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 June 30, 2005

 

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

 

98-0429991

(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    ý    NO    o

 

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 par value) outstanding as of August 1, 2005 was 74,876,769.

 

 



 

ASSURED GUARANTY LTD.

 

INDEX TO FORM 10-Q

 

PART I. FINANCIAL INFORMATION

 

Item 1.

Financial Statements:

 

 

Consolidated Balance Sheets (unaudited) as of June 30, 2005 and December 31, 2004

 

 

Consolidated Statements of Operations and Comprehensive Income (unaudited) for the Three and Six Months Ended June 30, 2005 and 2004

 

 

Consolidated Statements of Shareholders’ Equity (unaudited) for Six Months Ended June 30, 2005

 

 

Consolidated Statements of Cash Flows (unaudited) for Six Months Ended June 30, 2005 and 2004

 

 

Notes to Consolidated Financial Statements (unaudited)

 

Item 2.

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

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

Item 4.

Controls and Procedures

 

PART II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

Item 3.

Defaults Upon Senior Securities

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

Item 5.

Other Information

 

Item 6.

Exhibits

 

 

2



 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Assured Guaranty Ltd.
Consolidated Balance Sheets
(in thousands of U.S. dollars except per share and share amounts)

(Unaudited)

 

 

 

June 30,

 

December 31,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Fixed maturity securities, at fair value (amortized cost: $1,985,790 in 2005 and $1,873,450 in 2004)

 

$

2,076,842

 

$

1,965,051

 

Short-term investments, at cost which approximates fair value

 

121,106

 

175,837

 

Total investments

 

2,197,948

 

2,140,888

 

Cash and cash equivalents

 

4,748

 

16,978

 

Accrued investment income

 

21,448

 

21,924

 

Deferred acquisition costs

 

188,194

 

186,354

 

Prepaid reinsurance premiums

 

13,803

 

15,204

 

Reinsurance recoverable on ceded losses

 

112,351

 

120,220

 

Loss recovery receivable

 

63,676

 

 

Premiums receivable

 

28,507

 

40,819

 

Goodwill

 

85,417

 

85,417

 

Unrealized gains on derivative financial instruments

 

34,471

 

43,901

 

Other assets

 

21,001

 

22,306

 

Total assets

 

$

2,771,564

 

$

2,694,011

 

 

 

 

 

 

 

Liabilities and shareholders’ equity

 

 

 

 

 

Liabilities

 

 

 

 

 

Unearned premium reserves

 

$

530,151

 

$

521,271

 

Reserves for losses and loss adjustment expenses

 

206,352

 

226,503

 

Profit commissions payable

 

45,421

 

61,671

 

Reinsurance balances payable

 

21,862

 

25,112

 

Current income taxes

 

28,407

 

 

Deferred income taxes

 

18,217

 

40,053

 

Funds held by Company under reinsurance contracts

 

53,771

 

50,768

 

Long-term debt

 

197,330

 

197,356

 

Other liabilities

 

50,545

 

43,665

 

Total liabilities

 

1,152,056

 

1,166,399

 

Commitments and contingencies

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Common stock ($0.01 par value, 500,000,000 shares authorized; 74,880,706 and 75,678,792 shares issued and outstanding in 2005 and 2004)

 

749

 

757

 

Treasury stock held in trust, at cost (436,000 shares outstanding)

 

(7,850

)

(7,850

)

Additional paid-in capital

 

884,389

 

894,219

 

Unearned stock grant compensation

 

(10,106

)

(6,729

)

Retained earnings

 

674,832

 

568,255

 

Accumulated other comprehensive income

 

77,494

 

78,960

 

Total shareholders’ equity

 

1,619,508

 

1,527,612

 

Total liabilities and shareholders’ equity

 

$

2,771,564

 

$

2,694,011

 

 

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

 

3



 

Assured Guaranty Ltd.
Consolidated Statements of Operations and Comprehensive Income
(in thousands of U.S. dollars except per share amounts)

(Unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

Revenues

 

 

 

 

 

 

 

 

 

Gross written premiums

 

$

40,470

 

$

64,355

 

$

118,567

 

$

62,812

 

Ceded premiums

 

(10,314

)

(94,298

)

(11,942

)

(99,626

)

Net written premiums

 

30,156

 

(29,943

)

106,625

 

(36,814

)

Decrease (increase) in net unearned premium reserves

 

18,108

 

20,613

 

(10,271

)

114,150

 

Net earned premiums

 

48,264

 

(9,330

)

96,354

 

77,336

 

Net investment income

 

23,668

 

23,456

 

46,800

 

47,841

 

Net realized investment gains

 

1,666

 

8,687

 

3,457

 

9,869

 

Unrealized (losses) gains on derivative financial instruments

 

(12,502

)

14,653

 

(9,430

)

22,003

 

Other income

 

(190

)

14

 

93

 

546

 

Total revenues

 

60,906

 

37,480

 

137,274

 

157,595

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Loss and loss adjustment expenses

 

(59,133

)

(60,008

)

(68,529

)

(36,340

)

Profit commission expense

 

3,345

 

4,847

 

4,332

 

10,334

 

Acquisition costs

 

11,713

 

8,437

 

21,929

 

21,544

 

Other operating expenses

 

14,487

 

26,608

 

28,995

 

39,229

 

Interest expense

 

3,410

 

2,546

 

6,706

 

3,980

 

Other expense

 

2,488

 

 

2,488

 

1,645

 

Total expenses

 

(23,690

)

(17,570

)

(4,079

)

40,392

 

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

84,596

 

55,050

 

141,353

 

117,203

 

Provision for income taxes

 

 

 

 

 

 

 

 

 

Current

 

46,385

 

5,248

 

51,468

 

7,427

 

Deferred

 

(28,539

)

6,686

 

(21,213

)

19,767

 

Total provision for income taxes

 

17,846

 

11,934

 

30,255

 

27,194

 

Net income

 

66,750

 

43,116

 

111,098

 

90,009

 

Other comprehensive income (loss), net of taxes

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) on fixed maturity securities arising during the year

 

22,127

 

(64,814

)

1,489

 

(49,969

)

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

 

(1,245

)

4,137

 

(2,746

)

7,512

 

Change in net unrealized gains on fixed maturity securities

 

20,882

 

(60,677

)

(1,257

)

(42,457

)

Cash flow hedge

 

(104

)

19,250

 

(209

)

19,250

 

Other comprehensive income (loss), net of taxes

 

20,778

 

(41,427

)

(1,466

)

(23,207

)

Comprehensive income

 

$

87,528

 

$

1,689

 

$

109,632

 

$

66,802

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.90

 

$

0.57

 

$

1.50

 

$

1.20

 

Diluted

 

$

0.90

 

$

0.57

 

$

1.49

 

$

1.20

 

Dividends per share

 

$

0.03

 

$

 

$

0.06

 

$

 

 

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

 

4



 

Assured Guaranty Ltd.
Consolidated Statements of Shareholders’ Equity
For Six Months Ended June 30, 2005
(in thousands of U.S. dollars except per share amounts)

(Unaudited)

 

 

 

Common
Stock

 

Treasury
Stock

 

Additional
Paid-in
Capital

 

Unearned
Stock Grant
Compensation

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Income

 

Total
Shareholders’
Equity

 

Balance, January 1, 2005

 

$

757

 

$

(7,850

)

$

894,219

 

$

(6,729

)

$

568,255

 

$

78,960

 

$

1,527,612

 

Net income

 

 

 

 

 

111,098

 

 

111,098

 

Dividends ($0.06 per share)

 

 

 

 

 

(4,521

)

 

(4,521

)

Restricted stock issuance, net

 

3

 

 

6,390

 

 

 

 

6,393

 

Common stock repurchases

 

(10

)

 

(19,004

)

 

 

 

(19,014

)

Share activity under option and incentive plans

 

(1

)

 

(1,275

)

 

 

 

(1,276

)

Tax benefit for options exercised

 

 

 

4,059

 

 

 

 

4,059

 

Cash flow hedge, net of tax of $(113)

 

 

 

 

 

 

(209

)

(209

)

Unrealized loss on fixed maturity securities, net of tax of $(572)

 

 

 

 

 

 

(1,257

)

(1,257

)

Unearned stock grant compensation, net

 

 

 

 

(3,377

)

 

 

(3,377

)

Balance, June 30, 2005

 

$

749

 

$

(7,850

)

$

884,389

 

$

(10,106

)

$

674,832

 

$

77,494

 

$

1,619,508

 

 

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

 

5



 

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

(Unaudited)

 

 

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

Operating activities

 

 

 

 

 

Net income

 

$

111,098

 

$

90,009

 

Adjustments to reconcile net income to net cash flows provided by (used in) operating activities:

 

 

 

 

 

Non-cash interest and operating expenses

 

3,349

 

4,833

 

Net amortization of premium on fixed maturity securities

 

3,460

 

4,752

 

Goodwill impairment

 

 

1,645

 

(Benefit) provision for deferred income taxes

 

(21,213

)

20,194

 

Net realized investment gains

 

(3,457

)

(5,563

)

Change in unrealized losses(gains) on derivative financial instruments

 

9,430

 

(22,003

)

Change in deferred acquisition costs

 

(1,840

)

(8,148

)

Change in accrued investment income

 

476

 

1,684

 

Change in premiums receivable

 

12,312

 

30,829

 

Change in due from affiliate

 

 

115,000

 

Change in prepaid reinsurance premiums

 

1,401

 

(14,166

)

Change in unearned premium reserves

 

8,880

 

(99,984

)

Change in loss recovery receivable

 

(63,676)

 

 

Change in reserves for losses and loss adjustment expenses, net

 

(15,532

)

(234,340

)

Change in profit commissions payable

 

(16,250

)

(13,973

)

Change in value of reinsurance business assumed

 

 

14,226

 

Change in funds held by Company under reinsurance contracts

 

3,003

 

42,405

 

Change in current income taxes

 

32,971

 

(4,081

)

Other

 

6,154

 

(36,555

)

Net cash flows provided by (used in) operating activities

 

70,566

 

(113,236

)

 

 

 

 

 

 

Investing activities

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

Purchases

 

(513,987

)

(312,051

)

Sales

 

388,644

 

392,885

 

Maturities

 

13,000

 

14,172

 

Sales (purchases) of short-term investments, net

 

54,731

 

(42,919

)

Net proceeds from sale of subsidiary

 

 

39,784

 

Net cash flows (used in) provided by investing activities

 

(57,612

)

91,871

 

 

 

 

 

 

 

Financing activities

 

 

 

 

 

Repurchases of common stock

 

(19,014

)

 

Dividends paid

 

(4,521

)

 

Share activity under options and incentive plans

 

(1,276

)

 

Net proceeds from issuance of senior notes

 

 

197,311

 

Repayment of note payable

 

 

(200,000

)

Proceeds from cash flow hedge

 

 

19,250

 

Net cash flows (used in) provided by financing activities

 

(24,811

)

16,561

 

Effect of exchange rate changes

 

(373

)

1,023

 

Decrease in cash and cash equivalents

 

(12,230

)

(3,781

)

Cash and cash equivalents at beginning of period

 

16,978

 

32,365

 

Cash and cash equivalents at end of period

 

$

4,748

 

$

28,584

 

 

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

 

6



 

Assured Guaranty Ltd.
Notes to Consolidated Financial Statements

June 30, 2005

(Unaudited)

 

1.  Business and Organization

 

On April 28, 2004, subsidiaries of ACE Limited (“ACE”), completed an initial public offering (“IPO”) of 49,000,000 of their 75,000,000 common shares, par value $0.01 per share, of Assured Guaranty Ltd. (the “Company”), formerly AGC Holdings Ltd.  Assured Guaranty Ltd.’s common shares are traded on the New York Stock Exchange under the symbol “AGO”. The IPO raised approximately $840.1 million in net proceeds, all of which went to the selling shareholders.  As part of the IPO, the Company and ACE entered into various agreements which govern various settlement issues.  As part of these agreements all pre-IPO intercompany receivables and payables were settled with ACE on June 10, 2004.  In connection with the IPO, the following transactions took place:

 

                  On April 15, 2004, Assured Guaranty Re Overseas Ltd. (“AGRO”)  (an indirect subsidiary of Assured Guaranty Ltd.)  sold 100% of the common stock of its subsidiary, ACE Capital Title Reinsurance Company (“ACTR”), to ACE Bermuda Insurance Ltd., a subsidiary of ACE, for $39.8 million. There was no gain or loss associated with the sale.

 

                  On April 28, 2004, 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 caused a $(6.5) million underwriting loss, offset by a $6.8 million realized gain from the asset transfer.

 

Assured Guaranty Ltd. is a Bermuda-based holding company which provides, through its operating subsidiaries, credit enhancement products to the public 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. Assured Guaranty Ltd. 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. Assured Guaranty Ltd. markets its products directly to and through financial institutions, serving the U.S. and international markets.  Assured Guaranty Ltd.’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 10.

 

Financial guaranty insurance provides an unconditional and irrevocable guaranty that protects the holder of a financial obligation against non-payment of principal and interest when due. Financial guaranty insurance may be issued to the holders of the insured obligations at the time of issuance of those obligations, or may be issued in the secondary market to holders of public bonds and structured securities.  A loss event occurs upon existing or anticipated credit deterioration, while a payment under a policy occurs when the insured obligation defaults.  This requires the Company to pay the required principal and interest when due in accordance with the underlying contract.  The principal types of obligations covered by the Company’s financial guaranty direct and financial guaranty assumed reinsurance businesses are structured finance obligations and public finance obligations. Because both businesses involve similar risks, the Company analyzes and monitors its financial guaranty direct portfolio and financial guaranty assumed reinsurance portfolio on a coordinated basis.

 

Mortgage guaranty insurance is a specialized class of credit insurance that provides protection to mortgage lending institutions against the default of borrowers on mortgage loans that, at the time of the advance, had a loan to value in excess of a specified ratio. Reinsurance in the mortgage guaranty insurance industry is used to increase the insurance capacity of the ceding company, to assist the ceding company in meeting applicable regulatory and rating agency requirements, to augment the financial strength of the ceding company, and to manage the ceding company’s risk profile.   The Company provides mortgage guaranty protection on an excess of loss basis.

 

7



 

The Company has participated in several lines of business that are reflected in its historical financial statements but that the Company exited in connection with the IPO, including equity layer credit protection, trade credit reinsurance, title reinsurance, life, accident and health and auto residual value reinsurance.  These lines of business make up the Company’s other segment.

 

2.  Basis of Presentation

 

The unaudited interim consolidated financial statements, which include the accounts of the Company, 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 statement of the Company’s financial condition, results of operations and cash flows for the periods presented.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates. These unaudited interim consolidated financial statements cover the three-month periods ended June 30, 2005 (“Second Quarter 2005”) and June 30, 2004 (“Second Quarter 2004”), and the six-month periods ended June 30, 2005 (“Six Months 2005”) and June 30, 2004 (“Six Months 2004”). Operating results for the three- and six-month periods ended June 30, 2005 and 2004 are not necessarily indicative of the results that may be expected for a full year.  Certain items in the prior year consolidated financial statements have been reclassified to conform with the current period presentation. These unaudited interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, filed with the Securities and Exchange Commission.

 

Amounts presented prior to April 28, 2004, the IPO date, were prepared on an historical combined basis, since Assured Guaranty Ltd. and its subsidiaries were included in the results of ACE. However, since the entities are the same for all periods presented, the financial statements have been prepared and reported on a consolidated basis.  This presentation has no impact on the Company’s results of operations or financial condition. Certain expenses reflected in the June 30, 2004 consolidated financial statements include allocations of corporate expenses incurred by ACE, related to general and administrative services provided to the Company, including tax consulting and preparation services, internal audit services and liquidity facility costs.

 

Certain of the Company’s subsidiaries are subject to U.S. income tax.  The provision for income taxes is calculated in accordance with Statement of Financial Accounting Standards (“FAS”) 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.  The Company’s tax sharing agreement is further discussed in Note 9.

 

3.  Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued FAS No. 123 (revised 2004), “Share-Based Payment” (“FAS 123R”). FAS 123R replaces FAS No.123, “Accounting for Stock-Based Compensation” (“FAS 123”) and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). As permitted by FAS 123, the Company currently accounts for share-based payments to employees using APB 25’s intrinsic value method and, as such, generally recognizes no compensation expense for employee stock options. Accordingly, the adoption of FAS 123R’s fair value method will impact the Company’s results of operations, although it will have no impact on its overall financial position. The impact of adoption of FAS 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted FAS 123R in prior periods, the impact of that standard would have approximated the impact of FAS 123 as described in the disclosure of pro forma net income and earnings per share in Note 7. FAS 123R also requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows

 

8



 

in periods after adoption. While the Company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in Six Months 2005 and Six Months 2004 for such excess tax deductions were $4.1 million and $5.4 million, respectively. In April 2005, the Securities and Exchange Commission delayed the effective date for adoption of FAS 123R for the Company until January 1, 2006.

 

In March 2004, the Emerging Issues Task Force (“EITF”) reached a final consensus on EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairments and its Application to Certain Investments” (“EITF 03-1”), which provides guidance on recognizing other-than-temporary impairments on several types of investments including debt securities classified as held-to-maturity and available-for-sale under FAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities”.  In June 2005, the FASB decided to rescind the guidance in paragraphs 10-20 of EITF 03-1. The disclosure requirements of EITF 03-1 remain in effect. These pronouncements will not materially effect the Company’s results of operations or financial position.

 

4.  Impact of Reinsurance Transactions

 

To limit its exposure on assumed risks, at the time of the IPO, the Company entered into certain proportional and non-proportional retrocessional agreements with other insurance companies, primarily subsidiaries of ACE, to cede a portion of the risk underwritten by the Company. In addition, the Company enters into reinsurance agreements with non-affiliated companies to limit its exposure to risk on an on-going basis.

 

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 amounts were as follows:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

(in thousands of U.S. dollars)

 

Premiums Written

 

 

 

 

 

 

 

 

 

Direct

 

$

20,942

 

$

14,118

 

$

44,697

 

$

(76,924

)

Assumed

 

19,528

 

50,237

 

73,870

 

139,736

 

Ceded

 

(10,314

)

(94,298

)

(11,942

)

(99,626

)

Net

 

$

30,156

 

$

(29,943

)

$

106,625

 

$

(36,814

)

 

 

 

 

 

 

 

 

 

 

Premiums Earned

 

 

 

 

 

 

 

 

 

Direct

 

$

16,806

 

$

12,932

 

$

38,036

 

$

30,446

 

Assumed

 

42,248

 

58,993

 

71,660

 

130,664

 

Ceded

 

(10,790

)

(81,255

)

(13,342

)

(83,774

)

Net

 

$

48,264

 

$

(9,330

)

$

96,354

 

$

77,336

 

 

 

 

 

 

 

 

 

 

 

Loss and Loss Adjustment Expenses

 

 

 

 

 

 

 

 

 

Direct

 

$

4,703

 

$

847

 

$

2,636

 

$

(7,676

)

Assumed

 

(71,385

)

15,117

 

(80,574

)

48,328

 

Ceded

 

7,549

 

(75,972

)

9,409

 

(76,992

)

Net

 

$

(59,133

)

$

(60,008

)

$

(68,529

)

$

(36,340

)

 

Loss and loss adjustment expenses of $(59.1) million in Second Quarter 2005, was the result of a third party settlement agreement that was reached during Second Quarter 2005, with two parties relating to a reinsurance claim incurred in 1998 and 1999, resulting in an accrual of $63.7 million.  We expect to receive the cash during August 2005.  During First Quarter 2005 the Company recovered $6.8 million relating to this same reinsurance claim.  These recoveries are shown in the statements of operations and comprehensive income in loss and loss adjusted expenses.  Recovery efforts relating to this and other claims are continuing. In addition, during First Quarter 2005, the Company recovered $1.1 million relating to its equity layer credit protection business, which was exited in connection with the IPO.

 

9



 

In connection with the IPO, the Company entered 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 the Company’s results of operations to otherwise be lower during the period in which, if at all, the Company recognizes a loss for adverse development on one of these agreements, notwithstanding the reinsurance, and will be recaptured through income in the period in which the Company actually recovers the underlying loss. For Second Quarter 2004, at the inception of these retroactive reinsurance contracts, ceded premiums written increased $92.5 million, ceded premiums earned increased $66.9 million and ceded loss and loss adjustment expenses increased $56.9 million.

 

For Six Months 2004 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 either through reinsurance or commutation the Company does not expect to underwrite in the future.

 

Reinsurance recoverable on ceded losses and LAE as of June 30, 2005 and December 31, 2004 were $112.4 million and $120.2 million, respectively, and were all related to our other segment. Of these amounts, $90.0 million and $97.8 million, respectively, related to reinsurance agreements with ACE.

 

For Second Quarter 2005, $9.7 million and $4.2 million of our gross written premiums was ceded by Ambac Assurance Corporation (“Ambac”) and MBIA Insurance Corporation (“MBIA”), respectively.  Also during Second Quarter 2005, Financial Security Assurance Inc. (“FSA”) ceded $10.4 million of gross written premiums, excluding $18.4 million of reassumption premiums related to our healthcare business described below in the section titled “Agreement with FSA.” For Second Quarter 2004, $17.1 million, $9.5 million and $6.7 million of our gross written premiums was ceded by FSA, Ambac and MBIA, respectively.

 

For Six Months 2005, $32.6 million, excluding the aforementioned $18.4 million of reassumption premiums related to our healthcare business, $20.4 million and $8.9 million of our gross written premiums was ceded by FSA, Ambac and MBIA, respectively.  For Six Months 2004, $45.1 million, $20.7 million and $16.6 million of our gross written premiums was ceded by FSA, Ambac and MBIA, respectively.

 

Agreement with FSA

 

During Second Quarter 2005, Assured Guaranty Corp. (“AGC”) and Assured Guaranty Re Ltd. (“AG Re”), two of our subsidiaries, entered into a reinsurance agreement with FSA pursuant to which substantially all of FSA’s financial guaranty risks previously ceded to AGC (the “Ceded Business”) were assumed by AG Re.  This agreement is effective as of January 1, 2005.   In connection with the transaction, AGC transferred liabilities of $169.0 million, consisting primarily of unearned premium reserves.  All profit and loss related items associated with this transfer were eliminated in consolidation, with the exception of profit commission expense, certain other operating expenses, and provision for income taxes.  Since this transaction transferred unearned premium reserve from AGC, a U.S. tax payer, to AG Re, a non-U.S. taxable entity, we released a deferred tax liability related to differences between the book and tax carrying amounts of unearned premium reserves which resulted in a tax benefit.  The total impact of all these items on net income was $3.7 million.  FSA has agreed it would release AGC from all liabilities with respect to the Ceded Business.  FSA and AG Re have agreed that AG Re shall assume substantially all of AGC’s liabilities with respect to the Ceded Business. FSA may receive a profit commission on the Ceded Business based on its future performance.

 

FSA has also reassumed from AG Re approximately $12.0 million of unearned premium reserves, net of ceding commissions, of healthcare related business with an approximate par value of $820.0 million.

 

10



 

5.  Commitments and Contingencies

 

Lawsuits arise in the ordinary course of the Company’s business. It is the opinion of the Company’s management, based upon the information available, that the expected outcome of these matters, individually or 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 a number of these items could have a material adverse effect on the Company’s results of operations or liquidity in a particular quarter or fiscal year.

 

In April 2005, AGC received a Notice of Order to Preserve (“Order”) from the Office of the Commissioner of Insurance, State of Georgia (“Commissioner”).  The Order was directed to “ACE Limited, and all affiliates” and requires the preservation of documents and other items related to “finite insurance” and a broad group of other insurance and reinsurance agreements.  Also in April, AGC, and numerous other insurers, received a subpoena from the Commissioner related to the “initial phase” of the Commissioner’s investigation into “finite-risk” transactions.  The subpoena requests information on AGC’s assumed and ceded reinsurance contracts in force during 2004.  AGC is cooperating with the Commissioner.

 

In the ordinary course of their respective businesses, certain of the Company’s subsidiaries assert claims in legal proceedings against third parties to recover losses paid in prior periods.  The amounts, if any, the Company will recover in these proceedings are uncertain, although recoveries in any one or more of these proceedings during any quarter or fiscal year could be material to the Company’s results of operations in that particular quarter or fiscal year.  See Note 4 for information on reinsurance recoveries due to the Company’s legal proceedings against third parties.

 

The Company is party to reinsurance agreements with most of the major 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 and to maintain a specified financial strength rating for the particular insurance subsidiary 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 after which the Company would be released from liability with respect to the ceded business. 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 Facilities

 

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

 

Senior Notes

 

On May 18, 2004, Assured Guaranty US Holdings Inc., a subsidiary of the Company, issued $200.0 million of 7.0% Senior Notes due 2034 for net proceeds of $197.3 million. The proceeds of the offering were used to repay substantially all of a $200.0 million promissory note issued to a subsidiary of ACE in April 2004 as part of the IPO related formation transactions.  The coupon on the Senior Notes is 7.0%, however, the effective rate will be approximately 6.4%, taking into account the effect of a cash flow hedge executed by the Company in March 2004.  The Company recorded interest expense, net of amortized gain on the cash flow hedge of $3.3 million and $1.6 million in Second Quarter 2005 and 2004, respectively.  The Company recorded interest expense, net of amortized gain on the cash flow hedge of $6.7 million and $1.6 million in Six Months 2005 and 2004, respectively.  These Senior Notes are fully and unconditionally guaranteed by Assured Guaranty Ltd.

 

11



 

Credit Facilities

 

$300.0 million Credit Facility

 

On April 15, 2005, Assured Guaranty Ltd. and certain of its subsidiaries entered into a $300.0 million three-year unsecured revolving credit facility (the “$300.0 million credit facility”) with a syndicate of banks, for which ABN AMRO Incorporated and Bank of America, N.A. acted as lead arrangers and KeyBank National Association (“KeyBank”) acted as syndication agent.  Under the $300.0 million credit facility, each of AGC, Assured Guaranty (UK) Ltd. (“AG (UK)”), a subsidiary of AGC organized under the laws of the United Kingdom, and subject to AG Re and AGRO entering into the guaranties discussed below, Assured Guaranty Ltd., AG Re and AGRO are entitled to request the banks to make loans to such borrower or to request that letters of credit be issued for the account of such borrower.  The $300.0 million credit facility replaced (1) the $250.0 million credit facility and (2)  the Letter of Credit Agreement, both discussed below.

 

The proceeds of the loans and letters of credit are to be used for the working capital and other general corporate purposes of the borrowers and to support reinsurance transactions.

 

At the closing of the $300.0 million credit facility, (i) AGC guaranteed the obligations of AG (UK) under such facility, (ii) Assured Guaranty Ltd. guaranteed the obligations of AG Re and AGRO under such facility and agreed that, if the Company Consolidated Assets (as defined in the related credit agreement) of AGC and its subsidiaries were to fall below $1.2 billion, it would, within 15 days, guarantee the obligations of AGC and AG (UK) under such facility and (iii) Assured Guaranty Overseas US Holdings Inc., as a Material Non-AGC Subsidiary (as defined in the related credit agreement), guaranteed the obligations of Assured Guaranty Ltd., AG Re and AGRO under such facility.  It was further agreed that none of Assured Guaranty Ltd., AG Re or AGRO would be able to borrow under the $300.0 million credit facility until AG Re and AGRO, as Material Non-AGC Subsidiaries, have both guaranteed the obligations of the other and of Assured Guaranty Ltd. under such facility.

 

The $300.0 million credit facility’s financial covenants require that Assured Guaranty Ltd. (a) maintain a minimum net worth of $1.2 billion, (b) maintain an interest coverage ratio of at least 2.5:1, and (c) maintain a maximum debt-to-capital ratio of 30%.  In addition, the $300.0 million credit facility requires that AGC: (x) maintain qualified statutory capital of at least 80% of its statutory capital as of the fiscal quarter prior to the closing date of the facility and (y) maintain a ratio of aggregate net par outstanding to qualified statutory capital of not more than 150:1.  Furthermore, the $300.0 million credit facility contains restrictions on Assured Guaranty Ltd. and its subsidiaries, including, among other things, in respect of their ability to incur debt, permit liens, become liable in respect of guaranties, make loans or investments, pay dividends or make distributions, dissolve or become party to a merger, consolidation or acquisition, dispose of assets or enter into affiliate transactions.  Most of these restrictions are subject to certain minimum thresholds and exceptions.  A default by one borrower will give rise to a right of the lenders to terminate the facility and accelerate all amounts then outstanding.  As of June 30, 2005, Assured Guaranty was in compliance with all of those financial covenants.

 

As of June 30, 2005, no amounts were outstanding under this facility nor have there been any borrowings under this facility.

 

$250.0 million Credit Facility

 

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, N.A. acted as co-arrangers. Each of Assured Guaranty, AGC and AG (UK), was a party, as borrower. The $250.0 million credit facility was terminated and replaced by the $300.0 million credit facility discussed above.

 

The $250.0 million credit facility was a 364-day facility available for general corporate purposes, and any amounts outstanding under the facility at its expiration were due and payable one year following the facility’s expiry. As of December 31, 2004, no amounts were outstanding under this facility nor had there been any borrowings under the life of this facility.  Under the $250.0 million credit facility, AGC could borrow up to $250.0 million, Assured Guaranty Ltd. had a borrowing limit not to exceed $50.0 million, and AG (UK) had a borrowing limit not to exceed

 

12



 

$12.5 million. The $250.0 million credit facility’s financial covenants required that Assured Guaranty: (a) maintain a minimum net worth of 75% of its pro forma net worth (determined as of the first required reporting date under the facility), (b) maintain an interest coverage ratio of at least 2.5:1, and (c) maintain a maximum debt-to-capital ratio of 30%. Assured Guaranty was in compliance with all of those financial covenants. In addition, the $250.0 million credit facility required that AGC: (a) maintain qualified statutory capital of at least 80% of its statutory capital as of the fiscal quarter prior to the closing date of the facility, (b) maintain a ratio of aggregate net par outstanding to qualified statutory capital of not more than 150:1, and (c) maintain a maximum debt-to-capital ratio of 35%. AGC was in compliance with all of those financial covenants.

 

Letter of Credit Agreement

 

On November 8, 2004, Assured Guaranty Ltd., AG Re and AGRO entered into a standby letter of credit agreement (the “LOC Agreement”) with KeyBank National Association (“KeyBank”). Under the LOC Agreement, KeyBank agreed to issue up to $50.0 million in letters of credit on our behalf. The obligations of Assured Guaranty Ltd., AG Re and AGRO under the LOC Agreement were joint and several. The letters of credit were used to satisfy AG Re’s or AGRO’s obligations under certain reinsurance agreements and for general corporate purposes. Under the LOC Agreement, KeyBank issued two letters of credit, both on behalf of AGRO, with an aggregate stated amount of approximately $20.7 million.  The parties to the LOC Agreement have agreed that no additional letters of credit would be issued, extended or renewed from and after the date of the closing of the $300.0 million credit facility and letters of credit that were outstanding on such date will, unless cancelled and surrendered by the respective beneficiaries thereof, remain outstanding until their respective stated expiration dates of December 31, 2005.  The LOC Agreement contains covenants that limit debt, liens, guaranties, loans and investments, dividends, liquidations, mergers, consolidations, acquisitions, sales of assets or subsidiaries and affiliate transactions.  Most of these restrictions were subject to certain minimum thresholds and exceptions. The LOC Agreement also contained financial covenants that required the Company: (i) to maintain the ratio of consolidated debt to total capitalization at not greater than 0.30 to 1.0; (ii) to maintain consolidated net worth of at least seventy-five percent (75%) of its consolidated net worth as of June 30, 2004; and (iii) to maintain the consolidated interest coverage ratio for any test period ending on the last day of a fiscal quarter at not less than 2.50 to 1.0. In addition, the LOC Agreement provided that the obligations of KeyBank to issue letters of credit may be terminated, and our obligations under the agreement may be accelerated, upon an event of default.  As of December 31, 2004, no amounts were payable under any letter of credit issued under this facility. The LOC Agreement expired on April 28, 2005 and was replaced by the $300.0 million credit facility discussed above.

 

Non-Recourse Credit Facility

 

AGC is also party to a non-recourse credit facility with a syndicate of banks which provides up to $175.0 million specifically designed to provide rating agency-qualified capital to further support AGC’s claims paying resources. The facility expires in December 2010 and is subject to annual extension for an additional term of one year in order to maintain its term at seven periods. As of June 30, 2005 and December 31, 2004, no amounts were outstanding under this facility nor have there been any borrowings under the life of this facility.

 

The Company’s failure to comply with certain covenants under our credit facilities could, subject to grace periods in the case of certain covenants, result in an event of default.  This could require the Company to repay any outstanding borrowings in an accelerated manner.

 

Committed Capital Securities

 

On April 8, 2005, AGC entered into four separate agreements with four different unaffiliated custodial trusts pursuant to which AGC may, at its option, cause each of the custodial trusts to purchase up to $50.0 million of perpetual preferred stock of AGC.  The custodial trusts were created as a vehicle for providing capital support to AGC by allowing AGC to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option.  If the put options were exercised, AGC would receive $200.0 million in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose including the payment of claims.  Initially, all of the CCS Securities were issued to a special purpose pass-through trust (the “Pass-Through Trust”).  The Pass-Through Trust is a newly created statutory trust organized under the Delaware

 

13



 

Statutory Trust Act formed for the purposes of (i) issuing $200,000,000 of Pass-Through Trust Securities to qualified institutional buyers within the meaning of Rule 144A under the Securities Act of 1933, as amended, (ii) investing the proceeds from the sale of the Pass-Through Trust Securities in, and holding, the CCS Securities issued by the Custodial Trusts and (iii) entering into related agreements.  Neither the Pass-Through Trust nor the Custodial Trusts are consolidated in Assured Guaranty’s financial statements.

 

AGC incurred $2.0 million of investment banking fees associated with the committed capital securities in Second Quarter 2005. In addition, AGC pays approximately $0.3 million in put option premiums on a monthly basis. These expenses are presented in the Company’s consolidated statements of operations and comprehensive income under other expenses.

 

7. Employee Benefit Plans and Stock Based Compensation

 

Employee Benefit Plans

 

Prior to the IPO, Assured Guaranty Ltd.’s officers and employees participated in ACE’s long-term incentive plans providing options to purchase ACE ordinary shares and restricted share unit awards.

 

Upon completion of the IPO, any unvested options to purchase ACE ordinary shares granted to the Company’s officers or employees under the ACE employee long term incentive plan immediately vested and any unvested restricted ACE ordinary shares were forfeited. These officers and employees generally had 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 the Company of approximately $3.5 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 a trustee, for the value of the restricted ACE ordinary shares forfeited by all of the Company’s officers and employees. These pre-tax charges took place during Second Quarter 2004.  The trust purchased common shares of Assured Guaranty Ltd. 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. This transaction is reported in shareholders’ equity as treasury stock and unearned stock grant compensation.  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. (The forfeiture restriction has been waived for one former employee of the Company.)  Any forfeited common shares will be delivered to us. The trustees do not have any beneficial interest in the trust. Since completion of the IPO, the Company’s officers and employees are no longer eligible to participate in ACE’s employee 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 shareholders’ equity.

 

Stock Based Compensation

 

The Company accounts for stock-based compensation plans in accordance with APB 25 and related interpretations. 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 123. In December 2002, the FASB issued FAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“FAS 148”). 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 shareholders’ equity. The unearned stock grant compensation is amortized into income ratably over the vesting period.

 

14



 

The following table outlines the Company’s net income, basic and diluted earnings per share for the three- and six-month periods ended June 30, 2005 and 2004, had the compensation expense been determined in accordance with the fair value method recommended in FAS 123.

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

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

 

Net income as reported

 

$

66,750

 

$

43,116

 

$

111,098

 

$

90,009

 

Add: Stock-based compensation expense due to accelerated vesting of ACE awards included in reported net income, net of income tax

 

 

9,652

 

 

9,652

 

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

 

1,445

 

849

 

2,653

 

1,331

 

Deduct: Compensation expense, net of income tax

 

(2,394

)

(11,097

)

(4,701

)

(11,578

)

Pro forma net income

 

$

65,801

 

$

42,520

 

$

109,050

 

$

89,414

 

 

 

 

 

 

 

 

 

 

 

Basic Earnings Per Share:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.90

 

$

0.57

 

$

1.50

 

$

1.20

 

Pro forma

 

$

0.89

 

$

0.57

 

$

1.47

 

$

1.19

 

Diluted Earnings Per Share:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.90

 

$

0.57

 

$

1.49

 

$

1.20

 

Pro forma

 

$

0.89

 

$

0.57

 

$

1.46

 

$

1.19

 

 

8. Earnings Per Share

 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

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

 

Net income as reported

 

$

66,750

 

$

43,116

 

$

111,098

 

$

90,009

 

Basic shares(1)

 

73,813

 

75,000

 

74,134

 

75,000

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock awards

 

281

 

1

 

362

 

1

 

Diluted shares(1)

 

74,094

 

75,001

 

74,496

 

75,001

 

Basic EPS

 

$

0.90

 

$

0.57

 

$

1.50

 

$

1.20

 

Diluted EPS

 

$

0.90

 

$

0.57

 

$

1.49

 

$

1.20

 

 


(1)          Since the shares held as treasury stock are required to be settled by delivery of employer stock, those shares are included in the calculation of basic and diluted EPS.

 

9.  Tax Allocation Agreement

 

In connection with the IPO, the Company and ACE Financial Services Inc. (“AFS”), a subsidiary of ACE, entered into a tax allocation agreement, whereby the Company and AFS will make a “Section 338 (h)(10)” election that will have the effect of increasing the tax basis of certain affected subsidiaries’ tangible and intangible assets to fair value.  Future tax benefits that the Company derives from the election will be payable to AFS when realized by the Company.

 

15



 

As a result of the election, the Company has adjusted its net deferred tax liability, to reflect the new tax basis of the Company’s affected assets.  The additional basis is expected to result in increased future income tax deductions and, accordingly, may reduce income taxes otherwise payable by the Company.  Any tax benefit realized by the Company will be paid to AFS.   Such tax benefits will generally be calculated by comparing the Company’s affected subsidiaries’ actual taxes to the taxes that would have been owed by those subsidiaries had the increase in basis not occurred.  After a 15-year period, to the extent there remains an unrealized tax benefit, the Company and AFS will negotiate a settlement of the unrealized benefit based on the expected realization at that time.

 

The Company initially recorded a $49.0 million reduction of its existing deferred tax liability, based on an estimate of the ultimate resolution of the Section 338(h)(10) election.  Under the tax allocation agreement, the Company estimates that as of the IPO date, it will pay $20.9 million to AFS and accordingly has established this amount as a liability. The initial difference, which is attributable to the change in the tax basis of certain liabilities for which there is no associated step-up in the tax basis of its assets and no amounts due to AFS, resulted in an increase to additional paid-in capital of $28.1 million during 2004.  During Second Quarter 2005, we paid AFS $0.4 million reducing the liability to $20.5 million, which is included in other liabilities on the balance sheet.

 

10.  Segment Reporting

 

The Company has four principal business segments: (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 (“CDOs”).

 

The Company does not segregate assets and liabilities at a segment level since management reviews and controls these assets and liabilities on a consolidated basis. The Company allocates operating expenses to each segment based on a comprehensive cost study.  The other segment received its proportional share of operating expenses up to the IPO date. From the IPO date, the other segment was not allocated operating expenses. Management uses underwriting gains and losses as the primary measure of each segment’s financial performance.

 

The following tables summarize the components of underwriting gain for each reporting segment:

 

 

 

Three Months Ended June 30, 2005

 

 

 

Financial
Guaranty
Direct

 

Financial
Guaranty
Reinsurance

 

Mortgage
Guaranty

 

Other

 

Total

 

 

 

(in millions of U.S. dollars)

 

Gross written premiums

 

$

20.9

 

$

8.2

 

$

1.9

 

$

9.5

 

$

40.5

 

Net written premiums

 

20.4

 

8.0

 

1.9

 

 

30.2

 

Net earned premiums

 

16.0

 

27.2

 

5.1

 

 

48.3

 

Loss and loss adjustment expenses

 

5.0

 

(64.1

)

 

 

(59.1

)

Profit commission expense

 

 

2.3

 

1.0

 

 

3.3

 

Acquisition costs

 

1.6

 

9.5

 

0.6

 

 

11.7

 

Other operating expenses

 

8.4

 

5.7

 

0.4

 

 

14.5

 

Underwriting gain

 

$

1.1

 

$

73.8

 

$

3.1

 

$

 

$

77.9

 

 

16



 

 

 

Three Months Ended June 30, 2004

 

 

 

Financial
Guaranty
Direct

 

Financial
Guaranty
Reinsurance

 

Mortgage
Guaranty

 

Other

 

Total

 

 

 

(in millions of U.S. dollars)

 

Gross written premiums

 

$

17.7

 

$

35.8

 

$

0.9

 

$

10.0

 

$

64.4

 

Net written premiums

 

17.3

 

35.8

 

0.9

 

(84.0

)

(29.9

)

Net earned premiums

 

16.1

 

25.6

 

15.0

 

(66.0

)

(9.3

)

Loss and loss adjustment expenses

 

1.6

 

(0.9

)

(3.3

)

(57.4

)

(60.0

)

Profit commission expense

 

 

0.3

 

4.3

 

0.2

 

4.8

 

Acquisition costs

 

0.1

 

6.6

 

1.7

 

 

8.4

 

Other operating expenses(1)

 

9.1

 

5.0

 

1.1

 

 

15.3

 

Underwriting gain (loss)

 

$

5.3

 

$

14.6

 

$

11.2

 

$

(8.8

)

$

22.3

 

 


(1)            Excludes $11.3 million of operating expenses, included in other operating expenses in the consolidated statements of operations and comprehensive income, related to the accelerated vesting of stock awards at the IPO date.

 

 

 

Six Months Ended June 30, 2005

 

 

 

Financial
Guaranty
Direct

 

Financial
Guaranty
Reinsurance

 

Mortgage
Guaranty

 

Other

 

Total

 

 

 

(in millions of U.S. dollars)

 

Gross written premiums

 

$

44.7

 

$

42.2

 

$

21.3

 

$

10.4

 

$

118.6

 

Net written premiums

 

43.5

 

42.0

 

21.3

 

 

106.6

 

Net earned premiums

 

36.4

 

50.2

 

9.7

 

 

96.4

 

Loss and loss adjustment expenses

 

3.5

 

(71.2

)

0.2

 

(1.1

)

(68.5

)

Profit commission expense

 

 

2.3

 

2.0

 

 

4.3

 

Acquisition costs

 

3.1

 

17.6

 

1.1

 

 

21.9

 

Other operating expenses

 

17.8

 

10.1

 

1.1

 

 

29.0

 

Underwriting gain

 

$

12.1

 

$

91.4

 

$

5.3

 

$

1.1

 

$

109.9

 

 

 

 

Six Months Ended June 30, 2004

 

 

 

Financial
Guaranty
Direct

 

Financial
Guaranty
Reinsurance

 

Mortgage
Guaranty

 

Other

 

Total

 

 

 

(in millions of U.S. dollars)

 

Gross written premiums

 

$

43.3

 

$

88.2

 

$

14.9

 

$

(83.6

)

$

62.8

 

Net written premiums

 

42.6

 

88.2

 

14.9

 

(182.5

)

(36.8

)

Net earned premiums

 

56.8

 

46.0

 

23.4

 

(48.9

)

77.3

 

Loss and loss adjustment expenses

 

15.0

 

3.0

 

(4.5

)

(49.9

)

(36.3

)

Profit commission expense

 

 

0.4

 

9.3

 

0.6

 

10.3

 

Acquisition costs

 

1.5

 

13.7

 

2.6

 

3.7

 

21.5

 

Other operating expenses(1)

 

14.6

 

8.0

 

1.8

 

3.5

 

27.9

 

Underwriting gain (loss)

 

$

25.7

 

$

20.9

 

$

14.3

 

$

(7.1

)

$

53.8

 

 


(1)            Excludes $11.3 million of operating expenses, included in other operating expenses in the consolidated statements of operations and comprehensive income, related to the accelerated vesting of stock awards at the IPO date.

 

17



 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

(in millions of U.S. dollars)

 

Total underwriting gain

 

$

77.9

 

$

22.3

 

$

109.9

 

$

53.8

 

Net investment income

 

23.7

 

23.5

 

46.8

 

47.8

 

Net realized investment gains

 

1.7

 

8.7

 

3.5

 

9.9

 

Unrealized (losses) gains on derivative financial instruments

 

(12.5

)

14.7

 

(9.4

)

22.0

 

Other income

 

(0.2

)

 

0.1

 

0.5

 

Accelerated vesting of stock awards

 

 

(11.3

)

 

(11.3

)

Interest expense

 

(3.4

)

(2.5

)

(6.7

)

(4.0

)

Other expense

 

(2.5

)

 

(2.5

)

(1.6

)

Income before provision for income taxes

 

$

84.6

 

$

55.1

 

$

141.4

 

$

117.2

 

 

The following table provides the lines of businesses from which each of the Company’s four reporting segments derive their net earned premiums:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

(in millions of U.S. dollars)

 

Financial guaranty direct:

 

 

 

 

 

 

 

 

 

Financial guaranty direct

 

$

16.0

 

$

16.1

 

$

36.4

 

$

56.8

 

 

 

 

 

 

 

 

 

 

 

Financial guaranty reinsurance:

 

 

 

 

 

 

 

 

 

Public finance

 

12.7

 

10.0

 

23.7

 

22.6

 

Structured finance

 

14.5

 

15.6

 

26.5

 

23.4

 

Total

 

27.2

 

25.6

 

50.2

 

46.0

 

 

 

 

 

 

 

 

 

 

 

Mortgage guaranty:

 

 

 

 

 

 

 

 

 

Mortgage guaranty

 

5.1

 

15.0

 

9.7

 

23.4

 

 

 

 

 

 

 

 

 

 

 

Other:

 

 

 

 

 

 

 

 

 

Equity layer credit protection

 

 

 

 

5.4

 

Trade credit reinsurance

 

 

(34.6

)

 

(25.3

)

Title reinsurance

 

 

0.8

 

 

3.3

 

Auto residual value reinsurance

 

 

(32.2

)

 

(32.2

)

Total

 

 

(66.0

)

 

(48.9

)

Total net earned premiums

 

$

48.3

 

$

(9.3

)

$

96.4

 

$

77.3

 

 

The Company’s other segment consists of certain non-core lines of business that the Company has stopped writing in connection with the IPO, including equity layer credit protection, trade credit reinsurance, title reinsurance, and auto residual value reinsurance. The Company manages these exited lines of business by focusing on the net earned premiums and the underwriting gain (loss).

 

18



 

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

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

(in millions of U.S. dollars)

 

Underwriting (loss) gain :

 

 

 

 

 

 

 

 

 

Equity layer credit protection

 

$

 

$

0.5

 

$

1.1

 

$

3.0

 

Trade credit reinsurance

 

 

(4.2

)

 

(2.8

)

Title reinsurance

 

 

0.3

 

 

1.0

 

Auto residual value reinsurance

 

 

(5.4

)

 

(7.9

)

Total

 

$

 

$

(8.8

)

$

1.1

 

$

(7.1

)

 

19



 

11. Subsidiary Information

 

The following tables present the unaudited condensed consolidated financial information for Assured Guaranty Ltd. Assured Guaranty US Holdings Inc., of which AGC is a subsidiary and AG Re and other subsidiaries of Assured Guaranty Ltd. as of June 30, 2005 and December 31, 2004 and for the three and six months ended June 30, 2005 and 2004.

 

CONDENSED CONSOLIDATING BALANCE SHEET

AS OF JUNE 30, 2005

(in thousands of U. S. dollars)

 

 

 

Assured
Guaranty Ltd.
(Parent
Company)

 

Assured
Guaranty US
Holdings Inc.

 

AG Re and
Other
Subsidiaries

 

Consolidating
Adjustments

 

Assured
Guaranty Ltd.
(Consolidated)

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Total investments and cash

 

$

89

 

$

1,108,220

 

$

1,094,387

 

$

 

$

2,202,696

 

Investment in subsidiaries

 

1,624,535

 

 

 

(1,624,535

)

 

Deferred acquisition costs

 

 

74,300

 

113,894

 

 

188,194

 

Reinsurance recoverable

 

 

32,551

 

83,761

 

(3,961

)

112,351

 

Goodwill

 

 

85,417

 

 

 

85,417

 

Premiums receivable

 

 

16,430

 

19,468

 

(7,391

)

28,507

 

Other

 

3,800

 

87,897

 

101,760

 

(39,058

)

154,399

 

Total assets

 

$

1,628,424

 

$

1,404,815

 

$

1,413,270

 

$

(1,674,945

)

$

2,771,564

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Unearned premium reserves

 

$

 

$

201,275

 

$

356,553

 

$

(27,677

)

$

530,151

 

Reserves for losses and loss adjustment expenses

 

 

70,901

 

139,047

 

(3,596

)

206,352

 

Profit commissions payable

 

 

4,004

 

41,417

 

 

45,421

 

Deferred income taxes

 

 

34,495

 

(16,278

)

 

18,217

 

Long-term debt

 

 

197,330

 

 

 

197,330

 

Other

 

8,916

 

72,909

 

91,897

 

(19,137

)

154,585

 

Total liabilities

 

8,916

 

580,914

 

612,636

 

(50,410

)

1,152,056

 

 

 

 

 

 

 

 

 

 

 

 

 

Total shareholders’ equity

 

1,619,508

 

823,901

 

800,634

 

(1,624,535

)

1,619,508

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

1,628,424

 

$

1,404,815

 

$

1,413,270

 

$

(1,674,945

)

$

2,771,564

 

 

20



 

CONDENSED CONSOLIDATING BALANCE SHEET

AS OF DECEMBER 31, 2004

(in thousands of U. S. dollars)

 

 

 

Assured
Guaranty Ltd.
(Parent
Company)

 

Assured
Guaranty US
Holdings Inc.

 

AG Re and
Other
Subsidiaries

 

Consolidating
Adjustments

 

Assured
Guaranty Ltd.
(Consolidated)

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Total investments and cash

 

$

75

 

$

1,263,906

 

$

893,885

 

$

 

$

2,157,866

 

Investment in subsidiaries

 

1,511,778

 

 

 

(1,511,778

)

 

Deferred acquisition costs

 

 

140,333

 

46,021

 

 

186,354

 

Reinsurance recoverable

 

 

36,379

 

88,418

 

(4,577

)

120,220

 

Goodwill

 

 

85,417

 

 

 

85,417

 

Premiums receivable

 

 

36,407

 

56,938

 

(52,518

)

40,827

 

Other

 

19,630

 

106,350

 

46,109

 

(68,762

)

103,327

 

Total assets

 

$

1,531,483

 

$

1,668,792

 

$

1,131,371

 

$

(1,637,635

)

$

2,694,011

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Unearned premium reserves

 

$

 

$

369,320

 

$

195,545

 

$

(43,594

)

$

521,271

 

Reserves for losses and loss adjustment expenses

 

 

118,403

 

112,312

 

(4,212

)

226,503

 

Profit commissions payable

 

 

4,181

 

57,490

 

 

61,671

 

Deferred income taxes

 

 

57,924

 

(17,871

)

 

40,053

 

Long-term debt

 

 

197,356

 

 

 

197,356

 

Other

 

3,871

 

103,795

 

89,930

 

(78,051

)

119,545

 

Total liabilities

 

3,871

 

850,979

 

437,406

 

(125,857

)

1,166,399

 

 

 

 

 

 

 

 

 

 

 

 

 

Total shareholders’ equity

 

1,527,612

 

817,813

 

693,965

 

(1,511,778

)

1,527,612

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$