Exhibit 99.2
Assured Guaranty Municipal Corp.
Consolidated Financial Statements
June 30, 2013
ASSURED GUARANTY MUNICIPAL CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page | |
Assured Guaranty Municipal Corp.
Consolidated Balance Sheets (Unaudited)
(dollars in millions except per share and share amounts)
As of June 30, 2013 | As of December 31, 2012 | ||||||
Assets | |||||||
Investment portfolio: | |||||||
Fixed maturity securities, available-for-sale, at fair value (amortized cost of $4,683 and $4,473) | $ | 4,847 | $ | 4,831 | |||
Short-term investments, at fair value | 623 | 473 | |||||
Other invested assets | 395 | 444 | |||||
Total investment portfolio | 5,865 | 5,748 | |||||
Loan receivable from affiliate | 83 | 83 | |||||
Cash | 63 | 47 | |||||
Premiums receivable, net of ceding commissions payable | 593 | 653 | |||||
Ceded unearned premium reserve | 1,111 | 1,187 | |||||
Reinsurance recoverable on unpaid losses | 81 | 75 | |||||
Salvage and subrogation recoverable | 240 | 383 | |||||
Credit derivative assets | 114 | 131 | |||||
Deferred tax asset, net | 384 | 409 | |||||
Financial guaranty variable interest entities’ assets, at fair value | 1,784 | 1,870 | |||||
Other assets | 128 | 127 | |||||
Total assets | $ | 10,446 | $ | 10,713 | |||
Liabilities and shareholder's equity | |||||||
Unearned premium reserve | $ | 3,557 | $ | 3,866 | |||
Loss and loss adjustment expense reserve | 225 | 230 | |||||
Reinsurance balances payable, net | 255 | 292 | |||||
Notes payable | 53 | 66 | |||||
Credit derivative liabilities | 424 | 414 | |||||
Financial guaranty variable interest entities’ liabilities with recourse, at fair value | 1,422 | 1,605 | |||||
Financial guaranty variable interest entities’ liabilities without recourse, at fair value | 717 | 678 | |||||
Other liabilities | 388 | 343 | |||||
Total liabilities | 7,041 | 7,494 | |||||
Commitments and contingencies (See Note 14) | |||||||
Preferred stock ($1,000 par value, 5,000.1 shares authorized; 0 shares issued and outstanding) | — | — | |||||
Common stock ($45,455 par value, 330 shares authorized; issued and outstanding) | 15 | 15 | |||||
Additional paid-in capital | 1,067 | 1,092 | |||||
Retained earnings | 2,216 | 1,880 | |||||
Accumulated other comprehensive income, net of tax of $58 and $125 | 107 | 232 | |||||
Total shareholder's equity | 3,405 | 3,219 | |||||
Total liabilities and shareholder's equity | $ | 10,446 | $ | 10,713 |
The accompanying notes are an integral part of these consolidated financial statements.
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Assured Guaranty Municipal Corp.
Consolidated Statements of Operations (Unaudited)
(in millions)
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
Revenues | |||||||||||||||
Net earned premiums | $ | 109 | $ | 156 | $ | 285 | $ | 290 | |||||||
Net investment income | 56 | 59 | 112 | 113 | |||||||||||
Net realized investment gains (losses): | |||||||||||||||
Other-than-temporary impairment losses | (13 | ) | — | (14 | ) | 0 | |||||||||
Less: portion of other-than-temporary impairment loss recognized in other comprehensive income | (10 | ) | 0 | (7 | ) | 2 | |||||||||
Other net realized investment gains (losses) | 1 | (9 | ) | (3 | ) | (6 | ) | ||||||||
Net realized investment gains (losses) | (2 | ) | (9 | ) | (10 | ) | (8 | ) | |||||||
Net change in fair value of credit derivatives: | |||||||||||||||
Realized gains and other settlements | 18 | (6 | ) | 29 | (7 | ) | |||||||||
Net unrealized gains (losses) | 45 | 53 | (22 | ) | 24 | ||||||||||
Net change in fair value of credit derivatives | 63 | 47 | 7 | 17 | |||||||||||
Fair value gain (loss) on committed capital securities | (1 | ) | 2 | (4 | ) | (3 | ) | ||||||||
Fair value gains (losses) on financial guaranty variable interest entities | 147 | 65 | 222 | 30 | |||||||||||
Other income | (9 | ) | 13 | (25 | ) | 96 | |||||||||
Total revenues | 363 | 333 | 587 | 535 | |||||||||||
Expenses | |||||||||||||||
Loss and loss adjustment expenses | 33 | 76 | 4 | 266 | |||||||||||
Amortization of deferred ceding commissions | (19 | ) | (1 | ) | (22 | ) | (2 | ) | |||||||
Interest expense | 2 | 3 | 3 | 4 | |||||||||||
Other operating expenses | 25 | 24 | 55 | 54 | |||||||||||
Total expenses | 41 | 102 | 40 | 322 | |||||||||||
Income (loss) before income taxes | 322 | 231 | 547 | 213 | |||||||||||
Provision (benefit) for income taxes: | |||||||||||||||
Current | 17 | (16 | ) | 81 | 18 | ||||||||||
Deferred | 86 | 86 | 92 | 36 | |||||||||||
Total provision (benefit) for income taxes | 103 | 70 | 173 | 54 | |||||||||||
Net income (loss) | $ | 219 | $ | 161 | $ | 374 | $ | 159 |
The accompanying notes are an integral part of these consolidated financial statements.
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Assured Guaranty Municipal Corp.
Consolidated Statements of Comprehensive Income (Unaudited)
(in millions)
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
Net income (loss) | $ | 219 | $ | 161 | $ | 374 | $ | 159 | |||||||
Unrealized holding gains (losses) arising during the period: | |||||||||||||||
Investments with no other-than-temporary impairment, net of tax provision (benefit) of $(43), $0, $(55) and $7 | (81 | ) | 0 | (103 | ) | 14 | |||||||||
Investments with other-than-temporary impairment, net of tax provision (benefit) of $(5), $1, $(16) and $2 | (11 | ) | 2 | (30 | ) | 4 | |||||||||
Unrealized holding gains (losses) arising during the period, net of tax | (92 | ) | 2 | (133 | ) | 18 | |||||||||
Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $(1), $(5), $(4) and $(6) | (3 | ) | (10 | ) | (8 | ) | (11 | ) | |||||||
Other comprehensive income (loss) | (89 | ) | 12 | (125 | ) | 29 | |||||||||
Comprehensive income (loss) | $ | 130 | $ | 173 | $ | 249 | $ | 188 |
The accompanying notes are an integral part of these consolidated financial statements.
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Assured Guaranty Municipal Corp.
Consolidated Statements of Shareholder’s Equity (unaudited)
For the Six Months Ended June 30, 2013
(dollars in millions, except share data)
Common Stock | Additional Paid-In Capital | Retained Earnings | Accumulated Other Comprehensive Income | Total Shareholder's Equity | ||||||||||||||||||
Shares | Amount | |||||||||||||||||||||
Balance at December 31, 2012 | 330 | $ | 15 | $ | 1,092 | $ | 1,880 | $ | 232 | $ | 3,219 | |||||||||||
Net income | — | — | — | 374 | — | 374 | ||||||||||||||||
Dividends | — | — | — | (38 | ) | — | (38 | ) | ||||||||||||||
Other comprehensive loss | — | — | — | — | (125 | ) | (125 | ) | ||||||||||||||
Return of capital | — | — | (25 | ) | — | — | (25 | ) | ||||||||||||||
Balance at June 30, 2013 | 330 | $ | 15 | $ | 1,067 | $ | 2,216 | $ | 107 | $ | 3,405 |
The accompanying notes are an integral part of these consolidated financial statements.
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Assured Guaranty Municipal Corp.
Consolidated Statements of Cash Flows (Unaudited)
(in millions)
Six Months Ended June 30, | |||||||
2013 | 2012 | ||||||
Net cash flows provided by (used in) operating activities | $ | 271 | $ | 274 | |||
Investing activities | |||||||
Fixed maturity securities: | |||||||
Purchases | (426 | ) | (326 | ) | |||
Sales | 44 | 185 | |||||
Maturities | 186 | 214 | |||||
Net sales (purchases) of short-term investments | (150 | ) | (77 | ) | |||
Net proceeds from paydowns on financial guaranty variable interest entities’ assets | 402 | 242 | |||||
Loan to affiliate | — | (83 | ) | ||||
Other investments | 12 | 26 | |||||
Net cash flows provided by (used in) investing activities | 68 | 181 | |||||
Financing activities | |||||||
Dividends paid | (38 | ) | (30 | ) | |||
Repayment of notes payable | (13 | ) | (23 | ) | |||
Net paydowns of financial guaranty variable interest entities' liabilities | (244 | ) | (331 | ) | |||
Return of capital | (25 | ) | (50 | ) | |||
Net cash flows provided by (used in) financing activities | (320 | ) | (434 | ) | |||
Effect of exchange rate changes | (3 | ) | (3 | ) | |||
Increase (decrease) in cash | 16 | 18 | |||||
Cash at beginning of period | 47 | 59 | |||||
Cash at end of period | $ | 63 | $ | 77 | |||
Supplemental cash flow information | |||||||
Cash paid (received) during the period for: | |||||||
Income taxes | $ | 23 | $ | (95 | ) | ||
Interest | $ | 3 | $ | 5 |
The accompanying notes are an integral part of these consolidated financial statements.
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Assured Guaranty Municipal Corp.
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2013
1. | Business and Basis of Presentation |
Business
Assured Guaranty Municipal Corp., formerly known as Financial Security Assurance Inc. (“AGM,” or together with its direct and indirect owned subsidiaries, the “Company”), a New York domiciled insurance company, is a wholly owned subsidiary of Assured Guaranty Municipal Holdings Inc. (“AGMH”). AGMH is an indirect and wholly owned subsidiary of Assured Guaranty Ltd. (“AGL” and, together with its subsidiaries, “Assured Guaranty”). AGL is a Bermuda based holding company that provides, through its operating subsidiaries, credit protection products to the United States (“U.S.”) and international public finance (including infrastructure) and structured finance markets.
The Company applies its credit underwriting judgment, risk management skills and capital markets experience to offer insurance that protects holders of debt instruments and other monetary obligations from defaults in scheduled payments, including scheduled interest and principal payments. The Company markets its credit protection products directly to issuers and underwriters of public finance securities as well as to investors in such obligations. The Company guarantees obligations issued in many countries, although its principal focus is on the U.S., as well as Europe and Australia. The Company had previously offered insurance and reinsurance in the global structured finance market, but has not done so since mid-2008.
Financial guaranty insurance policies provide an unconditional and irrevocable guaranty that protects the holder of a financial obligation against non-payment of principal and interest ("Debt Service") when due. Upon an obligor's default on scheduled principal or interest payments due on the obligation, the Company is required under the financial guaranty policy to pay the principal or interest shortfall. The Company has issued financial guaranty insurance policies on public finance obligations and, prior to mid-2008, structured finance obligations. Public finance obligations insured by the Company consist primarily of general obligation bonds supported by the taxing powers of U.S. state or municipal governmental authorities, as well as tax-supported bonds, revenue bonds and other obligations supported by covenants from state or municipal governmental authorities or other municipal obligors to impose and collect fees and charges for public services or specific infrastructure projects. The Company also includes within public finance obligations those obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including utilities, toll roads, health care facilities and government office buildings. Structured finance obligations insured by the Company are generally issued by special purpose entities and backed by pools of assets such as residential or commercial mortgage loans, consumer or trade receivables, securities or other assets having an ascertainable cash flow or market value. While AGM has ceased insuring new originations of asset-backed securities, a significant portfolio of such obligations remains outstanding and its wholly owned subsidiary Assured Guaranty (Europe) Ltd. (“AGE”) provides financial guarantees in both the international public finance and structured finance markets.
In the past, the Company had sold credit protection by issuing policies that guaranteed payment obligations under credit derivatives. Financial guaranty contracts accounted for as credit derivatives are generally structured such that the circumstances giving rise to the Company’s obligation to make loss payments are similar to those for financial guaranty insurance contracts and only occurs upon one or more defined credit events such as failure to pay or bankruptcy, in each case, as defined within the transaction documents, with respect to one or more third party referenced securities or loans. Financial guaranty contracts accounted for as credit derivatives are primarily comprised of credit default swaps (“CDS”). The Company’s credit derivative transactions are governed by International Swaps and Derivative Association, Inc. (“ISDA”) documentation. The Company has not entered into any new CDS in order to sell credit protection since the beginning of 2009, when regulatory guidelines were issued that limited the terms under which such protection could be sold. The capital and margin requirements applicable under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), also contributed to the decision of the Company not to enter into such new CDS in the foreseeable future. The Company actively pursues opportunities to terminate existing CDS, which have the effect of reducing future fair value volatility in income and/or reducing rating agency capital charges.
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Basis of Presentation
The unaudited interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and, in the opinion of management, reflect all adjustments that are of a normal recurring nature, necessary for a fair statement of the financial condition, results of operations and cash flows of the Company and its consolidated financial guaranty variable interest entities (“FG VIEs”) 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 are as of June 30, 2013 and cover the three-month period ended June 30, 2013 (“Second Quarter 2013”) and the three-month period ended June 30, 2012 (“Second Quarter 2012”), the six-month period ended June 30, 2013 ("Six Months 2013") and the six-month period ended June 30, 2012 ("Six Months 2012"). Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but is not required for interim reporting purposes, has been condensed or omitted. The year-end balance sheet data was derived from audited financial statements.
The unaudited interim consolidated financial statements include the accounts of AGM and its subsidiaries (collectively, the “Subsidiaries”), and its consolidated FG VIEs. Intercompany accounts and transactions between and among all consolidated entities have been eliminated. Certain prior year balances have been reclassified to conform to the current year's presentation.
These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements included in Exhibit 99.1 in AGL's Form 8-K dated April 23, 2013, filed with the U.S. Securities and Exchange Commission (the “SEC”).
As of June 30, 2013, AGM's direct and indirect subsidiaries were as follows:
•Assured Guaranty (Europe) Ltd., organized in the United Kingdom;
• | Assured Guaranty Municipal Insurance Company ("AGMIC"), domiciled in New York; and |
• | Assured Guaranty (Bermuda) Ltd. ("AGBM"), organized in Bermuda. |
As of the date of this filing, after giving effect to the completion on July 16, 2013 of a series of transactions that resulted in Municipal Assurance Corp. (“MAC”) becoming a subsidiary of AGM, with approximately $700 million of capital and $100 million of surplus note issued by MAC to AGM, AGM's direct and indirect subsidiaries are as follows:
•Assured Guaranty (Europe) Ltd.; organized in the United Kingdom and 100% owned by AGM;
• | Municipal Assurance Holdings Inc. (“MAC Holdings”), incorporated in Delaware and 61% owned by AGM and 39% owned by AGM's affiliate, Assured Guaranty Corp.; and |
• | Municipal Assurance Corp., domiciled in New York and 100% owned by Municipal Assurance Holdings Inc. |
The transactions are described in greater detail in Note 17, Subsequent Events.
2. | Business Changes and Accounting Developments |
Summarized below are updates of the most significant recent events that have had, or may have in the future, a material effect on the financial position, results of operations or business prospects of the Company.
Rating Actions
When a rating agency assigns a public rating to a financial obligation guaranteed by AGM or its subsidiaries AGE or MAC, it generally awards that obligation the same rating it has assigned to the financial strength of those insurance companies. Investors in products insured by AGM or MAC and guaranteed by AGE frequently rely on ratings published by nationally recognized statistical rating organizations (“NRSROs”) because such ratings influence the trading value of securities and form the basis for many institutions’ investment guidelines as well as individuals’ bond purchase decisions. Therefore, the Company manages its business with the goal of achieving high financial strength ratings. If the financial strength ratings were reduced below current levels, the Company expects it could have adverse effects on its future business opportunities as well as the premiums it could charge for its insurance policies and consequently, a downgrade could harm the Company’s new business production and results of operations in a material respect. The models used by NRSROs differ, presenting conflicting goals that
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may make it inefficient or impractical to reach the highest rating level. The models are not fully transparent, contain subjective data (such as assumptions about future market demand for the Company’s products) and change frequently. Ratings reflect only the views of the respective NRSROs and are subject to continuous review and revision or withdrawal at any time.
In the last several years, Standard & Poor’s Ratings Services (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”) have downgraded the financial strength ratings of AGM and AGE. On January 17, 2013, Moody’s downgraded the financial strength rating of AGM and AGE to A2 from Aa3. While the outlook for the ratings from S&P and Moody's is stable, there can be no assurance that S&P and Moody's will not take further action on AGM's and AGE's ratings. For a discussion of the effect of rating actions on AGM and AGE, see the following:
• | Note 5, Expected Loss to be Paid |
• | Note 13, Reinsurance and Other Monoline Exposures |
• | Note 15, Notes Payable and Credit Facilities (regarding the impact on the Company's insured leveraged lease transactions) |
In July 2013, MAC was assigned a financial strength rating of AA+ (stable outlook) from Kroll Bond Rating Agency and of AA- (stable outlook) from S&P. These ratings are also subject to continuous review and revision or withdrawal at any time.
Accounting Changes
In 2013, the Company expanded Note 16, Other Comprehensive Income, upon adoption of new guidance on other comprehensive income disclosures (per Accounting Standards Update (ASU) No. 2013-02).
Significant Transactions
• | On May 6, 2013, Assured Guaranty entered into an agreement with UBS Real Estate Securities Inc. and affiliates ("UBS") and a third party resolving the Assured Guaranty's claims and liabilities related to specified residential mortgage-backed securities ("RMBS") transactions that were issued, underwritten or sponsored by UBS and insured by AGM or Assured Guaranty Corp. ("AGC"), an affiliate of the Company, under financial guaranty insurance policies. See Note 5, Expected Loss to be Paid. |
• | On June 21, 2013, AGM entered into a settlement agreement with Flagstar Bank in connection with its litigation for breach of contract against Flagstar on the Flagstar Home Equity Loan Trust, Series 2005-1 and Series 2006-2 second lien transactions. The agreement followed judgments by the court in February and April 2013 in favor of AGM, which Flagstar had planned to appeal. As part of the settlement, AGM received a cash payment of $105 million and Flagstar withdrew its appeal. Flagstar also will reimburse AGM in full for all future claims on AGM’s financial guaranty insurance policies for such transactions. This settlement resolved all RMBS claims that AGM had asserted against Flagstar and each party agreed to release the other from any and all other future RMBS-related claims between them. |
• | In August 2013, AGM reached an agreement in principle with a servicer of certain RMBS transactions that AGM had insured. See Note 5, Expected Loss to be Paid. |
• | See Note 17, Subsequent Events, for transactions related to capitalization of MAC. |
3. | Outstanding Exposure |
The Company's financial guaranty contracts are written in either insurance or credit derivative form, but collectively are considered financial guaranty contracts. The Company seeks to limit its exposure to losses by underwriting obligations that are investment grade at inception, diversifying its insured portfolio and maintaining rigorous subordination or collateralization requirements on structured finance obligations. The Company also has utilized reinsurance by ceding business to third-party and affiliated reinsurers. The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs. Some of these VIEs are consolidated as described in Note 9, Consolidation of Variable Interest Entities. The outstanding par and Debt Service amounts presented below include outstanding exposures on VIEs whether or not they are consolidated.
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Debt Service Outstanding
Gross Debt Service Outstanding | Net Debt Service Outstanding | ||||||||||||||
June 30, 2013 | December 31, 2012 | June 30, 2013 | December 31, 2012 | ||||||||||||
(in millions) | |||||||||||||||
Public finance | $ | 503,820 | $ | 537,810 | $ | 365,771 | $ | 391,826 | |||||||
Structured finance | 53,347 | 60,926 | 46,528 | 53,449 | |||||||||||
Total financial guaranty | $ | 557,167 | $ | 598,736 | $ | 412,299 | $ | 445,275 |
Financial Guaranty Portfolio by Internal Rating
As of June 30, 2013
Public Finance U.S. | Public Finance Non-U.S. | Structured Finance U.S. | Structured Finance Non-U.S. | Total | ||||||||||||||||||||||||||||||
Rating Category | Net Par Outstanding | % | Net Par Outstanding | % | Net Par Outstanding | % | Net Par Outstanding | % | Net Par Outstanding | % | ||||||||||||||||||||||||
(dollars in millions) | ||||||||||||||||||||||||||||||||||
AAA | $ | 3,409 | 1.6 | % | $ | 516 | 2.4 | % | $ | 21,433 | 64.3 | % | $ | 5,918 | 75.3 | % | $ | 31,276 | 11.2 | % | ||||||||||||||
AA | 76,289 | 35.2 | % | 440 | 2.1 | % | 6,278 | 18.8 | % | 422 | 5.4 | % | 83,429 | 29.9 | % | |||||||||||||||||||
A | 112,866 | 52.1 | % | 5,371 | 25.5 | % | 463 | 1.4 | % | 344 | 4.3 | % | 119,044 | 42.7 | % | |||||||||||||||||||
BBB | 22,353 | 10.3 | % | 13,417 | 63.7 | % | 158 | 0.5 | % | 559 | 7.1 | % | 36,487 | 13.1 | % | |||||||||||||||||||
Below-investment-grade ("BIG") | 1,779 | 0.8 | % | 1,328 | 6.3 | % | 5,018 | 15.0 | % | 619 | 7.9 | % | 8,744 | 3.1 | % | |||||||||||||||||||
Total net par outstanding | $ | 216,696 | 100.0 | % | $ | 21,072 | 100.0 | % | $ | 33,350 | 100.0 | % | $ | 7,862 | 100.0 | % | $ | 278,980 | 100.0 | % |
Financial Guaranty Portfolio by Internal Rating
As of December 31, 2012
Public Finance U.S. | Public Finance Non-U.S. | Structured Finance U.S. | Structured Finance Non-U.S. | Total | ||||||||||||||||||||||||||||||
Rating Category | Net Par Outstanding | % | Net Par Outstanding | % | Net Par Outstanding | % | Net Par Outstanding | % | Net Par Outstanding | % | ||||||||||||||||||||||||
(dollars in millions) | ||||||||||||||||||||||||||||||||||
AAA | 3,521 | 1.5 | % | 508 | 2.2 | % | 24,416 | 63.7 | % | 6,626 | 73.8 | % | 35,071 | 11.7 | % | |||||||||||||||||||
AA | 82,798 | 36.2 | % | 789 | 3.4 | % | 6,833 | 17.8 | % | 469 | 5.2 | % | 90,889 | 30.3 | % | |||||||||||||||||||
A | 118,867 | 52.0 | % | 5,946 | 25.4 | % | 1,155 | 3.0 | % | 586 | 6.6 | % | 126,554 | 42.3 | % | |||||||||||||||||||
BBB | 21,795 | 9.5 | % | 14,506 | 62.0 | % | 215 | 0.6 | % | 676 | 7.5 | % | 37,192 | 12.4 | % | |||||||||||||||||||
BIG | 1,822 | 0.8 | % | 1,635 | 7.0 | % | 5,703 | 14.9 | % | 624 | 6.9 | % | 9,784 | 3.3 | % | |||||||||||||||||||
Total net par outstanding | $ | 228,803 | 100.0 | % | $ | 23,384 | 100.0 | % | $ | 38,322 | 100.0 | % | $ | 8,981 | 100.0 | % | $ | 299,490 | 100.0 | % |
The Company classifies those portions of risks benefiting from reimbursement obligations collateralized, or expected to be collateralized, by eligible assets held in trust in acceptable reimbursement structures as the higher of 'AA' or their current internal rating.
Securities purchased for loss mitigation purposes, which are generally rated BIG, represented $719 million and $703 million of gross par outstanding as of June 30, 2013 and December 31, 2012, respectively. In addition, under the terms of certain credit derivative contracts, the referenced obligations in such contracts have been delivered to the Company and recorded in other invested assets in the consolidated balance sheets. Such amounts totaled $218 million and $219 million in gross par outstanding as of June 30, 2013 and December 31, 2012, respectively.
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In addition to amounts shown in the tables above, AGM had outstanding commitments to provide guaranties of $136 million for structured finance and $1.5 billion for public finance obligations at June 30, 2013, of which up to $208 million can be used together with AGC, an affiliate of the Company. The structured finance commitments include the unfunded component of pooled corporate and other transactions. Public finance commitments typically relate to primary and secondary public finance debt issuances. The expiration dates for the public finance commitments range between July 1, 2013 and February 25, 2017; with $1.4 billion expiring prior to December 31, 2013. The commitments are contingent on the satisfaction of all conditions set forth in them and may expire unused or be canceled at the counterparty's request. Therefore, the total commitment amount does not necessarily reflect actual future guaranteed amounts.
Economic Exposure to the Selected European Countries
Several European countries continue to experience significant economic, fiscal and/or political strains such that the likelihood of default on obligations with a nexus to those countries may be higher than the Company anticipated when such factors did not exist. The European countries where it believes heightened uncertainties exist are: Hungary, Ireland, Italy, Portugal and Spain (the “Selected European Countries”). The Company is closely monitoring its exposures in Selected European Countries where it believes heightened uncertainties exist. Published reports have identified countries that may be experiencing reduced demand for their sovereign debt in the current environment. The Company selected these European countries based on these reports and its view that their credit fundamentals are deteriorating. The Company's economic exposure to the Selected European Countries (based on par for financial guaranty contracts and notional amount for financial guaranty contracts accounted for as derivatives) is shown in the following table net of ceded reinsurance.
Net Economic Exposure to Selected European Countries(1)
June 30, 2013
Hungary | Ireland | Italy | Portugal | Spain (2) | Total | |||||||||||||||||||
(in millions) | ||||||||||||||||||||||||
Sovereign and sub-sovereign exposure: | ||||||||||||||||||||||||
Public finance | $ | — | $ | — | $ | 806 | $ | 94 | $ | 214 | $ | 1,114 | ||||||||||||
Infrastructure finance | 309 | — | 10 | — | 142 | 461 | ||||||||||||||||||
Sub-total | 309 | — | 816 | 94 | 356 | 1,575 | ||||||||||||||||||
Non-sovereign exposure: | ||||||||||||||||||||||||
Regulated utilities | — | — | 126 | — | 0 | 126 | ||||||||||||||||||
RMBS | 205 | — | 461 | — | — | 666 | ||||||||||||||||||
Pooled corporate obligations | — | 74 | 56 | 12 | 109 | 251 | ||||||||||||||||||
Sub-total | 205 | 74 | 643 | 12 | 109 | 1,043 | ||||||||||||||||||
Total | $ | 514 | $ | 74 | $ | 1,459 | $ | 106 | $ | 465 | $ | 2,618 | ||||||||||||
Total BIG | $ | 514 | $ | 7 | $ | — | $ | 94 | $ | 356 | $ | 971 |
____________________
(1) | While the Company's exposures are shown in U.S. dollars, the obligations the Company insures are in various currencies, including U.S. dollars, Euros and British pounds sterling. One of the RMBS included in the table above includes residential mortgages in both Italy and Germany, and only the portion of the transaction equal to the portion of the original mortgage pool in Italian mortgages is shown in the table. |
(2) | See Note 5, Expected Loss to be Paid. |
When the Company directly insures an obligation, it assigns the obligation to a geographic location or locations based on its view of the geographic location of the risk. For direct exposure this can be a relatively straight-forward determination as, for example, a debt issue supported by availability payments for a toll road in a particular country. The Company may also assign portions of a risk to more than one geographic location.
The Company has included in the exposure tables above its indirect economic exposure to the Selected European Countries through exposure it provides on pooled corporate obligations. The Company considers economic exposure to a Selected European Country to be indirect when the exposure relates to only a small portion of an insured transaction that otherwise is not related to a Selected European Country. In most instances, the trustees and/or servicers for such transactions provide reports that identify the domicile of the underlying obligors in the pool, although occasionally such information is not
12
available to the Company. The Company has reviewed transactions through which it believes it may have indirect exposure to the Selected European Countries that is material to the transaction and included in the tables above the proportion of the insured par equal to the proportion of obligors so identified as being domiciled in a Selected European Country.
The Company no longer guarantees any sovereign bonds of the Selected European Countries. The exposure shown in the “Public Finance Category” is from transactions backed by receivable payments from sub-sovereigns in Italy, Spain and Portugal. Sub-sovereign debt is debt issued by a governmental entity or government backed entity, or supported by such an entity, that is other than direct sovereign debt of the ultimate governing body of the country.
Surveillance Categories
The Company segregates its insured portfolio into investment grade and BIG surveillance categories to facilitate the appropriate allocation of resources to monitoring and loss mitigation efforts and to aid in establishing the appropriate cycle for periodic review for each exposure. BIG exposures include all exposures with internal credit ratings below BBB-. The Company's internal credit ratings are based on internal assessments of the likelihood of default and loss severity in the event of default. Internal credit ratings are expressed on a ratings scale similar to that used by the rating agencies and are generally reflective of an approach similar to that employed by the rating agencies.
The Company monitors its investment grade credits to determine whether any new credits need to be internally downgraded to BIG. The Company refreshes its internal credit ratings on individual credits in quarterly, semi-annual or annual cycles based on the Company's view of the credit's quality, loss potential, volatility and sector. Ratings on credits in sectors identified as under the most stress or with the most potential volatility are reviewed every quarter.
Credits identified as BIG are subjected to further review to determine the probability of a loss (see Note 5, Expected Loss to be Paid). Surveillance personnel then assign each BIG transaction to the appropriate BIG surveillance category based upon whether a lifetime loss is expected and whether a claim has been paid. The Company expects “lifetime losses” on a transaction when the Company believes there is at least a 50% chance that, on a present value basis, it will pay more claims over the life of that transaction than it ultimately will have reimbursed. For surveillance purposes, the Company calculates present value using a constant discount rate of 5%. (A risk-free rate is used for recording of reserves for financial statement purposes.)
More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly. The three BIG categories are:
• | BIG Category 1: Below-investment-grade transactions showing sufficient deterioration to make lifetime losses possible, but for which none are currently expected. Transactions on which claims have been paid but are expected to be fully reimbursed (other than investment grade transactions on which only liquidity claims have been paid) are in this category. |
• | BIG Category 2: Below-investment-grade transactions for which lifetime losses are expected but for which no claims (other than liquidity claims which is a claim that the Company expects to be reimbursed within one year) have yet been paid. |
• | BIG Category 3: Below-investment-grade transactions for which lifetime losses are expected and on which claims (other than liquidity claims) have been paid. Transactions remain in this category when claims have been paid and only a recoverable remains. |
13
Financial Guaranty Exposures
(Insurance and Credit Derivative Form)
As of June 30, 2013
BIG Net Par Outstanding | Net Par | BIG Net Par as a % of Total Net Par | ||||||||||||||||||||
BIG 1 | BIG 2 | BIG 3 | Total BIG | Outstanding | Outstanding | |||||||||||||||||
(in millions) | ||||||||||||||||||||||
First lien U.S. RMBS: | ||||||||||||||||||||||
Prime first lien | $ | — | $ | — | $ | — | $ | — | $ | 71 | — | % | ||||||||||
Alt-A first lien | — | 295 | 536 | 831 | 1,036 | 0.3 | ||||||||||||||||
Option ARM | 0 | — | 196 | 196 | 521 | 0.1 | ||||||||||||||||
Subprime | 31 | 961 | 569 | 1,561 | 3,206 | 0.6 | ||||||||||||||||
Second lien U.S. RMBS: | ||||||||||||||||||||||
Closed end second lien | — | 20 | 207 | 227 | 372 | 0.1 | ||||||||||||||||
Home equity lines of credit ("HELOCs") | 129 | — | 1,725 | 1,854 | 2,224 | 0.7 | ||||||||||||||||
Total U.S. RMBS | 160 | 1,276 | 3,233 | 4,669 | 7,430 | 1.8 | ||||||||||||||||
Trust preferred securities ("TruPS") | — | — | — | — | 72 | 0.0 | ||||||||||||||||
Other structured finance | 669 | 210 | 89 | 968 | 33,710 | 0.3 | ||||||||||||||||
U.S. public finance | 1,494 | 49 | 236 | 1,779 | 216,696 | 0.5 | ||||||||||||||||
Non-U.S. public finance | 759 | 569 | — | 1,328 | 21,072 | 0.5 | ||||||||||||||||
Total | $ | 3,082 | $ | 2,104 | $ | 3,558 | $ | 8,744 | $ | 278,980 | 3.1 | % |
Financial Guaranty Exposures
(Insurance and Credit Derivative Form)
As of December 31, 2012
BIG Net Par Outstanding | Net Par | BIG Net Par as a % of Total Net Par | ||||||||||||||||||||
BIG 1 | BIG 2 | BIG 3 | Total BIG | Outstanding | Outstanding | |||||||||||||||||
(in millions) | ||||||||||||||||||||||
First lien U.S. RMBS: | ||||||||||||||||||||||
Prime first lien | $ | — | $ | — | $ | — | $ | — | $ | 77 | — | % | ||||||||||
Alt-A first lien | 26 | 285 | 571 | 882 | 1,104 | 0.3 | ||||||||||||||||
Option ARM | — | — | 525 | 525 | 762 | 0.2 | ||||||||||||||||
Subprime | 78 | 934 | 583 | 1,595 | 3,313 | 0.5 | ||||||||||||||||
Second lien U.S. RMBS: | ||||||||||||||||||||||
Closed end second lien | — | 205 | 98 | 303 | 461 | 0.1 | ||||||||||||||||
HELOCs | 72 | — | 1,967 | 2,039 | 2,464 | 0.7 | ||||||||||||||||
Total U.S. RMBS | 176 | 1,424 | 3,744 | 5,344 | 8,181 | 1.8 | ||||||||||||||||
TruPS | — | — | — | — | 90 | 0.0 | ||||||||||||||||
Other structured finance | 678 | 216 | 89 | 983 | 39,032 | 0.3 | ||||||||||||||||
U.S. public finance | 1,633 | — | 189 | 1,822 | 228,803 | 0.6 | ||||||||||||||||
Non-U.S. public finance | 1,635 | — | — | 1,635 | 23,384 | 0.6 | ||||||||||||||||
Total | $ | 4,122 | $ | 1,640 | $ | 4,022 | $ | 9,784 | $ | 299,490 | 3.3 | % |
14
Below-Investment-Grade Credits
By Category
As of June 30, 2013
Net Par Outstanding | Number of Risks(2) | ||||||||||||||||||||
Description | Financial Guaranty Insurance(1) | Credit Derivative | Total | Financial Guaranty Insurance(1) | Credit Derivative | Total | |||||||||||||||
(dollars in millions) | |||||||||||||||||||||
BIG: | |||||||||||||||||||||
Category 1 | $ | 2,894 | $ | 188 | $ | 3,082 | 65 | 6 | 71 | ||||||||||||
Category 2 | 2,104 | — | 2,104 | 26 | — | 26 | |||||||||||||||
Category 3 | 3,444 | 114 | 3,558 | 51 | 9 | 60 | |||||||||||||||
Total BIG | $ | 8,442 | $ | 302 | $ | 8,744 | 142 | 15 | 157 |
Below-Investment-Grade Credits
By Category
As of December 31, 2012
Net Par Outstanding | Number of Risks(2) | ||||||||||||||||||||
Description | Financial Guaranty Insurance(1) | Credit Derivative | Total | Financial Guaranty Insurance(1) | Credit Derivative | Total | |||||||||||||||
(dollars in millions) | |||||||||||||||||||||
BIG: | |||||||||||||||||||||
Category 1 | $ | 3,723 | $ | 399 | $ | 4,122 | 71 | 6 | 77 | ||||||||||||
Category 2 | 1,640 | — | 1,640 | 21 | — | 21 | |||||||||||||||
Category 3 | 3,892 | 130 | 4,022 | 50 | 9 | 59 | |||||||||||||||
Total BIG | $ | 9,255 | $ | 529 | $ | 9,784 | 142 | 15 | 157 |
____________________
(1) | Includes net par outstanding for FG VIE. |
(2) | A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making Debt Service payments. |
4. | Financial Guaranty Insurance Premiums |
The portfolio of outstanding exposures discussed in Note 3, Outstanding Exposure, includes financial guaranty contracts that meet the definition of insurance contracts as well as those that meet the definition of a derivative under GAAP. Amounts presented in this note relate only to financial guaranty insurance contracts. See Note 8, Financial Guaranty Contracts Accounted for as Credit Derivatives, for a discussion of credit derivative revenues.
15
Net Earned Premiums
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
Scheduled net earned premiums | $ | 79 | $ | 102 | $ | 166 | $ | 207 | |||||||
Acceleration of premium earnings | 27 | 51 | 113 | 76 | |||||||||||
Accretion of discount on net premiums receivable | 3 | 3 | 6 | 7 | |||||||||||
Total net earned premiums(1) | $ | 109 | $ | 156 | $ | 285 | $ | 290 |
___________________
(1) | Excludes $14 million and $15 million for Second Quarter 2013 and 2012, respectively, and $32 million and $31 million for the Six Months 2013 and 2012, respectively, related to consolidated FG VIEs. |
Components of Unearned Premium Reserve
As of June 30, 2013 | As of December 31, 2012 | ||||||||||||||||||||||
Gross | Ceded | Net(1) | Gross | Ceded | Net(1) | ||||||||||||||||||
(in millions) | |||||||||||||||||||||||
Deferred premium revenue | $ | 3,691 | $ | 1,144 | $ | 2,547 | $ | 4,016 | $ | 1,224 | $ | 2,792 | |||||||||||
Contra-paid | (134 | ) | (33 | ) | (101 | ) | (150 | ) | (37 | ) | (113 | ) | |||||||||||
Total | $ | 3,557 | $ | 1,111 | $ | 2,446 | $ | 3,866 | $ | 1,187 | $ | 2,679 |
____________________
(1) | Excludes $201 million and $251 million of deferred premium revenue and $58 million and $98 million of contra-paid related to FG VIEs as of June 30, 2013 and December 31, 2012, respectively. |
Gross Premium Receivable, Net of Ceding Commissions Roll Forward
Six Months | |||||||
2013 | 2012 | ||||||
(in millions) | |||||||
Balance beginning of period | $ | 653 | $ | 645 | |||
Premium written, net | 37 | 78 | |||||
Premium payments received, net | (81 | ) | (116 | ) | |||
Adjustments: | |||||||
Changes in the expected term of financial guaranty insurance contracts | (1 | ) | 17 | ||||
Accretion of discount | 9 | 11 | |||||
Foreign exchange remeasurement | (24 | ) | 0 | ||||
Consolidation of FG VIEs | 0 | (5 | ) | ||||
Other adjustments | — | (1 | ) | ||||
Balance, end of period (1) | $ | 593 | $ | 629 |
____________________
(1) | Excludes $9 million and $21 million as of June 30, 2013 and 2012, respectively, related to consolidated FG VIEs. |
Gains or losses due to foreign exchange rate changes relate to installment premium receivables denominated in currencies other than the U.S. dollar. Approximately 66%, 66% and 69% of installment premiums at June 30, 2013, December 31, 2012 and June 30, 2012, respectively, are denominated in currencies other than the U.S. dollar, primarily Euro and British Pound Sterling.
The timing and cumulative amount of actual collections may differ from expected collections in the tables below due to factors such as foreign exchange rate fluctuations, counterparty collectability issues, accelerations, commutations and changes in expected lives.
16
Expected Collections of Gross Premiums Receivable,
Net of Ceding Commissions (Undiscounted)
June 30, 2013 | |||
(in millions) | |||
2013 (July 1- September 30) | $ | 19 | |
2013 (October 1 - December 31) | 23 | ||
2014 | 65 | ||
2015 | 60 | ||
2016 | 56 | ||
2017 | 52 | ||
2018-2022 | 202 | ||
2023-2027 | 125 | ||
2028-2032 | 90 | ||
After 2032 | 104 | ||
Total(1) | $ | 796 |
____________________
(1) | Excludes expected cash collections on FG VIEs of $10 million. |
Scheduled Net Earned Premiums
Financial Guaranty Insurance Contracts
As of June 30, 2013 | |||
(in millions) | |||
2013 (July 1- September 30) | $ | 77 | |
2013 (October 1 - December 31) | 72 | ||
Subtotal 2013 | 149 | ||
2014 | 268 | ||
2015 | 231 | ||
2016 | 205 | ||
2017 | 180 | ||
2018-2022 | 661 | ||
2023-2027 | 396 | ||
2028-2032 | 229 | ||
After 2032 | 228 | ||
Total present value basis(1) | 2,547 | ||
Discount | 127 | ||
Total future value | $ | 2,674 |
____________________
(1) | Excludes scheduled net earned premiums on consolidated FG VIEs of $201 million. |
Selected Information for Policies Paid in Installments
As of June 30, 2013 | As of December 31, 2012 | ||||||
(dollars in millions) | |||||||
Premiums receivable, net of ceding commission payable | $ | 593 | $ | 653 | |||
Gross deferred premium revenue | 1,397 | 1,562 | |||||
Weighted-average risk-free rate used to discount premiums | 3.5 | % | 3.5 | % | |||
Weighted-average period of premiums receivable (in years) | 9.7 | 10.0 |
17
5. | Expected Loss to be Paid |
The following table presents a roll forward of the present value of net expected loss to be paid for all contracts, whether accounted for as insurance, credit derivatives, or FG VIEs, by sector after the benefit for contractual and expected breaches of representations and warranties ("R&W"). The Company used weighted average risk-free rates for U.S. dollar denominated obligations, which ranged from 0.0% to 4.03% as of June 30, 2013 and 0.0% to 3.28% as of December 31, 2012.
Net Expected Loss to be Paid
After Net Expected Recoveries for Breaches of R&W
Roll Forward
Second Quarter 2013
Net Expected Loss to be Paid as of March 31, 2013 | Economic Loss Development | (Paid) Recovered Losses(1) | Net Expected Loss to be Paid as of June 30, 2013(2) | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | 146 | $ | (2 | ) | $ | (11 | ) | $ | 133 | |||||
Option ARM | (317 | ) | 14 | 295 | (8 | ) | |||||||||
Subprime | 175 | 19 | (7 | ) | 187 | ||||||||||
Total first lien | 4 | 31 | 277 | 312 | |||||||||||
Second lien: | |||||||||||||||
Closed end second lien | (31 | ) | 7 | 1 | (23 | ) | |||||||||
HELOCs | (129 | ) | (12 | ) | 68 | (73 | ) | ||||||||
Total second lien | (160 | ) | (5 | ) | 69 | (96 | ) | ||||||||
Total U.S. RMBS | (156 | ) | 26 | 346 | 216 | ||||||||||
Other structured finance | 29 | (5 | ) | — | 24 | ||||||||||
U.S. public finance | (59 | ) | 15 | (3 | ) | (47 | ) | ||||||||
Non-U.S. public finance | 44 | 3 | — | 47 | |||||||||||
Total | $ | (142 | ) | $ | 39 | $ | 343 | $ | 240 |
18
Net Expected Loss to be Paid
After Net Expected Recoveries for Breaches of R&W
Roll Forward
Second Quarter 2012
Net Expected Loss to be Paid as of March 31, 2012 | Economic Loss Development | (Paid) Recovered Losses(1) | Net Expected Loss to be Paid as of June 30, 2012 | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | 82 | $ | 18 | $ | 53 | $ | 153 | |||||||
Option ARM | 52 | (4 | ) | (107 | ) | (59 | ) | ||||||||
Subprime | 159 | 10 | (20 | ) | 149 | ||||||||||
Total first lien | 293 | 24 | (74 | ) | 243 | ||||||||||
Second lien: | |||||||||||||||
Closed end second lien | (40 | ) | (5 | ) | (1 | ) | (46 | ) | |||||||
HELOCs | (84 | ) | 13 | (22 | ) | (93 | ) | ||||||||
Total second lien | (124 | ) | 8 | (23 | ) | (139 | ) | ||||||||
Total U.S. RMBS | 169 | 32 | (97 | ) | 104 | ||||||||||
Other structured finance | 33 | 5 | — | 38 | |||||||||||
U.S. public finance | (36 | ) | 18 | (1 | ) | (19 | ) | ||||||||
Non-U.S. public finance | 240 | (7 | ) | (34 | ) | 199 | |||||||||
Total | $ | 406 | $ | 48 | $ | (132 | ) | $ | 322 |
19
Net Expected Loss to be Paid
After Net Expected Recoveries for Breaches of R&W
Roll Forward
Six Months 2013
Net Expected Loss to be Paid as of December 31, 2012(2) | Economic Loss Development | (Paid) Recovered Losses(1) | Net Expected Loss to be Paid as of June 30, 2013(2) | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | 149 | $ | 1 | $ | (17 | ) | $ | 133 | ||||||
Option ARM | (142 | ) | (120 | ) | 254 | (8 | ) | ||||||||
Subprime | 162 | 33 | (8 | ) | 187 | ||||||||||
Total first lien | 169 | (86 | ) | 229 | 312 | ||||||||||
Second lien: | |||||||||||||||
Closed end second lien | (49 | ) | 8 | 18 | (23 | ) | |||||||||
HELOCs | (128 | ) | (10 | ) | 65 | (73 | ) | ||||||||
Total second lien | (177 | ) | (2 | ) | 83 | (96 | ) | ||||||||
Total U.S. RMBS | (8 | ) | (88 | ) | 312 | 216 | |||||||||
Other structured finance | 28 | (3 | ) | (1 | ) | 24 | |||||||||
U.S. public finance | (58 | ) | 30 | (19 | ) | (47 | ) | ||||||||
Non-U.S. public finance | 38 | 9 | 0 | 47 | |||||||||||
Total | $ | 0 | $ | (52 | ) | $ | 292 | $ | 240 |
20
Net Expected Loss to be Paid
After Net Expected Recoveries for Breaches of R&W
Roll Forward
Six Months 2012
Net Expected Loss to be Paid as of December 31, 2011 | Economic Loss Development | (Paid) Recovered Losses(1) | Net Expected Loss to be Paid as of June 30, 2012 | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | 93 | $ | 15 | $ | 45 | $ | 153 | |||||||
Option ARM | 135 | (11 | ) | (183 | ) | (59 | ) | ||||||||
Subprime | 155 | 21 | (27 | ) | 149 | ||||||||||
Total first lien | 383 | 25 | (165 | ) | 243 | ||||||||||
Second lien: | |||||||||||||||
Closed end second lien | (32 | ) | (8 | ) | (6 | ) | (46 | ) | |||||||
HELOCs | (75 | ) | 15 | (33 | ) | (93 | ) | ||||||||
Total second lien | (107 | ) | 7 | (39 | ) | (139 | ) | ||||||||
Total U.S. RMBS | 276 | 32 | (204 | ) | 104 | ||||||||||
Other structured finance | 62 | (23 | ) | (1 | ) | 38 | |||||||||
U.S. public finance | (35 | ) | 19 | (3 | ) | (19 | ) | ||||||||
Non-U.S. public finance | 38 | 150 | 11 | 199 | |||||||||||
Total | $ | 341 | $ | 178 | $ | (197 | ) | $ | 322 |
____________________
(1) | Net of ceded paid losses, whether or not such amounts have been settled with reinsurers. Ceded paid losses are typically settled 45 days after the end of the reporting period. Such amounts are recorded in reinsurance recoverable on paid losses included in other assets. |
(2) | Includes net expected loss adjustment expenses ("LAE") to be paid for mitigating claim liabilities of $12 million as of June 30, 2013 and $19 million as of December 31, 2012. The Company paid $12 million and $8 million in LAE for Second Quarter 2013 and 2012, respectively, and $20 million and $14 million in LAE for Six Months 2013 and 2012, respectively. |
21
Net Expected Recoveries from
Breaches of R&W Rollforward
Second Quarter 2013
Future Net R&W Benefit as of March 31, 2013 | R&W Development and Accretion of Discount During Second Quarter 2013 | R&W Recovered During Second Quarter 2013(1) | Future Net R&W Benefit as of June 30, 2013(2) | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
Alt-A first lien | $ | 130 | $ | — | (5 | ) | $ | 125 | |||||||
Option ARM | 581 | 13 | (399 | ) | 195 | ||||||||||
Subprime | 112 | (5 | ) | — | 107 | ||||||||||
Total first lien | 823 | 8 | (404 | ) | 427 | ||||||||||
Second lien: | |||||||||||||||
Closed end second lien | 88 | — | (2 | ) | 86 | ||||||||||
HELOC | 136 | 27 | (102 | ) | 61 | ||||||||||
Total second lien | 224 | 27 | (104 | ) | 147 | ||||||||||
Total | $ | 1,047 | $ | 35 | $ | (508 | ) | $ | 574 |
Net Expected Recoveries from
Breaches of R&W Rollforward
Second Quarter 2012
Future Net R&W Benefit as of March 31, 2012 | R&W Development and Accretion of Discount During Second Quarter 2012 | R&W Recovered During Second Quarter 2012(1) | Future Net R&W Benefit as of June 30, 2012(2) | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
Alt-A first lien | $ | 186 | $ | 10 | (62 | ) | $ | 134 | |||||||
Option ARM | 630 | 28 | (58 | ) | 600 | ||||||||||
Subprime | 96 | (4 | ) | — | 92 | ||||||||||
Total first lien | 912 | 34 | (120 | ) | 826 | ||||||||||
Second lien: | |||||||||||||||
Closed end second lien | 117 | 1 | (6 | ) | 112 | ||||||||||
HELOC | 114 | (1 | ) | (16 | ) | 97 | |||||||||
Total second lien | 231 | 0 | (22 | ) | 209 | ||||||||||
Total | $ | 1,143 | $ | 34 | $ | (142 | ) | $ | 1,035 |
___________________
(1) | Gross amounts recovered were $529 million and $155 million for Second Quarter 2013 and 2012, respectively. |
(2) | Includes excess spread that the Company will receive as salvage as a result of a settlement agreement with a R&W provider. |
22
Net Expected Recoveries from
Breaches of R&W Rollforward
Six Months 2013
Future Net R&W Benefit as of December 31, 2012 | R&W Development and Accretion of Discount During Six Months 2013 | R&W Recovered During Six Months 2013(1) | Future Net R&W Benefit as of June 30, 2013(2) | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
Alt-A first lien | $ | 132 | $ | — | (7 | ) | $ | 125 | |||||||
Option ARM | 481 | 162 | (448 | ) | 195 | ||||||||||
Subprime | 107 | — | — | 107 | |||||||||||
Total first lien | 720 | 162 | (455 | ) | 427 | ||||||||||
Second lien: | |||||||||||||||
Closed end second lien | 115 | (9 | ) | (20 | ) | 86 | |||||||||
HELOC | 125 | 44 | (108 | ) | 61 | ||||||||||
Total second lien | 240 | 35 | (128 | ) | 147 | ||||||||||
Total | $ | 960 | $ | 197 | $ | (583 | ) | $ | 574 |
Net Expected Recoveries from
Breaches of R&W Rollforward
Six Months 2012
Future Net R&W Benefit as of December 31, 2011 | R&W Development and Accretion of Discount During Six Months 2012 | R&W Recovered During Six Months 2012(1) | Future Net R&W Benefit as of June 30, 2012(2) | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
Alt-A first lien | $ | 181 | $ | 16 | (63 | ) | $ | 134 | |||||||
Option ARM | 619 | 56 | (75 | ) | 600 | ||||||||||
Subprime | 101 | (9 | ) | — | 92 | ||||||||||
Total first lien | 901 | 63 | (138 | ) | 826 | ||||||||||
Second lien: | |||||||||||||||
Closed end second lien | 118 | — | (6 | ) | 112 | ||||||||||
HELOC | 151 | (1 | ) | (53 | ) | 97 | |||||||||
Total second lien | 269 | (1 | ) | (59 | ) | 209 | |||||||||
Total | $ | 1,170 | $ | 62 | $ | (197 | ) | $ | 1,035 |
___________________
(1) | Gross amounts recovered were $608 million and $220 million for Six Months 2013 and 2012, respectively. |
(2) | Includes excess spread that the Company will receive as salvage as a result of a settlement agreement with a R&W provider. |
23
The following tables present the present value of net expected loss to be paid for all contracts by accounting model, by sector and after the benefit for estimated and contractual recoveries for breaches of R&W.
Net Expected Loss to be Paid
By Accounting Model
As of June 30, 2013
Financial Guaranty Insurance | FG VIEs(1) | Credit Derivatives | Total | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | 115 | $ | 18 | $ | — | $ | 133 | |||||||
Option ARM | (11 | ) | 3 | — | (8 | ) | |||||||||
Subprime | 118 | 69 | — | 187 | |||||||||||
Total first lien | 222 | 90 | — | 312 | |||||||||||
Second lien: | |||||||||||||||
Closed end second lien | (40 | ) | 19 | (2 | ) | (23 | ) | ||||||||
HELOCs | 20 | (93 | ) | — | (73 | ) | |||||||||
Total second lien | (20 | ) | (74 | ) | (2 | ) | (96 | ) | |||||||
Total U.S. RMBS | 202 | 16 | (2 | ) | 216 | ||||||||||
Other structured finance | 19 | — | 5 | 24 | |||||||||||
U.S. public finance | (47 | ) | — | — | (47 | ) | |||||||||
Non-U.S. public finance | 47 | — | — | 47 | |||||||||||
Total | $ | 221 | $ | 16 | $ | 3 | $ | 240 |
24
Net Expected Loss to be Paid
By Accounting Model
As of December 31, 2012
Financial Guaranty Insurance | FG VIEs(1) | Credit Derivatives | Total | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | 131 | $ | 18 | $ | — | $ | 149 | |||||||
Option ARM | (106 | ) | (36 | ) | — | (142 | ) | ||||||||
Subprime | 112 | 50 | — | 162 | |||||||||||
Total first lien | 137 | 32 | — | 169 | |||||||||||
Second lien: | |||||||||||||||
Closed end second lien | (62 | ) | 23 | (10 | ) | (49 | ) | ||||||||
HELOCs | 39 | (167 | ) | — | (128 | ) | |||||||||
Total second lien | (23 | ) | (144 | ) | (10 | ) | (177 | ) | |||||||
Total U.S. RMBS | 114 | (112 | ) | (10 | ) | (8 | ) | ||||||||
Other structured finance | 23 | — | 5 | 28 | |||||||||||
U.S. public finance | (58 | ) | — | — | (58 | ) | |||||||||
Non-U.S. public finance | 38 | — | — | 38 | |||||||||||
Total | $ | 117 | $ | (112 | ) | $ | (5 | ) | $ | 0 |
___________________
(1) | Refer to Note 9, Consolidation of Variable Interest Entities. |
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The following tables present the net economic loss development for all contracts by accounting model, by sector and after the benefit for estimated and contractual recoveries for breaches of R&W.
Net Economic Loss Development
By Accounting Model
Second Quarter 2013
Financial Guaranty Insurance | FG VIEs(1) | Credit Derivatives(2) | Total | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | (4 | ) | $ | 1 | $ | 1 | $ | (2 | ) | |||||
Option ARM | 8 | 5 | 1 | 14 | |||||||||||
Subprime | 4 | 16 | (1 | ) | 19 | ||||||||||
Total first lien | 8 | 22 | 1 | 31 | |||||||||||
Second lien: | |||||||||||||||
Closed end second lien | (5 | ) | 2 | 10 | 7 | ||||||||||
HELOCs | 10 | (22 | ) | — | (12 | ) | |||||||||
Total second lien | 5 | (20 | ) | 10 | (5 | ) | |||||||||
Total U.S. RMBS | 13 | 2 | 11 | 26 | |||||||||||
Other structured finance | (3 | ) | — | (2 | ) | (5 | ) | ||||||||
U.S. public finance | 15 | — | — | 15 | |||||||||||
Non-U.S.Public finance | 3 | — | — | 3 | |||||||||||
Total | $ | 28 | $ | 2 | $ | 9 | $ | 39 |
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Net Economic Loss Development
By Accounting Model
Second Quarter 2012
Financial Guaranty Insurance | FG VIEs(1) | Credit Derivatives(2) | Total | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | 4 | $ | 14 | $ | — | $ | 18 | |||||||
Option ARM | 75 | (79 | ) | — | (4 | ) | |||||||||
Subprime | (9 | ) | 19 | — | 10 | ||||||||||
Total first lien | 70 | (46 | ) | — | 24 | ||||||||||
Second lien: | |||||||||||||||
Closed end second lien | (49 | ) | 43 | 1 | (5 | ) | |||||||||
HELOCs | (68 | ) | 81 | — | 13 | ||||||||||
Total second lien | (117 | ) | 124 | 1 | 8 | ||||||||||
Total U.S. RMBS | (47 | ) | 78 | 1 | 32 | ||||||||||
Other structured finance | 6 | — | (1 | ) | 5 | ||||||||||
U.S. public finance | 18 | — | — | 18 | |||||||||||
Non-U.S.Public finance | (7 | ) | — | — | (7 | ) | |||||||||
Total | $ | (30 | ) | $ | 78 | $ | 0 | $ | 48 |
Net Economic Loss Development
By Accounting Model
Six Months 2013
Financial Guaranty Insurance | FG VIEs(1) | Credit Derivatives(2) | Total | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | — | $ | 1 | $ | — | $ | 1 | |||||||
Option ARM | (87 | ) | (33 | ) | — | (120 | ) | ||||||||
Subprime | 14 | 20 | (1 | ) | 33 | ||||||||||
Total first lien | (73 | ) | (12 | ) | (1 | ) | (86 | ) | |||||||
Second lien: | |||||||||||||||
Closed end second lien | (2 | ) | — | 10 | 8 | ||||||||||
HELOCs | 7 | (18 | ) | 1 | (10 | ) | |||||||||
Total second lien | 5 | (18 | ) | 11 | (2 | ) | |||||||||
Total U.S. RMBS | (68 | ) | (30 | ) | 10 | (88 | ) | ||||||||
Other structured finance | (3 | ) | — | — | (3 | ) | |||||||||
U.S. public finance | 30 | — | — | 30 | |||||||||||
Non-U.S.Public finance | 9 | — | — | 9 | |||||||||||
Total | $ | (32 | ) | $ | (30 | ) | $ | 10 | $ | (52 | ) |
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Net Economic Loss Development
By Accounting Model
Six Months 2012
Financial Guaranty Insurance | FG VIEs(1) | Credit Derivatives(2) | Total | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | 2 | $ | 13 | $ | — | $ | 15 | |||||||
Option ARM | 74 | (85 | ) | — | (11 | ) | |||||||||
Subprime | (4 | ) | 25 | — | 21 | ||||||||||
Total first lien | 72 | (47 | ) | — | 25 | ||||||||||
Second lien: | |||||||||||||||
Closed end second lien | (46 | ) | 39 | (1 | ) | (8 | ) | ||||||||
HELOCs | (66 | ) | 81 | — | 15 | ||||||||||
Total second lien | (112 | ) | 120 | (1 | ) | 7 | |||||||||
Total U.S. RMBS | (40 | ) | 73 | (1 | ) | 32 | |||||||||
Other structured finance | (19 | ) | — | (4 | ) | (23 | ) | ||||||||
U.S. public finance | 19 | — | — | 19 | |||||||||||
Non-U.S.Public finance | 150 | — | — | 150 | |||||||||||
Total | $ | 110 | $ | 73 | $ | (5 | ) | $ | 178 |
___________________
(1) Refer to Note 9, Consolidation of Variable Interest Entities.
(2) Refer to Note 8, Financial Guaranty Contracts Accounted for as Credit Derivatives.
Second Quarter 2013 U.S. RMBS Loss Projections
The Company's RMBS loss projection methodology assumes that the housing and mortgage markets will eventually improve. Each quarter the Company makes a judgment as to whether to change the assumptions it uses to make RMBS loss projections based on its observation during the quarter of the performance of its insured transactions (including early stage delinquencies, late stage delinquencies and, for first liens, loss severity) as well as the residential property market and economy in general, and, to the extent it observes changes, it makes a judgment as to whether those changes are normal fluctuations or part of a trend. During Second Quarter 2013 the Company observed improvements in the performance of its second lien RMBS transactions that, when viewed in the context of their performance in past quarters, suggested those transactions were beginning to respond to the improvements in the residential property market and economy being widely reported. The Company did not observe the same trends in the performance of its first lien RMBS transactions. Based on such observations, in projecting losses for its second lien RMBS the Company chose to decrease by two months in its base scenario and by three months in its optimistic scenario the period it assumed it would take the mortgage market to recover as compared to March 31, 2013 and December 31, 2012. Also based on such observations the Company chose to use essentially the same assumptions and scenarios to project RMBS losses as of June 30, 2013 as it used as of March 31, 2013 and December 31, 2012, in its first lien RMBS and in the pessimistic scenario for its second lien RMBS. The Company's use of essentially the same assumptions and scenarios to project RMBS losses for its first lien RMBS as of June 30, 2013, as at March 31, 2013 and December 31, 2012 was consistent with its view at June 30, 2013 that the housing and mortgage market recovery is not being reflected as quickly in the performance of those transactions as it had anticipated at March 31, 2013 or December 31, 2012. Since the Company's projections for each RMBS transaction are based on the delinquency performance of the loans in that individual RMBS transaction, improvement or deterioration in that aspect of a transaction's performance impacts the projections for that transaction. The methodology and assumptions the Company uses to project RMBS losses and the scenarios it employs are described in more detail below under "- U.S. Second Lien RMBS Loss Projections: HELOCs and Closed-End Second Lien" and " - U.S. First Lien RMBS Loss Projections: Alt A First Lien, Option ARM, Subprime and Prime".
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U.S. Second Lien RMBS Loss Projections: HELOCs and Closed End Second Lien
The Company believes the primary variables affecting its expected losses in second lien RMBS transactions are the amount and timing of future losses in the collateral pool supporting the transactions and the amount of loans repurchased for breaches of R&W (or agreements with R&W providers related to such obligations). Expected losses are also a function of the structure of the transaction; the voluntary prepayment rate (typically also referred to as conditional prepayment rate ("CPR") of the collateral); the interest rate environment; and assumptions about the draw rate and loss severity. These variables are interrelated, difficult to predict and subject to considerable volatility. If actual experience differs from the Company’s assumptions, the losses incurred could be materially different from the estimate. The Company continues to update its evaluation of these exposures as new information becomes available.
The following table shows the range of key assumptions for the calculation of expected loss to be paid for individual transactions for direct vintage 2004 - 2008 second lien U.S. RMBS.
Key Assumptions in Base Case Expected Loss Estimates
Second Lien RMBS(1)
HELOC key assumptions | As of June 30, 2013 | As of March 31, 2013 | As of December 31, 2012 | |||
Plateau conditional default rate ("CDR") | 3.4% - 9.8% | 5.0% - 17.2% | 3.8% - 15.9% | |||
Final CDR trended down to | 0.4% - 3.2% | 0.4% - 3.2% | 0.4% - 3.2% | |||
Expected period until final CDR | 34 months | 36 months | 36 months | |||
Initial CPR | 2.1% - 15.0% | 2.4% - 14.8% | 2.9% - 14.6% | |||
Final CPR | 10% | 10% | 10% | |||
Loss severity | 98% | 98% | 98% | |||
Initial draw rate | 0.0% - 3.3% | 0.0% - 3.3% | 0.0% - 4.8% |
Closed end second lien key assumptions | As of June 30, 2013 | As of March 31, 2013 | As of December 31, 2012 | |||
Plateau CDR | 9.1% - 15.8% | 9.7% - 18.6% | 10.6% - 20.7% | |||
Final CDR trended down to | 3.5% - 8.6% | 3.5% - 8.6% | 3.5% - 8.6% | |||
Expected period until final CDR | 34 months | 36 months | 36 months | |||
Initial CPR | 3.4% - 6.0% | 2.7% - 6.8% | 2.3% - 5.0% | |||
Final CPR | 10% | 10% | 10% | |||
Loss severity | 98% | 98% | 98% |
____________________
(1) | Represents variables for most heavily weighted scenario (the “base case”). |
In second lien transactions the projection of near-term defaults from currently delinquent loans is relatively straightforward because loans in second lien transactions are generally “charged off” (treated as defaulted) by the securitization’s servicer once the loan is 180 days past due. Most second lien transactions report the amount of loans in five monthly delinquency categories (i.e., 30-59 days past due, 60-89 days past due, 90-119 days past due, 120-149 days past due and 150-179 days past due). The Company estimates the amount of loans that will default over the next five months by calculating current representative liquidation rates (the percent of loans in a given delinquency status that are assumed to ultimately default) from selected representative transactions and then applying an average of the preceding twelve months’ liquidation rates to the amount of loans in the delinquency categories. The amount of loans projected to default in the first through fifth months is expressed as a CDR. The first four months’ CDR is calculated by applying the liquidation rates to the current period past due balances (i.e., the 150-179 day balance is liquidated in the first projected month, the 120-149 day balance is liquidated in the second projected month, the 90-119 day balance is liquidated in the third projected month and the 60-89 day balance is liquidated in the fourth projected month). For the fifth month the CDR is generally calculated using the average 30-59 day past due balances for the prior three months, adjusted as necessary to reflect one-time servicing events. The fifth month CDR is then used as the basis for the plateau period that follows the embedded five months of losses.
As of June 30, 2013, for the base case scenario, the CDR (the “plateau CDR”) was held constant for one month. Once the plateau period has ended, the CDR is assumed to gradually trend down in uniform increments to its final long-term steady
29
state CDR. In the base case scenario, the time over which the CDR trends down to its final CDR is 28 months. Therefore, the total stress period for second lien transactions is 34 months, comprising five months of delinquent data, a one month plateau period and 28 months of decrease to the steady state CDR. This is two months shorter than used for March 31, 2013 and December 31, 2012. The long-term steady state CDR is calculated as the constant CDR that would have yielded the amount of losses originally expected at underwriting. When a second lien loan defaults, there is generally a very low recovery. Based on current expectations of future performance, the Company assumes that it will only recover 2% of the collateral, the same as March 31, 2013 and December 31, 2012.
The rate at which the principal amount of loans is prepaid may impact both the amount of losses projected (which is a function of the CDR and the loan balance over time) as well as the amount of excess spread (which is the excess of the interest paid by the borrowers on the underlying loan over the amount of interest and expenses owed on the insured obligations). In the base case, the current CPR (based on experience of the most recent three quarters) is assumed to continue until the end of the plateau before gradually increasing to the final CPR over the same period the CDR decreases. For transactions where the initial CPR is higher than the final CPR, the initial CPR is held constant. The final CPR is assumed to be 10% for both HELOC and closed-end second lien transactions. This level is much higher than current rates for most transactions, but lower than the historical average, which reflects the Company’s continued uncertainty about the projected performance of the borrowers in these transactions. This pattern is consistent with how the Company modeled the CPR at March 31, 2013 and December 31, 2012. To the extent that prepayments differ from projected levels it could materially change the Company’s projected excess spread and losses.
The Company uses a number of other variables in its second lien loss projections, including the spread between relevant interest rate indices, and HELOC draw rates (the amount of new advances provided on existing HELOCs expressed as a percentage of current outstanding advances). For HELOC transactions, the draw rate is assumed to decline from the current level to a final draw rate over a period of three months. The final draw rates were assumed to range from 0.0% to 1.6%.
In estimating expected losses, the Company modeled and probability weighted three possible CDR curves applicable to the period preceding the return to the long-term steady state CDR. The Company believes that the level of the elevated CDR and the length of time it will persist is the primary driver behind the likely amount of losses the collateral will suffer (before considering the effects of repurchases of ineligible loans). The Company continues to evaluate the assumptions affecting its modeling results.
As of June 30, 2013, the Company’s base case assumed a one month CDR plateau and a 28 month ramp-down (for a total stress period of 34 months). The Company also modeled a scenario with a longer period of elevated defaults and another with a shorter period of elevated defaults and weighted them the same as of December 31, 2012. Increasing the CDR plateau to four months and increasing the ramp-down by five months to 33-months (for a total stress period of 42 months) would increase the expected loss by approximately $36 million for HELOC transactions and $2 million for closed-end second lien transactions. On the other hand, keeping the CDR plateau at one month but decreasing the length of the CDR ramp-down to 18 months (for a total stress period of 24 months) would decrease the expected loss by approximately $33 million for HELOC transactions and $2 million for closed-end second lien transactions.
U.S. First Lien RMBS Loss Projections: Alt-A First Lien, Option ARM, Subprime and Prime
The majority of projected losses in first lien RMBS transactions are expected to come from non-performing mortgage loans (those that are delinquent or in foreclosure or where the loan has been foreclosed and the RMBS issuer owns the underlying real estate). Changes in the amount of non-performing loans from the amount projected in the previous period are one of the primary drivers of loss development in this portfolio. In order to determine the number of defaults resulting from these delinquent and foreclosed loans, the Company applies a liquidation rate assumption to loans in each of various delinquency categories. The liquidation rate is a standard industry measure that is used to estimate the number of loans in a given aging category that will default within a specified time period. The Company arrived at its liquidation rates based on data purchased from a third party and assumptions about how delays in the foreclosure process may ultimately affect the rate at which loans are liquidated. The Company projects these liquidations to occur over two years. For both year-end 2012 and year-end 2011 the Company reviewed the data supplied by the third-party provider. Based on its review of that data, the Company maintained the same liquidation assumptions at December 31, 2012 as it had used at December 31, 2011, and used them at June 30, 2013 and March 31, 2013. The following table shows liquidation assumptions for various delinquency categories.
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First Lien Liquidation Rates
June 30, 2013 | December 31, 2012 | ||
30 - 59 Days Delinquent | |||
Alt-A and Prime | 35% | 35% | |
Option ARM | 50 | 50 | |
Subprime | 30 | 30 | |
60 - 89 Days Delinquent | |||
Alt-A and Prime | 55 | 55 | |
Option ARM | 65 | 65 | |
Subprime | 45 | 45 | |
90 + Days Delinquent | |||
Alt-A and Prime | 65 | 65 | |
Option ARM | 75 | 75 | |
Subprime | 60 | 60 | |
Bankruptcy | |||
Alt-A and Prime | 55 | 55 | |
Option ARM | 70 | 70 | |
Subprime | 50 | 50 | |
Foreclosure | |||
Alt-A and Prime | 85 | 85 | |
Option ARM | 85 | 85 | |
Subprime | 80 | 80 | |
Real Estate Owned | |||
All | 100 | 100 |
While the Company uses liquidation rates as described above to project defaults of non-performing loans, it projects defaults on presently current loans by applying a CDR trend. The start of that CDR trend is based on the defaults the Company projects will emerge from currently nonperforming loans. The total amount of expected defaults from the non-performing loans is translated into a constant CDR (i.e., the CDR plateau), which, if applied for each of the next 24 months, would be sufficient to produce approximately the amount of defaults that were calculated to emerge from the various delinquency categories. The CDR thus calculated individually on the delinquent collateral pool for each RMBS is then used as the starting point for the CDR curve used to project defaults of the presently performing loans.
In the base case, after the initial 24-month CDR plateau period, each transaction’s CDR is projected to improve over 12 months to an intermediate CDR (calculated as 20% of its CDR plateau); that intermediate CDR is held constant for 36 months and then trails off in steps to a final CDR of 5% of the CDR plateau. Under the Company’s methodology, defaults projected to occur in the first 24 months represent defaults that can be attributed to loans that are currently delinquent or in foreclosure, while the defaults projected to occur using the projected CDR trend after the first 24 month period represent defaults attributable to borrowers that are currently performing. The CDR trend the Company used in its base case for June 30, 2013 was the same as it used for March 31, 2013 and December 31, 2012.
Another important driver of loss projections is loss severity, which is the amount of loss the transaction incurs on a loan after the application of net proceeds from the disposal of the underlying property. Loss severities experienced in first lien transactions have reached historic high levels, and the Company is assuming that these high levels generally will continue for another year (in the case of subprime loans, the Company assumes the unprecedented 90% loss severity rate will continue for six months then drop to 80% for six months before following the ramp described below). The Company determines its initial loss severity based on actual recent experience. The Company’s loss severity assumptions for June 30, 2013 were the same as it used for March 31, 2013 and December 31, 2012. The Company then assumes that loss severities begin returning to levels consistent with underwriting assumptions beginning in one year, and in the base case scenario, decline from there over two years to 40%.
The following table shows the range of key assumptions used in the calculation of expected loss to be paid for individual transactions for direct vintage 2004 - 2008 first lien U.S. RMBS.
31
Key Assumptions in Base Case Expected Loss Estimates
First Lien RMBS(1)
As of June 30, 2013 | As of March 31, 2013 | As of December 31, 2012 | |||
Alt-A First Lien | |||||
Plateau CDR | 6.2% - 22.3% | 5.6% - 22.6% | 6.8% - 23.2% | ||
Intermediate CDR | 1.2% - 4.5% | 1.1% - 4.5% | 1.4% - 4.6% | ||
Final CDR | 0.3% - 1.1% | 0.3% - 1.1% | 0.3% - 1.2% | ||
Initial loss severity | 65% | 65% | 65% | ||
Initial CPR | 0.4% - 20.6% | 0.1% - 20.4% | 0.0% - 14.3% | ||
Final CPR | 15% | 15% | 15% | ||
Option ARM | |||||
Plateau CDR | 5.6% - 24.2% | 6.4% - 25.2% | 7.0% - 26.1% | ||
Intermediate CDR | 1.1% - 4.8% | 1.3% - 5.0% | 1.4% - 5.2% | ||
Final CDR | 0.3% - 1.2% | 0.3% - 1.3% | 0.4% - 1.3% | ||
Initial loss severity | 65% | 65% | 65% | ||
Initial CPR | 0.3% - 7.7% | 0.4% - 5.1% | 0.4% - 3.8% | ||
Final CPR | 15% | 15% | 15% | ||
Subprime | |||||
Plateau CDR | 10.0% - 24.7% | 7.8% - 20.3% | 7.3% - 21.2% | ||
Intermediate CDR | 2.0% - 4.9% | 1.6% - 4.1% | 1.5% - 4.2% | ||
Final CDR | 0.5% - 1.2% | 0.5% - 1.3% | 0.5% - 1.3% | ||
Initial loss severity | 90% | 90% | 90% | ||
Initial CPR | 0.0% - 7.1% | 0.0% - 7.5% | 0.0% - 9.2% | ||
Final CPR | 15% | 15% | 15% |
____________________
(1) Represents variables for most heavily weighted scenario (the “base case”).
The rate at which the principal amount of loans is prepaid may impact both the amount of losses projected (since that amount is a function of the conditional default rate, the loss severity and the loan balance over time) as well as the amount of excess spread (the amount by which the interest paid by the borrowers on the underlying loan exceeds the amount of interest owed on the insured obligations). The assumption for the CPR follows a similar pattern to that of the conditional default rate. The current level of voluntary prepayments is assumed to continue for the plateau period before gradually increasing over 12 months to the final CPR, which is assumed to be either 10% or 15% depending on the scenario run. For transactions where the initial CPR is higher than the final CPR, the initial CPR is held constant. These assumptions are the same as those the Company used for March 31, 2013 and December 31, 2012.
In estimating expected losses, the Company modeled and probability weighted sensitivities for first lien transactions by varying its assumptions of how fast a recovery is expected to occur. One of the variables used to model sensitivities was how quickly the conditional default rate returned to its modeled equilibrium, which was defined as 5% of the current conditional default rate. The Company also stressed CPR and the speed of recovery of loss severity rates. The Company probability weighted a total of five scenarios (including its base case) as of June 30, 2013. For June 30, 2013 the Company used the same five scenarios and weightings as it used for March 31, 2013 and December 31, 2012. In a somewhat more stressful environment than that of the base case, where the conditional default rate plateau was extended three months (to be 27 months long) before the same more gradual conditional default rate recovery and loss severities were assumed to recover over four rather than two years (and subprime loss severities were assumed to recover only to 60%), expected loss to be paid would increase from current projections by approximately $17 million for Alt-A first liens, $11 million for Option ARM and $82 million for subprime transactions. In an even more stressful scenario where loss severities were assumed to rise and then recover over eight years and the initial ramp-down of the CDR was assumed to occur over 15 months and other assumptions were the same as the other stress scenario), expected loss to be paid would increase from current projections by approximately $47 million for Alt-A first liens, $20 million for Option ARM and $127 million for subprime transactions. The Company also
32
considered two scenarios where the recovery was faster than in its base case. In a scenario with a somewhat less stressful environment than the base case, where conditional default rate recovery was somewhat less gradual and the initial subprime loss severity rate was assumed to be 80% for 12 months and was assumed to recover to 40% over two years, expected loss to be paid would decrease from current projections by approximately $1 million for Alt-A first lien, $12 million for Option ARM and $29 million for subprime transactions. In an even less stressful scenario where the conditional default rate plateau was three months shorter (21 months, effectively assuming that liquidation rates would improve) and the conditional default rate recovery was more pronounced, (including an initial ramp-down of the CDR over nine months) expected loss to be paid would decrease from current projections by approximately $17 million for Alt-A first lien, $32 million for Option ARM and $62 million for subprime transactions.
Breaches of Representations and Warranties
Generally, when mortgage loans are transferred into a securitization, the loan originator(s) and/or sponsor(s) provide R&W, that the loans meet certain characteristics, and a breach of such R&W often requires that the loan be repurchased from the securitization. In many of the transactions the Company insures, it is in a position to enforce these R&W provisions. Soon after the Company observed the deterioration in the performance of its insured RMBS following the deterioration of the residential mortgage and property markets, the Company began using internal resources as well as third party forensic underwriting firms and legal firms to pursue breaches of R&W on a loan-by-loan basis. Where a provider of R&W refused to honor its repurchase obligations, the Company sometimes chose to initiate litigation. See “-Recovery Litigation” below.The Company's success in pursuing these strategies permitted the Company to enter into agreements with R&W providers under which those providers made payments to the Company, agreed to make payments to the Company in the future, and / or repurchased loans from the transactions, all in return for releases of related liability by the Company. Such agreements provide the Company with many of the benefits of pursuing the R&W claims on a loan by loan basis or through litigation, but without the related expense and uncertainty. The Company continues to pursue these strategies against R&W providers with which it does not yet have agreements.
Using these strategies, through June 30, 2013 the Company has caused entities providing R&Ws to pay or agree to pay approximately $2.7 billion (gross of reinsurance) in respect of their R&W liabilities for transactions in which the Company has provided insurance.
(in billions) | |||
Agreement amounts already received | $ | 1.9 | |
Agreement amounts projected to be received in the future | 0.4 | ||
Repurchase amounts paid into the relevant RMBS prior to settlement (1) | 0.4 | ||
Total R&W payments, gross of reinsurance | $ | 2.7 |
____________________
(1) | These amounts were paid into the relevant RMBS transactions prior to settlement and distributed in accordance with the priority of payments set out in the relevant transaction documents. Because the Company may insure only a portion of the capital structure of a transaction, such payments will not necessarily directly benefit the Company dollar-for-dollar, especially in first lien transactions. |
Based on this success, the Company has included in its net expected loss estimates as of June 30, 2013 an estimated net benefit related to breaches of R&W of $574 million, which includes $388 million from agreements with R&W providers and $186 million in transactions where the Company does not yet have such an agreement, all net of reinsurance.
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Representations and Warranties Agreements (1)
Agreement Date | Current Net Par Covered | Receipts to June 30, 2013 (net of reinsurance) | Estimated Future Receipts (net of reinsurance) | Eligible Assets Held in Trust (gross of reinsurance) | |||||||||||||||
(in millions) | |||||||||||||||||||
Bank of America - First Lien | April 2011 | $ | 789 | $ | 379 | $ | 174 | $ | 564 | (2 | ) | ||||||||
Bank of America - Second Lien | April 2011 | 1,146 | 744 | N/A | N/A | ||||||||||||||
Deutsche Bank | May 2012 | 505 | 86 | 64 | 171 | (3 | ) | ||||||||||||
UBS | May 2013 | 733 | 347 | 93 | 227 | (4 | ) | ||||||||||||
Others | Various | 506 | 172 | 57 | — | ||||||||||||||
Total | $ | 3,679 | $ | 1,728 | $ | 388 | $ | 962 |
____________________
(1) | This table relates only to past and projected future recoveries under R&W and related agreements. Excluded is the $186 million of future net recoveries the Company projects receiving from R&W counterparties in transactions with $1,023 million of net par outstanding as of June 30, 2013 not covered by current agreements. |
(2) | Of the $564 million in trust, $237 million collateralizes Bank of America reimbursement obligations in respect of AGM-insured transactions, and $327 million is available to either AGM or AGC, as required. |
(3) | Of the $171 million in trust, $43 million collateralizes Deutsche Bank reimbursement obligations in respect of AGM-insured transactions, and $128 million is available to either AGM or AGC, as required. |
(4) | The entire $227 million in trust collateralizes UBS' reimbursement obligations in respect of AGM-insured transactions. Eligible assets were first placed in trust in July 2013, so that amount is shown here. |
The Company's agreements with the counterparties named in the table above required an initial payment to the Company to reimburse it for past claims as well as an obligation to reimburse it for a portion of future claims. The named counterparties placed eligible assets in trust to collateralize their future reimbursement obligations, and the amount of collateral they are required to post may be increased or decreased from time to time as determined by rating agency requirements. Reimbursement payments under these agreements are made either monthly or quarterly and have been made timely. With respect to the reimbursement for future claims:
• | Under the Company's agreement with Bank of America Corporation and certain of its subsidiaries (“Bank of America” or “BofA”), Bank of America agreed to reimburse Assured Guaranty for 80% of claims on the first lien transactions covered by the agreement that Assured Guaranty pays in the future, until the aggregate lifetime collateral losses (not insurance losses or claims) on those transactions reach $6.6 billion. As of June 30, 2013, aggregate lifetime collateral losses on those transactions was $3.5 billion ($3.2 billion for AGM and $0.3 billion for AGC), and Assured Guaranty was projecting in its base case that such collateral losses would eventually reach $5.1 billion ($4.7 billion for AGM and $0.4 billion for AGC). |
• | Under the Company's agreement with Deutsche Bank AG and certain of its affiliates (collectively, “Deutsche Bank”), Deutsche Bank agreed to reimburse Assured Guaranty for certain claims it pays in the future on eight first and second lien transactions, including 80% of claims it pays until the aggregate lifetime claims (before reimbursement) reach $319 million. As of June 30, 2013, Assured Guaranty was projecting in its base case that such aggregate lifetime claims would remain below $319 million. As of June 30, 2013, the projected base case aggregate lifetime claims are estimated to be $178 million for the AGM-insured covered transactions and $130 million for the AGC-insured covered transactions. The agreement also requires Deutsche Bank to reimburse Assured Guaranty for future claims it pays on certain RMBS re-securitizations that include uninsured tranches (“Uninsured Tranches”) of three of the eight transactions for which it is providing the reimbursement described above. Deutsche Bank is obligated to reimburse Assured Guaranty under the re-securitization transactions in an amount calculated as a percent of the losses in the Uninsured Tranches. That percent is 60% of losses up to $141 million and then from $161 million to $185 million, and 100% from $185 million to $248 million. There is no reimbursement from $141 million to $161 million and above $248 million. As of June 30, 2013, Assured Guaranty was projecting in its base case that such losses would be $146 million. There were no AGM insured transactions related to this portion of the settlement. Except for the reimbursement obligation relating to the Uninsured tranches, the Deutsche Bank Agreement does not include transactions where Assured Guaranty has provided protection to Deutsche Bank on RMBS transactions in CDS form. |
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• | Under the Company's agreement with UBS and a third party, UBS agreed to reimburse AGM for 85% of future losses on three first lien RMBS transactions. |
The Company includes in the table above payments it has received under agreements with various other counterparties for breaches of R&W. Included in the table are benefits of the settlement AGM reached with Flagstar in connection with the favorable judgment AGM had won against Flagstar, under which Flagstar paid AGM $105 million and agreed to reimburse AGM for all future losses on certain insured RMBS transactions. Also included in the table above are payments the Company received for breaches of underwriting and servicing obligations. Some of the agreements with various other counterparties include obligations to reimburse the Company for all or a portion of future claims. In one instance, the Company is entitled to reimbursement from the cash flow from the mortgage loans still outstanding from a securitization as to which the insured notes have been paid off, and the Company includes in its projected R&W benefit an amount based on the cash flow it projects receiving from those mortgage loans.
Finally, based on its experience to date, the Company calculated an expected recovery of $186 million from breaches of R&W in transactions not covered by agreements with $1,023 million of net par outstanding as of June 30, 2013. The Company did not incorporate any gain contingencies or damages paid from potential litigation in its estimated repurchases. The amount the Company will ultimately recover related to such contractual R&W is uncertain and subject to a number of factors including the counterparty’s ability to pay, the number and loss amount of loans determined to have breached R&W and, potentially, negotiated settlements or litigation recoveries. As such, the Company’s estimate of recoveries is uncertain and actual amounts realized may differ significantly from these estimates. In arriving at the expected recovery from breaches of R&W not already covered by agreements, the Company considered the creditworthiness of the provider of the R&W, the number of breaches found on defaulted loans, the success rate in resolving these breaches across those transactions where material repurchases have been made and the potential amount of time until the recovery is realized. The calculation of expected recovery from breaches of such contractual R&W involved a variety of scenarios which ranged from the Company recovering substantially all of the losses it incurred due to violations of R&W to the Company realizing limited recoveries. These scenarios were probability weighted in order to determine the recovery incorporated into the Company’s estimate of expected losses. This approach was used for both loans that had already defaulted and those assumed to default in the future. For the RMBS transactions as to which the Company had not yet reached an agreement with the R&W counterparty as of June 30, 2013, the Company had performed a detailed review of approximately 14,400 loan files, representing approximately $3.2 billion loans underlying insured transactions. In the majority of its loan file reviews, the Company identified breaches of one or more R&W regarding the characteristics of the loans, such as misrepresentation of income or employment of the borrower, occupancy, undisclosed debt and non-compliance with underwriting guidelines at loan origination.
The Company uses the same RMBS projection scenarios and weightings to project its future R&W benefit as it uses to project RMBS losses on its portfolio. To the extent the Company increases its loss projections, the R&W benefit (whether pursuant to an R&W agreement or not) generally will also increase, subject to the agreement limits and thresholds described above.
The Company accounts for the loss sharing obligations under the R&W agreements on financial guaranty contracts as subrogation, offsetting the losses it projects by an R&W benefit from the relevant party for the applicable portion of the projected loss amount. Proceeds projected to be reimbursed to the Company on transactions where the Company has already paid claims are viewed as a recovery on paid losses. For transactions where the Company has not already paid claims, projected recoveries reduce projected loss estimates. In either case, projected recoveries have no effect on the amount of the Company's exposure. Loss sharing obligations under R&W agreements covering CDS and consolidated FG VIEs are recorded at fair value. See Notes 7, Fair Value Measurement and 9, Consolidation of Variable Interest Entities.
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U.S. RMBS Risks with R&W Benefit
Number of Risks(1) as of | Debt Service as of | ||||||||||||
June 30, 2013 | December 31, 2012 | June 30, 2013 | December 31, 2012 | ||||||||||
(dollars in millions) | |||||||||||||
Alt-A first lien | 10 | 10 | $ | 1,026 | $ | 1,091 | |||||||
Option ARM | 7 | 7 | 464 | 666 | |||||||||
Subprime | 5 | 5 | 951 | 975 | |||||||||
Closed-end second lien | 2 | 2 | 72 | 145 | |||||||||
HELOC | 7 | 6 | 581 | 521 | |||||||||
Total | 31 | 30 | $ | 3,094 | $ | 3,398 |
____________________________
(1) | A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making Debt Service payments. This table shows the full future Debt Service (not just the amount of Debt Service expected to be reimbursed) for risks with projected future R&W benefit, whether pursuant to an agreement or not. |
The following table provides a breakdown of the development and accretion amount in the roll forward of estimated recoveries associated with alleged breaches of R&W.
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
Inclusion or removal of deals with breaches of R&W during period | $ | 6 | $ | (4 | ) | $ | 6 | $ | (4 | ) | |||||
Change in recovery assumptions as the result of additional file review and recovery success | 5 | (10 | ) | 16 | 68 | ||||||||||
Estimated increase (decrease) in defaults that will result in additional (lower) breaches | 15 | 46 | 24 | (8 | ) | ||||||||||
Results of settlements | 5 | — | 145 | — | |||||||||||
Accretion of discount on balance | 4 | 2 | 6 | 6 | |||||||||||
Total | $ | 35 | $ | 34 | $ | 197 | $ | 62 |
The Company assumes that recoveries on second lien transactions that were not subject to the settlement agreements will occur in two to four years from the balance sheet date depending on the scenarios and that recoveries on transactions backed by Alt-A first lien, Option ARM and Subprime loans will occur as claims are paid over the life of the transactions.
Selected U.S. Public Finance Transactions
U.S. municipalities and related entities have been under increasing pressure over the last few quarters, and a few have filed for protection under the U.S. Bankruptcy Code, entered into state processes designed to help municipalities in fiscal distress or otherwise indicated they may consider not meeting their obligations to make timely payments on their debts. Given some of these developments, and the circumstances surrounding each instance, the ultimate outcome cannot be certain and may lead to an increase in defaults on some of the Company's insured public finance obligations. The Company will continue to analyze developments in each of these matters closely. The municipalities whose obligations the Company has insured that have filed for protection under Chapter 9 of the U.S Bankruptcy Code are: Detroit, Michigan; Jefferson County, Alabama; and Stockton, California. The City Council of Harrisburg, Pennsylvania had also filed a purported bankruptcy petition, which was later dismissed by the bankruptcy court; a receiver for the City of Harrisburg was appointed by the Commonwealth Court of Pennsylvania on December 2, 2011.
The Company has net par exposure to the City of Detroit, Michigan of $1,505 million as of June 30, 2013. On July 18, 2013, the City of Detroit filed for bankruptcy under Chapter 9 of the U.S. Bankruptcy Code. Most of the Company's net exposure relates to $717 million of sewer revenue bonds and $738 million of water revenue bonds, both of which the Company rates triple-B. Both the sewer and water systems provide services to areas that extend beyond the city limits, and the bonds are secured by a pledge of "special revenues". The Company also has net par exposure of $50 million to the City's general
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obligation bonds (which are secured by a pledge of the unlimited tax, full faith, credit and resources of the City), which the Company rates below investment grade. The Company paid no claims in Second Quarter 2013.
The Company has net exposure to Jefferson County, Alabama of $268 million as of June 30, 2013. On November 9, 2011, Jefferson County filed for bankruptcy under Chapter 9 of the U.S. Bankruptcy Code. Some of the Company's net Jefferson County exposure relates to $114 million in sewer revenue exposure. The sewer revenue warrants are secured by a pledge of the net revenues of the sewer system. The bankruptcy court has affirmed that the net revenues constitute a “special revenue” under Chapter 9. Therefore, the lien on net revenues of the sewer system survives the bankruptcy filing and such net revenues are not subject to the automatic stay during the pendency of Jefferson County's bankruptcy case. BNY Mellon, as trustee, had brought a lawsuit regarding the amount of net revenues to which it is entitled. Since its bankruptcy filing, Jefferson County had been withholding estimated bankruptcy-related legal expenses and an amount representing a monthly reserve for future expenditures and depreciation and amortization from the monthly payments it had been making to the trustee from sewer revenues for Debt Service. On June 29, 2012, the Bankruptcy Court ruled that “Operating Expenses” as determined under the bond indenture do not include (1) a reserve for depreciation, amortization, or future expenditures, or (2) an estimate for professional fees and expenses, such that, after payment of Operating Expenses (as defined in the indenture), monies remaining in the Revenue Account created under the bond indenture must be distributed in accordance with the waterfall set forth in the indenture without withholding any monies for depreciation, amortization, reserves, or estimated expenditures that are the subject of this litigation. Whether sufficient net revenues will be available for the payment of regularly scheduled debt service ultimately depends on the bankruptcy court's valuation of the sewer revenue stream. The Company's remaining net exposure of $154 million to Jefferson County relates to obligations that are secured by, or payable from, certain taxes that may have the benefit of a statutory lien or a lien on “special revenues” or other collateral. In June 2013 AGM and several other monoline insurers and financial institutions having claims against Jefferson County entered into plan support agreements with the county, and in July 2013 Jefferson County filed its Chapter 9 plan of adjustment and related materials with the Bankruptcy Court.
On June 28, 2012, the City of Stockton, California filed for bankruptcy under Chapter 9 of the U.S. Bankruptcy Code. The Company's net exposure to Stockton's general fund is $64 million, consisting of pension obligation bonds. As of June 30, 2013, the Company had paid $6 million in net claims.
The Company has $132 million of net par exposure to The City of Harrisburg, Pennsylvania, of which $69 million is BIG. The Company has paid $13 million in net claims as of June 30, 2013.
The Company has $23 million remaining in net par exposure to bonds secured by the excess free cash flow of the Foxwoods Casino, run by the Mashantucket Pequot Tribe. The Company had paid $75 million in net claims as of June 30, 2013, and expects full recovery of such amount.
The Company projects that its total future expected net recovery across its troubled U.S. public finance credits as of June 30, 2013 will be $47 million. As of March 31, 2013 the Company was projecting a net recovery of $59 million across its troubled U.S. public finance credits. While the deterioration was due to a number of factors, it was attributable primarily to negative developments in Detroit.
Certain Selected European Country Transactions
The Company insures and reinsures credits with sub-sovereign exposure to various Spanish regions where a Spanish sovereign default causes the regions also to default. The Company's gross exposure to these credits is €434 million and its exposure net of reinsurance is €274 million. During 2012, the Company downgraded most of these exposures to the BB category due to concerns that these regions would not pay under their contractual obligations. The Company's Hungary exposure is to infrastructure bonds dependent on payments from Hungarian governmental entities and covered mortgage bonds issued by Hungarian banks. The Company's gross exposure to these credits is $621 million and its exposure net of reinsurance is $514 million, all of which is rated below investment grade. The Company estimated net expected losses of $38 million related to these Spanish and Hungarian credits down from $41 million as of March 31, 2013 largely due to movements in exchange rates, interest rates and timing of its projected defaults. Information regarding the Company's exposure to other Selected European Countries may be found under Note 3, Outstanding Exposure, –Economic Exposure to the Selected European Countries.
Manufactured Housing
The Company insures a total of $202 million net par of securities backed by manufactured housing loans, a total of $120 million rated BIG. The Company has expected loss to be paid of $18 million as of June 30, 2013 down from $22 million
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as of March 31, 2013, due primarily to the higher risk free rates used to discount losses and higher projected recoveries on certain transactions.
Infrastructure Finance
The Company has exposure to infrastructure transactions with refinancing risk as to which the Company may need to make claim payments that it did not anticipate paying when the policies were issued; the aggregate amount of the claim payments may be substantial and reimbursement may not occur for an extended time, if at all. Total liabilities for the three largest transactions with significant refinancing risk may amount to as much as $2.7 billion, payable in varying amounts over the next 13 years. Of this liability, as much as approximately $2.3 billion may be payable between 2014 and 2020. As of June 30, 2013, the Company estimates that it may pay claims of approximately $1.2 billion, without giving effect to any payments that the Company may receive from reinsurers to which it has ceded a portion of this exposure. This estimate is based on certain assumptions the Company has made as to the performance of the transactions, including the refinancing of a certain portion of the debt, the payment of certain anticipated contributions, and the Company prevailing in certain litigation proceedings. These transactions generally involve long-term infrastructure projects that are financed by bonds that mature prior to the expiration of the project concession. While the cash flows from these projects were expected to be sufficient to repay all of the debt over the life of the project concession, in order to pay the principal on the early maturing debt, the Company expected it to be refinanced in the market at or prior to its maturity. Due to market conditions, the Company may have to pay a claim at the maturity of the securities, and then recover its payment from cash flows produced by the project in the future. The Company generally projects that in most scenarios it will be fully reimbursed for such payments. However, the recovery of the payments may take a long time and is uncertain. The claim payments are anticipated to occur substantially between 2014 and 2018, while the recoveries could take from 10 to 35 years, depending on the transaction and the performance of the underlying collateral.
Recovery Litigation
RMBS Transactions
As of the date of this filing, AGM has lawsuits pending against a number of providers of representations and warranties in U.S. RMBS transactions insured by them, seeking damages. In all the lawsuits, AGM has alleged breaches of R&W in respect of the underlying loans in the transactions, and failure to cure or repurchase defective loans identified by AGM to such persons. In addition, in the lawsuits against DLJ Mortgage Capital, Inc. (“DLJ”) and Credit Suisse Securities (USA) LLC (“Credit Suisse”), AGM has alleged breaches of contract in procuring falsely inflated shadow ratings (a condition to the issuance by AGM of its policies) by providing false and misleading information to the rating agencies:
• | Deutsche Bank: AGM has sued Deutsche Bank AG affiliates DB Structured Products, Inc. and ACE Securities Corp. in the Supreme Court of the State of New York on the ACE Securities Corp. Home Equity Loan Trust, Series 2006-GP1 second lien transaction. |
• | ResCap: AGM has sued GMAC Mortgage, LLC (formerly GMAC Mortgage Corporation; Residential Asset Mortgage Products, Inc.; Ally Bank (formerly GMAC Bank); Residential Funding Company, LLC (formerly Residential Funding Corporation); Residential Capital, LLC (formerly Residential Capital Corporation, "ResCap"); Ally Financial (formerly GMAC, LLC); and Residential Funding Mortgage Securities II, Inc. on the GMAC RFC Home Equity Loan-Backed Notes, Series 2006-HSA3 and GMAC Home Equity Loan-Backed Notes, Series 2004-HE3 second lien transactions. On May 14, 2012, ResCap and several of its affiliates (the “Debtors”) filed for Chapter 11 protection with the U.S. Bankruptcy Court. The automatic stay of Bankruptcy Code Section 362 (a) stays lawsuits (such as the suit brought by AGM) against the Debtors. |
As a way of resolving ResCap's motion for an adversary proceeding, several defendants in the adversary proceeding (including AGM) and the debtors and their non-debtor affiliates filed a stipulation with the court agreeing to extend the automatic stay to the non-debtor affiliates until April 30, 2013. The agreement has expired and the debtors have not requested that it be extended. The debtors, however, have agreed to provide AGM with an extension of the time to respond to the adversary complaint until 60 days following notice from ResCap to AGM of its intent to continue the adversary proceeding. The Bankruptcy Court approved a plan support agreement which had the support of Ally Financial Inc. and a majority of the debtors' largest claimants on June 26, 2013 and entered an order on August 23, 2013 approving the disclosure statement regarding the Joint Chapter 11 Plan of Residential Capital, LLC, et al. and establishing procedures for the solicitation process. A hearing on confirmation of the plan is scheduled for November 19, 2013.
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• | Credit Suisse: AGM and its affiliate AGC have sued DLJ and Credit Suisse in the Supreme Court of the State of New York on first lien U.S. RMBS transactions insured by them. The ones insured by AGM are: CSAB Mortgage-Backed Pass Through Certificates, Series 2006-2; CSAB Mortgage-Backed Pass Through Certificates, Series 2006-3; CSAB Mortgage-Backed Pass Through Certificates, Series 2006-4; and CMSC Mortgage-Backed Pass Through Certificates, Series 2007-3. On December 6, 2011, DLJ and Credit Suisse filed a motion to dismiss the cause of action asserting breach of the document containing the condition precedent regarding the rating of the securities and claims for recissionary damages and other relief in the complaint, and on October 11, 2012, the Supreme Court of the State of New York granted the motion to dismiss. AGM and AGC intend to appeal the dismissal of certain of its claims. The causes of action against DLJ for breach of R&W and breach of its repurchase obligations remain. |
On March 26, 2013, AGM filed a lawsuit against RBS Securities Inc., RBS Financial Products Inc. and Financial Asset Securities Corp. (collectively, “RBS”) in the United States District Court for the Southern District of New York on the Soundview Home Loan Trust 2007-WMC1 transaction. The complaint alleges that RBS made fraudulent misrepresentations to AGM regarding the quality of the underlying mortgage loans in the transaction and that RBS's misrepresentations induced AGM into issuing a financial guaranty insurance policy in respect of the Class II-A-1 certificates issued in the transaction.
On August 9, 2012, AGM filed a complaint against OneWest Bank, FSB, the servicer of the mortgage loans underlying the HOA1 Transaction and the IndyMac Home Equity Mortgage Loan Asset-Backed Trust, Series 2007-H1 HELOC transaction seeking damages, specific performance and declaratory relief in connection with OneWest failing to properly service the mortgage loans.
Public Finance Transactions
In June 2010, AGM sued JPMorgan Chase Bank, N.A. and JPMorgan Securities, Inc. (together, “JPMorgan”), the underwriter of debt issued by Jefferson County, in the Supreme Court of the State of New York alleging that JPMorgan induced AGM to issue its insurance policies in respect of such debt through material and fraudulent misrepresentations and omissions, including concealing that it had secured its position as underwriter and swap provider through bribes to Jefferson County commissioners and others. In December 2010, the court denied JPMorgan’s motion to dismiss. After JPMorgan interpleaded Jefferson County into the lawsuit, the Jefferson County bankruptcy court ruled in April 2013 that the lawsuit against JPMorgan was subject to the automatic stay applicable to Jefferson County. As described above under "Selected U.S. Public Finance Transactions," AGM, JPMorgan and various other financial institutions entered into plan support agreements with Jefferson County in June 2013, and Jefferson County has filed a plan of adjustment with the bankruptcy court. As a result, the litigation is currently subject to a standstill order. AGM will dismiss the litigation if the Jefferson County bankruptcy plan is confirmed and is continuing its risk remediation efforts for its Jefferson County exposure.
In September 2010, AGM, together with TD Bank, National Association and Manufacturers and Traders Trust Company, as trustees, filed a complaint in the Court of Common Pleas of Dauphin County, Pennsylvania against The Harrisburg Authority, The City of Harrisburg, Pennsylvania, and the Treasurer of the City in connection with certain Resource Recovery Facility bonds and notes issued by The Harrisburg Authority, alleging, among other claims, breach of contract by both The Harrisburg Authority and The City of Harrisburg, and seeking remedies including an order of mandamus compelling the City to satisfy its obligations on the defaulted bonds and notes and the appointment of a receiver for The Harrisburg Authority ("RRF receiver"). Acting on its own, the City Council of Harrisburg filed a purported bankruptcy petition for the City in October 2011, which petition and a subsequent appeal were dismissed by the bankruptcy court in November 2011. The Commonwealth Court of Pennsylvania appointed a receiver for The City of Harrisburg (the “City receiver”) in December 2011. The City receiver filed a motion to intervene in the mandamus action and action for the appointment of the RRF receiver, and asserted that the provisions of Pennsylvania's Financially Distressed Municipalities Act (“Act 47”), which authorized his appointment, preempted AGM's statutory remedies. In March 2012, the judge issued an order granting the motion for the appointment of the RRF receiver and found that Act 47 did not preempt the more specific statutory remedies available. The Harrisburg Authority appealed the judge's order for the appointment of the RRF receiver and oral argument was heard by the court on June 4, 2012. The parties are awaiting a decision by the court. Subsequently, following the resignation of the original City receiver and the confirmation of a new City receiver, the new city Receiver has been negotiating the sale of Harrisburg's resource recovery facility and the lease of its parking system. In addition, in July 2012, the City receiver filed a petition for an order of mandamus to order a 1% increase in the earned income tax; the City Council of Harrisburg subsequently passed an increase in the earned income tax for calendar year 2013.
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6. Financial Guaranty Insurance Losses
Insurance Contracts' Loss Information
The following table provides balance sheet information on loss and LAE reserves, net of reinsurance and salvage and subrogation recoverable.
Loss and LAE Reserve (Recovery),
Net of Reinsurance and Salvage and Subrogation Recoverable
Insurance Contracts
As of June 30, 2013 | As of December 31, 2012 | ||||||||||||||||||||||
Loss and LAE Reserve, net | Salvage and Subrogation Recoverable, net | Net | Loss and LAE Reserve, net | Salvage and Subrogation Recoverable, net | Net | ||||||||||||||||||
(in millions) | |||||||||||||||||||||||
U.S. RMBS: | |||||||||||||||||||||||
First lien: | |||||||||||||||||||||||
Alt-A first lien | $ | 47 | $ | — | $ | 47 | $ | 52 | $ | — | $ | 52 | |||||||||||
Option ARM | 23 | 58 | (35 | ) | 29 | 213 | (184 | ) | |||||||||||||||
Subprime | 104 | 2 | 102 | 78 | — | 78 | |||||||||||||||||
Total first lien | 174 | 60 | 114 | 159 | 213 | (54 | ) | ||||||||||||||||
Second lien: | |||||||||||||||||||||||
Closed-end second lien | — | 48 | (48 | ) | — | 71 | (71 | ) | |||||||||||||||
HELOC | — | 98 | (98 | ) | — | 169 | (169 | ) | |||||||||||||||
Total second lien | — | 146 | (146 | ) | — | 240 | (240 | ) | |||||||||||||||
Total U.S. RMBS | 174 | 206 | (32 | ) | 159 | 453 | (294 | ) | |||||||||||||||
Other structured finance | 7 | — | 7 | 10 | — | 10 | |||||||||||||||||
U.S. public finance | 19 | 86 | (67 | ) | 16 | 86 | (70 | ) | |||||||||||||||
Non-U.S. public finance | 21 | — | 21 | 23 | — | 23 | |||||||||||||||||
Subtotal | 221 | 292 | (71 | ) | 208 | 539 | (331 | ) | |||||||||||||||
Effect of consolidating FG VIEs | (77 | ) | (103 | ) | 26 | (53 | ) | (217 | ) | 164 | |||||||||||||
Total (1) | $ | 144 | $ | 189 | $ | (45 | ) | $ | 155 | $ | 322 | $ | (167 | ) |
__________________
(1) See “Components of Net Reserves (Salvage)” table for loss and LAE reserve and salvage and subrogation recoverable components.
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The following table reconciles the loss and LAE reserve and salvage and subrogation components on the consolidated balance sheet to the financial guaranty net reserves (salvage) in the financial guaranty BIG transaction loss summary tables.
Components of Net Reserves (Salvage)
Insurance Contracts
As of June 30, 2012 | As of December 31, 2012 | ||||||
(in millions) | |||||||
Loss and LAE reserve | $ | 225 | $ | 230 | |||
Reinsurance recoverable on unpaid losses | (81 | ) | (75 | ) | |||
Subtotal | 144 | 155 | |||||
Salvage and subrogation recoverable | (240 | ) | (383 | ) | |||
Salvage and subrogation payable(1) | 51 | 61 | |||||
Subtotal | (189 | ) | (322 | ) | |||
Financial guaranty net reserves (salvage) | $ | (45 | ) | $ | (167 | ) |
____________________
(1) | Recorded as a component of reinsurance balances payable. |
Balance Sheet Classification of
Net Expected Recoveries for Breaches of R&W
Insurance Contracts
As of June 30, 2013 | As of December 31, 2012 | ||||||||||||||||||||||
For all Financial Guaranty Insurance Contracts | Effect of Consolidating FG VIEs | Reported on Balance Sheet (1) | For all Financial Guaranty Insurance Contracts | Effect of Consolidating FG VIEs | Reported on Balance Sheet (1) | ||||||||||||||||||
(in millions) | |||||||||||||||||||||||
Salvage and subrogation recoverable | $ | 153 | $ | (71 | ) | $ | 82 | $ | 393 | $ | (170 | ) | $ | 223 | |||||||||
Loss and LAE reserve | 333 | (6 | ) | 327 | 455 | (11 | ) | 444 |
____________________
(1) | The remaining benefit for R&W is either recorded at fair value in FG VIE assets, or not recorded on the balance sheet until the expected loss, net of R&W, exceeds unearned premium reserve. |
The table below provides a reconciliation of net expected loss to be paid to net expected loss to be expensed. Expected loss to be paid differs from expected loss to be expensed due to: (1) the contra-paid which represent the payments that have been made but have not yet been expensed, (2) for transactions with a net expected recovery, the addition of claim payments that have been made (and therefore are not included in expected loss to be paid) that are expected to be recovered in the future (and therefore have reduced expected loss to be paid), and (3) loss reserves that have already been established (and therefore expensed but not yet paid).
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Reconciliation of Net Expected Loss to be Paid and
Net Expected Loss to be Expensed
Insurance Contracts
As of June 30, 2013 | |||
(in millions) | |||
Net expected loss to be paid | $ | 237 | |
Less: net expected loss to be paid for FG VIEs | 16 | ||
Total | 221 | ||
Contra-paid, net | 101 | ||
Salvage and subrogation recoverable, net of reinsurance | 189 | ||
Loss and LAE reserve, net of reinsurance | (144 | ) | |
Net expected loss to be expensed (1) | $ | 367 |
(1) Excludes $99 million as of June 30, 2013 related to consolidated FG VIEs.
The following table provides a schedule of the expected timing of net expected losses to be expensed. The amount and timing of actual loss and LAE may differ from the estimates shown below due to factors such as refundings, accelerations, commutations, changes in expected lives and updates to loss estimates. A loss and LAE reserve is only recorded for the amount by which expected loss to be expensed exceeds deferred premium revenue determined on a contract-by-contract basis. This table excludes amounts related to consolidated FG VIEs, which are eliminated in consolidation.
Net Expected Loss to be Expensed
Insurance Contracts
As of June 30, 2013 | |||
(in millions) | |||
2013 (July 1- September 30) | $ | 17 | |
2013 (October 1 - December 31) | 15 | ||
Subtotal 2013 | 32 | ||
2014 | 48 | ||
2015 | 39 | ||
2016 | 34 | ||
2017 | 30 | ||
2018-2022 | 106 | ||
2023-2027 | 46 | ||
2028-2032 | 20 | ||
After 2032 | 12 | ||
Total present value basis(1) | 367 | ||
Discount | 141 | ||
Total future value | $ | 508 |
____________________
(1) | Consolidation of FG VIEs resulted in reductions of $99 million in net expected loss to be expensed. |
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The following table presents the loss and LAE recorded in the consolidated statements of operations by sector for non-derivative contracts. Amounts presented are net of reinsurance.
Loss and LAE
Reported on the
Consolidated Statements of Operations
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
U.S. RMBS: | |||||||||||||||
First lien: | |||||||||||||||
Alt-A first lien | $ | 0 | $ | 23 | $ | 8 | $ | 29 | |||||||
Option ARM | 21 | 11 | (64 | ) | 58 | ||||||||||
Subprime | 23 | 17 | 32 | 24 | |||||||||||
Total first lien | 44 | 51 | (24 | ) | 111 | ||||||||||
Second lien: | |||||||||||||||
Closed-end second lien | 0 | 0 | 19 | 0 | |||||||||||
HELOC | 0 | 2 | 7 | 11 | |||||||||||
Total second lien | 0 | 2 | 26 | 11 | |||||||||||
Total U.S. RMBS | 44 | 53 | 2 | 122 | |||||||||||
Other structured finance | (3 | ) | 3 | (3 | ) | (16 | ) | ||||||||
U.S. public finance | 15 | 19 | 23 | 19 | |||||||||||
Non-U.S. public finance | (1 | ) | 3 | (2 | ) | 154 | |||||||||
Total insurance contracts before FG VIE consolidation | 55 | 78 | 20 | 279 | |||||||||||
Effect of consolidating FG VIEs | (22 | ) | (2 | ) | (16 | ) | (13 | ) | |||||||
Total loss and LAE | $ | 33 | $ | 76 | $ | 4 | $ | 266 |
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The following table provides information on non-derivative financial guaranty insurance contracts categorized as BIG.
Financial Guaranty Insurance
BIG Transaction Loss Summary
June 30, 2013
BIG Categories | ||||||||||||||||||||||||||||||||||||
BIG 1 | BIG 2 | BIG 3 | Total BIG, Net | Effect of Consolidating VIEs | ||||||||||||||||||||||||||||||||
Gross | Ceded | Gross | Ceded | Gross | Ceded | Total | ||||||||||||||||||||||||||||||
(dollars in millions) | ||||||||||||||||||||||||||||||||||||
Number of risks(1) | 65 | (57 | ) | 26 | (26 | ) | 51 | (51 | ) | 142 | — | 142 | ||||||||||||||||||||||||
Remaining weighted-average contract period (in years) | 8.7 | 7.8 | 8.5 | 13.8 | 6.6 | 7.5 | 7.5 | — | 7.5 | |||||||||||||||||||||||||||
Outstanding exposure: | ||||||||||||||||||||||||||||||||||||
Principal | $ | 4,652 | $ | (1,758 | ) | $ | 2,695 | $ | (591 | ) | $ | 4,211 | $ | (767 | ) | $ | 8,442 | $ | — | $ | 8,442 | |||||||||||||||
Interest | 2,095 | (704 | ) | 999 | (254 | ) | 1,297 | (263 | ) | 3,170 | — | 3,170 | ||||||||||||||||||||||||
Total(2) | $ | 6,747 | $ | (2,462 | ) | $ | 3,694 | $ | (845 | ) | $ | 5,508 | $ | (1,030 | ) | $ | 11,612 | $ | — | $ | 11,612 | |||||||||||||||
Expected cash outflows (inflows) | $ | 1,164 | $ | (584 | ) | $ | 789 | $ | (120 | ) | $ | 1,711 | $ | (235 | ) | $ | 2,725 | $ | (594 | ) | $ | 2,131 | ||||||||||||||
Potential recoveries(3) | (1,217 | ) | 593 | (502 | ) | 36 | (1,407 | ) | 183 | (2,314 | ) | 545 | (1,769 | ) | ||||||||||||||||||||||
Subtotal | (53 | ) | 9 | 287 | (84 | ) | 304 | (52 | ) | 411 | (49 | ) | 362 | |||||||||||||||||||||||
Discount | (3 | ) | 1 | (73 | ) | 27 | (139 | ) | 13 | (174 | ) | 33 | (141 | ) | ||||||||||||||||||||||
Present value of expected cash flows | $ | (56 | ) | $ | 10 | $ | 214 | $ | (57 | ) | $ | 165 | $ | (39 | ) | $ | 237 | $ | (16 | ) | $ | 221 | ||||||||||||||
Deferred premium revenue | $ | 129 | $ | (53 | ) | $ | 209 | $ | (37 | ) | $ | 608 | $ | (109 | ) | $ | 747 | $ | (196 | ) | $ | 551 | ||||||||||||||
Reserves (salvage)(4) | $ | (81 | ) | $ | 17 | $ | 69 | $ | (36 | ) | $ | (29 | ) | $ | (11 | ) | $ | (71 | ) | $ | 26 | $ | (45 | ) |
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Financial Guaranty Insurance
BIG Transaction Loss Summary
December 31, 2012
BIG Categories | ||||||||||||||||||||||||||||||||||||
BIG 1 | BIG 2 | BIG 3 | Total BIG, Net | Effect of Consolidating VIEs | ||||||||||||||||||||||||||||||||
Gross | Ceded | Gross | Ceded | Gross | Ceded | Total | ||||||||||||||||||||||||||||||
(dollars in millions) | ||||||||||||||||||||||||||||||||||||
Number of risks(1) | 71 | (66 | ) | 21 | (21 | ) | 50 | (50 | ) | 142 | — | 142 | ||||||||||||||||||||||||
Remaining weighted-average contract period (in years) | 9.5 | 9.6 | 9.3 | 15.6 | 5.3 | 6.8 | 7.4 | — | 7.4 | |||||||||||||||||||||||||||
Outstanding exposure: | ||||||||||||||||||||||||||||||||||||
Principal | $ | 6,004 | $ | (2,281 | ) | $ | 1,820 | $ | (180 | ) | $ | 4,680 | $ | (788 | ) | $ | 9,255 | $ | — | $ | 9,255 | |||||||||||||||
Interest | 2,583 | (893 | ) | 982 | (179 | ) | 1,157 | (240 | ) | 3,410 | — | 3,410 | ||||||||||||||||||||||||
Total(2) | $ | 8,587 | $ | (3,174 | ) | $ | 2,802 | $ | (359 | ) | $ | 5,837 | $ | (1,028 | ) | $ | 12,665 | $ | — | $ | 12,665 | |||||||||||||||
Expected cash outflows (inflows) | $ | 1,535 | $ | (900 | ) | $ | 733 | $ | (64 | ) | $ | 1,827 | $ | (250 | ) | $ | 2,881 | $ | (617 | ) | $ | 2,264 | ||||||||||||||
Potential recoveries(3) | (1,586 | ) | 883 | (475 | ) | 22 | (1,818 | ) | 209 | (2,765 | ) | 713 | (2,052 | ) | ||||||||||||||||||||||
Subtotal | (51 | ) | (17 | ) | 258 | (42 | ) | 9 | (41 | ) | 116 | 96 | 212 | |||||||||||||||||||||||
Discount | (2 | ) | 6 | (78 | ) | 15 | (59 | ) | 7 | (111 | ) | 16 | (95 | ) | ||||||||||||||||||||||
Present value of expected cash flows | $ | (53 | ) | $ | (11 | ) | $ | 180 | $ | (27 | ) | $ | (50 | ) | $ | (34 | ) | $ | 5 | $ | 112 | $ | 117 | |||||||||||||
Deferred premium revenue | $ | 93 | $ | (36 | ) | $ | 211 | $ | (17 | ) | $ | 728 | $ | (122 | ) | $ | 857 | $ | (244 | ) | $ | 613 | ||||||||||||||
Reserves (salvage)(4) | $ | (100 | ) | $ | 6 | $ | 49 | $ | (15 | ) | $ | (266 | ) | $ | (5 | ) | $ | (331 | ) | $ | 164 | $ | (167 | ) |
____________________
(1) | A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making Debt Service payments. The ceded number of risks represents the number of risks for which the Company ceded a portion of its exposure. |
(2) | Includes BIG amounts related to FG VIEs. |
(3) | Includes estimated future recoveries for breaches of R&W as well as excess spread, and draws on HELOCs. |
(4) | See table “Components of net reserves (salvage).” |
Ratings Impact on Financial Guaranty Business
A downgrade of the Company or of one of its insurance subsidiaries may result in increased claims under financial guaranties issued by the Company, if the insured obligors were unable to pay.
For example, AGM has issued financial guaranty insurance policies in respect of the obligations of municipal obligors under interest rate swaps. Under the swaps, AGM insures periodic payments owed by the municipal obligors to the bank counterparties. Under certain of the swaps, AGM also insures termination payments that may be owed by the municipal obligors to the bank counterparties. If (i) AGM has been downgraded below the rating trigger set forth in a swap under which it has insured the termination payment, which rating trigger varies on a transaction by transaction basis; (ii) the municipal obligor has the right to cure by, but has failed in, posting collateral, replacing AGM or otherwise curing the downgrade of AGM; (iii) the transaction documents include as a condition that an event of default or termination event with respect to the municipal obligor has occurred, such as the rating of the municipal obligor being downgraded past a specified level, and such condition has been met; (iv) the bank counterparty has elected to terminate the swap; (v) a termination payment is payable by the municipal obligor; and (vi) the municipal obligor has failed to make the termination payment payable by it, then AGM would be required to pay the termination payment due by the municipal obligor, in an amount not to exceed the policy limit set forth
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in the financial guaranty insurance policy. At AGM's current financial strength ratings, if the conditions giving rise to the obligation of AGM to make a termination payment under the swap termination policies were all satisfied, then AGM could pay claims in an amount not exceeding approximately $118 million in respect of such termination payments. Taking into consideration whether the rating of the municipal obligor is below any applicable specified trigger, if the financial strength ratings of AGM were further downgraded below "A" by S&P or below "A2" by Moody's, and the conditions giving rise to the obligation of AGM to make a payment under the swap policies were all satisfied, then AGM could pay claims in an additional amount not exceeding approximately $332 million in respect of such termination payments.
As another example, with respect to variable rate demand obligations ("VRDOs") for which a bank has agreed to provide a liquidity facility, a downgrade of AGM or AGC may provide the bank with the right to give notice to bondholders that the bank will terminate the liquidity facility, causing the bondholders to tender their bonds to the bank. Bonds held by the bank accrue interest at a “bank bond rate” that is higher than the rate otherwise borne by the bond (typically the prime rate plus 2.00% — 3.00%, and capped at the lesser of 25% and the maximum legal limit). In the event the bank holds such bonds for longer than a specified period of time, usually 90-180 days, the bank has the right to demand accelerated repayment of bond principal, usually through payment of equal installments over a period of not less than five years. In the event that a municipal obligor is unable to pay interest accruing at the bank bond rate or to pay principal during the shortened amortization period, a claim could be submitted to AGM or AGC under its financial guaranty policy. As of June 30, 2013, AGM had insured approximately $7.0 billion net par of VRDOs, of which approximately $0.3 billion of net par constituted VRDOs issued by municipal obligors rated BBB- or lower pursuant to the Company’s internal rating. The specific terms relating to the rating levels that trigger the bank’s termination right, and whether it is triggered by a downgrade by one rating agency or a downgrade by all rating agencies then rating the insurer, vary depending on the transaction.
In addition, AGM may be required to pay claims in respect of AGMH’s former financial products business if Dexia SA (the parent of Dexia Holdings Inc.) and its affiliates do not comply with their obligations following a downgrade of the financial strength rating of AGM. Most of the guaranteed investment contracts ("GICs") insured by AGM allow for the withdrawal of GIC funds in the event of a downgrade of AGM, unless the relevant GIC issuer posts collateral or otherwise enhances its credit. Most GICs insured by AGM allow for the termination of the GIC contract and a withdrawal of GIC funds at the option of the GIC holder in the event of a downgrade of AGM below a specified threshold, generally below A- by S&P or A3 by Moody’s, with no right of the GIC issuer to avoid such withdrawal by posting collateral or otherwise enhancing its credit. Each GIC contract stipulates the thresholds below which the GIC issuer must post eligible collateral, along with the types of securities eligible for posting and the collateralization percentage applicable to each security type. These collateralization percentages range from 100% of the GIC balance for cash posted as collateral to, typically, 108% for asset-backed securities.
7. | Fair Value Measurement |
The Company carries a significant portion of its assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., exit price). The price represents the price available in the principal market for the asset or liability. If there is no principal market, then the price is based on a hypothetical market that maximizes the value received for an asset or minimizes the amount paid for a liability (i.e., the most advantageous market).
Fair value is based on quoted market prices, where available. If listed prices or quotes are not available, fair value is based on either internally developed models that primarily use, as inputs, market-based or independently sourced market parameters, including but not limited to yield curves, interest rates and debt prices or with the assistance of an independent third-party using a discounted cash flow approach and the third party’s proprietary pricing models. In addition to market information, models also incorporate transaction details, such as maturity of the instrument and contractual features designed to reduce the Company’s credit exposure, such as collateral rights as applicable.
Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments include amounts to reflect counterparty credit quality, the Company’s creditworthiness and constraints on liquidity. As markets and products develop and the pricing for certain products becomes more or less transparent, the Company may refine its methodologies and assumptions. During Six Months 2013, no changes were made to the Company’s valuation models that had or are expected to have, a material impact on the Company’s consolidated balance sheets or statements of operations and comprehensive income.
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The Company’s methods for calculating fair value produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. The use of different methodologies or assumptions to determine fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
The fair value hierarchy is determined based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Company estimates of market assumptions. The fair value hierarchy prioritizes model inputs into three broad levels as follows, with Level 1 being the highest and Level 3 the lowest. An asset or liability’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation.
Level 1—Quoted prices for identical instruments in active markets. The Company generally defines an active market as a market in which trading occurs at significant volumes. Active markets generally are more liquid and have a lower bid-ask spread than an inactive market.
Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and observable inputs other than quoted prices, such as interest rates or yield curves and other inputs derived from or corroborated by observable market inputs.
Level 3—Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation.
Transfers between Levels 1, 2 and 3 are recognized at the end of the period when the transfer occurs. The Company reviews the classification between Levels 1, 2 and 3 quarterly to determine whether a transfer is necessary. During the periods presented, there were no transfers between Level 1, 2 and 3.
Measured and Carried at Fair Value
Fixed Maturity Securities and Short-term Investments
The fair value of bonds in the investment portfolio is generally based on prices received from third party pricing services or alternative pricing sources with reasonable levels of price transparency. The pricing services prepare estimates of fair value measurements using their pricing applications, which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. Additional valuation factors that can be taken into account are nominal spreads and liquidity adjustments. The pricing services evaluate each asset class based on relevant market and credit information, perceived market movements, and sector news. The market inputs used in the pricing evaluation, listed in the approximate order of priority include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data and industry and economic events. Benchmark yields have in many cases taken priority over reported trades for securities that trade less frequently. The extent of the use of each input is dependent on the asset class and the market conditions. Given the asset class, the priority of the use of inputs may change or some market inputs may not be relevant. Additionally, the valuation of fixed maturity investments is more subjective when markets are less liquid due to the lack of market based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur.
Short-term investments, that are traded in active markets, are classified within Level 1 in the fair value hierarchy and are based on quoted market prices. Securities such as discount notes are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their cost approximates fair value.
Prices determined based upon model processes where at least one significant model assumption or input is unobservable, are considered to be Level 3 in the fair value hierarchy. At June 30, 2013, the Company used model processes to price 25 fixed maturity securities, which was 8.5% or $463 million of the Company's fixed-maturity securities and short-term investments at fair value. Level 3 securities were priced with the assistance of an independent third-party. The pricing is based on a discounted cash flow approach using the third-party’s proprietary pricing models. The models use inputs such as projected prepayment speeds; severity assumptions; recovery lag assumptions; estimated default rates (determined on the basis of an analysis of collateral attributes, historical collateral performance, borrower profiles and other features relevant to the evaluation of collateral credit quality); home price depreciation/appreciation rates based on macroeconomic forecasts and recent trading activity. The yield used to discount the projected cash flows is determined by reviewing various attributes of the bond including
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collateral type, weighted average life, sensitivity to losses, vintage, and convexity, in conjunction with market data on comparable securities. Significant changes to any of these inputs could materially change the expected timing of cash flows within these securities which is a significant factor in determining the fair value of the securities.
Other Invested Assets
Other invested assets includes certain investments that are carried and measured at fair value on a recurring basis and non-recurring basis, as well as assets not carried at fair value. Within other invested assets, $54 million are carried at fair value on a recurring basis as of June 30, 2013. These assets comprise certain short-term investments and fixed maturity securities classified as trading and are Level 2 in the fair value hierarchy. Also carried at fair value on a recurring basis are $2 million in notes classified as Level 3 in the fair value hierarchy. The fair value of these notes is determined by calculating the present value of the expected cash flows. The unobservable inputs used in the fair value measurement of the notes are discount rate, prepayment speed and default rate.
Within other invested assets, $6 million are carried at fair value on a non-recurring basis as of June 30, 2013. These assets are comprised of mortgage loans which are classified as Level 3 in the fair value hierarchy as there are significant unobservable inputs used in the valuation of such loans. The non-performing portion of these mortgage loans is valued using an average recovery rate. The performing loans are valued using management’s determination of future cash flows arising from these loans, discounted at the rate of return that would be required by a market participant. The unobservable inputs used in the fair value measurement of the mortgage loans are discount rate, recovery on delinquent loans, loss severity, prepayment speed and default rate.
Other Assets
Committed Capital Securities
The fair value of committed capital securities ("CCS"), which is recorded in “other assets” on the consolidated balance sheets, represents the difference between the present value of remaining expected put option premium payments under AGM Committed Preferred Trust Securities (the “AGM CPS Securities”) agreements, and the estimated present value that the Company would hypothetically have to pay currently for a comparable security (see Note 15, Notes Payable and Credit Facilities). The estimated current cost of the Company’s CCS depends on several factors, including broker-dealer quotes for the outstanding securities, the U.S. dollar forward swap curve, London Interbank Offered Rate ("LIBOR") curve projections and the term the securities are estimated to remain outstanding.
Financial Guaranty Contracts Accounted for as Credit Derivatives
The Company’s credit derivatives consist primarily of insured CDS contracts, and also include interest rate swaps that fall under derivative accounting standards requiring fair value accounting through the statement of operations. The Company does not enter into CDS with the intent to trade these contracts and the Company may not unilaterally terminate a CDS contract absent an event of default or termination event that entitles the Company to terminate; however, the Company has mutually agreed with various counterparties to terminate certain CDS transactions. Such terminations generally are completed for an amount that approximates the present value of future premiums, not at fair value.
The terms of the Company’s CDS contracts differ from more standardized credit derivative contracts sold by companies outside the financial guaranty industry. Management considers the non-standard terms of its credit derivative contracts in determining the fair value of these contracts. The non-standard terms include the absence of collateral support agreements or immediate settlement provisions. In addition, the Company employs relatively high attachment points and does not exit derivatives it sells or purchases for credit protection purposes, except under specific circumstances such as mutual agreements with counterparties to terminate certain CDS contracts.
Due to the lack of quoted prices for its instruments or for similar instruments, the Company determines the fair value of its credit derivative contracts primarily through modeling that uses various inputs to derive an estimate of the fair value of the Company’s contracts in principal markets. Observable inputs other than quoted market prices exist; however, these inputs reflect contracts that do not contain terms and conditions similar to the credit derivative contracts issued by the Company. Management does not believe there is an established market where financial guaranty insured credit derivatives are actively traded. The terms of the protection under an insured financial guaranty credit derivative do not, except for certain rare circumstances, allow the Company to exit its contracts. Management has determined that the exit market for the Company’s credit derivatives is a hypothetical one based on its entry market. Management has tracked the historical pricing of the Company’s deals to establish historical price points in the hypothetical market that are used in the fair value calculation. These
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contracts are classified as Level 3 in the fair value hierarchy since there is reliance on at least one unobservable input deemed significant to the valuation model, most importantly the Company’s estimate of the value of the non-standard terms and conditions of its credit derivative contracts and of the Company’s current credit standing.
The Company’s models and the related assumptions are continuously reevaluated by management and enhanced, as appropriate, based upon improvements in modeling techniques and availability of more timely and relevant market information.
The fair value of the Company’s credit derivative contracts represents the difference between the present value of remaining premiums the Company expects to receive or pay for the credit protection under the contract and the estimated present value of premiums that a financial guarantor of comparable credit-worthiness would hypothetically charge or pay the Company for the same protection. The fair value of the Company’s credit derivatives depends on a number of factors, including notional amount of the contract, expected term, credit spreads, changes in interest rates, the credit ratings of referenced entities, the Company’s own credit risk and remaining contractual cash flows. The expected remaining contractual cash flows are the most readily observable inputs since they are based on the CDS contractual terms. These cash flows include premiums to be received or paid under the terms of the contract. Credit spreads capture the effect of recovery rates and performance of underlying assets of these contracts, among other factors. If credit spreads of the underlying obligations change, the fair value of the related credit derivative changes. Market liquidity also affects valuations of the underlying obligations. Consistent with the previous several years, market conditions at June 30, 2013 were such that market prices of the Company’s CDS contracts were not available. Since market prices were not available, the Company used proprietary valuation models that used both unobservable and observable market data inputs as described under “Assumptions and Inputs” below. These models are primarily developed internally based on market conventions for similar transactions.
Valuation models include management estimates and current market information. Management is also required to make assumptions of how the fair value of credit derivative instruments is affected by current market conditions. Management considers factors such as current prices charged for similar agreements, when available, performance of underlying assets, life of the instrument, and the nature and extent of activity in the financial guaranty credit derivative marketplace. The assumptions that management uses to determine the fair value may change in the future due to market conditions. Due to the inherent uncertainties of the assumptions used in the valuation models to determine the fair value of these credit derivative products, actual experience may differ from the estimates reflected in the Company’s consolidated financial statements and the differences may be material.
Assumptions and Inputs
Listed below are various inputs and assumptions that are key to the establishment of the Company’s fair value for CDS contracts.
· How gross spread is calculated.
· The allocation of gross spread among:
• | the profit the originator, usually an investment bank, realizes for putting the deal together and funding the transaction (“bank profit”); |
• | premiums paid to the Company for the Company’s credit protection provided (“net spread”); and |
• | the cost of CDS protection purchased by the originator to hedge their counterparty credit risk exposure to the Company (“hedge cost”). |
· The weighted average life which is based on expected remaining contractual cash flows and Debt Service schedules.
· The rates used to discount future premium expected cash flows.
The expected future premium cash flows for the Company's credit derivatives were discounted at rates ranging from 0.24% to 3.44% at June 30, 2013 and 0.25% to 2.81% at December 31, 2012.
Gross spread is used to ultimately determine the net spread a comparable financial guarantor would charge the Company to transfer its risk at the reporting date. The Company obtains gross spreads on risks assumed from market data sources published by third parties (e.g. dealer spread tables for the collateral similar to assets within the Company’s
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transactions) as well as collateral-specific spreads provided by trustees or obtained from market sources. If observable market credit spreads are not available or reliable for the underlying reference obligations, then market indices are used that most closely resemble the underlying reference obligations, considering asset class, credit quality rating and maturity of the underlying reference obligations. These indices are adjusted to reflect the non-standard terms of the Company’s CDS contracts. Market sources determine credit spreads by reviewing new issuance pricing for specific asset classes and receiving price quotes from their trading desks for the specific asset in question. Management validates these quotes by cross-referencing quotes received from one market source against quotes received from another market source to ensure reasonableness. In addition, the Company compares the relative change in price quotes received from one quarter to another, with the relative change experienced by published market indices for a specific asset class. Collateral specific spreads obtained from third-party, independent market sources are un-published spread quotes from market participants or market traders who are not trustees. Management obtains this information as the result of direct communication with these sources as part of the valuation process.
With respect to CDS transactions for which there is an expected claim payment within the next twelve months, the allocation of gross spread reflects a higher allocation to the cost of credit rather than the bank profit component. In the current market, it is assumed that a bank would be willing to accept a lower profit on distressed transactions in order to remove these transactions from its financial statements.
The following spread hierarchy is utilized in determining which source of gross spread to use, with the rule being to use CDS spreads where available. If not available, CDS spreads are either interpolated or extrapolated based on similar transactions or market indices.
· Actual collateral specific credit spreads (if up-to-date and reliable market-based spreads are available).
· Deals priced or closed during a specific quarter within a specific asset class and specific rating.
· Credit spreads interpolated based upon market indices.
· Credit spreads provided by the counterparty of the CDS.
· Credit spreads extrapolated based upon transactions of similar asset classes, similar ratings, and similar time to maturity.
Information by Credit Spread Type (1)
As of June 30, 2013 | As of December 31, 2012 | ||||
Based on actual collateral specific spreads | 0.2 | % | 0.2 | % | |
Based on market indices | 99.8 | % | 99.8 | % | |
Total | 100 | % | 100 | % |
____________________
(1) Based on par.
Over time the data inputs can change as new sources become available or existing sources are discontinued or are no longer considered to be the most appropriate. It is the Company’s objective to move to higher levels on the hierarchy whenever possible, but it is sometimes necessary to move to lower priority inputs because of discontinued data sources or management’s assessment that the higher priority inputs are no longer considered to be representative of market spreads for a given type of collateral. This can happen, for example, if transaction volume changes such that a previously used spread index is no longer viewed as being reflective of current market levels.
The Company interpolates a curve based on the historical relationship between the premium the Company receives when a credit derivative is close to the daily closing price of the market index related to the specific asset class and rating of the deal. This curve indicates expected credit spreads at each indicative level on the related market index. For transactions with unique terms or characteristics where no price quotes are available, management extrapolates credit spreads based on an alternative transaction for which the Company has received a spread quote from one of the first three sources within the Company’s spread hierarchy. This alternative transaction will be within the same asset class, have similar underlying assets, similar credit ratings, and similar time to maturity. The Company then calculates the percentage of relative spread change quarter over quarter for the alternative transaction. This percentage change is then applied to the historical credit spread of the
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transaction for which no price quote was received in order to calculate the transactions’ current spread. Counterparties determine credit spreads by reviewing new issuance pricing for specific asset classes and receiving price quotes from their trading desks for the specific asset in question. These quotes are validated by cross-referencing quotes received from one market source with those quotes received from another market source to ensure reasonableness.
The premium the Company receives is referred to as the “net spread.” The Company’s pricing model takes into account not only how credit spreads on risks that it assumes affect pricing, but also how the Company’s own credit spread affects the pricing of its deals. The Company’s own credit risk is factored into the determination of net spread based on the impact of changes in the quoted market price for credit protection bought on the Company, as reflected by quoted market prices on CDS referencing AGM. For credit spreads on the Company’s name the Company obtains the quoted price of CDS contracts traded on AGM from market data sources published by third parties. The cost to acquire CDS protection referencing AGM affects the amount of spread on CDS deals that the Company retains and, hence, their fair value. As the cost to acquire CDS protection referencing AGM increases, the amount of premium the Company retains on a deal generally decreases. As the cost to acquire CDS protection referencing AGM decreases, the amount of premium the Company retains on a deal generally increases. In the Company’s valuation model, the premium the Company captures is not permitted to go below the minimum rate that the Company would currently charge to assume similar risks. This assumption can have the effect of mitigating the amount of unrealized gains that are recognized on certain CDS contracts. Given the current market conditions and the Company’s own credit spreads, approximately 29%, and 82%, based on number of deals, of the Company's CDS contracts are fair valued using this minimum premium as of June 30, 2013 and December 31, 2012, respectively. The change period over period is driven by AGM's credit spreads narrowing to levels not seen since 2008. As a result of this, the cost to hedge AGM's name has declined significantly causing more transactions to price above previously established floor levels. The Company corroborates the assumptions in its fair value model, including the portion of exposure to AGM hedged by its counterparties, with independent third parties each reporting period. The current level of AGM’s own credit spread has resulted in the bank or deal originator hedging a significant portion of its exposure to AGM. This reduces the amount of contractual cash flows AGM can capture as premium for selling its protection.
The amount of premium a financial guaranty insurance market participant can demand is inversely related to the cost of credit protection on the insurance company as measured by market credit spreads assuming all other assumptions remain constant. This is because the buyers of credit protection typically hedge a portion of their risk to the financial guarantor, due to the fact that the Company’s contracts’ contractual terms typically do not require the posting of collateral by the guarantor. The widening of a financial guarantor’s own credit spread increases the cost to buy credit protection on the guarantor, thereby reducing the amount of premium the guarantor can capture out of the gross spread on the deal. The extent of the hedge depends on the types of instruments insured and the current market conditions.
A fair value resulting in a credit derivative asset on protection sold is the result of contractual cash inflows on in-force deals in excess of what a hypothetical financial guarantor could receive if it sold protection on the same risk as of the reporting date. If the Company were able to freely exchange these contracts (i.e., assuming its contracts did not contain proscriptions on transfer and there was a viable exchange market), it would be able to realize a gain representing the difference between the higher contractual premiums to which it is entitled and the current market premiums for a similar contract. The Company determines the fair value of its CDS contracts by applying the difference between the current net spread and the contractual net spread for the remaining duration of each contract to the notional value of its CDS contracts.
Example
Following is an example of how changes in gross spreads, the Company’s own credit spread and the cost to buy protection on the Company affect the amount of premium the Company can demand for its credit protection. The assumptions used in these examples are hypothetical amounts. Scenario 1 represents the market conditions in effect on the transaction date and Scenario 2 represents market conditions at a subsequent reporting date.
Scenario 1 | Scenario 2 | ||||||||||
bps | % of Total | bps | % of Total | ||||||||
Original gross spread/cash bond price (in bps) | 185 | — | 500 | — | |||||||
Bank profit (in bps) | 115 | 62 | % | 50 | 10 | % | |||||
Hedge cost (in bps) | 30 | 16 | % | 440 | 88 | % | |||||
The Company premium received per annum (in bps) | 40 | 22 | % | 10 | 2 | % |
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In Scenario 1, the gross spread is 185 basis points. The bank or deal originator captures 115 basis points of the original gross spread and hedges 10% of its exposure to AGM, when the CDS spread on AGM was 300 basis points (300 basis points × 10% = 30 basis points). Under this scenario the Company received premium of 40 basis points, or 22% of the gross spread.
In Scenario 2, the gross spread is 500 basis points. The bank or deal originator captures 50 basis points of the original gross spread and hedges 25% of its exposure to AGM, when the CDS spread on AGM was 1,760 basis points (1,760 basis points × 25% = 440 basis points). Under this scenario the Company would receive premium of 10 basis points, or 2% of the gross spread. Due to the increased cost to hedge AGM's name, the amount of profit the bank would expect to receive, and the premium the Company would expect to receive decline significantly.
In this example, the contractual cash flows (the Company premium received per annum above) exceed the amount a market participant would require the Company to pay in today's market to accept its obligations under the CDS contract, thus resulting in an asset. This credit derivative asset is equal to the difference in premium rates discounted at the corresponding LIBOR over the weighted average remaining life of the contract.
Strengths and Weaknesses of Model
The Company's credit derivative valuation model, like any financial model, has certain strengths and weaknesses.
The primary strengths of the Company's CDS modeling techniques are:
· The model takes into account the transaction structure and the key drivers of market value. The transaction structure includes par insured, weighted average life, level of subordination and composition of collateral.
· The model maximizes the use of market-driven inputs whenever they are available. The key inputs to the model are market-based spreads for the collateral, and the credit rating of referenced entities. These are viewed by the Company to be the key parameters that affect fair value of the transaction.
· The model is a consistent approach to valuing positions. The Company has developed a hierarchy for market-based spread inputs that helps mitigate the degree of subjectivity during periods of high illiquidity.
The primary weaknesses of the Company's CDS modeling techniques are:
· There is no exit market or actual exit transactions. Therefore the Company’s exit market is a hypothetical one based on the Company’s entry market.
· There is a very limited market in which to validate the reasonableness of the fair values developed by the Company’s model.
· At June 30, 2013 and December 31, 2012, the markets for the inputs to the model were highly illiquid, which impacts their reliability.
· Due to the non-standard terms under which the Company enters into derivative contracts, the fair value of its credit derivatives may not reflect the same prices observed in an actively traded market of credit derivatives that do not contain terms and conditions similar to those observed in the financial guaranty market.
These contracts were classified as Level 3 in the fair value hierarchy because there is a reliance on at least one unobservable input deemed significant to the valuation model, most significantly the Company's estimate of the value of non-standard terms and conditions of its credit derivative contracts and of amount of protection purchased on AGM's name.
Fair Value Option on FG VIEs' Assets and Liabilities
The Company elected the fair value option for all the FG VIEs assets and liabilities. See Note 9, Consolidation of Variable Interest Entities.
The FG VIEs that are consolidated by the Company issued securities collateralized by HELOCs, first lien and second lien RMBS, subprime automobile loans, and other loans and receivables. The lowest level input that is significant to the fair value measurement of these assets and liabilities in its entirety was a Level 3 input (i.e. unobservable), therefore management classified them as Level 3 in the fair value hierarchy. Prices were generally determined with the assistance of an independent third-party. The pricing is based on a discounted cash flow approach and the third-party’s proprietary pricing models. The
52
models to price the FG VIEs’ liabilities used, where appropriate, inputs such as estimated prepayment speeds; market values of the assets that collateralize the securities; estimated default rates (determined on the basis of an analysis of collateral attributes, historical collateral performance, borrower profiles and other features relevant to the evaluation of collateral credit quality); discount rates implied by market prices for similar securities; house price depreciation/appreciation rates based on macroeconomic forecasts and, for those liabilities insured by the Company, the benefit from the Company’s insurance policy guaranteeing the timely payment of principal and interest for the FG VIE tranches insured by the Company, taking into account the timing of the potential default and the Company’s own credit rating. The third-party also utilizes an internal model to determine an appropriate yield at which to discount the cash flows of the security, by factoring in collateral types, weighted-average lives, and other structural attributes specific to the security being priced. The expected yield is further calibrated by utilizing algorithm’s designed to aggregate market color, received by the third-party, on comparable bonds.
Changes in fair value of the FG VIEs’ assets and liabilities are included in fair value gains (losses) on FG VIEs within the consolidated statement of operations. Except for net credit impairment that triggers a claim on the financial guaranty contract (i.e. net expected loss to be paid as described in Note 5), the unrealized fair value gains (losses) related to the consolidated FG VIEs will reverse to zero over the terms of these financial instruments.
The fair value of the Company’s FG VIE assets is sensitive to changes related to estimated prepayment speeds; estimated default rates (determined on the basis of an analysis of collateral attributes such as: historical collateral performance, borrower profiles and other features relevant to the evaluation of collateral credit quality); discount rates implied by market prices for similar securities; and house price depreciation/appreciation rates based on macroeconomic forecasts. Significant changes to some of these inputs could materially change the market value of the FG VIE’s assets and the implied collateral losses within the transaction. In general, the fair value of the FG VIE asset is most sensitive to changes in the projected collateral losses, where an increase in collateral losses typically leads to a decrease in the fair value of FG VIE assets, while a decrease in collateral losses typically leads to an increase in the fair value of FG VIE assets. These factors also directly impact the fair value of the Company’s FG VIE liabilities.
The fair value of the Company’s FG VIE liabilities is also sensitive to changes relating to estimated prepayment speeds; market values of the underlying assets; estimated default rates (determined on the basis of an analysis of collateral attributes such as: historical collateral performance, borrower profiles and other features relevant to the evaluation of collateral credit quality); discount rates implied by market prices for similar securities; and house price depreciation/appreciation rates based on macroeconomic forecasts. In addition, the Company’s FG VIE liabilities with recourse are also sensitive to changes in the Company’s implied credit worthiness. Significant changes to any of these inputs could materially change the timing of expected losses within the insured transaction which is a significant factor in determining the implied benefit from the Company’s insurance policy guaranteeing the timely payment of principal and interest for the tranches of debt issued by the FG VIE that is insured by the Company. In general, extending the timing of expected loss payments by the Company into the future typically leads to a decrease in the value of the Company’s insurance and a decrease in the fair value of the Company’s FG VIE liabilities with recourse, while a shortening of the timing of expected loss payments by the Company typically leads to an increase in the value of the Company’s insurance and an increase in the fair value of the Company’s FG VIE liabilities with recourse.
Not Carried at Fair Value
Financial Guaranty Insurance Contracts
The fair value of the Company’s financial guaranty contracts accounted for as insurance was based on management’s estimate of what a similarly rated financial guaranty insurance company would demand to acquire the Company’s in-force book of financial guaranty insurance business. This amount was based on the pricing assumptions management has observed for portfolio transfers that have occurred in the financial guaranty market and included adjustments to the carrying value of unearned premium reserve for stressed losses, ceding commissions and return on capital. The significant inputs were not readily observable. The Company accordingly classified this fair value measurement as Level 3.
Other Invested Assets
Other invested assets primarily consist of a surplus note issued by AGC to AGM and assets acquired in refinancing transactions. The fair value of the surplus note was determined by calculating the effect of changes in U.S. Treasury yield adjusted for a credit factor at the end of each reporting period.
The fair value of the assets acquired in refinancing transactions was determined by calculating the present value of the expected cash flows. The Company uses a market approach to determine discounted future cash flows using market driven
53
discount rates and a variety of assumptions, including LIBOR curve projections and prepayment and default assumptions. The fair value measurement was classified as Level 3 in the fair value hierarchy because there is a reliance on significant unobservable inputs to the valuation model, including the discount rates, prepayment and default assumptions, loss severity and recovery on delinquent loans.
Other Assets and Other Liabilities
The Company’s other assets and other liabilities consist predominantly of accrued interest, receivables for securities sold and payables for securities purchased, the carrying values of which approximate fair value.
Notes Payable
The fair value of the notes payable was determined by calculating the present value of the expected cash flows. The Company uses a market approach to determine discounted future cash flows using market driven discount rates and a variety of assumptions, if applicable, including LIBOR curve projections, prepayment and default assumptions, and AGM CDS spreads. The fair value measurement was classified as Level 3 in the fair value hierarchy.
Loan Receivable from Affiliate
The fair value of the Company's loan receivable from affiliate is determined by calculating the effect of changes in U.S. Treasury yield adjusted for a credit factor at the end of each reporting period. Please refer to Note 17, Subsequent Events, for information impacting the loan receivable.
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Financial Instruments Carried at Fair Value
Amounts recorded at fair value in the Company's financial statements are included in the tables below.
Fair Value Hierarchy of Financial Instruments Carried at Fair Value
As of June 30, 2013
Fair Value Hierarchy | |||||||||||||||
Fair Value | Level 1 | Level 2 | Level 3 | ||||||||||||
(in millions) | |||||||||||||||
Assets: | |||||||||||||||
Investment portfolio, available-for-sale: | |||||||||||||||
Fixed maturity securities | |||||||||||||||
U.S. government and agencies | $ | 79 | $ | — | $ | 79 | $ | — | |||||||
Obligations of state and political subdivisions | 3,379 | — | 3,368 | 11 | |||||||||||
Corporate securities | 359 | — | 359 | — | |||||||||||
Mortgage-backed securities: | |||||||||||||||
RMBS | 385 | — | 159 | 226 | |||||||||||
Commercial mortgage-backed securities ("CMBS") | 131 | — | 131 | — | |||||||||||
Asset-backed securities | 340 | — | 114 | 226 | |||||||||||
Foreign government securities | 174 | — | 174 | — | |||||||||||
Total fixed maturity securities | 4,847 | — | 4,384 | 463 | |||||||||||
Short-term investments | 623 | 530 | 93 | — | |||||||||||
Other invested assets (1) | 62 | — | 54 | 8 | |||||||||||
Credit derivative assets | 114 | — | — | 114 | |||||||||||
FG VIEs’ assets, at fair value | 1,784 | — | — | 1,784 | |||||||||||
Other assets(2) | 10 | — | — | 10 | |||||||||||
Total assets carried at fair value | $ | 7,440 | $ | 530 | $ | 4,531 | $ | 2,379 | |||||||
Liabilities: | |||||||||||||||
Credit derivative liabilities | $ | 424 | $ | — | $ | — | $ | 424 | |||||||
FG VIEs’ liabilities with recourse, at fair value | 1,422 | — | — | 1,422 | |||||||||||
FG VIEs’ liabilities without recourse, at fair value | 717 | — | — | 717 | |||||||||||
Total liabilities carried at fair value | $ | 2,563 | $ | — | $ | — | $ | 2,563 |
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Fair Value Hierarchy of Financial Instruments Carried at Fair Value
As of December 31, 2012
Fair Value Hierarchy | |||||||||||||||
Fair Value | Level 1 | Level 2 | Level 3 | ||||||||||||
(in millions) | |||||||||||||||
Assets: | |||||||||||||||
Investment portfolio, available-for-sale: | |||||||||||||||
Fixed maturity securities | |||||||||||||||
U.S. government and agencies | $ | 93 | $ | — | $ | 93 | $ | — | |||||||
Obligations of state and political subdivisions | 3,503 | — | 3,491 | 12 | |||||||||||
Corporate securities | 230 | — | 230 | — | |||||||||||
Mortgage-backed securities: | |||||||||||||||
RMBS | 359 | — | 175 | 184 | |||||||||||
CMBS | 103 | — | 103 | — | |||||||||||
Asset-backed securities | 341 | — | 92 | 249 | |||||||||||
Foreign government securities | 202 | — | 202 | — | |||||||||||
Total fixed maturity securities | 4,831 | — | 4,386 | 445 | |||||||||||
Short-term investments | 473 | 308 | 165 | — | |||||||||||
Other invested assets (1) | 97 | — | 89 | 8 | |||||||||||
Credit derivative assets | 131 | — | — | 131 | |||||||||||
FG VIEs’ assets, at fair value | 1,870 | — | — | 1,870 | |||||||||||
Other assets(2) | 14 | — | — | 14 | |||||||||||
Total assets carried at fair value | $ | 7,416 | $ | 308 | $ | 4,640 | $ | 2,468 | |||||||
Liabilities: | |||||||||||||||
Credit derivative liabilities | $ | 414 | $ | — | $ | — | $ | 414 | |||||||
FG VIEs’ liabilities with recourse, at fair value | 1,605 | — | — | 1,605 | |||||||||||
FG VIEs’ liabilities without recourse, at fair value | 678 | — | — | 678 | |||||||||||
Total liabilities carried at fair value | $ | 2,697 | $ | — | $ | — | $ | 2,697 |
____________________
(1) | Includes mortgage loans that are recorded at fair value on a non-recurring basis. At June 30, 2013 and December 31, 2012, such investments were carried at their market value of $6 million and $7 million, respectively. |
(2) | Includes fair value of CCS. |
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Changes in Level 3 Fair Value Measurements
The table below presents a roll forward of the Company's Level 3 financial instruments carried at fair value on a recurring basis during Second Quarter 2013 and 2012 and Six Months 2013 and 2012.
Fair Value Level 3 Rollforward
Recurring Basis
Second Quarter 2013
Fixed Maturity Securities | ||||||||||||||||||||||||||||||||||||||||||||
Obligations of State and Political Subdivisions | RMBS | Asset- Backed Securities | Other Invested Assets | FG VIEs’ Assets at Fair Value | Other Assets | Credit Derivative Asset (Liability), net(5) | FG VIEs' Liabilities with Recourse, at Fair Value | FG VIEs’ Liabilities without Recourse, at Fair Value | ||||||||||||||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||||||||||||||
Fair value as of March 31, 2013 | $ | 11 | $ | 188 | $ | 225 | $ | 1 | $ | 1,948 | $ | 11 | $ | (351 | ) | $ | (1,566 | ) | $ | (708 | ) | |||||||||||||||||||||||
Total pretax realized and unrealized gains/(losses) recorded in:(1) | ||||||||||||||||||||||||||||||||||||||||||||
Net income (loss) | 0 | (2 | ) | 5 | (2 | ) | 3 | (2 | ) | (1 | ) | 299 | (3 | ) | (1 | ) | (4 | ) | 63 | (6 | ) | (59 | ) | (3 | ) | (90 | ) | (3 | ) | |||||||||||||||
Other comprehensive income (loss) | 0 | (3 | ) | (1 | ) | 2 | — | — | — | — | — | |||||||||||||||||||||||||||||||||
Purchases | — | 47 | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||
Settlements | 0 | (11 | ) | (1 | ) | — | (285 | ) | — | (22 | ) | 68 | 33 | |||||||||||||||||||||||||||||||
FG VIE consolidations | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||
FG VIE deconsolidations | — | — | — | — | (178 | ) | — | — | 135 | 48 | ||||||||||||||||||||||||||||||||||
Fair value as of June 30, 2013 | $ | 11 | $ | 226 | $ | 226 | $ | 2 | $ | 1,784 | $ | 10 | $ | (310 | ) | $ | (1,422 | ) | $ | (717 | ) | |||||||||||||||||||||||
Change in unrealized gains/(losses) related to financial instruments held as of June 30, 2013 | $ | 0 | $ | (2 | ) | $ | (1 | ) | $ | 2 | $ | 171 | $ | (1 | ) | $ | 47 | $ | (60 | ) | $ | (96 | ) |
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Fair Value Level 3 Rollforward
Recurring Basis
Second Quarter 2012
Fixed Maturity Securities | ||||||||||||||||||||||||||||||||||||||||||||
Obligations of State and Political Subdivisions | RMBS | Asset- Backed Securities | Other Invested Assets | FG VIEs’ Assets at Fair Value | Other Assets | Credit Derivative Asset (Liability), net(5) | FG VIEs' Liabilities with Recourse, at Fair Value | FG VIEs’ Liabilities without Recourse, at Fair Value | ||||||||||||||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||||||||||||||
Fair value as of March 31, 2012 | $ | 10 | $ | 108 | $ | 229 | $ | 2 | $ | 2,050 | $ | 17 | $ | (352 | ) | $ | (1,881 | ) | $ | (724 | ) | |||||||||||||||||||||||
Total pretax realized and unrealized gains/(losses) recorded in:(1) | ||||||||||||||||||||||||||||||||||||||||||||
Net income (loss) | 0 | (2 | ) | 4 | (2 | ) | 7 | (2 | ) | — | 19 | (3 | ) | 2 | (4 | ) | 47 | (6 | ) | (15 | ) | (3 | ) | (7 | ) | (3 | ) | |||||||||||||||||
Other comprehensive income (loss) | 0 | (15 | ) | 3 | (1 | ) | — | — | — | — | — | |||||||||||||||||||||||||||||||||
Purchases | — | 54 | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||
Settlements | — | (9 | ) | (2 | ) | 0 | (124 | ) | — | 4 | 126 | 41 | ||||||||||||||||||||||||||||||||
FG VIE consolidations | — | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||
Fair value as of June 30, 2012 | $ | 10 | $ | 142 | $ | 237 | $ | 1 | $ | 1,945 | $ | 19 | $ | (301 | ) | $ | (1,770 | ) | $ | (690 | ) | |||||||||||||||||||||||
Change in unrealized gains/(losses) related to financial instruments held as of June 30, 2012 | $ | 0 | $ | (16 | ) | $ | 2 | $ | (1 | ) | $ | (94 | ) | $ | 2 | $ | 52 | $ | 62 | $ | 44 |
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Fair Value Level 3 Rollforward
Recurring Basis
Six Months 2013
Fixed Maturity Securities | ||||||||||||||||||||||||||||||||||||||||||||
Obligations of State and Political Subdivisions | RMBS | Asset- Backed Securities | Other Invested Assets | FG VIEs’ Assets at Fair Value | Other Assets | Credit Derivative Asset (Liability), net(5) | FG VIEs' Liabilities with Recourse, at Fair Value | FG VIEs’ Liabilities without Recourse, at Fair Value | ||||||||||||||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||||||||||||||
Fair value as of December 31, 2012 | $ | 12 | $ | 184 | $ | 249 | $ | 1 | $ | 1,870 | $ | 14 | $ | (283 | ) | $ | (1,605 | ) | $ | (678 | ) | |||||||||||||||||||||||
Total pretax realized and unrealized gains/(losses) recorded in:(1) | ||||||||||||||||||||||||||||||||||||||||||||
Net income (loss) | 0 | (2 | ) | 10 | (2 | ) | 7 | (2 | ) | (1 | ) | 446 | (3 | ) | (4 | ) | (4 | ) | 7 | (6 | ) | (110 | ) | (3 | ) | (124 | ) | (3 | ) | |||||||||||||||
Other comprehensive income (loss) | 0 | 4 | (27 | ) | 2 | — | — | — | — | — | ||||||||||||||||||||||||||||||||||
Purchases | — | 50 | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||
Settlements | (1 | ) | (22 | ) | (3 | ) | — | (402 | ) | — | (34 | ) | 170 | 74 | ||||||||||||||||||||||||||||||
FG VIE consolidations | — | — | — | — | 48 | — | — | (12 | ) | (37 | ) | |||||||||||||||||||||||||||||||||
FG VIE deconsolidations | — | — | — | — | (178 | ) | — | — | 135 | 48 | ||||||||||||||||||||||||||||||||||
Fair value as of June 30, 2013 | $ | 11 | $ | 226 | $ | 226 | $ | 2 | $ | 1,784 | $ | 10 | $ | (310 | ) | $ | (1,422 | ) | $ | (717 | ) | |||||||||||||||||||||||
Change in unrealized gains/(losses) related to financial instruments held as of June 30, 2013 | $ | 0 | $ | 5 | $ | (26 | ) | $ | 2 | $ | 288 | $ | (4 | ) | $ | (21 | ) | $ | (108 | ) | $ | (142 | ) |
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Fair Value Level 3 Rollforward
Recurring Basis
Six Months 2012
Fixed Maturity Securities | ||||||||||||||||||||||||||||||||||||||||||||
Obligations of State and Political Subdivisions | RMBS | Asset- Backed Securities | Other Invested Assets | FG VIEs’ Assets at Fair Value | Other Assets | Credit Derivative Asset (Liability), net(5) | FG VIEs' Liabilities with Recourse, at Fair Value | FG VIEs’ Liabilities without Recourse, at Fair Value | ||||||||||||||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||||||||||||||
Fair value as of December 31, 2011 | $ | 10 | $ | 105 | $ | 211 | $ | 2 | $ | 2,057 | $ | 22 | $ | (316 | ) | $ | (1,926 | ) | $ | (704 | ) | |||||||||||||||||||||||
Total pretax realized and unrealized gains/(losses) recorded in:(1) | ||||||||||||||||||||||||||||||||||||||||||||
Net income (loss) | 0 | (2 | ) | 5 | (2 | ) | 12 | (2 | ) | — | 122 | (3 | ) | (3 | ) | (4 | ) | 17 | (6 | ) | (82 | ) | (3 | ) | (66 | ) | (3 | ) | ||||||||||||||||
Other comprehensive income (loss) | 1 | (6 | ) | (1 | ) | (1 | ) | — | — | — | — | — | ||||||||||||||||||||||||||||||||
Purchases | — | 54 | 18 | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||
Settlements | (1 | ) | (16 | ) | (3 | ) | — | (242 | ) | — | (2 | ) | 251 | 80 | ||||||||||||||||||||||||||||||
FG VIE consolidations | — | — | — | — | 8 | — | — | (13 | ) | — | ||||||||||||||||||||||||||||||||||
Fair value as of June 30, 2012 | $ | 10 | $ | 142 | $ | 237 | $ | 1 | $ | 1,945 | $ | 19 | $ | (301 | ) | $ | (1,770 | ) | $ | (690 | ) | |||||||||||||||||||||||
Change in unrealized gains/(losses) related to financial instruments held as of June 30, 2012 | $ | 1 | $ | (9 | ) | $ | (1 | ) | $ | (1 | ) | $ | 57 | $ | (3 | ) | $ | 22 | $ | (21 | ) | $ | (21 | ) |
____________________
(1) | Realized and unrealized gains (losses) from changes in values of Level 3 financial instruments represent gains (losses) from changes in values of those financial instruments only for the periods in which the instruments were classified as Level 3. |
(2) | Included in net realized investment gains (losses) and net investment income. |
(3) | Included in fair value gains (losses) on FG VIEs. |
(4) | Recorded in fair value gains (losses) on CCS. |
(5) | Represents net position of credit derivatives. The consolidated balance sheet presents gross assets and liabilities based on net counterparty exposure. |
(6) | Reported in net change in fair value of credit derivatives. |
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Level 3 Fair Value Disclosures
Quantitative Information About Level 3 Fair Value Inputs
At June 30, 2013
Financial Instrument Description | Fair Value at June 30, 2013(in millions) | Valuation Technique | Significant Unobservable Inputs | Range | ||||||||||
Assets: | ||||||||||||||
Fixed maturity securities: | ||||||||||||||
Obligations of state and political subdivisions | $ | 11 | Discounted | Rate of inflation | 1.0 | % | - | 3.0% | ||||||
cash flow | Cash flow receipts | 4.8 | % | - | 22.9% | |||||||||
Yield | 4.6% | |||||||||||||
Collateral recovery period | 1 month | - | 9 years | |||||||||||
RMBS | 226 | Discounted | CPR | 1.0 | % | - | 7.0% | |||||||
cash flow | CDR | 5.9 | % | - | 23.0% | |||||||||
Severity | 51.6 | % | - | 102.8% | ||||||||||
Yield | 4.8 | % | - | 9.7% | ||||||||||
Asset-backed securities: | ||||||||||||||
Whole business securitization | 62 | Discounted cash flow | Annual gross revenue projections (in millions) | $54 | - | $96 | ||||||||
Value of primary financial guaranty policy | 43.8% | |||||||||||||
Liquidity discount | 5.0 | % | - | 20.0% | ||||||||||
Investor owned utility | 164 | Discounted cash flow | Liquidation value (in millions) | $216 | - | $217 | ||||||||
Years to liquidation | 0 years | - | 2.5 years | |||||||||||
Collateral recovery period | 6 months | - | 6 years | |||||||||||
Discount factor | 15.3% | |||||||||||||
Other invested assets | 8 | Discounted cash flow | Discount for lack of liquidity | 10.0 | % | - | 20.0% | |||||||
Recovery on delinquent loans | 20.0 | % | - | 60.0% | ||||||||||
Default rates | 1.0 | % | - | 11.0% | ||||||||||
Loss severity | 40.0 | % | - | 90.0% | ||||||||||
Prepayment speeds | 6.0 | % | - | 15.0% | ||||||||||
FG VIEs’ assets, at fair value | 1,784 | Discounted | CPR | 0.6 | % | - | 9.7% | |||||||
cash flow | CDR | 2.8 | % | - | 27.8% | |||||||||
Loss severity | 38.1 | % | - | 101.9% | ||||||||||
Yield | 2.8 | % | - | 8.9% |
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Financial Instrument Description | Fair Value at June 30, 2013(in millions) | Valuation Technique | Significant Unobservable Inputs | Range | ||||||||
Other assets | 10 | Discounted cash flow | Quotes from third party pricing | $57 | ||||||||
Term (years) | 3 years | |||||||||||
Liabilities: | ||||||||||||
Credit derivative liabilities, net | (310 | ) | Discounted | Hedge cost (in bps) | 17.9 | - | 365.0 | |||||
cash flow | Bank profit (in bps) | 1.0 | - | 1,364.0 | ||||||||
Internal floor (in bps) | 7.0 | - | 100.0 | |||||||||
Internal credit rating | AAA | - | BIG | |||||||||
FG VIEs’ liabilities, at fair value | (2,139 | ) | Discounted | CPR | 0.6 | % | - | 9.7% | ||||
cash flow | CDR | 2.8 | % | - | 27.8% | |||||||
Loss severity | 38.1 | % | - | 101.9% | ||||||||
Yield | 2.8 | % | - | 8.9% |
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Quantitative Information About Level 3 Fair Value Inputs
At December 31, 2012
Financial Instrument Description | Fair Value at December 31, 2012 (in millions) | Valuation Technique | Significant Unobservable Inputs | Range | ||||||||||
Assets: | ||||||||||||||
Fixed maturity securities: | ||||||||||||||
Obligations of state and political subdivisions | $ | 12 | Discounted | Rate of inflation | 1.0 | % | - | 3.0% | ||||||
cash flow | Cash flow receipts | 4.9 | % | - | 29.7% | |||||||||
Yield | 4.6% | |||||||||||||
Collateral recovery period | 1 month | - | 11 years | |||||||||||
RMBS | 184 | Discounted | CPR | 1.0 | % | - | 6.9% | |||||||
cash flow | CDR | 6.2 | % | - | 23.0% | |||||||||
Severity | 51.6 | % | - | 102.8% | ||||||||||
Yield | 3.5 | % | - | 12.5% | ||||||||||
Asset-backed securities: | ||||||||||||||
Whole business securitization | 63 | Discounted cash flow | Annual gross revenue projections (in millions) | $54 | - | $96 | ||||||||
Value of primary financial guaranty policy | 43.8% | |||||||||||||
Liquidity discount | 5.0 | % | - | 20.0% | ||||||||||
Investor owned utility | 186 | Discounted cash flow | Liquidation value (in millions) | $212 | - | $242 | ||||||||
Years to liquidation | 0 years | - | 3 years | |||||||||||
Discount factor | 15.3% | |||||||||||||
Other invested assets | 8 | Discounted cash flow | Discount for lack of liquidity | 10.0 | % | - | 20.0% | |||||||
Recovery on delinquent loans | 20.0 | % | - | 60.0% | ||||||||||
Default rates | 1.0 | % | - | 12.0% | ||||||||||
Loss severity | 40.0 | % | - | 90.0% | ||||||||||
Prepayment speeds | 6.0 | % | - | 15.0% | ||||||||||
FG VIEs’ assets, at fair value | 1,870 | Discounted | CPR | 0.5 | % | - | 9.3% | |||||||
cash flow | CDR | 3.6 | % | - | 28.6% | |||||||||
Loss severity | 50.6 | % | - | 103.8% | ||||||||||
Yield | 4.5 | % | - | 20.0% |
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Financial Instrument Description | Fair Value at December 31, 2012 (in millions) | Valuation Technique | Significant Unobservable Inputs | Range | ||||||||
Other assets | 14 | Discounted cash flow | Quotes from third party pricing | $45 | - | $51 | ||||||
Term (years) | 3 years | |||||||||||
Liabilities: | ||||||||||||
Credit derivative liabilities, net | (283 | ) | Discounted | Hedge cost (in bps) | 64.2 | - | 536.2 | |||||
cash flow | Bank profit (in bps) | 1.0 | - | 1,312.9 | ||||||||
Internal floor (in bps) | 7.0 | - | 60.0 | |||||||||
Internal credit rating | AAA | - | BIG | |||||||||
FG VIEs’ liabilities, at fair value | (2,283 | ) | Discounted | CPR | 0.5 | % | - | 9.3% | ||||
cash flow | CDR | 3.6 | % | - | 28.6% | |||||||
Loss severity | 50.6 | % | - | 103.8% | ||||||||
Yield | 4.5 | % | - | 20.0% |
The carrying amount and estimated fair value of the Company's financial instruments are presented in the following table.
Fair Value of Financial Instruments
As of June 30, 2013 | As of December 31, 2012 | ||||||||||||||
Carrying Amount | Estimated Fair Value | Carrying Amount | Estimated Fair Value | ||||||||||||
(in millions) | |||||||||||||||
Assets: | |||||||||||||||
Fixed maturity securities | $ | 4,847 | $ | 4,847 | $ | 4,831 | $ | 4,831 | |||||||
Short-term investments | 623 | 623 | 473 | 473 | |||||||||||
Other invested assets | 395 | 461 | 441 | 548 | |||||||||||
Loan receivable from affiliate | 83 | 80 | 83 | 82 | |||||||||||
Credit derivative assets | 114 | 114 | 131 | 131 | |||||||||||
FG VIEs’ assets, at fair value | 1,784 | 1,784 | 1,870 | 1,870 | |||||||||||
Other assets | 94 | 94 | 72 | 72 | |||||||||||
Liabilities: | |||||||||||||||
Financial guaranty insurance contracts(1) | 2,013 | 2,096 | 2,091 | 2,949 | |||||||||||
Note payable | 53 | 55 | 66 | 72 | |||||||||||
Credit derivative liabilities | 424 | 424 | 414 | 414 | |||||||||||
FG VIEs’ liabilities with recourse, at fair value | 1,422 | 1,422 | 1,605 | 1,605 | |||||||||||
FG VIEs’ liabilities without recourse, at fair value | 717 | 717 | 678 | 678 | |||||||||||
Other liabilities | 37 | 37 | 25 | 25 |
____________________
(1) | Carrying amount includes the assets and liabilities related to financial guaranty insurance contract premiums, losses, and salvage and subrogation and other recoverables net of reinsurance. |
8. | Financial Guaranty Contracts Accounted for as Credit Derivatives |
The Company has a portfolio of financial guaranty contracts that meet the definition of a derivative in accordance with GAAP (primarily CDS). Until the Company ceased selling credit protection through credit derivative contracts in the beginning of 2009, following the issuance of regulatory guidelines that limited the terms under which the credit protection could be sold, management considered these agreements to be a normal part of its financial guaranty business. The potential capital or margin
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requirements that may apply under the Dodd-Frank Wall Street Reform and Consumer Protection Act contributed to the decision of the Company not to sell new credit protection through CDS in the foreseeable future.
Credit derivative transactions are governed by ISDA documentation and have different characteristics from financial guaranty insurance contracts. For example, the Company’s control rights with respect to a reference obligation under a credit derivative may be more limited than when the Company issues a financial guaranty insurance contract. In addition, while the Company’s exposure under credit derivatives, like the Company’s exposure under financial guaranty insurance contracts, has been generally for as long as the reference obligation remains outstanding, unlike financial guaranty contracts, a credit derivative may be terminated for a breach of the ISDA documentation or other specific events. A loss payment is made only upon the occurrence of one or more defined credit events with respect to the referenced securities or loans. A credit event may be a non-payment event such as a failure to pay, bankruptcy or restructuring, as negotiated by the parties to the credit derivative transactions. If events of default or termination events specified in the credit derivative documentation were to occur, the non-defaulting or the non-affected party, which may be either the Company or the counterparty, depending upon the circumstances, may decide to terminate a credit derivative prior to maturity. The Company may be required to make a termination payment to its swap counterparty upon such termination. The Company may not unilaterally terminate a CDS contract; however, the Company on occasion has mutually agreed with various counterparties to terminate certain CDS transactions.
Credit Derivative Net Par Outstanding by Sector
The estimated remaining weighted average life of credit derivatives was 2.4 years at June 30, 2013 and 2.5 years at December 31, 2012. The components of the Company's credit derivative net par outstanding are presented below.
Credit Derivatives Net Par Outstanding
As of June 30, 2013 | As of December 31, 2012 | |||||||||||||||||||||||
Asset Type | Net Par Outstanding | Original Subordination (1) | Current Subordination (1) | Weighted Average Credit Rating | Net Par Outstanding | Original Subordination (1) | Current Subordination (1) | Weighted Average Credit Rating | ||||||||||||||||
(dollars in millions) | ||||||||||||||||||||||||
Pooled corporate obligations: | ||||||||||||||||||||||||
Collateralized loan obligations/collateralized bond obligations | $ | 12,706 | 29.3 | % | 30.9 | % | AAA | $ | 15,614 | 29.1 | % | 30.4 | % | AAA | ||||||||||
Synthetic investment grade pooled corporate | 9,057 | 21.1 | 19.2 | AAA | 9,089 | 21.1 | 19.2 | AAA | ||||||||||||||||
Synthetic high yield pooled corporate | 2,684 | 47.2 | 41.1 | AAA | 3,616 | 35.0 | 30.4 | AAA | ||||||||||||||||
Trust preferred securities collateralized debt obligations ("TruPS CDOs") | 28 | 55.3 | 85.8 | AAA | 41 | 55.1 | 78.8 | AAA | ||||||||||||||||
Market value CDOs of corporate obligations | 1,184 | 17.0 | 31.0 | AAA | 1,492 | 17.0 | 29.9 | AAA | ||||||||||||||||
Total pooled corporate obligations | 25,659 | 27.7 | 27.9 | AAA | 29,852 | 26.8 | 27.0 | AAA | ||||||||||||||||
U.S. RMBS: | ||||||||||||||||||||||||
Subprime first lien (including net interest margin) | 69 | — | — | AA | 72 | — | — | AA | ||||||||||||||||
Closed end second lien and HELOCs | 79 | — | — | BBB+ | 101 | — | — | BBB | ||||||||||||||||
Total U.S. RMBS | 148 | — | — | A | 173 | — | — | A | ||||||||||||||||
Other | 2,899 | — | — | A- | 3,269 | — | — | A- | ||||||||||||||||
Total | $ | 28,706 | AAA | $ | 33,294 | AAA |
____________________
(1) | Represents the sum of subordinate tranches and over-collateralization and does not include any benefit from excess interest collections that may be used to absorb losses. |
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Except for TruPS CDOs, the Company’s exposure to pooled corporate obligations is highly diversified in terms of obligors and industries. Most pooled corporate transactions are structured to limit exposure to any given obligor and industry. The majority of the Company’s pooled corporate exposure consists of collateralized loan obligation (“CLO”) or synthetic pooled corporate obligations. Most of these CLOs have an average obligor size of less than 1% of the total transaction and typically restrict the maximum exposure to any one industry to approximately 10%. The Company’s exposure also benefits from embedded credit enhancement in the transactions which allows a transaction to sustain a certain level of losses in the underlying collateral, further insulating the Company from industry specific concentrations of credit risk on these deals.
The $2.9 billion of exposure in “Other” CDS contracts as of June 30, 2013 comprises numerous deals typically structured with significant underlying credit enhancement and spread across various asset classes, such as commercial receivables, international RMBS, infrastructure, regulated utilities and consumer receivables.
Distribution of Credit Derivative Net Par Outstanding by Internal Rating
As of June 30, 2013 | As of December 31, 2012 | |||||||||||||
Ratings | Net Par Outstanding | % of Total | Net Par Outstanding | % of Total | ||||||||||
(dollars in millions) | ||||||||||||||
AAA | $ | 24,534 | 85.5 | % | $ | 27,826 | 83.6 | % | ||||||
AA | 1,970 | 6.9 | 1,839 | 5.5 | ||||||||||
A | 827 | 2.9 | 1,781 | 5.3 | ||||||||||
BBB | 1,073 | 3.6 | 1,319 | 4.0 | ||||||||||
BIG | 302 | 1.1 | 529 | 1.6 | ||||||||||
Total credit derivative net par outstanding | $ | 28,706 | 100.0 | % | $ | 33,294 | 100.0 | % |
Net Change in Fair Value of Credit Derivatives
Net Change in Fair Value of Credit Derivatives Gain (Loss)
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
Net credit derivative premiums received and receivable | $ | 18 | $ | 14 | $ | 30 | $ | 23 | |||||||
Net ceding commissions (paid and payable) received and receivable | 1 | 1 | 1 | 1 | |||||||||||
Realized gains on credit derivatives | 19 | 15 | 31 | 24 | |||||||||||
Net credit derivative losses (paid and payable) recovered and recoverable | (1 | ) | (21 | ) | (2 | ) | (31 | ) | |||||||
Total realized gains (losses) and other settlements on credit derivatives | 18 | (6 | ) | 29 | (7 | ) | |||||||||
Net unrealized gains (losses) on credit derivatives | 45 | 53 | (22 | ) | 24 | ||||||||||
Net change in fair value of credit derivatives | $ | 63 | $ | 47 | $ | 7 | $ | 17 |
In Second Quarter 2013 and 2012, CDS contracts totaling $1.4 billion and $0.4 billion, respectively, in net par were terminated resulting in accelerations of credit derivative revenue of $9 million and $0.4 million, respectively. In Six Months 2013 and 2012, CDS contracts totaling $2.4 billion and $0.5 billion, respectively, in net par were terminated resulting in accelerations of credit derivative revenue of $10 million and $0.5 million, respectively.
Changes in the fair value of credit derivatives occur primarily because of changes in interest rates, credit spreads, notional amounts, credit ratings of the referenced entities, expected terms, realized gains (losses) and other settlements, and the issuing company’s own credit rating, credit spreads and other market factors. Except for net estimated credit impairments (i.e., net expected loss to be paid as discussed in Note 5), the unrealized gains and losses on credit derivatives are expected to reduce to zero as the exposure approaches its maturity date. With considerable volatility continuing in the market, unrealized gains (losses) on credit derivatives may fluctuate significantly in future periods.
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Net Change in Unrealized Gains (Losses) on Credit Derivatives By Sector
Second Quarter | Six Months | |||||||||||||||
Asset Type | 2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | ||||||||||||||||
Pooled corporate obligations | $ | 2 | $ | 7 | $ | (28 | ) | $ | 20 | |||||||
U.S. RMBS | — | 20 | (2 | ) | 27 | |||||||||||
Other | 43 | 26 | 8 | (23 | ) | |||||||||||
Total | $ | 45 | $ | 53 | $ | (22 | ) | $ | 24 |
During Second Quarter 2013, unrealized fair value gains were driven primarily by the price improvement on a XXX life securitization transaction in the Other sector. The cost of AGM's 5 Year and 1 Year credit protection also changed during Second Quarter 2013, but did not lead to significant fair value losses, as the policies which represent the majority of the Company's current outstanding exposure continue to price at previous established floor level (or the minimum rate at which the Company would expect to consider assuming these risks based on historical experience).
During Six Months 2013, the cost to buy protection on AGM's name declined. This led to unrealized fair value losses which were generated primarily in the high yield and investment grade synthetic pooled corporate sectors. The wider implied net spreads were primarily a result of the decreased cost to buy protection in AGM's name as the market cost of AGM's credit decreased significantly during the period. Several transactions were pricing above their floor levels; therefore when the cost of purchasing CDS protection on AGM, which management refers to as the CDS spread on AGM, decreased the implied spreads that the Company would expect to receive on these transactions increased. Six Months 2013 changes in fair value of credit derivatives in the Other category includes a $17 million loss for guaranteed interest rate swaps identified during 2013.
During Second Quarter 2012, unrealized fair value gains were generated primarily in the subprime first lien and Other sectors due to narrower implied net spread. The narrower implied net spreads were primarily a result of the increased cost to buy protection on AGM's name as the market cost of AGM's credit increased during the period. Several transactions were pricing above their floor levels; therefore when the cost of purchasing CDS protection on AGM increased, the implied spreads that the Company would expect to receive on these transactions decreased. The unrealized gain in the Other sector was driven primarily by the price improvement on a XXX life securitization transaction.
During Six Months 2012, the unrealized fair value gains were generated primarily in the high yield and investment grade synthetic pooled corporate sectors, as well as the subprime first lien sector. The gains in all three sectors were a result of a significant run-off of par outstanding as the transactions in these sectors approach maturity, as well as the expiration of several large transactions. The unrealized gains were partially offset by unrealized losses in the Other sector. The unrealized losses in Other were a result of the decreased cost to buy protection in AGM's name as the market cost of AGM's credit decreased during the period. Several transactions were pricing above their floor levels; therefore when the cost of purchasing CDS protection on AGM decreased, the implied spreads that the Company would expect to receive on these transactions increased.
The impact of changes in credit spreads will vary based upon the volume, tenor, interest rates, and other market conditions at the time these fair values are determined. In addition, since each transaction has unique collateral and structural terms, the underlying change in fair value of each transaction may vary considerably. The fair value of credit derivative contracts also reflects the change in the Company’s own credit cost based on the price to purchase credit protection on AGM. The Company determines its own credit risk based on quoted CDS prices traded on the Company at each balance sheet date. Generally, a widening of the CDS prices traded on AGM has an effect of offsetting unrealized losses that result from widening general market credit spreads, while a narrowing of the CDS prices traded on AGM has an effect of offsetting unrealized gains that result from narrowing general market credit spreads.
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Five Year CDS Spread on AGM
As of June 30, 2013 | As of March 31, 2013 | As of December 31, 2012 | As of June 30, 2012 | As of March 31, 2012 | As of December 31, 2011 | ||||||
Quoted price of CDS contract (in basis points) | 365 | 380 | 536 | 652 | 555 | 778 |
One-Year CDS Spread on AGM
As of June 30, 2013 | As of March 31, 2013 | As of December 31, 2012 | As of June 30, 2012 | As of March 31, 2012 | As of December 31, 2011 | ||||||
Quoted price of CDS contract (in basis points) | 72 | 60 | 257 | 416 | 378 | 538 |
As of June 30, 2013 | As of December 31, 2012 | ||||||
(in millions) | |||||||
Fair value of credit derivatives before effect of AGM credit spread | $ | (492 | ) | $ | (627 | ) | |
Plus: Effect of AGM credit spread | 182 | 344 | |||||
Net fair value of credit derivatives | $ | (310 | ) | $ | (283 | ) |
The fair value of CDS contracts at June 30, 2013, before considering the implications of AGM’s credit spreads, is a direct result of continued wide credit spreads in the fixed income security markets and ratings downgrades. The asset classes that remain most affected are pooled corporate securities and a XXX life securitization transaction. Comparing June 30, 2013 with December 31, 2012, there was a narrowing of spreads primarily related to pooled corporate obligations and a XXX life securitization transaction. This narrowing of spreads combined with the run-off of par outstanding and termination of securities, resulted in a gain of approximately $135 million, before taking into account AGM’s credit spreads.
Management believes that the trading level of AGM’s credit spreads over the past several years has been due to the correlation between AGM’s risk profile and the current risk profile of the broader financial markets and to increased demand for credit protection against AGM as the result of its financial guaranty volume, as well as the overall lack of liquidity in the CDS market. Offsetting the benefit attributable to AGM’s credit spread were higher credit spreads in the fixed income security markets. The higher credit spreads in the fixed income security market are due to the lack of liquidity in the high yield CDO, and CLO markets as well as continuing market concerns over the most recent vintages of RMBS.
The following table presents the fair value and the present value of expected claim payments or recoveries (i.e. net expected loss to be paid as described in Note 5) for contracts accounted for as derivatives.
Net Fair Value and Expected Losses of Credit Derivatives by Sector
Fair Value of Credit Derivative Asset (Liability), net | Present Value of Expected Claim (Payments) Recoveries (1) | |||||||||||||||
Asset Type | As of June 30, 2013 | As of December 31, 2012 | As of June 30, 2013 | As of December 31, 2012 | ||||||||||||
(in millions) | ||||||||||||||||
Pooled corporate obligations | $ | (34 | ) | $ | (5 | ) | $ | — | $ | — | ||||||
U.S. RMBS | (12 | ) | (10 | ) | 2 | 10 | ||||||||||
Other | (264 | ) | (268 | ) | (4 | ) | (4 | ) | ||||||||
Total | $ | (310 | ) | $ | (283 | ) | $ | (2 | ) | $ | 6 |
____________________
(1) | Represents amount in excess of the present value of future installment fees to be received of $1 million as of June 30, 2013 and $1 million as of December 31, 2012. There is no R&W benefit on credit derivatives as of June 30, 2013 and as of December 31, 2012. |
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Sensitivity to Changes in Credit Spread
The following table summarizes the estimated change in fair values on the net balance of the Company's credit derivative positions assuming immediate parallel shifts in credit spreads on AGM and on the risks that it assumes.
Effect of Changes in Credit Spread
As of June 30, 2013
Credit Spreads(1) | Estimated Net Fair Value (Pre-Tax) | Estimated Change in Gain/(Loss) (Pre-Tax) | ||||||
(in millions) | ||||||||
100% widening in spreads | $ | (571 | ) | $ | (261 | ) | ||
50% widening in spreads | (440 | ) | (130 | ) | ||||
25% widening in spreads | (375 | ) | (65 | ) | ||||
10% widening in spreads | (335 | ) | (25 | ) | ||||
Base Scenario | (310 | ) | — | |||||
10% narrowing in spreads | (292 | ) | 18 | |||||
25% narrowing in spreads | (265 | ) | 45 | |||||
50% narrowing in spreads | (221 | ) | 89 |
(1) | Includes the effects of spreads on both the underlying asset classes and the Company’s own credit spread. |
9. | Consolidation of Variable Interest Entities |
The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs. AGM does not sponsor any VIEs when underwriting third party financial guaranty insurance or credit derivative transactions, nor does it act as the servicer or collateral manager for any VIE obligations that it insures. The transaction structure generally provides certain financial protections to the Company. This financial protection can take several forms, the most common of which are overcollateralization, first loss protection (or subordination) and excess spread. In the case of overcollateralization (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by the Company), the structure allows defaults of the securitized assets before a default is experienced on the structured finance obligation guaranteed by the Company. In the case of first loss, the financial guaranty insurance policy only covers a senior layer of losses experienced by multiple obligations issued by special purpose entities, including VIEs. The first loss exposure with respect to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to special purpose entities, including VIEs, generate cash flows that are in excess of the interest payments on the debt issued by the special purpose entity. Such excess spread is typically distributed through the transaction’s cash flow waterfall and may be used to create additional credit enhancement, applied to redeem debt issued by the special purpose entities, including VIEs (thereby, creating additional overcollateralization), or distributed to equity or other investors in the transaction.
AGM is not primarily liable for the debt obligations issued by the VIEs they insure and would only be required to make payments on these debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due. AGM’s creditors do not have any rights with regard to the collateral supporting the debt issued by the FG VIEs. Proceeds from sales, maturities, prepayments and interest from such underlying collateral may only be used to pay Debt Service on VIE liabilities. Net fair value gains and losses on FG VIEs are expected to reverse to zero at maturity of the VIE debt, except for net premiums received and receivable, and net claims paid and expected to be paid by AGM under the financial guaranty insurance contract. The Company’s estimate of expected loss to be paid for FG VIEs is included in Note 5, Expected Loss to be Paid.
As part of the terms of its financial guaranty contracts, the Company obtains certain protective rights with respect to the VIE that are triggered by the occurrence of certain events, such as failure to be in compliance with a covenant due to poor deal performance or a deterioration in a servicer or collateral manager's financial condition. At deal inception, the Company typically is not deemed to control a VIE; however, once a trigger event occurs, the Company's control of the VIE typically increases. The Company continuously evaluates its power to direct the activities that most significantly impact the economic performance of VIEs that have debt obligations insured by the Company and, accordingly, where the Company is obligated to absorb VIE losses or receive benefits that could potentially be significant to the VIE. The Company obtains protective rights
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under its insurance contracts that give the Company additional controls over a VIE if there is either deterioration of deal performance or in the financial health of the deal servicer. The Company is deemed to be the control party under GAAP, typically when its protective rights give it the power to both terminate and replace the deal servicer, which are characteristics specific to the Company's financial guaranty contracts. If the Company’s protective rights that could make it the control party have not been triggered, then it does not consolidate the VIE. As of June 30, 2013, the Company had issued financial guaranty contracts for approximately 500 VIEs that it did not consolidate.
Consolidated FG VIEs
Number of FG VIE's Consolidated
As of June 30, 2013 | As of December 31, 2012 | ||||
Beginning of the period | 25 | 26 | |||
Consolidated(1) | 11 | 1 | |||
Deconsolidated(1) | (2 | ) | — | ||
Matured | (1 | ) | (2 | ) | |
End of the year | 33 | 25 |
____________________
(1) | Net loss on consolidation and deconsolidation was $7 million in Six Months 2013 and $5 million in 2012, respectively, and recorded in “fair value gains (losses) on FG VIEs” in the consolidated statement of operations. |
The total unpaid principal balance for the FG VIEs' assets that were over 90 days or more past due was approximately $603 million at June 30, 2013. The aggregate unpaid principal of the FG VIEs' assets was approximately $1,666 million greater than the aggregate fair value at June 30, 2013. The change in the instrument-specific credit risk of the FG VIEs' assets for Second Quarter 2013 and Six Months were gains of $71 million and $123 million, respectively. The change in the instrument-specific credit risk of the FG VIEs’ assets for Second Quarter 2012 and Six Months 2012 were gains of $73 million and $105 million, respectively.
The aggregate unpaid principal balance was approximately $1,297 million greater than the aggregate fair value of the FG VIEs’ liabilities as of June 30, 2013.
The table below shows the carrying value of the consolidated FG VIEs' assets and liabilities in the consolidated financial statements, segregated by the types of assets that collateralize their respective debt obligations.
Consolidated FG VIEs
By Type of Collateral
As of June 30, 2013 | As of December 31, 2012 | ||||||||||||||||||||
Number of FG VIEs | Assets | Liabilities | Number of FG VIEs | Assets | Liabilities | ||||||||||||||||
(dollars in millions) | |||||||||||||||||||||
With recourse: | |||||||||||||||||||||
First liens: | 23 | $ | 598 | $ | 789 | 12 | $ | 565 | $ | 767 | |||||||||||
Second lien | 9 | 422 | 621 | 11 | 553 | 799 | |||||||||||||||
Other | 1 | 12 | 12 | 2 | 39 | 39 | |||||||||||||||
Total with recourse | 33 | 1,032 | 1,422 | 25 | 1,157 | 1,605 | |||||||||||||||
Without recourse | — | 752 | 717 | — | 713 | 678 | |||||||||||||||
Total | 33 | $ | 1,784 | $ | 2,139 | 25 | $ | 1,870 | $ | 2,283 |
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Unpaid Principal for FG VIEs' Liabilities
With Recourse
As of June 30, 2013 | As of December 31, 2012 | ||||||
(in millions) | |||||||
Unpaid principal for FG VIEs’ liabilities with recourse(1) | $ | 1,780 | $ | 2,087 |
____________________
(1) | FG VIE liabilities with recourse will mature at various dates ranging from 2025 to 2047, except for $12 million maturing in 2014. |
The consolidation of FG VIEs has a significant effect on net income and shareholder’s equity due to (1) changes in fair value gains (losses) on FG VIE assets and liabilities, (2) the elimination of premiums and losses related to the AGM FG VIE liabilities with recourse and (3) the elimination of investment balances related to the Company’s purchase of AGM insured FG VIE debt. Upon consolidation of a FG VIE, the related insurance and, if applicable, the related investment balances, are considered intercompany transactions and therefore eliminated. Such eliminations are included in the table below to present the full effect of consolidating FG VIEs.
Effect of Consolidating FG VIEs on Net Income
and Shareholder's Equity
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
Net earned premiums | $ | (14 | ) | $ | (15 | ) | $ | (32 | ) | $ | (31 | ) | |||
Net investment income | (3 | ) | (3 | ) | (6 | ) | (5 | ) | |||||||
Net realized investment gains (losses) | 0 | 3 | 1 | 4 | |||||||||||
Fair value gains (losses) on FG VIEs | 147 | 65 | 222 | 30 | |||||||||||
Loss and LAE | 22 | 2 | 16 | 13 | |||||||||||
Total pretax effect on net income | 152 | 52 | 201 | 11 | |||||||||||
Less: tax provision (benefit) | 53 | 17 | 70 | 3 | |||||||||||
Total effect on net income (loss) | $ | 99 | $ | 35 | $ | 131 | $ | 8 |
As of June 30, 2013 | As of December 31, 2012 | ||||||
(in millions) | |||||||
Total (decrease) increase on shareholder’s equity | $ | (193 | ) | $ | (321 | ) |
Fair value gains (losses) on FG VIEs represent the net change in fair value on the consolidated FG VIEs' assets and liabilities. For Second Quarter 2013, the Company recorded a pre-tax fair value gain on FG VIEs of $147 million. The primary driver of this gain was a $149 million fair value gain as a result of R&W benefits recognized during the quarter on policies relating to Flagstar and UBS. This was also the primary driver of the $222 million pre-tax fair value gain of consolidated FG VIEs during Six Months 2013. The additional gain for Six Months 2013 was primarily also a result of a $64 million R&W benefit related to the Flagstar policies referenced above. During Second Quarter 2013, the Company signed an agreement that resulted in the deconsolidation of two FG VIEs.
During Second Quarter 2012, the Company recorded a pre-tax net fair value gain of consolidated FG VIEs of $65 million. The majority of this gain, $57 million, is a result of a R&W settlement with Deutsche Bank during the period. This was also the primary driver of the $30 million pre-tax fair value gain of consolidated FG VIEs during Six Months 2012. The Six Months 2012 amount was partially offset by an unrealized loss in first quarter 2012, which resulted from price appreciation on wrapped FG VIE liabilities, as market participants gave more value to the guarantees provided by monoline insurers.
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Non-Consolidated VIEs
To date, the Company's analyses have indicated that it does not have a controlling financial interest in any other VIEs and, as a result, they are not consolidated in the consolidated financial statements. The Company's exposure provided through its financial guaranties with respect to debt obligations of special purpose entities is included within net par outstanding in Note 3, Outstanding Exposure.
10. | Investments and Cash |
Investment Portfolio
Net investment income is a function of the yield that the Company earns on invested assets and the size of the portfolio. The investment yield is a function of market interest rates at the time of investment as well as the type, credit quality and maturity of the invested assets. Income earned on the general portfolio excluding loss mitigation bonds declined due to lower reinvestment rates. Accrued interest on investment portfolio and loan receivable from affiliate was $63 million and $54 million as of June 30, 2013 and December 31, 2012, respectively.
Net Investment Income
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
Income from fixed maturity securities in general investment portfolio | $ | 40 | $ | 43 | $ | 79 | $ | 84 | |||||||
Income from fixed maturity securities purchased or obtained for loss mitigation purposes | 11 | 12 | 23 | 21 | |||||||||||
Interest income from notes receivable from affiliates | 5 | 4 | 9 | 8 | |||||||||||
Other(1) | 1 | 1 | 3 | 2 | |||||||||||
Gross investment income | 57 | 60 | 114 | 115 | |||||||||||
Investment expenses | (1 | ) | (1 | ) | (2 | ) | (2 | ) | |||||||
Net investment income | $ | 56 | $ | 59 | $ | 112 | $ | 113 |
____________________
(1) Includes income from short-term investments and assets acquired in refinancing transactions.
Net Realized Investment Gains (Losses)
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
Gross realized gains on investment portfolio | $ | 3 | $ | 8 | $ | 5 | $ | 15 | |||||||
Gross realized losses on investment portfolio | (2 | ) | (17 | ) | (8 | ) | (21 | ) | |||||||
Other-than-temporary impairment ("OTTI") | (3 | ) | 0 | (7 | ) | (2 | ) | ||||||||
Net realized investment gains (losses) | $ | (2 | ) | $ | (9 | ) | $ | (10 | ) | $ | (8 | ) |
The following table presents the roll-forward of the credit losses of fixed maturity securities for which the Company has recognized OTTI and where the portion of the fair value adjustment related to other factors was recognized in other comprehensive income ("OCI").
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Roll Forward of Credit Losses in the Investment Portfolio
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
Balance, beginning of period | $ | 40 | $ | 34 | $ | 36 | $ | 31 | |||||||
Additions for credit losses on securities for which an OTTI was not previously recognized | — | — | 1 | — | |||||||||||
Additions for credit losses on securities for which an OTTI was previously recognized | 1 | 0 | 4 | 3 | |||||||||||
Balance, end of period | $ | 41 | $ | 34 | $ | 41 | $ | 34 |
Fixed Maturity Securities and Short-Term Investments
by Security Type
As of June 30, 2013
Investment Category | Percent of Total(1) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | AOCI (2) Gain (Loss) on Securities with OTTI | Weighted Average Credit Quality(3) | ||||||||||||||||||
(dollars in millions) | |||||||||||||||||||||||||
Fixed maturity securities: | |||||||||||||||||||||||||
U.S. government and agencies | 1 | % | $ | 75 | $ | 5 | $ | (1 | ) | $ | 79 | $ | — | AA+ | |||||||||||
Obligations of state and political subdivisions | 60 | 3,203 | 187 | (11 | ) | 3,379 | 3 | AA | |||||||||||||||||
Corporate securities | 7 | 360 | 6 | (7 | ) | 359 | — | AA- | |||||||||||||||||
Mortgage-backed securities(4): | |||||||||||||||||||||||||
RMBS | 8 | 425 | 10 | (50 | ) | 385 | (42 | ) | BBB- | ||||||||||||||||
CMBS | 3 | 129 | 3 | (1 | ) | 131 | — | AAA | |||||||||||||||||
Asset-backed securities | 6 | 314 | 26 | 0 | 340 | 14 | BIG | ||||||||||||||||||
Foreign government securities | 3 | 177 | 1 | (4 | ) | 174 | 0 | AA+ | |||||||||||||||||
Total fixed maturity securities | 88 | 4,683 | 238 | (74 | ) | 4,847 | (25 | ) | AA- | ||||||||||||||||
Short-term investments | 12 | 623 | 0 | 0 | 623 | — | AAA | ||||||||||||||||||
Total investment portfolio | 100 | % | $ | 5,306 | $ | 238 | $ | (74 | ) | $ | 5,470 | $ | (25 | ) | AA- |
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Fixed Maturity Securities and Short-Term Investments
by Security Type
As of December 31, 2012
Investment Category | Percent of Total(1) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | AOCI Gain (Loss) on Securities with OTTI | Weighted Average Credit Quality(3) | ||||||||||||||||||
(dollars in millions) | |||||||||||||||||||||||||
Fixed maturity securities: | |||||||||||||||||||||||||
U.S. government and agencies | 2 | % | $ | 86 | $ | 8 | $ | 0 | $ | 94 | $ | — | AA+ | ||||||||||||
Obligations of state and political subdivisions | 65 | 3,197 | 306 | 0 | 3,503 | 6 | AA | ||||||||||||||||||
Corporate securities | 4 | 215 | 15 | 0 | 230 | — | AA- | ||||||||||||||||||
Mortgage-backed securities(4): | |||||||||||||||||||||||||
RMBS | 8 | 398 | 13 | (53 | ) | 358 | (37 | ) | BBB- | ||||||||||||||||
CMBS | 2 | 97 | 6 | — | 103 | — | AAA | ||||||||||||||||||
Asset-backed securities | 6 | 288 | 54 | — | 342 | 41 | BIG | ||||||||||||||||||
Foreign government securities | 3 | 192 | 9 | 0 | 201 | 1 | AAA | ||||||||||||||||||
Total fixed maturity securities | 90 | 4,473 | 411 | (53 | ) | 4,831 | 11 | AA- | |||||||||||||||||
Short-term investments | 10 | 473 | 0 | — | 473 | — | AAA | ||||||||||||||||||
Total investment portfolio | 100 | % | $ | 4,946 | $ | 411 | $ | (53 | ) | $ | 5,304 | $ | 11 | AA- |
____________________
(1) | Based on amortized cost. |
(2) | Accumulated OCI ("AOCI"). See also Note 16. |
(3) | Ratings in the tables above represent the lower of the Moody's and S&P classifications except for bonds purchased for loss mitigation or risk management strategies, which use internal ratings classifications. The Company's portfolio consists primarily of high-quality, liquid instruments. |
(4) | Government-agency obligations were approximately 31% of mortgage backed securities as of June 30, 2013 and 38% as of December 31, 2012 based on fair value. |
The Company’s investment portfolio in tax-exempt and taxable municipal securities includes issuances by a wide number of municipal authorities across the U.S. and its territories. Securities rated lower than A-/A3 by S&P or Moody’s are not eligible to be purchased for the Company’s portfolio unless acquired for loss mitigation or risk management strategies.
The Company’s investment portfolio is managed by four outside managers. As municipal investments are a material portion of the Company’s overall investment portfolio, the Company has established detailed guidelines regarding credit quality, exposure to a particular sector and exposure to a particular obligor within a sector. Each of the portfolio managers perform independent analysis on every municipal security they purchase for the Company’s portfolio. The Company meets with each of its portfolio managers quarterly and reviews all investments with a change in credit rating as well as any investments on the manager’s watch list of securities with the potential for downgrade.
The following tables summarize, for all securities in an unrealized loss position, the aggregate fair value and gross unrealized loss by length of time the amounts have continuously been in an unrealized loss position.
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Fixed Maturity Securities
Gross Unrealized Loss by Length of Time
As of June 30, 2013
Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
Fair value | Unrealized loss | Fair value | Unrealized loss | Fair value | Unrealized loss | ||||||||||||||||||
(dollars in millions) | |||||||||||||||||||||||
U.S. government and agencies | $ | 11 | $ | (1 | ) | $ | — | $ | — | $ | 11 | (1 | ) | ||||||||||
Obligations of state and political subdivisions | 272 | (11 | ) | — | — | 272 | (11 | ) | |||||||||||||||
Corporate securities | 174 | (7 | ) | — | — | 174 | (7 | ) | |||||||||||||||
Mortgage-backed securities: | |||||||||||||||||||||||
RMBS | 128 | (9 | ) | 122 | (41 | ) | 250 | (50 | ) | ||||||||||||||
CMBS | 32 | (1 | ) | — | — | 32 | (1 | ) | |||||||||||||||
Asset-backed securities | 19 | 0 | — | — | 19 | 0 | |||||||||||||||||
Foreign government securities | 126 | (4 | ) | — | — | 126 | (4 | ) | |||||||||||||||
Total | $ | 762 | $ | (33 | ) | $ | 122 | $ | (41 | ) | $ | 884 | $ | (74 | ) | ||||||||
Number of securities | 167 | 12 | 179 | ||||||||||||||||||||
Number of securities with OTTI | 6 | 7 | 13 |
Fixed Maturity Securities
Gross Unrealized Loss by Length of Time
As of December 31, 2012
Less than 12 months | 12 months or more | Total | |||||||||||||||||||||
Fair value | Unrealized loss | Fair value | Unrealized loss | Fair value | Unrealized loss | ||||||||||||||||||
(dollars in millions) | |||||||||||||||||||||||
U.S. government and agencies | $ | 12 | $ | 0 | $ | — | $ | — | $ | 12 | 0 | ||||||||||||
Obligations of state and political subdivisions | 17 | 0 | — | — | 17 | 0 | |||||||||||||||||
Corporate securities | 5 | 0 | — | — | 5 | 0 | |||||||||||||||||
Mortgage-backed securities: | |||||||||||||||||||||||
RMBS | 76 | (17 | ) | 97 | (36 | ) | 173 | (53 | ) | ||||||||||||||
Foreign government securities | 6 | 0 | — | — | 6 | 0 | |||||||||||||||||
Total | $ | 116 | $ | (17 | ) | $ | 97 | $ | (36 | ) | $ | 213 | $ | (53 | ) | ||||||||
Number of securities | 16 | 10 | 26 | ||||||||||||||||||||
Number of securities with OTTI | 5 | 4 | 9 |
Of the securities in an unrealized loss position for 12 months or more as of June 30, 2013, eight securities had unrealized losses greater than 10% of book value. The total unrealized loss for these securities as of June 30, 2013 was $41 million. The Company has determined that the unrealized losses recorded as of June 30, 2013 are yield related and not the result of OTTI.
The amortized cost and estimated fair value of available-for-sale fixed maturity securities by contractual maturity as of June 30, 2013 are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
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Distribution of Fixed-Maturity Securities
by Contractual Maturity
As of June 30, 2013
Amortized Cost | Estimated Fair Value | ||||||
(in millions) | |||||||
Due within one year | $ | 45 | $ | 45 | |||
Due after one year through five years | 694 | 717 | |||||
Due after five years through 10 years | 1,461 | 1,520 | |||||
Due after 10 years | 1,929 | 2,049 | |||||
Mortgage-backed securities: | |||||||
RMBS | 425 | 385 | |||||
CMBS | 129 | 131 | |||||
Total | $ | 4,683 | $ | 4,847 |
Under agreements with its cedants and in accordance with statutory requirements, the Company maintains fixed maturity securities in trust accounts for the benefit of reinsured companies, which amounted to $21 million as of June 30, 2013 and December 31, 2012. In addition, to fulfill state licensing requirements, the Company has placed on deposit eligible securities of $11 million and $15 million as of June 30, 2013 and December 31, 2012, respectively, for the protection of policyholders.
No material investments of the Company were non-income producing for Six Months 2013 and 2012, respectively.
Loss Mitigation Assets
One of the Company's strategies for mitigating losses has been to purchase insured securities that have expected losses at discounted prices. The Company may also obtain the obligations referenced in CDS transactions that have triggered the insured's obligation to put these bonds to AGM, or assets may be obtained as part of a negotiated agreement.
Loss Mitigation Assets
Carrying Value
As of June 30, 2013 | As of December 31, 2012 | ||||||
(in millions) | |||||||
Fixed maturity securities: | |||||||
Obligations of state and political subdivisions | $ | 11 | $ | 12 | |||
RMBS | 207 | 184 | |||||
Asset-backed securities | 226 | 249 | |||||
Other invested assets: | |||||||
Assets acquired in refinancing transactions | 61 | 72 | |||||
Other | 2 | 1 | |||||
Total | $ | 507 | $ | 518 |
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11. | Insurance Company Regulatory Requirements |
Dividend Restrictions and Capital Requirements
AGM is a New York domiciled insurance company. Under New York insurance law, AGM may pay dividends out of "earned surplus", which is the portion of a company's surplus that represents the net earnings, gains or profits (after deduction of all losses) that have not been distributed to shareholders as dividends or transferred to stated capital or capital surplus, or applied to other purposes permitted by law, but does not include unrealized appreciation of assets. AGM may pay an ordinary dividend that, together with all dividends paid in the prior 12 months, does not exceed the lesser of 10% of its policyholders' surplus (as of the last annual or quarterly statement filed) or 100% of its adjusted net investment income during that period. As of June 30, 2013, approximately $141 million was available for distribution of dividends, after giving effect to dividends paid in the prior 12 months of $38 million. This amount does not take into account the July 2013 transactions to capitalize MAC, including AGM contributing MAC's outstanding common stock, cash and marketable securities to MAC Holdings (a new company formed to own 100% of the outstanding stock of MAC - please refer to Note 17 Subsequent Events for additional information), ceding a portfolio of policies covering U.S. municipal bonds to MAC, and paying MAC unearned premium for such cession.
Dividends Paid and Repayment of Surplus Note
By Insurance Company
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
Dividends paid by AGM to AGMH | $ | 38 | $ | — | $ | 38 | $ | 30 | |||||||
Repayment of surplus note by AGM to AGMH | — | 50 | 25 | 50 |
12. | Income Taxes |
Provision for Income Taxes
The Company's Bermuda subsidiary, AGBM (formerly Financial Security Assurance International Ltd.), is not subject to any income, withholding or capital gains taxes under current Bermuda law. The Company has received an assurance from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, AGBM will be exempt from taxation in Bermuda until March 28, 2035. Please refer to Note 17, Subsequent Events for series of transactions impacting AGBM in July 2013.
The Company's U.S. and United Kingdom (“U.K.”) subsidiary are subject to income taxes imposed by U.S. and U.K. authorities at marginal corporate income tax rates of 35% and 23.25%, respectively, and file applicable tax returns. For periods subsequent to April 1, 2013, the U.K. corporation tax rate has been reduced to 23%, for the period April 1, 2012 to April 1, 2013 the U.K. corporation tax rate was 24% resulting in a blended tax rate of 23.25% in 2013 and prior to April 1, 2012, the U.K. corporation rate was 26% resulting in a blended tax rate of 24.5% in 2012. The Company's overall corporate effective tax rate fluctuates based on the distribution of income across jurisdictions. In addition, AGE, a U.K. domiciled company, has elected under Section 953(d) of the U.S. Internal Revenue Code to be taxed as a U.S. domestic corporation.
In conjunction with AGL's purchase of AGMH on July 1, 2009, AGM and its insurance company subsidiaries have joined the consolidated federal tax group of Assured Guaranty US Holdings Inc. ("AGUS"), an indirect parent holding company of AGM. A new tax sharing agreement was entered into effective July 1, 2009 whereby each company in the AGUS consolidated tax group pays or receives its proportionate share of the consolidated federal tax burden for the group as if each company filed on a separate return basis with current period credit for net losses.
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 fair value of its credit derivatives, which prevents the Company from projecting a reliable
estimated annual effective tax rate and pretax income for the full year 2013. A discrete calculation of the provision is calculated
for each interim period.
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A reconciliation of the difference between the provision for income taxes and the expected tax provision at statutory rates in taxable jurisdictions is presented below:
Effective Tax Rate Reconciliation
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
Expected tax provision (benefit) at statutory rate | $ | 113 | $ | 81 | $ | 192 | $ | 75 | |||||||
Tax-exempt interest | (10 | ) | (11 | ) | (20 | ) | (22 | ) | |||||||
Other | — | — | 1 | 1 | |||||||||||
Total provision (benefit) for income taxes | $ | 103 | $ | 70 | $ | 173 | $ | 54 | |||||||
Effective tax rate | 32.0 | % | 30.7 | % | 31.6 | % | 25.6 | % |
The expected tax provision at statutory rates in taxable jurisdictions is calculated as the sum of pretax income in each jurisdiction multiplied by the statutory tax rate of the jurisdiction by which it will be taxed. Pretax income of the Company’s subsidiaries which are not U.S. domiciled but are subject to U.S. tax by election or as controlled foreign corporations are included at the U.S. statutory tax rate.
Valuation Allowance
The Company came to the conclusion that it is more likely than not that its net deferred tax asset will be fully realized after weighing all positive and negative evidence available as required under GAAP. The positive evidence that was considered included the cumulative operating income Assured Guaranty US Holdings Inc. together with its U.S. subsidiaries has earned over the last three years, and the significant unearned premium income to be included in taxable income. The positive evidence outweighs any negative evidence that exists. As such, the Company believes that no valuation allowance is necessary in connection with this deferred tax asset. The Company will continue to analyze the need for a valuation allowance on a quarterly basis.
13. | Reinsurance and Other Monoline Exposures |
AGM assumes exposure on insured obligations (“Assumed Business”) and cedes portions of its exposure on obligations it has insured (“Ceded Business”) in exchange for premiums, net of ceding commissions.
Ceded and Assumed Business
The Company has Ceded Business to affiliated and non-affiliated companies to limit its exposure to risk. Under these relationships, the Company cedes a portion of its insured risk in exchange for a premium paid to the reinsurer. The Company remains primarily liable for all risks it directly underwrites and is required to pay all gross claims. It then seeks reimbursement from the reinsurer for its proportionate share of claims. The Company may be exposed to risk for this exposure if it were required to pay the gross claims and not be able to collect ceded claims from an assuming company experiencing financial distress. A number of the financial guaranty insurers to which the Company has ceded par have experienced financial distress and been downgraded by the rating agencies as a result. In addition, state insurance regulators have intervened with respect to some of these insurers. The Company's ceded contracts generally allow the Company to recapture Ceded Business after certain triggering events, such as reinsurer downgrades.
Commutations of Ceded Business resulted in net increase to unearned premium reserves of $106 million, net par outstanding of $19,073 million and gains of $83 million which were recorded in other income, for Six Months 2012. There were no commutations in 2013. While certain Ceded Business has been reassumed, the Company still has significant Ceded Business with third parties.
78
The following table presents the components of premiums and losses reported in the consolidated statement of operations and the contribution of the Company's Assumed and Ceded Businesses.
Effect of Reinsurance on Statement of Operations
Second Quarter | Six Months | ||||||||||||||
2013 | 2012 | 2013 | 2012 | ||||||||||||
(in millions) | |||||||||||||||
Premiums Written: | |||||||||||||||
Direct | $ | 18 | $ | 48 | $ | 35 | $ | 95 | |||||||
Ceded | (7 | ) | (18 | ) | (13 | ) | 63 | ||||||||
Net | $ | 11 | $ | 30 | $ | 22 | $ | 158 | |||||||
Premiums Earned: | |||||||||||||||
Direct | $ | 152 | $ | 213 | $ | 381 | $ | 394 | |||||||
Ceded | (43 | ) | (57 | ) | (96 | ) | (104 | ) | |||||||
Net | $ | 109 | $ | 156 | $ | 285 | $ | 290 | |||||||
Loss and LAE: | |||||||||||||||
Direct | $ | 46 | $ | 100 | $ | 31 | $ | 411 | |||||||
Ceded | (13 | ) | (24 | ) | (27 | ) | (145 | ) | |||||||
Net | $ | 33 | $ | 76 | $ | 4 | $ | 266 |
Reinsurer Exposure
In addition to assumed and ceded reinsurance arrangements, the Company may also have exposure to some financial guaranty reinsurers (i.e., monolines) in other areas. Second-to-pay insured par outstanding represents transactions the Company has insured that were previously insured by other monolines. The Company underwrites such transactions based on the underlying insured obligation without regard to the primary insurer. Another area of exposure is in the investment portfolio where the Company holds fixed maturity securities that are wrapped by monolines and whose value may decline based on the rating of the monoline. At June 30, 2013, based on fair value, the Company had $457 million of fixed maturity securities in its investment portfolio wrapped by National Public Finance Guarantee Corporation, $363 million by Ambac Assurance Corporation ("Ambac"), $81 million by AGC, and $23 million by other guarantors.
79
Exposure by Reinsurer
Ratings as of August 21, 2013 | Par Outstanding as of June 30, 2013 | |||||||||||||||
Reinsurer | Moody’s Reinsurer Rating | S&P Reinsurer Rating | Ceded Par Outstanding(1) | Second-to-Pay Insured Par Outstanding | Assumed Par Outstanding | |||||||||||
(dollars in millions) | ||||||||||||||||
Affiliated Companies | (2) | (2) | $ | 62,689 | $ | 491 | $ | 26 | ||||||||
Non-Affiliated Companies: | ||||||||||||||||
Tokio Marine & Nichido Fire Insurance Co., Ltd. | Aa3(3) | AA-(3) | 7,660 | — | — | |||||||||||
American Overseas Reinsurance Company Limited (f/k/a Ram Re) | WR(4) | WR | 7,149 | — | 30 | |||||||||||
Radian Asset Assurance Inc. | Ba1 | B+ | 4,840 | 39 | — | |||||||||||
Syncora Guarantee Inc. | WR | WR | 4,031 | 610 | — | |||||||||||
Mitsui Sumitomo Insurance Co. Ltd. | A1 | A+(3) | 2,186 | — | — | |||||||||||
ACA Financial Guaranty Corp. | NR | WR | 810 | 5 | — | |||||||||||
Swiss Reinsurance Co. | A1 | AA- | 426 | — | — | |||||||||||
CIFG Assurance North America Inc. ("CIFG") | WR | WR | 61 | 119 | — | |||||||||||
MBIA Inc. | (5) | (5) | — | 7,497 | — | |||||||||||
Ambac | WR | WR | — | 3,010 | — | |||||||||||
Financial Guaranty Insurance Co. | WR | WR | — | 1,032 | — | |||||||||||
Other | Various | Various | 877 | — | 1 | |||||||||||
Non-Affiliated Companies | 28,040 | 12,312 | 31 | |||||||||||||
Total | $ | 90,729 | $ | 12,803 | $ | 57 |
____________________
(1) | Includes $3,067 million in ceded par outstanding related to insured credit derivatives. |
(2) | As of the date of this document, the affiliates of AGM are Assured Guaranty Re Ltd. and its subsidiaries (“AG Re”), rated Baa1 (stable) by Moody's and AA- (stable) by S&P, and AGC and its subsidiaries, rated A3 (stable) by Moody's and AA- (stable) by S&P. |
(3) | The Company has structural collateral agreements satisfying the triple-A credit requirement of S&P and/or Moody’s. |
(4) | Represents “Withdrawn Rating.” |
(5) | MBIA Inc. includes various subsidiaries which are rated A and B by S&P and Baa1, B1, B3, WR and NR by Moody’s. |
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Amounts Due (To) From Reinsurers
As of June 30, 2013
Ceded Premium, net of Commissions | Ceded Expected Loss and LAE | ||||||
(in millions) | |||||||
Affiliated Companies | $ | (54 | ) | $ | 29 | ||
Tokio Marine & Nichido Fire Insurance Co., Ltd. | (23 | ) | 36 | ||||
American Overseas Reinsurance Company Limited (f/k/a Ram Re) | (9 | ) | 5 | ||||
Radian Asset Assurance Inc. | (18 | ) | 1 | ||||
Syncora Guarantee Inc. | (40 | ) | 1 | ||||
Mitsui Sumitomo Insurance Co. Ltd. | (4 | ) | 8 | ||||
Swiss Reinsurance Co. | (3 | ) | 2 | ||||
CIFG | — | 5 | |||||
Other | (40 | ) | — | ||||
Total | $ | (191 | ) | $ | 87 |
14. Commitments and Contingencies
Legal Proceedings
Litigation
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 litigation against the Company, individually or in the aggregate, will not have a material adverse effect on the Company’s financial position or liquidity, although an adverse resolution of litigation against the Company in a fiscal quarter or year could have a material adverse effect on the Company’s results of operations in a particular quarter or year.
The Company establishes accruals for litigation and regulatory matters to the extent it is probable that a loss has been incurred and the amount of that loss can be reasonably estimated. For litigation and regulatory matters where a loss may be reasonably possible, but not probable, or is probable but not reasonably estimable, no accrual is established, but if the matter is material, it is disclosed, including matters discussed below. The Company reviews relevant information with respect to its litigation and regulatory matters on a quarterly, and annual basis and updates its accruals, disclosures and estimates of reasonably possible loss based on such reviews.
In addition, in the ordinary course of its business, the Company asserts claims in legal proceedings against third parties to recover losses paid in prior periods. For example, as described in the "Recovery Litigation" section within Note 5, Expected Loss to be Paid, as of the date of this filing, AGM has filed complaints against certain sponsors and underwriters of RMBS securities that AGM had insured, alleging, among other claims, that such persons had breached R&W in the transaction documents, failed to cure or repurchase defective loans and/or violated state securities laws. The amounts, if any, the Company will recover in proceedings to recover losses are uncertain, and recoveries, or failure to obtain recoveries, in any one or more of these proceedings during any quarter or year could be material to the Company’s results of operations in that particular quarter or year.
Proceedings Relating to the Company's Financial Guaranty Business
AGM and AGMH receive subpoenas duces tecum and interrogatories from regulators from time to time.
In August 2008, a number of financial institutions and other parties, including AGM and other bond insurers, were named as defendants in a civil action brought in the circuit court of Jefferson County, Alabama relating to the County’s problems meeting its sewer debt obligations: Charles E. Wilson vs. JPMorgan Chase & Co et al (filed the Circuit Court of Jefferson County, Alabama), Case No. 01-CV-2008-901907.00, a putative class action. The action was brought on behalf of rate payers, tax payers and citizens residing in Jefferson County, and alleges conspiracy and fraud in connection with the issuance
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of the County’s debt. The complaint in this lawsuit seeks equitable relief, unspecified monetary damages, interest, attorneys’ fees and other costs. On January, 13, 2011, the circuit court issued an order denying a motion by the bond insurers and other defendants to dismiss the action. Defendants, including the bond insurers, have petitioned the Alabama Supreme Court for a writ of mandamus to the circuit court vacating such order and directing the dismissal with prejudice of plaintiffs’ claims for lack of standing. Currently, the litigation is stayed pending confirmation of Jefferson County's plan of adjustment or further court orders. In July 2013, Jefferson County filed its Chapter 9 plan of adjustment, disclosure statement, and motions to approve the disclosure statement and solicitation procedures with the bankruptcy court and in August 2013, the bankruptcy court approved Jefferson County's disclosure statement and related solicitation procedures. The Company cannot reasonably estimate the possible loss or range of loss, if any, that may arise from this lawsuit.
Beginning in July 2008, AGM and various other financial guarantors were named in complaints filed in the Superior Court for the State of California, City and County of San Francisco by a number of plaintiffs. Subsequently, plaintiffs' counsel filed amended complaints against AGM and AGC and added additional plaintiffs. These complaints alleged that the financial guaranty insurer defendants (i) participated in a conspiracy in violation of California's antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and created market demand for municipal bond insurance, (ii) participated in risky financial transactions in other lines of business that damaged each insurer's financial condition (thereby undermining the value of each of their guaranties), and (iii) failed to adequately disclose the impact of those transactions on their financial condition. In addition to their antitrust claims, various plaintiffs asserted claims for breach of the covenant of good faith and fair dealing, fraud, unjust enrichment, negligence, and negligent misrepresentation. At hearings held in July and October 2011 relating to AGM, AGC and the other defendants' demurrer, the court overruled the demurrer on the following claims: breach of contract, violation of California's antitrust statute and of its unfair business practices law, and fraud. The remaining claims were dismissed. On December 2, 2011, AGM, AGC and the other bond insurer defendants filed an anti-SLAPP ("Strategic Lawsuit Against Public Participation") motion to strike the complaints under California's Code of Civil Procedure. On July 9, 2013, the court entered its order denying in part and granting in part the bond insurers' motion to strike. As a result of the order, the causes of action that remain against AGM and AGC are: claims of breach of contract and fraud, brought by the City of San Jose, the City of Stockton, East Bay Municipal Utility District and Sacramento Suburban Water District, relating to the failure to disclose the impact of risky financial transactions on their financial condition; and a claim of breach of the unfair business practices law brought by The Jewish Community Center of San Francisco. The complaints generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss, if any, that may arise from these lawsuits.
On November 19, 2012, Lehman Brothers Holdings Inc. (“LBHI”) and Lehman Brothers Special Financing Inc. (“LBSF") commenced an adversary complaint and claim objection in the United States Bankruptcy Court for the Southern District of New York against Credit Protection Trust 283 (“CPT 283”), FSA Administrative Services, LLC, as trustee for CPT 283, and AGM, in connection with CPT 283's termination of a CDS between LBSF and CPT 283. CPT 283 terminated the CDS as a consequence of LBSF failing to make a scheduled payment owed to CPT 283, which termination occurred after LBHI filed for bankruptcy but before LBSF filed for bankruptcy. The CDS provided that CPT 283 was entitled to receive from LBSF a termination payment in that circumstance of approximately $43.8 million (representing the economic equivalent of the future fixed payments CPT 283 would have been entitled to receive from LBSF had the CDS not been terminated), and CPT 283 filed proofs of claim against LBSF and LBHI (as LBSF's credit support provider) for such amount. LBHI and LBSF seek to disallow and expunge (as impermissible and unenforceable penalties) CPT 283's proofs of claim against LBHI and LBSF and recover approximately $67.3 million, which LBHI and LBSF allege was the mark-to-market value of the CDS to LBSF (less unpaid amounts) on the day CPT 283 terminated the CDS, plus interest, attorney's fees, costs and other expenses. On the same day, LBHI and LBSF also commenced an adversary complaint and claim objection against Credit Protection Trust 207 (“CPT 207”), FSA Administrative Services, LLC, as trustee for CPT 207, and AGM, in connection with CPT 207's termination of a CDS between LBSF and CPT 207. Similarly, the CDS provided that CPT 207 was entitled to receive from LBSF a termination payment in that circumstance of $492,555. LBHI and LBSF seek to disallow and expunge CPT 207's proofs of claim against LBHI and LBSF and recover approximately $1.5 million. AGM believes the terminations of the CDS and the calculation of the termination payment amounts were consistent with the terms of the ISDA master agreements between the parties. The Company cannot reasonably estimate the possible loss, if any, that may arise from this lawsuit.
Proceedings Related to AGMH's Former Financial Products Business
The following is a description of legal proceedings involving AGMH’s former financial products business. Although Assured Guaranty did not acquire AGMH’s former financial products business, which included AGMH’s former GIC business, medium term notes business and portions of the leveraged lease businesses, certain legal proceedings relating to those businesses are against entities that Assured Guaranty did acquire. While Dexia SA and Dexia Crédit Local S.A. (“DCL”), jointly and severally, have agreed to indemnify Assured Guaranty against liability arising out of the proceedings described below in the “—Proceedings Related to AGMH’s Former Financial Products Business” section, such indemnification might not
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be sufficient to fully hold Assured Guaranty harmless against any injunctive relief or civil or criminal sanction that is imposed against AGMH or its subsidiaries.
Governmental Investigations into Former Financial Products Business
AGMH and/or AGM have received subpoenas duces tecum and interrogatories or civil investigative demands from the Attorneys General of the States of Connecticut, Florida, Illinois, Massachusetts, Missouri, New York, Texas and West Virginia relating to their investigations of alleged bid rigging of municipal GICs. AGMH is responding to such requests. AGMH may receive additional inquiries from these or other regulators and expects to provide additional information to such regulators regarding their inquiries in the future. In addition,
• | AGMH received a subpoena from the Antitrust Division of the Department of Justice in November 2006 issued in connection with an ongoing criminal investigation of bid rigging of awards of municipal GICs and other municipal derivatives; |
• | AGM received a subpoena from the Securities and Exchange Commission ("SEC") in November 2006 related to an ongoing industry-wide investigation concerning the bidding of municipal GICs and other municipal derivatives; and |
• | AGMH received a “Wells Notice” from the staff of the Philadelphia Regional Office of the SEC in February 2008 relating to the investigation concerning the bidding of municipal GICs and other municipal derivatives. The Wells Notice indicates that the SEC staff is considering recommending that the SEC authorize the staff to bring a civil injunctive action and/or institute administrative proceedings against AGMH, alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 17(a) of the Securities Act. |
Pursuant to the subpoenas, AGMH has furnished to the Department of Justice and SEC records and other information with respect to AGMH’s municipal GIC business. The ultimate loss that may arise from these investigations remains uncertain.
In July 2010, a former employee of AGM who had been involved in AGMH's former financial products business was indicted along with two other persons with whom he had worked at Financial Guaranty Insurance Company. Such former employee and the other two persons were convicted on fraud conspiracy counts. They have appealed the convictions.
Lawsuits Relating to Former Financial Products Business
During 2008, nine putative class action lawsuits were filed in federal court alleging federal antitrust violations in the municipal derivatives industry, seeking damages and alleging, among other things, a conspiracy to fix the pricing of, and manipulate bids for, municipal derivatives, including GICs. These cases have been coordinated and consolidated for pretrial proceedings in the U.S. District Court for the Southern District of New York as MDL 1950, In re Municipal Derivatives Antitrust Litigation, Case No. 1:08-cv-2516 ("MDL 1950").
Five of these cases named both AGMH and AGM: (a) Hinds County, Mississippi v. Wachovia Bank, N.A.; (b) Fairfax County, Virginia v. Wachovia Bank, N.A.; (c) Central Bucks School District, Pennsylvania v. Wachovia Bank, N.A.; (d) Mayor and City Council of Baltimore, Maryland v. Wachovia Bank, N.A.; and (e) Washington County, Tennessee v. Wachovia Bank, N.A. In April 2009, the MDL 1950 court granted the defendants' motion to dismiss on the federal claims, but granted leave for the plaintiffs to file a second amended complaint. In June 2009, interim lead plaintiffs' counsel filed a Second Consolidated Amended Class Action Complaint; although the Second Consolidated Amended Class Action Complaint currently describes some of AGMH's and AGM's activities, it does not name those entities as defendants. In March 2010, the MDL 1950 court denied the named defendants' motions to dismiss the Second Consolidated Amended Class Action Complaint. In March 2013, the putative class plaintiffs served a Third Consolidated Amended Class Action Complaint that does not list AGMH or AGM. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss, if any, or range of loss that may arise from these lawsuits.
Four of the cases named AGMH (but not AGM) and also alleged that the defendants violated California state antitrust law and common law by engaging in illegal bid-rigging and market allocation, thereby depriving the cities or municipalities of competition in the awarding of GICs and ultimately resulting in the cities paying higher fees for these products: (f) City of Oakland, California v. AIG Financial Products Corp.; (g) County of Alameda, California v. AIG Financial Products Corp.; (h) City of Fresno, California v. AIG Financial Products Corp.; and (i) Fresno County Financing Authority v. AIG Financial Products Corp. When the four plaintiffs filed a consolidated complaint in September 2009, the plaintiffs did not name AGMH as a defendant. However, the complaint does describe some of AGMH's and AGM's activities. The consolidated complaint
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generally seeks unspecified monetary damages, interest, attorneys' fees and other costs. In April 2010, the MDL 1950 court granted in part and denied in part the named defendants' motions to dismiss this consolidated complaint.
In 2008, AGMH and AGM also were named in five non-class action lawsuits originally filed in the California Superior Courts alleging violations of California law related to the municipal derivatives industry: (a) City of Los Angeles, California v. Bank of America, N.A.; (b) City of Stockton, California v. Bank of America, N.A.; (c) County of San Diego, California v. Bank of America, N.A.; (d) County of San Mateo, California v. Bank of America, N.A.; and (e) County of Contra Costa, California v. Bank of America, N.A. Amended complaints in these actions were filed in September 2009, adding a federal antitrust claim and naming AGM (but not AGMH) and AGUS, among other defendants. These cases have been transferred to the Southern District of New York and consolidated with MDL 1950 for pretrial proceedings.
In late 2009, AGM and AGUS, among other defendants, were named in six additional non-class action cases filed in federal court, which also have been coordinated and consolidated for pretrial proceedings with MDL 1950: (f) City of Riverside, California v. Bank of America, N.A.; (g) Sacramento Municipal Utility District v. Bank of America, N.A.; (h) Los Angeles World Airports v. Bank of America, N.A.; (i) Redevelopment Agency of the City of Stockton v. Bank of America, N.A.; (j) Sacramento Suburban Water District v. Bank of America, N.A.; and (k) County of Tulare, California v. Bank of America, N.A.
The MDL 1950 court denied AGM and AGUS's motions to dismiss these eleven complaints in April 2010. Amended complaints were filed in May 2010. On October 29, 2010, AGM and AGUS were voluntarily dismissed with prejudice from the Sacramento Municipal Utility District case only. The complaints in these lawsuits generally seek or sought unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss, if any, or range of loss that may arise from the remaining lawsuits.
In May 2010, AGM and AGUS, among other defendants, were named in five additional non-class action cases filed in federal court in California: (a) City of Richmond, California v. Bank of America, N.A. (filed on May 18, 2010, N.D. California); (b) City of Redwood City, California v. Bank of America, N.A. (filed on May 18, 2010, N.D. California); (c) Redevelopment Agency of the City and County of San Francisco, California v. Bank of America, N.A. (filed on May 21, 2010, N.D. California); (d) East Bay Municipal Utility District, California v. Bank of America, N.A. (filed on May 18, 2010, N.D. California); and (e) City of San Jose and the San Jose Redevelopment Agency, California v. Bank of America, N.A (filed on May 18, 2010, N.D. California). These cases have also been transferred to the Southern District of New York and consolidated with MDL 1950 for pretrial proceedings. In September 2010, AGM and AGUS, among other defendants, were named in a sixth additional non-class action filed in federal court in New York, but which alleges violation of New York's Donnelly Act in addition to federal antitrust law: Active Retirement Community, Inc. d/b/a Jefferson's Ferry v. Bank of America, N.A. (filed on September 21, 2010, E.D. New York), which has also been transferred to the Southern District of New York and consolidated with MDL 1950 for pretrial proceedings. In December 2010, AGM and AGUS, among other defendants, were named in a seventh additional non-class action filed in federal court in the Central District of California, Los Angeles Unified School District v. Bank of America, N.A., and in an eighth additional non-class action filed in federal court in the Southern District of New York, Kendal on Hudson, Inc. v. Bank of America, N.A. These cases also have been consolidated with MDL 1950 for pretrial proceedings. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss, if any, or range of loss that may arise from these lawsuits.
In January 2011, AGM and AGUS, among other defendants, were named in an additional non-class action case filed in federal court in New York, which alleges violation of New York's Donnelly Act in addition to federal antitrust law: Peconic Landing at Southold, Inc. v. Bank of America, N.A. This case has been consolidated with MDL 1950 for pretrial proceedings. The complaint in this lawsuit generally seeks unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss, if any, or range of loss that may arise from this lawsuit.
In September 2009, the Attorney General of the State of West Virginia filed a lawsuit (Circuit Ct. Mason County, W. Va.) against Bank of America, N.A. alleging West Virginia state antitrust violations in the municipal derivatives industry, seeking damages and alleging, among other things, a conspiracy to fix the pricing of, and manipulate bids for, municipal derivatives, including GICs. An amended complaint in this action was filed in June 2010, adding a federal antitrust claim and naming AGM (but not AGMH) and AGUS, among other defendants. This case has been removed to federal court as well as transferred to the S.D.N.Y. and consolidated with MDL 1950 for pretrial proceedings. The complaint in this lawsuit generally seeks civil penalties, unspecified monetary damages, interest, attorneys’ fees, costs and other expenses. The Company cannot reasonably estimate the possible loss, if any, or range of loss that may arise from this lawsuit.
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15. | Notes Payable and Credit Facilities |
Notes Payable
Notes Payable represents debt issued by VIEs consolidated by AGM to one of the Financial Products Companies that were transferred to Dexia Holdings prior to the AGMH Acquisition. The funds borrowed were used to finance the purchase of the underlying obligations of AGM-insured obligations which had breached triggers allowing AGM to exercise its right to accelerate payment of a claim in order to mitigate loss. The assets purchased are classified as assets acquired in refinancing transactions and recorded in “other invested assets.” The terms of the notes payable match the terms of the assets acquired in refinancing transactions. On the Acquisition Date, the fair value of these notes payable was $164 million, including a premium of $10 million that is being amortized over the term of the debt.
The principal and carrying values of the Company's notes payable are presented in the table below.
Principal and Carrying Amounts of Notes Payable
As of June 30, 2013 | As of December 31, 2012 | ||||||||||||||
Principal | Carrying Value | Principal | Carrying Value | ||||||||||||
(in millions) | |||||||||||||||
Notes Payable | $ | 48 | $ | 53 | $ | 61 | $ | 66 |
Recourse Credit Facilities
In connection with the AGMH Acquisition, AGM agreed to retain the risks relating to the debt and strip policy portions of the leveraged lease business. The liquidity risk to AGM related to the strip policy portion of the leveraged lease business is mitigated by the strip coverage facility described below.
In a leveraged lease transaction, a tax-exempt entity (such as a transit agency) transfers tax benefits to a tax-paying entity by transferring ownership of a depreciable asset, such as subway cars. The tax-exempt entity then leases the asset back from its new owner.
If the lease is terminated early, the tax-exempt entity must make an early termination payment to the lessor. A portion of this early termination payment is funded from monies that were pre-funded and invested at the closing of the leveraged lease transaction (along with earnings on those invested funds). The tax-exempt entity is obligated to pay the remaining, unfunded portion of this early termination payment (known as the “strip coverage”) from its own sources. AGM issued financial guaranty insurance policies (known as “strip policies”) that guaranteed the payment of these unfunded strip coverage amounts to the lessor, in the event that a tax-exempt entity defaulted on its obligation to pay this portion of its early termination payment. AGM can then seek reimbursement of its strip policy payments from the tax-exempt entity, and can also sell the transferred depreciable asset and reimburse itself from the sale proceeds.
Currently, all the leveraged lease transactions in which AGM acts as strip coverage provider are breaching a rating trigger related to AGM and are subject to early termination. However, early termination of a lease does not result in a draw on the AGM policy if the tax-exempt entity makes the required termination payment. If all the leases were to terminate early and the tax-exempt entities do not make the required early termination payments, then AGM would be exposed to possible liquidity claims on gross exposure of approximately $1.7 billion as of June 30, 2013. To date, none of the leveraged lease transactions that involve AGM has experienced an early termination due to a lease default and a claim on the AGM policy. It is difficult to determine the probability that AGM will have to pay strip provider claims or the likely aggregate amount of such claims. At June 30, 2013, approximately $1 billion of cumulative strip par exposure had been terminated since 2008 on a consensual basis. The consensual terminations have resulted in no claims on AGM.
On July 1, 2009, AGM and DCL, acting through its New York Branch (“Dexia Crédit Local (NY)”), entered into a credit facility (the “Strip Coverage Facility”). Under the Strip Coverage Facility, Dexia Crédit Local (NY) agreed to make loans to AGM to finance all draws made by lessors on AGM strip policies that were outstanding as of November 13, 2008, up to the commitment amount. The commitment amount of the Strip Coverage Facility was $1 billion at closing of the AGMH Acquisition but is scheduled to amortize over time. As of June 30, 2013, the maximum commitment amount of the Strip Coverage Facility has amortized to $981 million. It may also be reduced in 2014 to $750 million, if AGM does not have a specified consolidated net worth at that time.
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Fundings under this facility are subject to certain conditions precedent, and their repayment is collateralized by a security interest that AGM granted to Dexia Crédit Local (NY) in amounts that AGM recovers—from the tax-exempt entity, or from asset sale proceeds—following its payment of strip policy claims. The Strip Coverage Facility will terminate upon the earliest to occur of an AGM change of control, the reduction of the commitment amount to $0, and January 31, 2042.
The Strip Coverage Facility’s financial covenants require that AGM and its subsidiaries maintain a maximum debt-to-capital ratio of 30% and maintain a minimum net worth of 75% of consolidated net worth as of July 1, 2009, plus, starting July 1, 2014, (i) 25% of the aggregate consolidated net income (or loss) for the period beginning July 1, 2009 and ending on June 30, 2014 or, (2) zero, if the commitment amount has been reduced to $750 million as described above. The Company is in compliance with all financial covenants as of June 30, 2013.
The Strip Coverage Facility contains restrictions on AGM, including, among other things, in respect of its ability to incur debt, permit liens, pay dividends or make distributions, dissolve or become party to a merger or consolidation. Most of these restrictions are subject to exceptions. The Strip Coverage Facility has customary events of default, including (subject to certain materiality thresholds and grace periods) payment default, bankruptcy or insolvency proceedings and cross-default to other debt agreements.
As of June 30, 2013, no amounts were outstanding under this facility, nor have there been any borrowings during the life of this facility.
AGM CPS Securities
In June 2003, $200 million of “AGM CPS Securities”, money market preferred trust securities, were issued by trusts created for the primary purpose of issuing the AGM CPS Securities, investing the proceeds in high-quality commercial paper and selling put options to AGM, allowing AGM to issue the trusts non-cumulative redeemable perpetual preferred stock (the “AGM Preferred Stock”) of AGM in exchange for cash. There are four trusts, each with an initial aggregate face amount of $50 million. These trusts hold auctions every 28 days, at which time investors submit bid orders to purchase AGM CPS Securities. If AGM were to exercise a put option, the applicable trust would transfer the portion of the proceeds attributable to principal received upon maturity of its assets, net of expenses, to AGM in exchange for AGM Preferred Stock. AGM pays a floating put premium to the trusts, which represents the difference between the commercial paper yield and the winning auction rate (plus all fees and expenses of the trust). If an auction does not attract sufficient clearing bids, however, the auction rate is subject to a maximum rate of one-month LIBOR plus 200 basis points for the next succeeding distribution period. Beginning in August 2007, the AGM CPS Securities required the maximum rate for each of the relevant trusts. AGM continues to have the ability to exercise its put option and cause the related trusts to purchase AGM Preferred Stock. The trusts provide AGM access to new capital at its sole discretion through the exercise of the put options. As of June 30, 2013 the put option had not been exercised. The Company does not consider itself to be the primary beneficiary of the trusts. See Note 7, Fair Value Measurement, –Other Assets–Committed Capital Securities, for a fair value measurement discussion.
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16. Other Comprehensive Income
The following tables present the changes in the balances of each component of accumulated other comprehensive income and the effect of significant reclassifications out of AOCI on the respective line items in net income.
Changes in Accumulated Other Comprehensive Income by Component
Second Quarter 2013
Net Unrealized Gains (Losses) on Investments with no OTTI | Net Unrealized Gains (Losses) on Investments with OTTI | Total Accumulated Other Comprehensive Income | |||||||||
(in millions) | |||||||||||
Balance, March 31, 2013 | $ | 204 | $ | (8 | ) | $ | 196 | ||||
Other comprehensive income before reclassifications | (81 | ) | (11 | ) | (92 | ) | |||||
Amounts reclassified from AOCI to: | |||||||||||
Other net realized investment gains (losses) | — | 4 | 4 | ||||||||
Tax (provision) benefit | — | (1 | ) | (1 | ) | ||||||
Total amounts reclassified from AOCI, net of tax | — | 3 | 3 | ||||||||
Net current period other comprehensive income (loss) | (81 | ) | (8 | ) | (89 | ) | |||||
Balance, June 30, 2013 | $ | 123 | $ | (16 | ) | $ | 107 |
Changes in Accumulated Other Comprehensive Income by Component
Second Quarter 2012
Net Unrealized Gains (Losses) on Investments with no OTTI | Net Unrealized Gains (Losses) on Investments with OTTI | Total Accumulated Other Comprehensive Income | |||||||||
(in millions) | |||||||||||
Balance, March 31, 2012 | $ | 175 | $ | (2 | ) | $ | 173 | ||||
Other comprehensive income (loss) | 10 | 2 | 12 | ||||||||
Balance, June 30, 2012 | $ | 185 | $ | 0 | $ | 185 |
Changes in Accumulated Other Comprehensive Income by Component
Six Months 2013
Net Unrealized Gains (Losses) on Investments with no OTTI | Net Unrealized Gains (Losses) on Investments with OTTI | Total Accumulated Other Comprehensive Income | |||||||||
(in millions) | |||||||||||
Balance, December 31, 2012 | $ | 226 | $ | 6 | $ | 232 | |||||
Other comprehensive income before reclassifications | (103 | ) | (30 | ) | (133 | ) | |||||
Amounts reclassified from AOCI to: | |||||||||||
Other net realized investment gains (losses) | 0 | 12 | 12 | ||||||||
Tax (provision) benefit | 0 | (4 | ) | (4 | ) | ||||||
Total amounts reclassified from AOCI, net of tax | 0 | 8 | 8 | ||||||||
Net current period other comprehensive income (loss) | (103 | ) | (22 | ) | (125 | ) | |||||
Balance, June 30, 2013 | $ | 123 | $ | (16 | ) | $ | 107 |
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Changes in Accumulated Other Comprehensive Income by Component
Six Months 2012
Net Unrealized Gains (Losses) on Investments with no OTTI | Net Unrealized Gains (Losses) on Investments with OTTI | Total Accumulated Other Comprehensive Income | |||||||||
(in millions) | |||||||||||
Balance, December 31, 2011 | $ | 161 | $ | (5 | ) | $ | 156 | ||||
Other comprehensive income (loss) | 24 | 5 | 29 | ||||||||
Balance, June 30, 2012 | $ | 185 | $ | 0 | $ | 185 |
17. | Subsequent Events |
On July 16, 2013, subsidiaries of Assured Guaranty Ltd. completed a series of transactions that resulted in the capitalization of its subsidiary, MAC, to approximately $700 million. In addition, AGM purchased a surplus note issued by MAC in the principal amount of $100 million.
AGM and its subsidiaries AGMIC and AGBM terminated the pooling reinsurance agreement pursuant to which AGMIC and AGBM had assumed a quota share percentage of the financial guaranty insurance policies issued by AGM, and AGM reassumed such ceded business. Subsequently, AGMIC was merged into AGM, with AGM as the surviving company.
AGBM, which had made a loan of $82.5 million to AGUS, an indirect parent holding company of AGM, received all of the outstanding shares of MAC held by AGUS and cash, in full satisfaction of the principal of and interest on such loan. AGBM dividended substantially all of its assets, including the MAC shares, to AGM and AGM sold AGBM to its affiliate AG Re. Subsequently, AGBM and AG Re merged, with AG Re as the surviving company. The sale of AGBM to, and subsequent merger with, AG Re were each effective as of July 17, 2013.
A new company, MAC Holdings, was formed to own 100% of the outstanding stock of MAC. AGM contributed approximately $425 million and AGM's affiliate AGC contributed approximately $275 million, consisting of all of MAC's outstanding common stock (in the case of AGM), cash and marketable securities, to MAC Holdings. AGM and AGC received approximately 61% and 39% of the outstanding MAC Holdings common stock, respectively.
MAC Holdings then contributed cash and marketable securities having a fair market value sufficient to increase MAC's policyholders' surplus to approximately $400 million, and purchased a surplus note issued by MAC in the principal amount of $300 million.
Following MAC's capitalization, AGM ceded par exposure of approximately $87 billion and unearned premiums of approximately $468 million to MAC, and AGC ceded par exposure of approximately $24 billion and unearned premiums of approximately $249 million.
In addition, on July 15, 2013, AGM and AGE (together, the "AGM Group") were notified that the New York State Department of Financial Services ("NYSDFS") does not object to the AGM Group reassuming contingency reserves that they had ceded to AG Re and electing to cease ceding future contingency reserves to AG Re under the following circumstances:
• | The AGM Group may reassume 33% of a contingency reserve base of approximately $250 million (the “NY Contingency Reserve Base”) in 2013, after July 16, 2013, the date on which the transactions for the capitalization of MAC were completed (the “Closing Date”). |
• | The AGM Group may reassume 50% of the NY Contingency Reserve Base in 2014, no earlier than the one year anniversary of the Closing Date, with the prior approval of the NYSDFS. |
• | The AGM Group may reassume the remaining 17% of the NY Contingency Reserve Base in 2015, no earlier than the two year anniversary of the Closing Date, with the prior approval of the NYSDFS. |
The reassumption of the contingency reserves by the AGM Group would have the effect of increasing contingency reserves by the amount reassumed and decreasing policyholders' surplus by the same amount; there would be no impact on the
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statutory or rating agency capital of the AGM Group. The reassumption of contingency reserves by the AGM Group permits the release of amounts from the AG Re trust accounts securing AG Re's reinsurance of the AGM Group.
Subsequent events have been considered through August 29, 2013, the date on which these financial statements were issued.
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