UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

x

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

 

For the Quarterly Period Ended June 30, 2006

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) 299-9375
(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    x    NO    o

 

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

 

Large accelerated filer x

Accelerated filer o

 

Non-accelerated filer o

 

 

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

The number of registrant’s Common Shares ($0.01 par value) outstanding as of August 1, 2006 was 73,230,687.

 

 




 

ASSURED GUARANTY LTD.

INDEX TO FORM 10-Q

 

 

Page

 

PART 1. FINANCIAL INFORMATION

 

 

 

Item 1.

 

Financial Statements:

 

 

 

 

 

Consolidated Balance Sheets as of June 30, 2006 (unaudited) and December 31, 2005

 

3

 

 

 

Consolidated Statements of Operations and Comprehensive Income (unaudited) for the Three and Six Months Ended June 30, 2006 and 2005

 

4

 

 

 

Consolidated Statements of Shareholders’ Equity (unaudited) for Six Months Ended June 30, 2006

 

5

 

 

 

Consolidated Statements of Cash Flows (unaudited) for Six Months Ended June 30, 2006 and 2005

 

6

 

 

 

Notes to Consolidated Financial Statements (unaudited)

 

7

 

Item 2.

 

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

 

29

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

62

 

Item 4.

 

Controls and Procedures

 

62

 

 

 

 

 

 

 

PART II. OTHER INFORMATION

 

 

 

Item 1.

 

Legal Proceedings

 

63

 

Item 1A.

 

Risk Factors

 

63

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

64

 

Item 6.

 

Exhibits

 

64

 

 

 

 

 

 

 

 

 

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,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Fixed maturity securities, at fair value (amortized cost: $2,067,526 in 2006 and
$2,082,363 in 2005)

 

$

2,069,156

 

$

2,133,997

 

Short-term investments, at cost which approximates fair value

 

170,731

 

115,826

 

Total investments

 

2,239,887

 

2,249,823

 

Cash and cash equivalents

 

29,197

 

6,190

 

Accrued investment income

 

22,653

 

22,676

 

Deferred acquisition costs

 

205,307

 

193,442

 

Prepaid reinsurance premiums

 

12,442

 

12,478

 

Reinsurance recoverable on ceded losses

 

11,293

 

12,350

 

Premiums receivable

 

42,182

 

33,011

 

Goodwill

 

85,417

 

85,417

 

Unrealized gains on derivative financial instruments

 

52,338

 

53,037

 

Current income taxes receivable

 

7,644

 

3,005

 

Receivables for securities sold

 

9,650

 

984

 

Other assets

 

17,428

 

16,710

 

Total assets

 

$

2,735,438

 

$

2,689,123

 

 

 

 

 

 

 

Liabilities and shareholders’ equity

 

 

 

 

 

Liabilities

 

 

 

 

 

Unearned premium reserves

 

$

601,930

 

$

537,149

 

Reserves for losses and loss adjustment expenses

 

114,636

 

121,219

 

Profit commissions payable

 

29,616

 

52,993

 

Reinsurance balances payable

 

1,409

 

3,724

 

Deferred income taxes

 

24,328

 

26,629

 

Funds held by Company under reinsurance contracts

 

20,339

 

19,186

 

Unrealized losses on derivative financial instruments

 

6,211

 

12,652

 

Long-term debt

 

197,359

 

197,344

 

Liability for tax basis step-up adjustment

 

19,756

 

20,129

 

Payables for securities purchased

 

12,140

 

813

 

Other liabilities

 

24,936

 

35,772

 

Total liabilities

 

1,052,660

 

1,027,610

 

Commitments and contingencies

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Common stock ($0.01 par value, 500,000,000 shares authorized; 73,231,065 and
74,761,577 shares issued and outstanding in 2006 and 2005)

 

732

 

748

 

Additional paid-in capital

 

855,258

 

881,998

 

Unearned stock grant compensation

 

 

(14,756

)

Retained earnings

 

821,826

 

747,691

 

Accumulated other comprehensive income

 

4,962

 

45,832

 

Total shareholders’ equity

 

1,682,778

 

1,661,513

 

Total liabilities and shareholders’ equity

 

$

2,735,438

 

$

2,689,123

 


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,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

Gross written premiums

 

$

111,484

 

$

40,470

 

$

166,868

 

$

118,567

 

Ceded premiums

 

(1,139

)

(10,314

)

(5,739

)

(11,942

)

Net written premiums

 

110,345

 

30,156

 

161,129

 

106,625

 

(Increase) decrease in net unearned premium reserves

 

(62,161

)

18,108

 

(64,890

)

(10,271

)

Net earned premiums

 

48,184

 

48,264

 

96,239

 

96,354

 

Net investment income

 

27,255

 

23,668

 

53,493

 

46,800

 

Net realized investment (losses) gains

 

(1,005

)

1,666

 

(2,011

)

3,457

 

Unrealized gains (losses) on derivative financial
instruments

 

5,713

 

(12,502

)

5,742

 

(9,430

)

Other income

 

23

 

(190

)

23

 

93

 

Total revenues

 

80,170

 

60,906

 

153,486

 

137,274

 

 

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

 

 

Loss and loss adjustment expenses

 

(6,513

)

(59,133

)

(6,895

)

(68,529

)

Profit commission expense

 

1,697

 

3,345

 

3,005

 

4,332

 

Acquisition costs

 

11,308

 

11,713

 

22,093

 

21,929

 

Other operating expenses

 

15,615

 

14,487

 

32,765

 

28,995

 

 Interest expense

 

3,367

 

3,410

 

6,742

 

6,706

 

Other expense

 

692

 

2,488

 

1,306

 

2,488

 

Total expenses

 

26,166

 

(23,690

)

59,016

 

(4,079

)

 

 

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

54,004

 

84,596

 

94,470

 

141,353

 

Provision for income taxes

 

 

 

 

 

 

 

 

 

Current

 

6,165

 

46,385

 

8,808

 

51,468

 

Deferred

 

3,325

 

(28,539

)

6,266

 

(21,213

)

Total provision for income taxes

 

9,490

 

17,846

 

15,074

 

30,255

 

Net income

 

44,514

 

66,750

 

79,396

 

111,098

 

Other comprehensive (loss) income, net of taxes

 

 

 

 

 

 

 

 

 

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

 

(18,038

)

22,127

 

(42,098

)

1,489

 

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

 

779

 

(1,245

)

1,437

 

(2,746

)

Change in net unrealized gains on fixed maturity securities

 

(17,259

)

20,882

 

(40,661

)

(1,257

)

Cash flow hedge

 

(104

)

(104

)

(209

)

(209

)

Other comprehensive (loss) income, net of taxes

 

(17,363

)

20,778

 

(40,870

)

(1,466

)

Comprehensive income

 

$

27,151

 

$

87,528

 

$

38,526

 

$

109,632

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.60

 

$

0.90

 

$

1.08

 

$

1.50

 

Diluted

 

$

0.60

 

$

0.90

 

$

1.06

 

$

1.49

 

Dividends per share

 

$

0.035

 

$

0.03

 

$

0.07

 

$

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, 2006
(in thousands of U.S. dollars except per share amounts)
(Unaudited)

 

 

 

Common
Stock

 

Additional
Paid-in
Capital

 

Unearned
Stock Grant
Compensation

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Income

 

Total
Shareholders’
Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2005

 

$

748

 

$

881,998

 

$

(14,756

)

$

747,691

 

$

45,832

 

$

1,661,513

 

Net income

 

 

 

 

79,396

 

 

79,396

 

Dividends ($0.07 per share)

 

 

 

 

(5,261

)

 

(5,261

)

Common stock repurchases

 

(7

)

(17,183

)

 

 

 

(17,190

)

Shares cancelled to pay withholding taxes

 

(1

)

(2,752

)

 

 

 

(2,753

)

Option exercises

 

 

443

 

 

 

 

443

 

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

 

 

 

 

 

(209

)

(209

)

Unrealized loss on fixed maturity securities, net of tax of $(8,322)

 

 

 

 

 

(40,661

)

(40,661

)

Reclassification due to adoption of FAS 123R

 

(10

)

(14,746

)

14,756

 

 

 

 

Share-based compensation and other

 

2

 

7,498

 

 

 

 

7,500

 

Balance, June 30, 2006

 

$

732

 

$

855,258

 

$

 

$

821,826

 

$

4,962

 

$

1,682,778

 

 

 

 

 

 

 

 

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,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

Net income

 

$

79,396

 

$

111,098

 

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

 

 

 

 

 

Non-cash interest and operating expenses

 

7,825

 

3,349

 

Net amortization of premium on fixed maturity securities

 

2,916

 

3,460

 

Provision (benefit) for deferred income taxes

 

6,266

 

(21,213

)

Net realized investment losses (gains)

 

2,011

 

(3,457

)

Change in unrealized (gains) losses on derivative financial instruments

 

(5,742

)

9,430

 

Change in deferred acquisition costs

 

(11,865

)

(1,840

)

Change in accrued investment income

 

23

 

476

 

Change in premiums receivable

 

(9,171

)

12,312

 

Change in prepaid reinsurance premiums

 

36

 

1,401

 

Change in unearned premium reserves

 

64,781

 

8,880

 

Change in loss recovery receivable

 

 

(63,676

)

Change in reserves for losses and loss adjustment expenses, net

 

(7,841

)

(15,532

)

Change in profit commissions payable

 

(23,377

)

(16,250

)

Change in funds held by Company under reinsurance contracts

 

1,153

 

3,003

 

Change in current income taxes

 

(4,639

)

32,971

 

Tax benefit from employee stock options

 

 

4,059

 

Other

 

(10,410

)

2,095

 

Net cash flows provided by operating activities

 

91,362

 

70,566

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

Fixed maturity securities:

 

 

 

 

 

Purchases

 

(434,471

)

(513,987

)

Sales

 

432,861

 

388,644

 

Maturities

 

14,295

 

13,000

 

(Purchases) sales of short-term investments, net

 

(55,019

)

54,731

 

Net cash flows used in investing activities

 

(42,334

)

(57,612

)

 

 

 

 

 

 

Financing activities

 

 

 

 

 

Repurchases of common stock

 

(17,190

)

(19,014

)

Dividends paid

 

(5,253

)

(4,521

)

Share activity under option and incentive plans

 

(2,310

)

(1,276

)

Repayment of notes assumed during formation transactions

 

(2,000

)

 

Net cash flows used in financing activities

 

(26,753

)

(24,811

)

Effect of exchange rate changes

 

732

 

(373

)

Increase (decrease) in cash and cash equivalents

 

23,007

 

(12,230

)

Cash and cash equivalents at beginning of period

 

6,190

 

16,978

 

Cash and cash equivalents at end of period

 

$

29,197

 

$

4,748

 

 

 

 

 

 

 

Supplementary cash flow information

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Income taxes

 

$

13,440

 

$

14,609

 

Interest

 

$

7,081

 

$

7,000

 

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

6




Assured Guaranty Ltd.
Notes to Consolidated Financial Statements
June 30, 2006
 (Unaudited)

1.  Business and Organization

Assured Guaranty Ltd. (the “Company”) 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 asset. 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.

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 it’s 2004 initial public offering (“IPO”), including, but not limited to, equity layer credit protection, trade credit reinsurance and title 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

7




unaudited interim consolidated financial statements cover the three-month period ended June 30, 2006 (“Second Quarter 2006”) and the three-month period ended June 30, 2005 (“Second Quarter 2005”), and the six-month period ended June 30, 2006 (“Six Months 2006”) and the six-month period ended June 30, 2005 (“Six Months 2005”). Operating results for the three- and six-month periods ended June 30, 2006 and 2005 are not necessarily indicative of the results that may be expected for a full year.  Certain items in the prior year unaudited interim 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, 2005, filed with the Securities and Exchange Commission.

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.

3.  Recent Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (“FASB”) issued FAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“FAS 155”) which amends FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”) and FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“FAS 140”), and addresses issues raised in FAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” The primary objectives of FAS 155 are: (i) with respect to FAS 133, to address the accounting for beneficial interests in securitized financial assets and (ii) with respect to FAS 140, eliminate a restriction on the passive derivative instruments that a qualifying special purpose entity may hold. FAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company is currently evaluating the implications of FAS 155 on its financial statements.

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  FIN 48  also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is assessing FIN 48 and has not determined the impact that the adoption of FIN 48 will have on its results of operations or financial position.

4.  Analysis of premiums written, premiums earned and loss and loss adjustment expenses

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 Limited (“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.

8




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,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

(in thousands of U.S. dollars)

 

 

 

 

 

 

 

 

 

 

 

 

 

Premiums Written

 

 

 

 

 

 

 

 

 

Direct

 

$

68,418

 

$

20,942

 

$

98,666

 

$

44,697

 

Assumed

 

43,066

 

19,528

 

68,202

 

73,870

 

Ceded

 

(1,139

)

(10,314

)

(5,739

)

(11,942

)

Net

 

$

110,345

 

$

30,156

 

$

161,129

 

$

106,625

 

 

 

 

 

 

 

 

 

 

 

Premiums Earned

 

 

 

 

 

 

 

 

 

Direct

 

$

21,887

 

$

16,806

 

$

43,115

 

$

38,036

 

Assumed

 

28,475

 

42,248

 

59,003

 

71,660

 

Ceded

 

(2,178

)

(10,790

)

(5,879

)

(13,342

)

Net

 

$

48,184

 

$

48,264

 

$

96,239

 

$

96,354

 

 

 

 

 

 

 

 

 

 

 

Loss and Loss Adjustment Expenses

 

 

 

 

 

 

 

 

 

Direct

 

$

(12,644

)

$

4,703

 

$

(15,675

)

$

2,636

 

Assumed

 

7,250

 

(71,385

)

10,542

 

(80,574

)

Ceded

 

(1,119

)

7,549

 

(1,762

)

9,409

 

Net

 

$

(6,513

)

$

(59,133

)

$

(6,895

)

$

(68,529

)

 

Net written premiums for Second Quarter 2006 and Six Months 2006 were $110.3 million and $161.1 million, respectively, compared with $30.2 million and $106.6 million for Second Quarter 2005 and Six Months 2005, respectively.  The increase in direct written premiums for both periods is primarily attributable to several financial guaranty transactions written during Second Quarter 2006 in the United Kingdom (“UK”) with upfront premiums totaling $41.0 million.  Assumed written premiums increased in Second Quarter 2006 compared with Second Quarter 2005 due to more deals being written on an upfront basis during Second Quarter 2006 while Second Quarter 2005 was comprised of more installment based deals.   Also contributing to the increase is a Second Quarter 2005 transaction whereby Financial Security Assurance Inc. (“FSA”) reassumed from Assured Guaranty Re Ltd. (“AG Re”) $18.4 million of healthcare related business (“FSA transaction”).

The decrease in assumed written premiums for Six Months 2006 compared with Six Months 2005 is primarily due to a large excess of loss reinsurance transaction of  $16.3 million written during the three month period ended March 31, 2005 in our mortgage guaranty segment.

Ceded written and earned premiums have decreased in Second Quarter 2006 compared with Second Quarter 2005 and  Six Months 2006 compared with Six Months 2005 due to the run-off and novation of our trade credit business, which is 100% retroceded to ACE.

Loss and loss adjustment expenses (“LAE”) were $(6.5) million and $(6.9) million for Second Quarter 2006 and Six Months 2006, respectively.  The major component of these amounts is  a $10.1 million loss recovery from third party litigation settlements recorded during  Second Quarter 2006 from our equity layer credit protection business, which was exited in connection with the IPO.  This recovery was partially offset by increased loss reserves of $5.4 million in our financial guaranty reinsurance segment, of which $3.8 million related to a rating downgrade of a European infrastructure  transaction and $1.6 million related to the rating downgrade of various credits.  In addition to these increases Six Months 2006 also contained a $2.5 million case reserve addition due to a U.S. public infrastructure transaction.

Loss and loss adjustment expenses of $(59.1) million in Second Quarter 2005 and $(68.5) million in Six Months 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 a recovery of $63.7 million.

9




Also in First Quarter 2005 the Company recovered $6.8 million relating to this same reinsurance claim.  In addition, during First Quarter 2005, the Company recovered $1.1 million relating to its exited equity layer credit protection business. Loss recoveries for all periods presented are shown in the statements of operations and comprehensive income in loss and loss adjusted expenses.

Reinsurance recoverable on ceded losses and LAE as of June 30, 2006 and December 31, 2005 were $11.3 million and $12.4 million, respectively and are all related to our other segment. Of these amounts, $11.1 million and $12.3 million, respectively, relate to reinsurance agreements with ACE.

The following summarizes the Company’s gross written premiums by significant client:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

Gross Written Premiums by Client

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

($ in millions)

 

 

 

Financial Security Assurance Inc.(1)

 

$

18.2

 

$

10.4

 

$

25.7

 

$

32.6

 

Ambac Assurance Corporation

 

10.5

 

9.7

 

14.8

 

20.4

 

Financial Guaranty Insurance Company

 

9.5

 

3.3

 

12.9

 

5.6

 

MBIA Insurance Corporation

 

2.3

 

4.2

 

5.8

 

8.9

 


(1)   Second Quarter 2005 and Six Months 2005 excludes $18.4 million of reassumption premiums related to the Company’s healthcare business.

Agreement with Financial Security Assurance Inc.

During Second Quarter 2005, Assured Guaranty Corp. (“AGC”) and AG Re, two of the Company’s 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”) was assumed by AG Re.  This agreement was 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 paying entity, to AG Re, a non-U.S. tax paying entity, the Company 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 increased net income $1.9 million for both  Second Quarter 2005 and Six Months 2005.  FSA has released AGC from all liabilities with respect to the Ceded Business.  AG Re has assumed 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.

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 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.

10




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 2005, 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 provided the required information in response to the subpoena in January of 2006 and has not been contacted further by the Commissioner.

During Second Quarter 2006, the Company’s wholly owned subsidiary, Assured Guaranty Re Overseas Ltd. (“AGRO”), and a number of other parties, completed various settlements with defendants in the In re: National Century Financial Enterprises Inc. Investment Litigation now pending in the United States District Court for the Southern District of Ohio - Eastern District. AGRO received approximately $10.1 million (pre-tax) in Second Quarter 2006, from the settlements. AGRO originally paid claims in 2003 of approximately $41.7 million (pre-tax) related to National Century Financial Enterprises Inc. To date, including the settlements described above, the Company has recovered $16.6 million (pre-tax). This is a partial settlement of the litigation, and the litigation will continue against other parties.

The Company is party to reinsurance agreements with all 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 of $3.3 million, including $0.2 million of amortized gain on the cash flow hedge, for both Second Quarter 2006 and Second Quarter 2005. The Company recorded interest expense of $6.7 million, including $0.3 million of amortized gain on the cash flow hedge, for both Six Months 2006 and Six Months 2005. 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, 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. Two letters of credit have been issued, both on behalf of AGRO, with an aggregate stated amount of approximately $20.7 million.

If drawn, the proceeds of the loans and letters of credit are to be used for 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. Subsequently, AG Re and AGRO, as Material Non-AGC Subsidiaries, 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, 2006 and December 31, 2005, Assured Guaranty was in compliance with all of those financial covenants.

As of June 30, 2006 and December 31, 2005, no amounts were outstanding under this facility nor have there been any borrowings under this facility.

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. As of June 30, 2006 and December 31, 2005, no amounts were outstanding under this facility nor have there been any borrowings under this facility.

The Company’s failure to comply with certain covenants under the Company’s 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

12




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. The put options were not exercised as of June 30, 2006.  Initially, all of the committed capital securities (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 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 Ltd.’s financial statements.

During Second Quarter 2006 and Six Months 2006, AGC incurred $0.7 million and $1.3 million, respectively, of put option premiums which are an on-going expense. During both Second Quarter 2005 and Six Months 2005, AGC incurred $2.5 million which consists of $2.0 million of investment banking fees associated with the committed capital securities and put option premiums which are an on-going expense. These expenses are presented in the Company’s unaudited interim consolidated statements of operations and comprehensive income under other expense.

7. Share-Based Compensation

Effective January 1, 2006, the Company adopted FAS No. 123 (revised), “Share-Based Payment” (“FAS 123R”), which replaces FAS No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”) and supersedes Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). FAS 123R requires all share-based compensation transactions with employees, including grants of employee stock options, to be recognized as compensation expense over the requisite service period based on their relative fair values.

Prior to the adoption of FAS 123R, the Company followed the guidance of APB 25 and did not record share-based compensation expense related to employee stock options in the statement of operations, since for all grants the exercise price was equal to the market value of the common stock on the grant date.

The Company elected to use the modified prospective transition method for implementing FAS 123R. Under this transition method, compensation expense includes:  (a) compensation expense for all share-based payments granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FAS 123, and (b) compensation expense for all share-based payments granted on or after January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of FAS 123R. Because we elected to use the modified prospective transition method, results for prior periods have not been restated and new awards are valued and accounted for prospectively upon adoption.

Beginning January 1, 2006, upon adoption of FAS 123R, the Company recorded share-based compensation for the cost of stock options, restricted stock and the Company sponsored employee stock purchase plan. As a result of adopting FAS 123R on January 1, 2006, the Company’s Second Quarter 2006 income before income taxes and net income are $1.5 million and $1.1 million lower, respectively, and for Six Months 2006 are $3.2 million and $2.5 million lower, respectively, than if it had continued to account for share-based compensation under APB 25. Basic and diluted earnings per share for Second Quarter 2006 and Six Months 2006 are $0.01 and $0.03 lower, respectively, than if the Company had continued to account for share-based compensation under APB 25.

Share-based compensation expense in Second Quarter 2006 and Six Months 2006 was $3.1 million ($2.5 million after tax) and $6.3 million ($5.2 million after tax), respectively.  The effect on basic and diluted earnings per share for Second Quarter 2006 and Six Months 2006 was $0.03 and $0.07, respectively. Included in Second Quarter 2006 and Six Months 2006 expense was $0.5 million and $1.2 million, respectively, for stock award grants to retirement-eligible employees. FAS 123R requires these awards to be expensed over the period through the date the employee first becomes eligible to retire  and is no longer required to provide service to earn part or all of the award, regardless of the employees intent of retirement. The amount of share-based compensation capitalized in Second

13




Quarter 2006 and Six Months 2006 as deferred acquisition costs (“DAC”) was $0.7 million and $1.2 million, respectively. Share-based compensation expense in Second Quarter 2005 and Six Months 2005 was $1.7 million ($1.4 million after tax) and $3.0 million ($2.7 million after tax), respectively.

The following table presents pre-DAC and pre-tax, share-based compensation cost by share-based type:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

(in thousands of U.S. dollars)

 

2006

 

2005

 

2006

 

2005

 

Share-Based Employee Cost

 

 

 

 

 

 

 

 

 

Restricted Stock

 

 

 

 

 

 

 

 

 

Recurring amortization

 

$

1,957

 

$

1,382

 

$

3,764

 

$

2,561

 

Accelerated amortization for retirement eligible

employees

 

364

 

 

807

 

 

Subtotal

 

2,321

 

1,382

 

4,571

 

2,561

 

Stock Options

 

 

 

 

 

 

 

 

 

Recurring amortization

 

909

 

 

1,953

 

 

Accelerated amortization for retirement eligible

employees

 

150

 

 

355

 

 

Subtotal

 

1,059

 

 

2,308

 

 

ESPP

 

32

 

 

64

 

 

Total Share-Based Employee Cost

 

3,412

 

1,382

 

6,943

 

2,561

 

 

 

 

 

 

 

 

 

 

 

Share-Based Directors Cost

 

 

 

 

 

 

 

 

 

Restricted Stock

 

72

 

120

 

139

 

150

 

Restricted Stock Units

 

229

 

149

 

413

 

307

 

Total Share-Based Directors Cost

 

301

 

269

 

552

 

457

 

Total Share-Based Cost

 

$

3,713

 

$

1,651

 

7,495

 

$

3,018

 

 

For Second Quarter 2005 and Six Months 2005, had the compensation expense been determined in accordance with the fair value method recommended in FAS 123, the Company’s net income and net income per share would have been adjusted to the pro forma amounts indicated below:

 

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

 

Three Months Ended
June 30, 2005

 

Six Months Ended
June 30, 2005

 

Net income as reported

 

$

66,750

 

$

111,098

 

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

 

1,445

 

2,653

 

Deduct: Compensation expense, in accordance with FAS
123, net of income tax

 

2,394

 

4,701

 

Pro forma net income

 

$

65,801

 

$

109,050

 

Basic Earnings Per Share:

 

 

 

 

 

As reported

 

$

0.90

 

$

1.50

 

Pro forma

 

$

0.89

 

$

1.47

 

Diluted Earnings Per Share:

 

 

 

 

 

As reported

 

$

0.90

 

$

1.49

 

Pro forma

 

$

0.89

 

$

1.46

 

 

Assured Guaranty Ltd. Share-Based Compensation Plans

As of April 27, 2004, the Company adopted the Assured Guaranty Ltd. 2004 Long-Term Incentive Plan (the “Incentive Plan”). 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 the Company’s common shares. The number of common shares that may be delivered under the Incentive Plan may not exceed 7,500,000. As of June 30, 2006, 2,682,432 common shares were available for grant under the Incentive Plan. In January 2005, the Company implemented the Stock Purchase Plan (“Stock Purchase Plan”) in accordance with Internal Revenue Code

14




Section 423. The Company reserved for issuance and purchases under the Stock Purchase Plan 100,000 shares of its common stock.  As of June 30, 2006, 80,512 common shares were available for grant under the Stock Purchase Plan. The Incentive Plan and the Stock Purchase Plan are described more fully in the Company’s 2005 Annual Report on Form 10-K.

Stock Options

Nonqualified or incentive stock options may be granted to employees and directors of the Company.   Stock options are generally granted once a year with exercise prices equal to the closing price on the date of grant.  To date, the Company has only issued nonqualified stock options.  All stock options granted to employees vest in equal annual installments over a three-year period and expire 10 years from the date of grant. None of our options have a performance or market condition.  The following table summarizes stock option activity for the six months ended June 30, 2006:

 

 

 

 

 

Weighted Average

 

Aggregate

 

 

 

Options for

 

Weighted

 

Remaining

 

Intrinsic

 

 

 

Common

 

Average

 

Contractual

 

Value (1)

 

Options

 

Shares

 

Exercise Price

 

Term (years)

 

(in thousands)

 

Outstanding at December 31, 2005

 

2,457,302

 

$

18.05

 

 

 

 

 

Granted

 

785,967

 

$

25.49

 

 

 

 

 

Exercised

 

(24,774

)

$

17.91

 

 

 

 

 

Forfeited

 

(52,996

)

$

19.99

 

 

 

 

 

Outstanding at June 30, 2006

 

3,165,499

 

$

19.86

 

8.2

 

17,442

 

Vested and exercisable at June 30, 2006

 

1,348,481

 

$

17.95

 

7.5

 

$

9,999

 


(1)                                  The aggregate intrinsic value was calculated based on the positive difference between the closing price of the Company’s common stock on June 30, 2006 (i.e. $25.37) and the weighted average exercise price of the underlying options.

The Company recorded $1.1 million ($0.8 million after tax) and $2.3 million ($1.8 million after tax) in share-based compensation related to stock options during Second Quarter 2006 and Six Months 2006, respectively. As of June 30, 2006 the total unrecognized compensation expense related to outstanding non-vested stock options was $5.2 million, which will be adjusted in the future for the difference between estimated and actual forfeitures. The Company expects to recognize that expense over the weighted-average remaining service period of 1.6 years.

The weighted-average grant-date fair value of options granted were $6.86 and $5.08 for Second Quarter 2006 and Second Quarter 2005, respectively. The weighted-average grant-date fair value of options granted were $6.71 and $4.53 for Six Months 2006 and Six Months 2005, respectively. The fair value of 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 in 2006 and 2005:

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

2006

 

2005

 

2006

 

2005

Dividend yield

 

0.6%

 

0.6%

 

0.5%

 

0.7%

Expected volatility

 

20.12%

 

20.92%

 

20.44%

 

20.82%

Risk free interest rate

 

5.1%

 

4.2%

 

4.6%

 

4.1%

Expected life

 

5 years

 

5 years

 

5 years

 

5 years

Forfeiture rate

 

6.0%

 

6.0%

 

6.0%

 

6.0%

 

These assumptions were based on the following:

·                  The expected dividend yield is based on the current expected annual dividend and company share price on the grant date,

·                  Expected volatility is estimated at the date of grant based on the historical share price volatility, calculated on a daily basis,

15




 

·                  The risk-free interest rate is the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term to the granted stock options,

·                  The expected life is based on the average expected term of our guideline companies, which are defined as similar entities, since the Company has insufficient expected life data,

·                  The forfeiture rate is based on the rate used by our guideline companies, since the Company has insufficient forfeiture data. Estimated forfeitures will be reassessed at each balance sheet date and may change based on new facts and circumstances.

For options granted before January 1, 2006, the Company amortizes the fair value on an accelerated basis. For options granted on or after January 1, 2006, the Company amortizes the fair value on a straight-line basis. All options are amortized over the requisite service periods of the awards, which are generally the vesting periods, with the exception of retirement-eligible employees.  For retirement-eligible employees options are amortized over the period through the date the employee first becomes eligible to retire and is no longer required to provide service to earn part or all of the award.  The Company may elect to use different assumptions under the Black-Scholes option valuation model in the future, which could materially affect the Company’s net income or earnings per share.

The total intrinsic value of options exercised during Six Months 2006 was $0.2 million. During Six Months 2006, $0.4 million was received from the exercise of stock options and an immaterial related tax benefit was recorded.

Restricted Stock Awards

The Company has granted restricted stock awards to employees and directors of the Company. Restricted stock awards generally vest in equal annual installments over a four-year period.   Restricted stock awards are amortized over the requisite service periods of the awards, which are generally the vesting periods, with the exception of retirement-eligible employees, discussed above. Prior to the adoption of FAS 123R, the Company presented restricted stock issuances on the balance sheet in common stock and additional paid-in capital with an offset in unearned stock grant compensation as a separate component of shareholders’ equity. In accordance with the provisions of FAS 123R, on January 1, 2006, the Company reclassified the balance in unearned stock grant compensation to common stock and additional paid-in capital in shareholders’ equity. The following table summarizes restricted stock award activity for the six months ended June 30, 2006:


Nonvested Shares

 

Number of
Shares

 

Weighted Average 
Grant-Date
Fair Value

 

Nonvested at December 31, 2005

 

1,021,124

 

$

18.12

 

Granted

 

454,333

 

$

25.49

 

Vested

 

(268,638

)

$

18.00

 

Forfeited

 

(30,336

)

$

19.54

 

Nonvested at June 30, 2006

 

1,176,483

 

$

20.96

 

 

The Company recorded $2.4 million ($1.9 million after tax) and $4.7 million ($3.7 million after tax) in share-based compensation, related to restricted stock awards, during Second Quarter 2006 and Six Months 2006, respectively. Restricted stock awards are expensed on a straight-line basis over the vesting period. As of June 30, 2006 the total unrecognized compensation cost related to outstanding nonvested restricted stock awards was $20.8 million, which the Company expects to recognize over the weighted-average remaining service period of 2.4 years.

Restricted Stock Units

The Company has granted restricted stock units to directors of the Company. Restricted stock units vest over a one-year period.

The following table summarizes restricted stock unit activity (excluding dividend equivalents) for the six months ended June 30, 2006:

16




 


Nonvested Stock Units

 

Number of
Stock Units

 

Weighted Average Grant-Date
Fair Value

 

Nonvested at December 31, 2005

 

36,301

 

$

20.25

 

Granted

 

34,030

 

$

24.39

 

Vested

 

(28,773

)

$

19.29

 

Forfeited

 

 

$

 

Nonvested at June 30, 2006

 

41,558

 

$

24.30

 

 

The Company recorded $0.2 million ($0.2 million after tax) and $0.4 million ($0.4 million after tax) in share-based compensation during Second Quarter 2006 and Six Months 2006, respectively. The compensation for restricted stock units is expensed on a straight-line basis over the vesting period. As of June 30, 2006, the total unrecognized compensation cost related to outstanding nonvested restricted stock units was $0.7 million, which the Company expects to recognize over the weighted-average remaining service period of 0.7 years.

Employee Stock Purchase Plan

Participation in the Stock Purchase Plan is available to all eligible employees. Maximum annual purchases by participants are limited to the number of whole shares that can be purchased by an amount equal to 10 percent of the participant’s compensation or, if less, shares having a value of $25,000. Participants may purchase shares at a purchase price equal to 85 percent of the lesser of the fair market value of the stock on the first day or the last day of the subscription period. The Company recorded $32,000 ($23,000 after tax) and $64,000 ($45,000 after tax) in share-based compensation during Second Quarter 2006 and Six Months 2006, respectively.

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,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

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

 

Net income as reported

 

$

44,514

 

$

66,750

 

$

79,396

 

$

111,098

 

Basic shares

 

73,633

 

73,813

 

73,695

 

74,134

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock awards

 

809

 

281

 

947

 

362

 

Diluted shares

 

74,442

 

74,094

 

74,642

 

74,496

 

Basic EPS

 

$

0.60

 

$

0.90

 

$

1.08

 

$

1.50

 

Diluted EPS

 

$

0.60

 

$

0.90

 

$

1.06

 

$

1.49

 

 

9.  Liability For Tax Basis Step-Up Adjustment

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.

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

17




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 both Six Months 2006 and Six Months 2005 the Company paid AFS $0.4 million.

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 could take the form of a credit derivative; (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, but not limited to equity layer credit protection, trade credit reinsurance and title reinsurance.

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. During 2006, the Company implemented a new operating expense methodology to more closely apply expenses to the individual operating segments. This new methodology was based on a comprehensive study and is based on departmental time estimates and headcount. 2005 amounts have been restated to show this new methodology on a comparative basis.  Management uses underwriting gains as the primary measure of each segment’s financial performance.

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

 

 

 

Three Months Ended June 30, 2006

 

 

 

Financial
Guaranty
Direct

 

Financial
Guaranty
Reinsurance

 

Mortgage 
Guaranty

 

Other

 

Total

 

 

 

(in millions of U.S. dollars)

 

Gross written premiums

 

$

68.4

 

$

41.7

 

$

1.2

 

$

0.1

 

$

111.5

 

Net written premiums

 

67.8

 

41.3

 

1.2

 

 

110.3

 

Net earned premiums

 

21.2

 

23.1

 

3.7

 

 

48.2

 

Loss and loss adjustment expenses

 

(2.5

)

5.7

 

0.4

 

(10.1

)

(6.5

)

Profit commission expense

 

 

1.0

 

0.7

 

 

1.7

 

Acquisition costs

 

2.3

 

8.5

 

0.3

 

 

11.3

 

Other operating expenses

 

12.0

 

3.4

 

0.3

 

 

15.6

 

Underwriting gain

 

$

9.4

 

$

4.6

 

$

2.0

 

$

10.1

 

$

26.1

 

 

18




 

 

 

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

 

9.5

 

4.7

 

0.3

 

 

14.5

 

Underwriting (loss) gain

 

$

(0.1

)

$

74.8

 

$

3.2

 

$

 

$

77.9

 

 

 

 

Six Months Ended June 30, 2006

 

 

 

Financial
Guaranty
Direct

 

Financial
Guaranty
Reinsurance

 

Mortgage
Guaranty

 

Other

 

Total

 

 

 

(in millions of U.S. dollars)

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross written premiums

 

$

98.6

 

$

60.5

 

$

3.8

 

$

3.9

 

$

166.9

 

Net written premiums

 

97.5

 

59.8

 

3.8

 

 

161.1

 

Net earned premiums

 

41.9

 

46.4

 

7.9

 

 

96.2

 

Loss and loss adjustment expenses

 

(4.3

)

8.5

 

0.2

 

(11.3

)

(6.9

)

Profit commission expense

 

 

1.4

 

1.6

 

 

3.0

 

Acquisition costs

 

4.2

 

17.2

 

0.6

 

 

22.1

 

Other operating expenses

 

25.4

 

6.8

 

0.6

 

 

32.8

 

Underwriting gain

 

$

16.6

 

$

12.6

 

$

4.8

 

$

11.3

 

$

45.2

 

 

 

 

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

 

20.9

 

7.5

 

0.6

 

 

29.0

 

Underwriting gain

 

$

8.9

 

$

94.0

 

$

5.8

 

$

1.1

 

$

109.9

 

 

19




 

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,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in millions of U.S. dollars)

 

 

 

 

 

 

 

 

 

 

 

Total underwriting gain

 

$

26.1

 

$

77.9

 

$

45.2

 

$

109.9

 

Net investment income

 

27.3

 

23.7

 

53.5

 

46.8

 

Net realized investment (losses) gains

 

(1.0

)

1.7

 

(2.0

)

3.5

 

Unrealized gains (losses) on derivative financial instruments

 

5.7

 

(12.5

)

5.7

 

(9.4

)

Other income

 

 

(0.2

)

 

0.1

 

Interest expense

 

(3.4

)

(3.4

)

(6.7

)

(6.7

)

Other expense

 

(0.7

)

(2.5

)

(1.3

)

(2.5

)

Income before provision for income taxes

 

$

54.0

 

$

84.6

 

$

94.5

 

$

141.4

 

 

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

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in millions of U.S. dollars)

 

Financial guaranty direct:

 

 

 

 

 

 

 

 

 

Public finance

 

$

1.7

 

$

0.4

 

$

2.8

 

$

0.5

 

Structured finance

 

19.5

 

15.6

 

39.1

 

35.9

 

Total

 

21.2

 

16.0

 

41.9

 

36.4

 

Financial guaranty reinsurance:

 

 

 

 

 

 

 

 

 

Public finance

 

14.4

 

12.7

 

30.0

 

23.7

 

Structured finance

 

8.7

 

14.5

 

16.4

 

26.5

 

Total

 

23.1

 

27.2

 

46.4

 

50.2

 

Mortgage guaranty:

 

 

 

 

 

 

 

 

 

Mortgage guaranty

 

3.7

 

5.1

 

7.9

 

9.7

 

Total net earned premiums

 

$

48.2

 

$

48.3

 

$

96.2

 

$

96.4

 

 

The other segment had an underwriting gain of $10.1 million for Second Quarter 2006 and $11.3 million and $1.1 million for Six Months 2006 and Six Months 2005, respectively, as the equity layer credit protection business recorded loss recoveries in both periods. During Second Quarter 2005 the other segment had no underwriting gain or loss.

20




 

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 other subsidiaries of Assured Guaranty Ltd. as of June 30, 2006 and December 31, 2005 and for the three and six months ended June 30, 2006 and 2005.

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF JUNE 30, 2006
(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

 

$

683

 

$

1,175,922

 

$

1,092,479

 

$

 

$

2,269,084

 

Investment in subsidiaries

 

1,690,407

 

 

 

(1,690,407

)

 

Deferred acquisition costs

 

 

72,314

 

132,993

 

 

205,307

 

Reinsurance recoverable

 

 

8,358

 

4,495

 

(1,560

)

11,293

 

Goodwill

 

 

85,417

 

 

 

85,417

 

Premiums receivable

 

 

17,963

 

43,246

 

(19,027

)

42,182

 

Other

 

10,263

 

129,667

 

57,331

 

(75,106

)

122,155

 

Total assets

 

$

1,701,353

 

$

1,489,641

 

$

1,330,544

 

$

(1,786,100

)

$

2,735,438

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

Unearned premium reserves

 

$

 

$

236,644

 

$

409,978

 

$

(44,692

)

$

601,930

 

Reserves for losses and loss adjustment expenses

 

 

58,766

 

57,430

 

(1,560

)

114,636

 

Profit commissions payable

 

 

3,715

 

25,901

 

 

29,616

 

Deferred income taxes

 

 

31,796

 

(7,468

)

 

24,328

 

Long-term debt

 

 

197,359

 

 

 

197,359

 

Other

 

18,575

 

75,193

 

40,464

 

(49,441

)

84,791

 

Total liabilities

 

18,575

 

603,473

 

526,305

 

(95,693

)

1,052,660

 

 

 

 

 

 

 

 

 

 

 

 

 

Total shareholders’ equity

 

1,682,778

 

886,168

 

804,239

 

(1,690,407

)

1,682,778

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

1,701,353

 

$

1,489,641

 

$

1,330,544

 

$

(1,786,100

)

$

2,735,438

 

 

21




 

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 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

 

$

163

 

$

1,116,387

 

$

1,139,463

 

$

 

$

2,256,013

 

Investment in subsidiaries

 

1,665,392

 

 

 

(1,665,392

)

 

Deferred acquisition costs

 

 

73,803

 

119,639

 

 

193,442

 

Reinsurance recoverable

 

 

11,410

 

4,108

 

(3,168

)

12,350

 

Goodwill

 

 

85,417

 

 

 

85,417

 

Premiums receivable

 

 

17,168

 

17,278

 

(1,435

)

33,011

 

Other

 

1,172

 

107,211

 

27,121

 

(26,614

)

108,890

 

Total assets

 

$

1,666,727

 

$

1,411,396

 

$

1,307,609

 

$

(1,696,609

)

$

2,689,123