Affiliate reinsurance

 

 

(2.7

)

Total

 

$

1.9

 

$

(5.0

)

 

The following table provides the lines of business from which the Company’s other reporting segment derives its net earned premiums:

 

 

 

Three Months Ended
March 31,

 

(in millions of U.S. dollars)

 

2004

 

2003

 

Net earned premiums:

 

 

 

 

 

Other:

 

 

 

 

 

Equity layer credit protection

 

$

5.4

 

$

12.6

 

Trade credit reinsurance

 

9.3

 

10.7

 

Title reinsurance

 

2.5

 

1.2

 

Auto residual value reinsurance

 

 

0.7

 

Life, accident and health reinsurance

 

 

 

Affiliate reinsurance

 

 

(2.8

)

Total

 

$

17.2

 

$

22.4

 

 

13



 

 

10. Subsidiary information

 

The following tables present, in thousands of U.S. dollars, the condensed combined financial information for Assured Guaranty Ltd., Assured Guaranty US Holdings Inc.  and our other subsidiaries at March 31, 2004 and December 31, 2003 and for the three months ended March 31, 2004 and 2003.

 

CONDENSED COMBINING BALANCE SHEET

at March 31, 2004

 

 

 

Assured
Guaranty Ltd.
(Parent Company)

 

Assured
Guaranty US
Holdings
Inc.

 

Other
Subsidiaries

 

Combining
Adjustments

 

Assured
Guaranty Ltd.
(Combined)

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Total investments and cash

 

$

 

$

1,239,968

 

$

1,016,590

 

$

 

$

2,256,558

 

Investments in subsidiaries

 

1,584,516

 

 

 

(1,584,516

)

 

Deferred acquisition costs

 

 

150,775

 

32,042

 

3,450

 

186,267

 

Reinsurance recoverable

 

 

 

106,131

 

 

106,131

 

Goodwill

 

 

85,417

 

 

 

85,417

 

Premiums receivable

 

 

27,607

 

7,526

 

 

35,133

 

Other

 

12

 

42,229

 

42,544

 

(5,067

)

79,718

 

Total assets

 

$

1,584,528

 

$

1,545,996

 

$

1,204,833

 

$

(1,586,133

)

$

2,749,224

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholder’s equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unearned premium reserves

 

$

 

$

398,118

 

$

139,812

 

$

 

$

537,930

 

Reserve for losses and loss adjustment Expenses

 

 

111,860

 

319,437

 

 

431,297

 

Profit commissions payable

 

 

4,094

 

52,710

 

 

56,804

 

Deferred income taxes

 

 

87,303

 

(13,802

)

364

 

73,865

 

Long-term debt

 

 

 

 

75,000

 

75,000

 

Other

 

 

32,160

 

34,621

 

(2,526

)

64,255

 

Total liabilities

 

 

633,535

 

532,778

 

72,838

 

1,239,151

 

 

 

 

 

 

 

 

 

 

 

 

 

Total shareholder’s equity

 

1,584,528

 

912,461

 

672,055

 

(1,658,971

)

1,510,073

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholder’s equity

 

$

1,584,528

 

$

1,545,996

 

$

1,204,833

 

$

(1,586,133

)

$

2,749,224

 

 

14



 

CONDENSED COMBINING BALANCE SHEET

at DECEMBER 31, 2003

 

 

 

Assured

 

Assured

 

 

 

 

 

Assured

 

 

 

Guaranty Ltd.

 

Guaranty US

 

Other

 

Combining

 

Guaranty Ltd.

 

 

 

(Parent Company)

 

Holdings Inc.

 

Subsidiaries

 

Adjustments

 

(Combined)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Total investments and cash

 

$

 

$

1,205,536

 

$

1,016,563

 

$

 

$

2,222,099

 

Investment in subsidiaries

 

1,512,068

 

 

 

(1,512,068

)

 

Deferred acquisition costs

 

 

146,926

 

28,297

 

3,450

 

178,673

 

Reinsurance recoverable

 

 

 

122,124

 

 

122,124

 

Goodwill

 

 

87,062

 

 

 

87,062

 

Premiums receivable

 

 

28,434

 

155,631

 

(5,068

)

178,997

 

Other

 

12

 

36,227

 

45,731

 

(13,058

)

68,912

 

Total assets

 

$

1,512,080

 

$

1,504,185

 

$

1,368,346

 

$

(1,526,744

)

$

2,857,867

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholder’s equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unearned premium reserves

 

$

 

$

389,027

 

$

240,367

 

$

(3,965

)

$

625,429

 

Reserve for losses and loss adjustment expenses

 

 

106,252

 

416,341

 

 

522,593

 

Profit commissions payable

 

 

4,007

 

67,230

 

 

71,237

 

Deferred income taxes

 

 

78,054

 

(22,781

)

364

 

55,637

 

Long-term debt

 

 

 

 

75,000

 

75,000

 

Other

 

 

47,719

 

34,247

 

(11,619

)

70,347

 

Total liabilities

 

 

625,059

 

735,404

 

59,780

 

1,420,243

 

 

 

 

 

 

 

 

 

 

 

 

 

Total shareholder’s equity

 

1,512,080

 

879,126

 

632,942

 

(1,586,524

)

1,437,624

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholder’s equity

 

$

1,512,080

 

$

1,504,185

 

$

1,368,346

 

$

(1,526,744

)

$

2,857,867

 

 

15



 

CONDENSED COMBINING STATEMENT OF OPERATIONS

at March 31, 2004

 

 

 

Assured
Guaranty Ltd.
(Parent Company)

 

Assured
Guaranty US
Holdings Inc.

 

Other
Subsidiaries

 

Combining
Adjustments

 

Assured
Guaranty Ltd.
(Combined)

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Net premiums written

 

$

 

$

47,565

 

$

(54,435

)

$

 

$

(6,871

)

Net premiums earned

 

 

37,933

 

48,733

 

 

86,667

 

Net investment income

 

 

12,742

 

11,643

 

 

24,385

 

Net realized gains

 

 

 

1,182

 

 

1,182

 

Unrealized gains (losses) on derivative financial instruments

 

 

9,931

 

(2,581

)

 

7,350

 

Other revenues

 

 

 

1,218

 

(687

)

532

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

 

$

60,606

 

$

60,195

 

$

(687

)

$

120,115

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

 

 

Loss and loss adjustment expenses

 

$

 

$

8,713

 

$

14,955

 

$

 

$

23,668

 

Acquisition costs and other operating expenses

 

 

20,455

 

12,724

 

(687

)

32,493

 

Other

 

 

1,595

 

(1,228

)

1,434

 

1,801

 

 

 

 

 

 

 

 

 

 

 

 

 

Total expenses

 

$

 

$

30,763

 

$

26,452

 

$

748

 

$

57,962

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

$

 

$

29,843

 

$

33,744

 

$

(1,434

)

$

62,153

 

 

 

 

 

 

 

 

 

 

 

 

 

Total provision for income taxes

 

 

8,428

 

7,334

 

(502

)

15,260

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

 

$

21,415

 

$

26,410

 

$

(932

)

$

46,893

 

 

16



 

CONDENSED COMBINING STATEMENT OF OPERATIONS

at March 31, 2003

 

 

 

Assured
Guaranty Ltd.
(Parent Company)

 

Assured
Guaranty US
Holdings Inc.

 

Other
Subsidiaries

 

Combining
Adjustments

 

Assured
Guaranty Ltd.
(Combined)

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Net premiums written

 

$

 

$

52,345

 

$

51,728

 

$

 

$

104,073

 

Net premiums earned

 

 

35,010

 

28,578

 

 

63,588

 

Net investment income

 

 

11,451

 

12,650

 

 

24,101

 

Net realized gains

 

 

1,363

 

540

 

 

1,903

 

Unrealized gains (losses) on derivative financial instruments

 

 

(4,440

)

1,234

 

2,096

 

(1,110

)

Other revenues

 

 

221

 

754

 

(419

)

557

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

 

$

43,605

 

$

43,756

 

$

1,678

 

$

89,039

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

 

 

Loss and loss adjustment expenses

 

$

 

$

8,035

 

$

15,153

 

$

 

$

23,188

 

Acquisition costs and other operating expenses

 

 

15,377

 

9,689

 

1,279

 

26,345

 

Other

 

 

(235

)

337

 

1,434

 

1,536

 

 

 

 

 

 

 

 

 

 

 

 

 

Total expenses

 

$

 

$

23,177

 

$

25,179

 

$

2,713

 

$

51,069

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

$

 

$

20,428

 

$

18,577

 

$

(1,035

)

$

37,970

 

 

 

 

 

 

 

 

 

 

 

 

 

Total provision for income taxes

 

 

4,997

 

1,585

 

(363

)

6,219

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

 

$

15,431

 

$

16,992

 

$

(672

)

$

31,751

 

 

17



 

CONDENSED COMBINING STATEMENT OF CASH FLOWS

at March 31, 2004

 

 

 

Assured
Guaranty Ltd.
(Parent Company)

 

Assured
Guaranty US
Holdings Inc.

 

Other
Subsidiaries

 

Combining
Adjustments

 

Assured
Guaranty Ltd.
(Combined)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by operating activities

 

$

 

$

24,839

 

$

(14,609

)

$

 

$

10,230

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

 

Purchases

 

$

 

$

(46,882

)

$

(125,939

)

$

 

$

(172,821

)

Sales

 

 

20,816

 

158,822

 

 

179,638

 

Maturities

 

 

 

160

 

 

160

 

Other

 

 

6,214

 

(20,878

)

 

(14,664

)

 

 

 

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

 

(19,852

)

12,165

 

 

(7,687

)

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

 

 

Dividends paid

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in financing activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

 

4,987

 

(2,444

)

 

2,543

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of year

 

 

22,075

 

10,290

 

 

32,365

 

Effect of exchange rate changes

 

 

 

 

1,346

 

 

1,346

 

Cash and cash equivalents at end of year

 

$

 

$

27,062

 

$

9,192

 

$

 

$

36,254

 

 

18



 

CONDENSED COMBINING STATEMENT OF CASH FLOWS

at MARCH 31, 2003

 

 

 

Assured
Guaranty Ltd.
(Parent Company)

 

Assured
Guaranty US
Holdings Inc.

 

Other
Subsidiaries

 

Combining
Adjustments

 

Assured
Guaranty Ltd.
(Combined)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash flows from operating activities

 

$

 

$

21,908

 

$

452

 

$

 

$

22,360

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

 

 

 

 

 

Purchases

 

 

(82,138

)

(135,295

)

 

(217,433

)

Sales

 

 

59,844

 

126,175

 

 

186,019

 

Maturities

 

 

 

3,180

 

 

3,180

 

Other

 

 

(21

)

8,779

 

 

8,758

 

 

 

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

 

(22,315

)

2,839

 

 

(19,476

)

 

 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

 

Dividends paid

 

 

(2,000

)

 

 

(2,000

)

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in financing activities

 

 

(2,000

)

 

 

(2,000

)

 

 

 

 

 

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalants

 

 

(2,407

)

3,291

 

 

884

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of year

 

 

3,301

 

6,144

 

 

9,445

 

Effect of exchange rate changes

 

 

 

2,017

 

 

2,017

 

Cash and cash equivalents at end of year

 

$

 

$

894

 

$

11,452

 

$

 

$

12,346

 

 

11.    Subsequent Events

 

On May 18, 2004, Assured Guaranty US Holdings Inc., a subsidiary of the Company, issued $200.0 million of 7.0% senior notes due in 2034. The proceeds of the offering were used to repay a $200.0 million promissory note, established as part of the IPO related formation transactions, issued to a subsidiary of ACE prior to the Company’s IPO in April 2004.  The coupon on the senior notes is 7.0%, however, the effective rate will be approximately 6.2%, taking into account the effect of a treasury hedge executed by the Company in March 2004.  These senior notes are fully and unconditionally guaranteed by Assured Guaranty.

 

On April 15 , 2004, the Company sold 100% of the common stock of its subsidiary, ACE Capital Title Reinsurance Company, to ACE Bermuda Insurance Ltd, a subsidiary of ACE for $39.3 million.

 

On April 28, 2004, as part of the IPO, AGRO commuted its remaining auto residual value reinsurance business and transferred assets with a market value of $108.3 million to a subsidiary of ACE.  This transaction will not have a material impact on our results of operations, liquidity or financial condition.

 

19



 

Item 2.  Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

 

Forward-Looking Statements

 

Materials in this Form 10-Q may contain information that includes or is based upon forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements give Assured Guaranty’s expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current facts and relate to future operating or financial performance.

 

Any or all of Assured Guaranty’s forward-looking statements here or in other publications may turn out to be wrong and are based on current expectations and the current economic environment. Assured Guaranty’s actual results may vary materially, and there are no guarantees about the performance of our securities. Among factors that could cause actual results to differ materially are: (1) rating agency action such as a ratings downgrade; (2) difficulties with the execution of the Company’s new business strategy; (3) a significant reduction in the amount of reinsurance ceded by one or more of our principal ceding companies; (4) developments in the world’s financial and capital markets; (5) more severe losses or more frequent losses associated with products affecting the adequacy of the Company’s loss reserve; (6) changes in regulation or tax laws; (7) the Company’s dependence on customers; (8) decreased demand or increased competition; (9) loss of key personnel; (10) the effects of mergers, acquisitions and divestitures; (11) changes in accounting policies or practices and (12) changes in general economic conditions, as well as management’s response to these factors. Assured Guaranty is not obligated to publicly correct or update any forward-looking statement if we later become aware that it is not likely to be achieved, except as required by law. You are advised, however, to consult any further disclosures we make on related subjects in Assured Guaranty’s reports filed with the Securities and Exchange Commission.

 

Executive Summary

 

On April 28, 2004, subsidiaries of ACE Limited (“ACE”), completed an initial public offering (“IPO”) of 49,000,000 common shares of their wholly-owned subsidiary, Assured Guaranty Ltd. (“Assured Guaranty” or the “Company”, formerly AGC Holdings Ltd.).  The Company’s common shares are traded on the New York Stock Exchange under the symbol AGO. This offering raised approximately $840.1 million in net proceeds, all of which went to the selling shareholders.

 

We are a Bermuda-based company providing credit enhancement products to the municipal finance, structured finance and mortgage markets. We apply our credit expertise, risk management skills and capital markets experience to develop insurance, reinsurance and credit derivative products that meet the credit enhancement needs of our customers. We market our products directly to and through financial institutions, serving the U.S. and international markets.  Information about Assured Guaranty is available through our web site http://www.assuredguaranty.com.  In addition, our press releases and filings with the Securities and Exchange Commission are available free of charge on the investor information portion of our web site.  The information on our web site is not a part of this report.

 

Our financial results include three operating segments: financial guaranty direct, financial guaranty reinsurance and mortgage guaranty. For financial reporting purposes, we have a fourth segment, which we refer to as other. The other segment consists of a number of businesses that we have exited, including equity layer credit protection, trade credit reinsurance, title reinsurance, life, accident and health reinsurance (“LA&H”) and auto residual value reinsurance. Because we exited some of these businesses after March 31, 2004, our results of operations for the quarter ended March 31, 2004 will reflect the results of operations of these businesses through the date as of which we exited them.

 

We derive our revenues principally from premiums from our insurance, reinsurance and credit derivative businesses, net investment income, net realized gains and losses from our investment portfolio and unrealized gains and losses on derivative financial instruments. Our premiums are a function of the

 

20



 

amount and type of contracts we write as well as prevailing market prices. We receive premiums on an upfront basis when the policy is issued or the contract is executed and/or on an installment basis over the life of the applicable transaction.

 

Our investment income is a function of our invested assets and the yield that we earn on those assets. The investment yield will be a function of market interest rates at the time of investment as well as the type, credit quality and maturity of our invested assets. In addition, we could realize capital gains or losses on securities in our investment portfolio as a result of changing market conditions, including changes in market interest rates, and changes in the credit quality of our invested assets.

 

Unrealized gains and losses on derivative financial instruments are a function of changes in the estimated fair value of our credit derivative contracts. We expect these unrealized gains and losses to fluctuate primarily based on changes in credit spreads and the credit quality of the referenced entities. We generally hold these derivative contracts to maturity. Where we hold a derivative contract to maturity, the cumulative unrealized gains and losses will net to zero if we incur no credit losses on that contract.

 

Our expenses primarily consist of losses and loss adjustment expenses (“LAE”), profit commission expense, acquisition costs, operating expenses, interest expense and income taxes. Losses and LAE will be a function of the amount and types of business we write. Losses and LAE are based upon estimates of the ultimate aggregate losses inherent in the portfolio. The risks that we will take have a low expected frequency of loss and generally will be investment grade at the time we accept the risk. Profit commission expense represents payments made to ceding companies generally based on the profitability of the business reinsured by us. Acquisition costs are related to the production of new business. Certain acquisition costs are deferred and recognized over the period in which the related premiums are earned. Operating expenses consist primarily of salaries and other employee-related costs. These costs do not vary with the amount of premiums written. Interest expense is a function of outstanding debt and the contractual interest rate related to that debt. Income taxes are a function of our profitability and the applicable tax rate in the various jurisdictions in which we do business.

 

In connection with the IPO, we have entered, or will enter, into several reinsurance agreements with subsidiaries of ACE that are considered retroactive reinsurance contracts. Under applicable accounting rules related to retroactive reinsurance, the Company would not be able to recognize a reinsurance recoverable on future adverse loss development, if applicable, until the Company paid the underlying loss and the Company is reimbursed by ACE. This difference in timing will cause our results of operations to otherwise be lower during the period in which, if at all, we recognize a loss for adverse development on one of these agreements, notwithstanding the reinsurance, and will be recaptured through income in the period in which we actually pay the underlying loss.

 

21



 

Combined Results of Operations

 

 

 

Three Months Ended
March 31,

 

 

 

2004

 

2003

 

 

 

($ in millions)

 

Revenues

 

 

 

 

 

Gross written premiums

 

$

(1.5

)

$

112.7

 

Ceded premiums

 

5.3

 

8.7

 

Net written premiums

 

(6.9

)

104.1

 

(Increase)/decrease in net unearned premium reserves

 

93.5

 

(40.5

)

Net earned premiums

 

86.7

 

63.6

 

Net investment income

 

24.4

 

24.1

 

Net realized investment gains

 

1.2

 

1.9

 

 

 

 

 

 

 

Unrealized gains (losses) on derivative financial instruments

 

7.4

 

(1.1

)

Other income

 

0.5

 

0.6

 

Total revenues

 

120.1

 

89.0

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

Loss and loss adjustment expenses

 

$

23.7

 

$

23.2

 

Profit commissions expense

 

5.5

 

3.0

 

Acquisition costs

 

13.1

 

11.8

 

Other operating expenses

 

12.6

 

11.6

 

Goodwill impairment

 

1.6

 

 

Interest expense

 

1.4

 

1.4

 

Total expenses

 

58.0

 

51.1

 

 

 

 

 

 

 

Income before provision for income taxes

 

62.2

 

38.0

 

Provision/(benefit) for income taxes

 

 

 

 

 

Current

 

2.2

 

(2.0

)

Deferred

 

13.1

 

8.2

 

Total provision for income taxes

 

15.3

 

6.2

 

Net income

 

$

46.9

 

$

31.8

 

 

Underwriting Gain (Loss) by Segment:

 

 

 

 

 

Financial guaranty direct

 

$

22.6

 

$

10.0

 

Financial guaranty reinsurance

 

5.2

 

6.5

 

Mortgage guaranty

 

2.0

 

2.4

 

Other

 

1.9

 

(5.0

)

Total

 

$

31.7

 

$

13.9

 

 

Net Income

 

Net income was $46.9 million and $31.8 million for the periods ended March 31, 2004 and 2003, respectively.  The increase of $15.1 million in 2004 as compared with 2003 is primarily due to an increase in net earned premiums.

 

22



 

Gross Written Premiums

 

 

 

 

Three Months Ended
March 31,

 

Gross Written Premiums

 

2004

 

2003

 

 

 

($ in millions)

 

Financial guaranty direct

 

$

25.6

 

$

14.0

 

Financial guaranty reinsurance

 

52.4

 

29.8

 

Mortgage guaranty

 

14.0

 

8.1

 

Other

 

(93.6

)

60.9

 

Total

 

$

(1.5

)

$

112.7

 

 

Gross written premiums for the period ended March 31, 2004 were $(1.5) million compared with $112.7 million for the period ended March 31, 2003.  Gross premiums written in our other segment, which represents our exited lines of business, were reduced by $97.8 million in the quarter due to the accounting for the unwinding of equity layer credit protection products.  Partially offsetting this premium reduction was the recognition of $10.4 million of gross premiums written in the financial guaranty direct segment due to the closing out of transaction types in which we no longer participate.  The financial guaranty reinsurance and mortgage guaranty segments also had strong production this quarter, increasing 76% and 73%, respectively, as compared with the same quarter last year.

 

Net Earned Premiums

 

 

 

Three Months
EndedMarch 31,

 

Net Earned Premiums

 

2004

 

2003

 

 

 

($ in millions)

 

Financial guaranty direct

 

$

40.7

 

$

14.7

 

Financial guaranty reinsurance

 

20.4

 

16.9

 

Mortgage guaranty

 

8.4

 

9.6

 

Other

 

17.2

 

22.4

 

Total

 

$

86.7

 

$

63.6

 

 

Net earned premiums for the period ended March 31, 2004 increased $23.1 million, or 36%, compared with the same period of 2003.  Financial guaranty direct net earned premiums included $24.2 million associated with the closing out of transaction types that we do not expect to underwrite in the future.  Financial guaranty reinsurance net earned premiums were $20.4 million, up 21% from $16.9 million in the first quarter of 2003.  Included in this amount were $2.9 million of municipal bond refunding premiums, compared with $3.3 million in the first quarter of 2003.  Mortgage guaranty net earned premiums were $8.4 million, compared with $9.6 million in the first quarter of 2003, reflecting the run-off of our quota share mortgage guaranty reinsurance business.

 

Net Investment Income

 

Net investment income was $24.4 million and $24.1 million for the periods ended March 31, 2004 and 2003, respectively. Net investment income has remained relatively level across the periods as declining investment yields offset increasing investment balances. Average portfolio yields were 4.8% and 5.3% for the periods ended March 31, 2004 and 2003, respectively. The decrease in investment yields is due to declining market interest rates. Over this period the yield to maturity of the Lehman Aggregate Index, a commonly used benchmark for investment yields, declined to 3.9% as of March 31, 2004 from 4.2% as of December 31, 2003.

 

Net Realized Investment Gains

 

Net realized investment gains, principally from the sale of fixed maturity securities, were $1.2 million and $1.9 million for the periods ended March 31, 2004 and 2003. The Company had no write

 

23



 

downs of investments for other than temporary impairment losses for the periods ended March 31, 2004 and 2003. Included in net realized gains for the period ended March 31, 2004 is a write down of $1.3 million related to the Company’s exited title reinsurance business.  The investment related to this write down is included in the “other” assets caption on our balance sheets.  There was no such write down for the period ended March 31, 2003.  Net realized investment gains, net of related income taxes, were $0.8 million and $1.2 million for the periods ended March 31, 2004 and 2003, respectively.

 

Unrealized Gains (Losses) on Derivative Financial Instruments

 

Derivative financial instruments are recorded at fair value as required by FAS 133. We record part of the change in fair value in the loss and LAE reserves as well as unearned premium reserve. The fair value adjustment for the period ended March 31, 2004 was a $7.4 million gain as compared to a $1.1 million loss for the same period in 2003. The change in fair value is related to many factors but primarily due to tightening credit spreads.

 

The gain or loss created by the estimated fair value adjustment will rise or fall based on estimated market pricing and may not be an indication of ultimate claims. Fair value is defined as the amount at which an asset or liability could be bought or sold in a current transaction between willing parties. We generally plan to hold derivative financial instruments to maturity. Where we hold derivative financial instruments to maturity, these fair value adjustments would generally be expected to reverse resulting in no gain or loss over the entire term of the contract.

 

Loss and Loss Adjustment Expenses

 

 

 

Three Months
Ended March 31,

 

Loss and Loss Adjustment Expenses

 

2004