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ASSURED GUARANTY LTD - Quarter Report: 2013 June (Form 10-Q)

Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________________________________
FORM 10-Q
ý
 
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2013
Or
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition Period from              to               
Commission File No. 001-32141 
ASSURED GUARANTY LTD.
(Exact name of registrant as specified in its charter) 
Bermuda
 
98-0429991
(State or other jurisdiction
 
(I.R.S. employer
of incorporation)
 
identification no.)
 
30 Woodbourne Avenue
Hamilton HM 08
Bermuda
(Address of principal executive offices)
(441) 279-5700
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes x No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No x
The number of registrant’s Common Shares ($0.01 par value) outstanding as of August 1, 2013 was 182,986,125 (includes 48,273 unvested restricted shares).
 

Table of Contents


ASSURED GUARANTY LTD.

INDEX TO FORM 10-Q
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Table of Contents

PART I.
FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS

Assured Guaranty Ltd.

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 $9,267 and $9,346)
$
9,564

 
$
10,056

Short term investments, at fair value
943

 
817

Other invested assets
130

 
212

Total investment portfolio
10,637

 
11,085

Cash
143

 
138

Premiums receivable, net of ceding commissions payable
915

 
1,005

Ceded unearned premium reserve
510

 
561

Deferred acquisition costs
125

 
116

Reinsurance recoverable on unpaid losses
60

 
58

Salvage and subrogation recoverable
331

 
456

Credit derivative assets
101

 
141

Deferred tax asset, net
850

 
721

Financial guaranty variable interest entities’ assets, at fair value
2,674

 
2,688

Other assets
262

 
273

Total assets
$
16,608

 
$
17,242

Liabilities and shareholders’ equity
 

 
 

Unearned premium reserve
$
4,812

 
$
5,207

Loss and loss adjustment expense reserve
564

 
601

Reinsurance balances payable, net
188

 
219

Long-term debt
827

 
836

Credit derivative liabilities
2,349

 
1,934

Financial guaranty variable interest entities’ liabilities with recourse, at fair value
1,940

 
2,090

Financial guaranty variable interest entities’ liabilities without recourse, at fair value
1,134

 
1,051

Other liabilities
310

 
310

Total liabilities
12,124

 
12,248

Commitments and contingencies (See Note 14)

 

Common stock ($0.01 par value, 500,000,000 shares authorized; 182,901,083 and 194,003,297 shares issued and outstanding)
2

 
2

Additional paid-in capital
2,483

 
2,724

Retained earnings
1,786

 
1,749

Accumulated other comprehensive income, net of tax of $83 and $198
209

 
515

Deferred equity compensation (320,193 and 320,193 shares)
4

 
4

Total shareholders’ equity
4,484

 
4,994

Total liabilities and shareholders’ equity
$
16,608

 
$
17,242

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


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Assured Guaranty Ltd.

Consolidated Statements of Operations (unaudited)
 
(dollars in millions except per share amounts)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Revenues
 
 
 
 
 
 
 
Net earned premiums
$
163

 
$
219

 
$
411

 
$
413

Net investment income
93

 
101

 
187

 
199

Net realized investment gains (losses):
 
 
 
 
 
 
 
Other-than-temporary impairment losses
(16
)
 
(9
)
 
(17
)
 
(37
)
Less: portion of other-than-temporary impairment loss
recognized in other comprehensive income
(9
)
 
(7
)
 
(5
)
 
(30
)
Other net realized investment gains (losses)
9

 
(1
)
 
42

 
5

Net realized investment gains (losses)
2

 
(3
)
 
30

 
(2
)
Net change in fair value of credit derivatives:
 
 
 
 
 
 
 
Realized gains (losses) and other settlements
(86
)
 
(23
)
 
(68
)
 
(80
)
Net unrealized gains (losses)
160

 
284

 
(450
)
 
(350
)
Net change in fair value of credit derivatives
74

 
261

 
(518
)
 
(430
)
Fair value gains (losses) on committed capital securities
(3
)
 
4

 
(13
)
 
(10
)
Fair value gains (losses) on financial guaranty variable interest entities
143

 
168

 
213

 
127

Other income
(7
)
 
5

 
(21
)
 
96

Total revenues
465

 
755

 
289

 
393

Expenses


 


 
 
 
 
Loss and loss adjustment expenses
62

 
118

 
14

 
360

Amortization of deferred acquisition costs
1

 
5

 
4

 
10

Interest expense
21

 
25

 
42

 
50

Other operating expenses
52

 
53

 
112

 
115

Total expenses
136

 
201

 
172

 
535

Income (loss) before income taxes
329

 
554

 
117

 
(142
)
Provision (benefit) for income taxes
 

 
 

 
 
 
 
Current
3

 
(29
)
 
58

 
0

Deferred
107

 
206

 
(16
)
 
(36
)
Total provision (benefit) for income taxes
110

 
177

 
42

 
(36
)
Net income (loss)
$
219

 
$
377

 
$
75

 
$
(106
)
 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic
$
1.17

 
$
2.02

 
$
0.39

 
$
(0.58
)
Diluted
$
1.16

 
$
2.01

 
$
0.39

 
$
(0.58
)
Dividends per share
$
0.10

 
$
0.09

 
$
0.20

 
$
0.18

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

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Assured Guaranty Ltd.

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

 
$
377

 
$
75

 
$
(106
)
Unrealized holding gains (losses) arising during the period on:
 
 
 
 
 
 
 
Investments with no other-than-temporary impairment, net of tax provision (benefit) of $(79), $8, $(98), and $27
(219
)
 
32

 
(269
)
 
74

Investments with other-than-temporary impairment, net of tax provision (benefit) of $(7), $(1), $(15) and $(8)
(16
)
 
(4
)
 
(32
)
 
(18
)
Unrealized holding gains (losses) arising during the period, net of tax
(235
)
 
28

 
(301
)
 
56

Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $0, $(4), $(2) and $(5)
2

 
(4
)
 
(1
)
 
(5
)
Change in net unrealized gains on investments
(237
)
 
32

 
(300
)
 
61

Other, net of tax provision
(1
)
 
(1
)
 
(6
)
 
1

Other comprehensive income (loss)
$
(238
)
 
$
31

 
$
(306
)
 
$
62

Comprehensive income (loss)
$
(19
)
 
$
408

 
$
(231
)
 
$
(44
)
 
The accompanying notes are an integral part of these consolidated financial statements.
 


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Assured Guaranty Ltd.

Consolidated Statements of Shareholders’ 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
 
Deferred
Equity Compensation
 
Total
Shareholders’ Equity
 
Shares
 
Amount
 
 
 
 
 
Balance at December 31, 2012
194,003,297

 
$
2

 
$
2,724

 
$
1,749

 
$
515

 
$
4

 
$
4,994

Net income
—

 
—

 
—

 
75

 
—

 
—

 
75

Dividends ($0.20 per share)
—

 
—

 
—

 
(38
)
 
—

 
—

 
(38
)
Common stock repurchases
(11,489,529
)
 
0

 
(244
)
 
—

 
—

 
—

 
(244
)
Share-based compensation and other
387,315

 
0

 
3

 
—

 
—

 
—

 
3

Other comprehensive loss
—

 
—

 
—

 
—

 
(306
)
 
—

 
(306
)
Balance at June 30, 2013
182,901,083

 
$
2

 
$
2,483

 
$
1,786

 
$
209

 
$
4

 
$
4,484

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


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Table of Contents

Assured Guaranty Ltd.

Consolidated Statements of Cash Flows (unaudited)
 
(in millions)
 
 
Six Months Ended June 30,
 
2013
 
2012
Net cash flows provided by (used in) operating activities
$
122

 
$
162

Investing activities
 

 
 

Fixed maturity securities:
 

 
 

Purchases
(987
)
 
(924
)
Sales
632

 
526

Maturities
446

 
515

Net sales (purchases) of short-term investments
(126
)
 
(108
)
Net proceeds from paydowns on financial guaranty variable interest entities’ assets
440

 
283

Acquisition of MAC, net of cash acquired
—

 
(91
)
Other
67

 
72

Net cash flows provided by (used in) investing activities
472

 
273

Financing activities
 

 
 

Proceeds from issuance of common stock
—

 
173

Dividends paid
(38
)
 
(33
)
Repurchases of common stock
(244
)
 
(24
)
Share activity under option and incentive plans
(1
)
 
(2
)
Net paydowns of financial guaranty variable interest entities’ liabilities
(289
)
 
(389
)
Repayment of long-term debt
(13
)
 
(196
)
Net cash flows provided by (used in) financing activities
(585
)
 
(471
)
Effect of exchange rate changes
(4
)
 
(4
)
Increase (decrease) in cash
5

 
(40
)
Cash at beginning of period
138

 
215

Cash at end of period
$
143

 
$
175

Supplemental cash flow information
 

 
 

Cash paid (received) during the period for:
 

 
 

Income taxes
$
69

 
$
(16
)
Interest
$
38

 
$
47

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

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Table of Contents

Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (unaudited)
 
June 30, 2013

1.
Business and Basis of Presentation
 
Business
 
Assured Guaranty Ltd. (“AGL” and, together with its subsidiaries, “Assured Guaranty” or the “Company”) is a Bermuda-based holding company that provides, through its operating subsidiaries, credit protection products to the United States (“U.S.”) and international public finance (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 and structured 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.

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 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. The Company also includes within structured finance obligations other specialized financial obligations.
 
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.

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

6
Table of Contents

2012"), 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 AGL and its direct and indirect 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 AGL’s Annual Report on Form 10-K for the year ended December 31, 2012, filed with the U.S. Securities and Exchange Commission (the “SEC”).

As of the date of this filing, following a series of transactions in July 2013 to capitalize a new insurance subsidiary, the Company's principal insurance company subsidiaries are:

•
Assured Guaranty Municipal Corp. ("AGM"), domiciled in New York;
•
Assured Guaranty Corp. ("AGC"), domiciled in Maryland;
•
Municipal Assurance Corporation ("MAC"), domiciled in New York, which commenced underwriting U.S. public finance business in August 2013;
•
Assured Guaranty (Europe) Ltd., organized in the United Kingdom; and
•
Assured Guaranty Re Ltd. (“AG Re”), domiciled in Bermuda.
    
The Company’s organizational structure includes various holdings companies, two of which — Assured Guaranty US Holdings Inc. (“AGUS”) and Assured Guaranty Municipal Holdings Inc. (“AGMH”) — have public debt outstanding. See Note 15, Long Term Debt and Credit Facilities.

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 one of AGL’s insurance company subsidiaries, it generally awards that obligation the same rating it has assigned to the financial strength of the AGL subsidiary that provides the guaranty. Investors in products insured by AGL’s insurance company subsidiaries 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 of the Company’s insurance subsidiaries 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 further downgrade could harm the Company’s new business production and results of operations in a material respect. However, the models used by NRSROs differ, presenting conflicting goals that 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 the Company’s insurance subsidiaries. On January 17, 2013, Moody’s downgraded the financial strength rating of AGM to A2 from Aa3, the financial strength rating of AGC to A3 from Aa3, and the financial strength rating of AG Re to Baa1 from A1. In the same rating action, Moody's also downgraded the senior unsecured debt ratings of AGUS and AGMH to Baa2 from A3. 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 the Company’s ratings. For a discussion of the effect of rating actions on the Company, see the following:

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•
Note 5, Expected Loss to be Paid
•
Note 8, Financial Guaranty Contracts Accounted for as Credit Derivatives
•
Note 13, Reinsurance and Other Monoline Exposures
•
Note 15, Long Term Debt 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.
 
Significant Transactions

•
In 2013, the Company was authorized to repurchase a total of $315 million of its common shares. From this authorization, the Company repurchased 1.9 million common shares for a total of $39 million in first quarter 2013 and 9.6 million common shares for a total of $205 million in Second Quarter 2013, including 5.0 million common shares purchased on June 5, 2013 from funds associated with WL Ross & Co. LLC and its affiliates (collectively, the “WLR Funds”) and Wilbur L. Ross, Jr., a director of the Company, for $109.7 million. This share purchase reduced the WLR Funds’ and Mr. Ross’s ownership of Assured Guaranty’s common shares to approximately 14.9 million common shares, or to approximately 8% of Assured Guaranty’s total common shares outstanding, from approximately 10.5% of such outstanding common shares. The purchase of these shares was funded with existing funds and was part of Assured Guaranty’s previously announced common share repurchase plan. After giving effect to the share repurchases in first quarter 2013 and Second Quarter 2013, approximately $71 million remains available under the Company's common share repurchase authorization.

•
On May 6, 2013, the Company entered into an agreement with UBS Real Estate Securities Inc. and affiliates ("UBS") and a third party resolving the Company’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 AGC 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, AGC entered into a settlement agreement with a representations and warranties ("R&W") provider that resolved AGC’s claims relating to specified RMBS transactions that AGC had insured and AGM reached an agreement in principle with a servicer of certain RMBS transactions that AGM had insured.

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 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
$
678,792

 
$
722,562

 
$
637,104

 
$
677,369

Structured finance
97,754

 
112,388

 
90,893

 
104,811

Total financial guaranty
$
776,546

 
$
834,950

 
$
727,997

 
$
782,180

 
In addition to the amounts shown in the table above, the Company’s net mortgage guaranty insurance in force was approximately $148 million as of June 30, 2013. The net mortgage guaranty insurance in force is assumed excess of loss business written between 2004 and 2006 and comprises $137 million covering loans originated in Ireland and $11 million covering loans originated in the United Kingdom ("U.K.").

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
 
$
4,311

 
1.2
%
 
$
1,657

 
4.9
%
 
$
36,292

 
55.5
%
 
$
11,079

 
65.8
%
 
$
53,339

 
11.0
%
AA
 
115,820

 
31.2

 
487

 
1.4

 
9,808

 
15.0

 
669

 
4.0

 
126,784

 
26.0

A
 
202,440

 
54.6

 
8,965

 
26.6

 
2,872

 
4.4

 
863

 
5.1

 
215,140

 
44.2

BBB
 
43,554

 
11.7

 
20,701

 
61.5

 
3,526

 
5.4

 
2,313

 
13.7

 
70,094

 
14.4

Below-investment-grade (“BIG”)
 
4,930

 
1.3

 
1,890

 
5.6

 
12,898

 
19.7

 
1,914

 
11.4

 
21,632

 
4.4

Total net par outstanding
 
$
371,055

 
100.0
%
 
$
33,700

 
100.0
%
 
$
65,396

 
100.0
%
 
$
16,838

 
100.0
%
 
$
486,989

 
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
 
$
4,502

 
1.2
%
 
$
1,706

 
4.5
%
 
$
42,187

 
56.5
%
 
$
13,169

 
66.8
%
 
$
61,564

 
11.9
%
AA
 
124,525

 
32.1

 
875

 
2.3

 
9,589

 
12.8

 
722

 
3.7

 
135,711

 
26.1

A
 
210,124

 
54.1

 
9,781

 
26.1

 
4,670

 
6.2

 
1,409

 
7.2

 
225,984

 
43.4

BBB
 
44,213

 
11.4

 
22,885

 
61.0

 
3,717

 
5.0

 
2,427

 
12.3

 
73,242

 
14.1

BIG
 
4,603

 
1.2

 
2,293

 
6.1

 
14,532

 
19.5

 
1,964

 
10.0

 
23,392

 
4.5

Total net par outstanding
 
$
387,967

 
100.0
%
 
$
37,540

 
100.0
%
 
$
74,695

 
100.0
%
 
$
19,691

 
100.0
%
 
$
519,893

 
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 $1,193 million and $1,133 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

9
Table of Contents

recorded in other invested assets in the consolidated balance sheets. Such amounts totaled $219 million and $220 million in gross par outstanding as of June 30, 2013 and December 31, 2012, respectively.

In addition to amounts shown in the tables above, the Company had outstanding commitments to provide guaranties of $1.0 billion for structured finance and $1.5 billion for public finance obligations at June 30, 2013. 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: Greece, 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

 
Greece
 
Hungary (2)
 
Ireland
 
Italy
 
Portugal
 
Spain (2)
 
Total
 
(in millions)
Sovereign and sub-sovereign exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

Public finance
$
—

 
$
—

 
$
—

 
$
981

 
$
102

 
$
261

 
$
1,344

Infrastructure finance
—

 
413

 
23

 
83

 
97

 
167

 
783

Sub-total
—

 
413

 
23

 
1,064

 
199

 
428

 
2,127

Non-sovereign exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

Regulated utilities
—

 
—

 
—

 
215

 
—

 
0

 
215

RMBS
—

 
214

 
137

 
479

 
—

 
—

 
830

Commercial receivables
—

 
1

 
12

 
59

 
14

 
3

 
89

Pooled corporate
22

 
—

 
172

 
224

 
15

 
499

 
932

Sub-total
22

 
215

 
321

 
977

 
29

 
502

 
2,066

Total
$
22

 
$
628

 
$
344

 
$
2,041

 
$
228

 
$
930

 
$
4,193

Total BIG
$
—

 
$
591

 
$
7

 
$
2

 
$
118

 
$
412

 
$
1,130

 ____________________
(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. Included in the table above is $137 million of reinsurance assumed on a 2004 - 2006 pool of Irish residential mortgages that is part of the Company’s remaining legacy mortgage reinsurance business. One of the residential mortgage-backed securities 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

10
Table of Contents

assign portions of a risk to more than one geographic location. The Company may also have direct exposures to the Selected European Countries in business assumed from unaffiliated monoline insurance companies. In the case of assumed business for direct exposures, the Company depends upon geographic information provided by the primary insurer.

The Company has included in the exposure tables above its indirect economic exposure to the Selected European Countries through exposure it provides on (a) pooled corporate and (b) commercial receivables transactions. 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 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 may also have indirect exposures to Selected European Countries in business assumed from unaffiliated monoline insurance companies. However, in the case of assumed business for indirect exposures, unaffiliated primary insurers generally do not provide such information to the Company.

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. The Company’s insured credit ratings on assumed credits are based on the Company’s reviews of low-rated credits or credits in volatile sectors, unless such information is not available, in which case, the ceding company’s credit rating of the transactions are used. The Company models most assumed RMBS credits with par above $1 million, as well as certain RMBS credits below that amount.
 
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.
 

11
Table of Contents

•
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.
 
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
$
26

 
$
406

 
$
10

 
$
442

 
$
595

 
0.1
%
Alt-A first lien
94

 
1,834

 
1,394

 
3,322

 
4,258

 
0.7

Option ARM
17

 
369

 
314

 
700

 
1,212

 
0.1

Subprime
168

 
1,162

 
1,023

 
2,353

 
6,894

 
0.5

Second lien U.S. RMBS:
 

 
 

 
 

 
 

 
 

 
 

Closed end second lien
—

 
20

 
301

 
321

 
428

 
0.1

Home equity lines of credit (“HELOCs”)
130

 
24

 
2,326

 
2,480

 
2,881

 
0.5

Total U.S. RMBS
435

 
3,815

 
5,368

 
9,618

 
16,268

 
2.0

Trust preferred securities (“TruPS”)
1,488

 
—

 
924

 
2,412

 
5,223

 
0.5

Other structured finance
1,177

 
439

 
1,166

 
2,782

 
60,743

 
0.5

U.S. public finance
3,389

 
659

 
882

 
4,930

 
371,055

 
1.0

Non-U.S. public finance
992

 
898

 
—

 
1,890

 
33,700

 
0.4

Total
$
7,481

 
$
5,811

 
$
8,340

 
$
21,632

 
$
486,989

 
4.4
%


12
Table of Contents

 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
$
28

 
$
436

 
$
11

 
$
475

 
$
641

 
0.1
%
Alt-A first lien
109

 
1,987

 
1,479

 
3,575

 
4,589

 
0.7

Option ARM
61

 
392

 
643

 
1,096

 
1,550

 
0.2

Subprime (including net interest margin securities)
152

 
1,161

 
1,024

 
2,337

 
7,330

 
0.4

Second lien U.S. RMBS:
 

 
 

 
 

 
 

 
 

 
 

Closed end second lien
—

 
247

 
157

 
404

 
521

 
0.1

HELOCs
91

 
—

 
2,627

 
2,718

 
3,196

 
0.5

Total U.S. RMBS
441

 
4,223

 
5,941

 
10,605

 
17,827

 
2.0

TruPS
1,920

 
—

 
952

 
2,872

 
5,693

 
0.6

Other structured finance
1,310

 
384

 
1,325

 
3,019

 
70,866

 
0.6

U.S. public finance
3,290

 
500

 
813

 
4,603

 
387,967

 
0.9

Non-U.S. public finance
2,293

 
—

 
—

 
2,293

 
37,540

 
0.4

Total
$
9,254

 
$
5,107

 
$
9,031

 
$
23,392

 
$
519,893

 
4.5
%

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
 
$
5,976

 
$
1,505

 
$
7,481

 
144

 
27

 
171

Category 2
 
3,309

 
2,502

 
5,811

 
83

 
25

 
108

Category 3
 
6,549

 
1,791

 
8,340

 
148

 
31

 
179

Total BIG
 
$
15,834

 
$
5,798

 
$
21,632

 
375

 
83

 
458



13
Table of Contents

 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
 
$
7,049

 
$
2,205

 
$
9,254

 
153

 
30

 
183

Category 2
 
2,606

 
2,501

 
5,107

 
76

 
27

 
103

Category 3
 
7,028

 
2,003

 
9,031

 
142

 
32

 
174

Total BIG
 
$
16,683

 
$
6,709

 
$
23,392

 
371

 
89

 
460

_____________________
(1)    Includes net par outstanding for FG VIEs.
 
(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.

Net Earned Premiums
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Scheduled net earned premiums
$
113

 
$
145

 
$
241

 
$
297

Acceleration of premium earnings
46

 
68

 
159

 
105

Accretion of discount on net premiums receivable
3

 
6

 
10

 
11

  Total financial guaranty insurance
162

 
219

 
410

 
413

Other
1

 
0

 
1

 
0

  Total net earned premiums(1)
$
163

 
$
219

 
$
411

 
$
413

 ___________________
(1)
Excludes $15 million and $16 million for Second Quarter 2013 and 2012, respectively, and $33 million and $33 million for the Six Months 2013 and 2012, respectively, related to consolidated FG VIEs.


14
Table of Contents

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:
 
 
 
 
 
 
 
 
 
 
 
   Financial guaranty
$
4,941

 
$
533

 
$
4,408

 
$
5,349

 
$
586

 
$
4,763

   Other
6

 
—

 
6

 
7

 
—

 
7

Total deferred premium revenue
$
4,947

 
$
533

 
$
4,414

 
$
5,356

 
$
586

 
$
4,770

Contra-paid
(135
)
 
(23
)
 
(112
)
 
(149
)
 
(25
)
 
(124
)
Total
$
4,812

 
$
510

 
$
4,302

 
$
5,207

 
$
561

 
$
4,646

 ____________________
(1)
Excludes $210 million and $262 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
$
1,005

 
$
1,003

Premium written, net of ceding commissions
32

 
103

Premium payments received, net of ceding commissions
(109
)
 
(167
)
Adjustments:
 
 
 
Changes in the expected term of financial guaranty insurance contracts
1

 
19

Accretion of discount, net of ceding commissions
13

 
13

Foreign exchange translation
(27
)
 
(1
)
Consolidation of FG VIEs
—

 
(5
)
Other adjustments
—

 
(1
)
Balance, end of period (1)
$
915

 
$
964

____________________
(1)
Excludes $20 million and $32 million as of June 30, 2013 and June 30, 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 46%, 47% and 49% 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.

15
Table of Contents

 
Expected Collections of Gross Premiums Receivable,
Net of Ceding Commissions (Undiscounted)

 
June 30, 2013
 
(in millions)
2013 (July 1 – September 30)
$
39

2013 (October 1 – December 31)
34

2014
104

2015
91

2016
85

2017
78

2018-2022
307

2023-2027
190

2028-2032
129

After 2032
147

Total(1)
$
1,204

 ____________________
(1)
Excludes expected cash collections on FG VIEs of $25 million.

Scheduled Net Earned Premiums
Financial Guaranty Insurance Contracts
 
 
As of June 30, 2013
 
(in millions)
2013 (July 1 - September 30)
$
119

2013 (October 1–December 31)
113

Subtotal 2013
232

2014
427

2015
374

2016
338

2017
302

2018 - 2022
1,161

2023 - 2027
731

2028 - 2032
436

After 2032
407

Total present value basis(1)
4,408

Discount
247

Total future value
$
4,655

 ____________________
(1)
Excludes scheduled net earned premiums on consolidated FG VIEs of $210 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
$
915

 
$
1,005

Gross deferred premium revenue
1,725

 
1,908

Weighted-average risk-free rate used to discount premiums
3.4
%
 
3.5
%
Weighted-average period of premiums receivable (in years)
9.4

 
9.6


16
Table of Contents


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 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
 
(in millions)
U.S. RMBS:
 

 
 

 
 

 
 

First lien:
 

 
 

 
 

 
 

Prime first lien
$
11

 
$
7

 
$
—

 
$
18

Alt-A first lien
313

 
(7
)
 
(18
)
 
288

Option ARM
(327
)
 
21

 
286

 
(20
)
Subprime
263

 
23

 
(12
)
 
274

Total first lien
260

 
44

 
256

 
560

Second lien:
 

 
 

 
 

 
 

Closed-end second lien
(21
)
 
6

 
1

 
(14
)
HELOCs
(122
)
 
(31
)
 
56

 
(97
)
Total second lien
(143
)
 
(25
)
 
57

 
(111
)
Total U.S. RMBS
117

 
19

 
313

 
449

TruPS
23

 
1

 
9

 
33

Other structured finance
307

 
(24
)
 
(125
)
 
158

U.S. public finance
(9
)
 
87

 
(7
)
 
71

Non-U.S public finance
62

 
4

 
—

 
66

Other
(13
)
 
—

 
10

 
(3
)
Total
$
487

 
$
87

 
$
200

 
$
774



17
Table of Contents

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:
 

 
 

 
 

 
 

Prime first lien
$
2

 
$
2

 
$
—

 
$
4

Alt-A first lien
268

 
15

 
38

 
321

Option ARM
119

 
11

 
(127
)
 
3

Subprime
248

 
10

 
(22
)
 
236

Total first lien
637

 
38

 
(111
)
 
564

Second lien:
 
 
 
 
 
 
 
Closed-end second lien
(101
)
 
(1
)
 
73

 
(29
)
HELOCs
(43
)
 
14

 
(35
)
 
(64
)
Total second lien
(144
)
 
13

 
38

 
(93
)
Total U.S. RMBS
493

 
51

 
(73
)
 
471

TruPS
58

 
(7
)
 
(1
)
 
50

Other structured finance
296

 
32

 
(8
)
 
320

U.S. public finance
33

 
35

 
(9
)
 
59

Non-U.S public finance
303

 
(16
)
 
15

 
302

Other
2

 
(6
)
 
—

 
(4
)
Total
$
1,185

 
$
89

 
$
(76
)
 
$
1,198



18
Table of Contents

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
 
Economic Loss
Development
 
(Paid)
Recovered
Losses(1)
 
Net Expected
Loss to be
Paid as of
June 30, 2013
 
(in millions)
U.S. RMBS:
 

 
 

 
 

 
 

First lien:
 

 
 

 
 

 
 

Prime first lien
$
6

 
$
13

 
$
(1
)
 
$
18

Alt-A first lien
315

 
2

 
(29
)
 
288

Option ARM
(131
)
 
(117
)
 
228

 
(20
)
Subprime
242

 
48

 
(16
)
 
274

Total first lien
432

 
(54
)
 
182

 
560

Second lien:
 
 
 
 
 
 
 
Closed-end second lien
(39
)
 
7

 
18

 
(14
)
HELOCs
(111
)
 
(34
)
 
48

 
(97
)
Total second lien
(150
)
 
(27
)
 
66

 
(111
)
Total U.S. RMBS
282

 
(81
)
 
248

 
449

TruPS
27

 
(2
)
 
8

 
33

Other structured finance
312

 
(26
)
 
(128
)
 
158

U.S. public finance
7

 
94

 
(30
)
 
71

Non-U.S public finance
52

 
14

 
—

 
66

Other
(3
)
 
(10
)
 
10

 
(3
)
Total
$
677

 
$
(11
)
 
$
108

 
$
774



19
Table of Contents

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:
 

 
 

 
 

 
 

Prime first lien
$
2

 
$
2

 
$
—

 
$
4

Alt-A first lien
295

 
13

 
13

 
321

Option ARM
210

 
9

 
(216
)
 
3

Subprime
241

 
26

 
(31
)
 
236

Total first lien
748

 
50

 
(234
)
 
564

Second lien:
 
 
 
 
 
 
 
Closed-end second lien
(86
)
 
(4
)
 
61

 
(29
)
HELOCs
(31
)
 
22

 
(55
)
 
(64
)
Total second lien
(117
)
 
18

 
6

 
(93
)
Total U.S. RMBS
631

 
68

 
(228
)
 
471

TruPS
64

 
(11
)
 
(3
)
 
50

Other structured finance
342

 
10

 
(32
)
 
320

U.S. public finance
16

 
58

 
(15
)
 
59

Non-U.S public finance
51

 
182

 
69

 
302

Other
2

 
(6
)
 
—

 
(4
)
Total
$
1,106

 
$
301

 
$
(209
)
 
$
1,198

 ____________________
(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.

20
Table of Contents

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:
 
 
 
 
 
 
 
First lien:
 
 
 
 
 
 
 
Prime first lien
$
4

 
$
—

 
$
—

 
$
4

Alt-A first lien
362

 
(5
)
 
(9
)
 
348

Option ARM
690

 
13

 
(410
)
 
293

Subprime
113

 
(5
)
 
—

 
108

Total first lien
1,169

 
3

 
(419
)
 
753

Second lien:
 
 
 
 
 
 
 
Closed end second lien
108

 
(3
)
 
(3
)
 
102

HELOC
161

 
51

 
(103
)
 
109

Total second lien
269

 
48

 
(106
)
 
211

Total
$
1,438

 
$
51

 
$
(525
)
 
$
964

 
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:
 
 
 
 
 
 
 
First lien:
 
 
 
 
 
 
 
Prime first lien
$
4

 
$
—

 
$
—

 
$
4

Alt-A first lien
433

 
17

 
(63
)
 
387

Option ARM
735

 
34

 
(58
)
 
711

Subprime
96

 
(3
)
 
—

 
93

Total first lien
1,268

 
48

 
(121
)
 
1,195

Second lien:
 
 
 
 
 
 
 
Closed end second lien
222

 
—

 
(85
)
 
137

HELOC
141

 
(2
)
 
(17
)
 
122

Total second lien
363

 
(2
)
 
(102
)
 
259

Total
$
1,631

 
$
46

 
$
(223
)
 
$
1,454

____________________
(1)
Gross amounts recovered were $543 million and $234 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 an R&W provider.


21
Table of Contents

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 2013
 
R&W Recovered
During 2013(1)
 
Future Net
R&W Benefit as of
June 30, 2013(2)
 
(in millions)
U.S. RMBS:
 
 
 
 
 
 
 
First lien:
 
 
 
 
 
 
 
Prime first lien
$
4

 
$
—

 
$
—

 
$
4

Alt-A first lien
378

 
(13
)
 
(17
)
 
348

Option ARM
591

 
166

 
(464
)
 
293

Subprime
109

 
(1
)
 
—

 
108

Total first lien
1,082

 
152

 
(481
)
 
753

Second lien:
 
 
 
 
 
 
 
Closed end second lien
138

 
(12
)
 
(24
)
 
102

HELOC
150

 
68

 
(109
)
 
109

Total second lien
288

 
56

 
(133
)
 
211

Total
$
1,370

 
$
208

 
$
(614
)
 
$
964


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 2012
 
R&W Recovered
During 2012(1)
 
Future Net
R&W Benefit as of
June 30, 2012(2)
 
(in millions)
U.S. RMBS:
 
 
 
 
 
 
 
First lien:
 
 
 
 
 
 
 
Prime first lien
$
3

 
$
1

 
$
—

 
$
4

Alt-A first lien
407

 
44

 
(64
)
 
387

Option ARM
725

 
62

 
(76
)
 
711

Subprime
101

 
(8
)
 
—

 
93

Total first lien
1,236

 
99

 
(140
)
 
1,195

Second lien:
 
 
 
 
 
 
 
Closed end second lien
224

 
(2
)
 
(85
)
 
137

HELOC
190

 
—

 
(68
)
 
122

Total second lien
414

 
(2
)
 
(153
)
 
259

Total
$
1,650

 
$
97

 
$
(293
)
 
$
1,454

____________________
(1)
Gross amounts recovered were $635 million and $311 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 an R&W provider.


22
Table of Contents

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:
 

 
 

 
 

 
 

Prime first lien
$
3

 
$
—

 
$
15

 
$
18

Alt-A first lien
138

 
26

 
124

 
288

Option ARM
(30
)
 
3

 
7

 
(20
)
Subprime
124

 
69

 
81

 
274

Total first lien
235

 
98

 
227

 
560

Second lien:
 

 
 

 
 

 
 

Closed-end second lien
(38
)
 
26

 
(2
)
 
(14
)
HELOCs
(4
)
 
(93
)
 
—

 
(97
)
Total second lien
(42
)
 
(67
)
 
(2
)
 
(111
)
Total U.S. RMBS
193

 
31

 
225

 
449

TruPS
3

 
—

 
30

 
33

Other structured finance
199

 
—

 
(41
)
 
158

U.S. public finance
71

 
—

 
—

 
71

Non-U.S. public finance
64

 
—

 
2

 
66

Subtotal
$
530

 
$
31

 
$
216

 
777

Other
 
 
 
 
 
 
(3
)
Total
 
 
 
 
 
 
$
774



23
Table of Contents

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:
 
 
 
 
 
 
 
Prime first lien
$
4

 
$
—

 
$
2

 
$
6

Alt-A first lien
164

 
27

 
124

 
315

Option ARM
(114
)
 
(37
)
 
20

 
(131
)
Subprime
118

 
50

 
74

 
242

Total first lien
172

 
40

 
220

 
432

Second lien:
 

 
 

 
 

 
 

Closed-end second lien
(60
)
 
31

 
(10
)
 
(39
)
HELOCs
56

 
(167
)
 
—

 
(111
)
Total second lien
(4
)
 
(136
)
 
(10
)
 
(150
)
Total U.S. RMBS
168

 
(96
)
 
210

 
282

TruPS
1

 
—

 
26

 
27

Other structured finance
224

 
—

 
88

 
312

U.S. public finance
7

 
—

 
—

 
7

Non-U.S. public finance
51

 
—

 
1

 
52

Subtotal
$
451

 
$
(96
)
 
$
325

 
680

Other
 
 
 
 
 
 
(3
)
Total
 
 
 
 
 
 
$
677

___________________
(1)    Refer to Note 9, Consolidation of Variable Interest Entities.



24
Table of Contents

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:
 
 
 
 
 
 
 
Prime first lien
$
(1
)
 
$
—

 
$
8

 
$
7

Alt-A first lien
(12
)
 
1

 
4

 
(7
)
Option ARM
15

 
4

 
2

 
21

Subprime
3

 
16

 
4

 
23

Total first lien
5

 
21

 
18

 
44

Second lien:
 

 
 

 
 

 
 

Closed-end second lien
(7
)
 
2

 
11

 
6

HELOCs
(10
)
 
(22
)
 
1

 
(31
)
Total second lien
(17
)
 
(20
)
 
12

 
(25
)
Total U.S. RMBS
(12
)
 
1

 
30

 
19

TruPS
0

 
—

 
1

 
1

Other structured finance
(9
)
 
—

 
(15
)
 
(24
)
U.S. public finance
87

 
—

 
—

 
87

Non-U.S. public finance
4

 
—

 
—

 
4

Subtotal
$
70

 
$
1

 
$
16

 
87

Other
 
 
 
 
 
 
—

Total
 
 
 
 
 
 
$
87



25
Table of Contents

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:
 
 
 
 
 
 
 
Prime first lien
$
—

 
$
—

 
$
2

 
$
2

Alt-A first lien
(4
)
 
27

 
(8
)
 
15

Option ARM
80

 
(79
)
 
10

 
11

Subprime
(6
)
 
17

 
(1
)
 
10

Total first lien
70

 
(35
)
 
3

 
38

Second lien:
 

 
 

 
 

 
 

Closed-end second lien
(62
)
 
59

 
2

 
(1
)
HELOCs
(71
)
 
85

 
—

 
14

Total second lien
(133
)
 
144

 
2

 
13

Total U.S. RMBS
(63
)
 
109

 
5

 
51

TruPS
(1
)
 
—

 
(6
)
 
(7
)
Other structured finance
31

 
—

 
1

 
32

U.S. public finance
35

 
—

 
—

 
35

Non-U.S. public finance
(15
)
 
—

 
(1
)
 
(16
)
Subtotal
$
(13
)
 
$
109

 
$
(1
)
 
95

Other
 
 
 
 
 
 
(6
)
Total
 
 
 
 
 
 
$
89



26
Table of Contents

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:
 
 
 
 
 
 
 
Prime first lien
$
(1
)
 
$
—

 
$
14

 
$
13

Alt-A first lien
(7
)
 
—

 
9

 
2

Option ARM
(78
)
 
(33
)
 
(6
)
 
(117
)
Subprime
15

 
20

 
13

 
48

Total first lien
(71
)
 
(13
)
 
30

 
(54
)
Second lien:
 

 
 

 
 

 
 

Closed-end second lien
(2
)
 
(1
)
 
10

 
7

HELOCs
(17
)
 
(18
)
 
1

 
(34
)
Total second lien
(19
)
 
(19
)
 
11

 
(27
)
Total U.S. RMBS
(90
)
 
(32
)
 
41

 
(81
)
TruPS
0

 
—

 
(2
)
 
(2
)
Other structured finance
(19
)
 
—

 
(7
)
 
(26
)
U.S. public finance
94

 
—

 
—

 
94

Non-U.S. public finance
13

 
—

 
1

 
14

Subtotal
$
(2
)
 
$
(32
)
 
$
33

 
(1
)
Other
 
 
 
 
 
 
(10
)
Total
 
 
 
 
 
 
$
(11
)


27
Table of Contents

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:
 
 
 
 
 
 
 
Prime first lien
$
1

 
$
—

 
$
1

 
$
2

Alt-A first lien
(8
)
 
22

 
(1
)
 
13

Option ARM
84

 
(85
)
 
10

 
9

Subprime
(3
)
 
25

 
4

 
26

Total first lien
74

 
(38
)
 
14

 
50

Second lien:
 

 
 

 
 

 
 

Closed-end second lien
(59
)
 
55

 
—

 
(4
)
HELOCs
(59
)
 
81

 
—

 
22

Total second lien
(118
)
 
136

 
—

 
18

Total U.S. RMBS
(44
)
 
98

 
14

 
68

TruPS
(6
)
 
—

 
(5
)
 
(11
)
Other structured finance
12

 
—

 
(2
)
 
10

U.S. public finance
58

 
—

 
—

 
58

Non-U.S. public finance
183

 
—

 
(1
)
 
182

Subtotal
$
203

 
$
98

 
$
6

 
307

Other
 
 
 
 
 
 
(6
)
Total
 
 
 
 
 
 
$
301

_________________
(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.

28
Table of Contents

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".

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
%
–
20.1%
 
2.4
%
–
18.9%
 
2.9
%
–
15.4%
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
 
7.3
%
–
15.8%
 
6.7
%
–
18.6%
 
7.3
%
–
20.7%
Final CDR trended down to
 
3.5
%
–
9.1%
 
3.5
%
–
9.1%
 
3.5
%
–
9.1%
Expected period until final CDR
 
34 months
 
36 months
 
36 months
Initial CPR
 
1.7
%
–
14.0%
 
2.7
%
–
13.4%
 
1.9
%
–
12.5%
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

29
Table of Contents

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 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 $47 million for HELOC transactions and $3 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 $47 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

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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.
 
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

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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.
 
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
3.7
%
–
22.3%
 
3.7
%
–
22.6%
 
3.8
%
–
23.2%
Intermediate CDR
0.7
%
–
4.5%
 
0.7
%
–
4.5%
 
0.8
%
–
4.6%
Final CDR
0.2
%
–
1.1%
 
0.2
%
–
1.1%
 
0.2
%
–
1.2%
Initial loss severity
65%
 
65%
 
65%
Initial CPR
0.4
%
–
32.2%
 
0.1
%
–
39.6%
 
0.0
%
–
39.4%
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%
 
0.3
%
–
10.6%
 
0.0
%
–
10.7%
Final CPR
15%
 
15%
 
15%
Subprime
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
6.7
%
–
24.7%
 
7.8
%
–
25.6%
 
7.3
%
–
26.2%
Intermediate CDR
1.3
%
–
4.9%
 
1.6
%
–
5.1%
 
1.5
%
–
5.2%
Final CDR
0.3
%
–
1.2%
 
0.4
%
–
1.3%
 
0.4
%
–
1.3%
Initial loss severity
90%
 
90%
 
90%
Initial CPR
0.0
%
–
14.8%
 
0.0
%
–
14.7%
 
0.0
%
–
17.6%
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

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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 $70 million for Alt-A first liens, $20 million for Option ARM, $105 million for subprime and $6 million for prime 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 conditional default rate 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 $192 million for Alt-A first liens, $47 million for Option ARM, $166 million for subprime and $16 million for prime transactions. The Company also 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 $6 million for Alt-A first lien, $15 million for Option ARM, $33 million for subprime and $1 million for prime 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 $66 million for Alt-A first lien, $42 million for Option ARM, $76 million for subprime and $6 million for prime 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 $3.5 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

$
2.3

Agreement amounts projected to be received in the future
0.6

Repurchase amounts paid into the relevant RMBS prior to settlement (1)
0.6

Total R&W payments, gross of reinsurance

$
3.5

____________________
(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 $964 million, which includes $614 million from agreements (and pending agreements) with R&W providers and $350 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
 
$
1,246

 
$
406

 
$
263

 
$
665

 
Bank of America - Second Lien
April 2011
 
1,621

 
968

 
N/A

 
N/A

 
Deutsche Bank
May 2012
 
2,162

 
173

 
139

 
271

 
UBS
May 2013
 
979

 
347

 
93

 
227

(2)
Others
Various
 
585

 
172

 
119

 
N/A

 
Total
 
 
$
6,593

 
$
2,066

 
$
614

 
$
1,163

 
____________________
(1)
This table relates only to past and projected future recoveries under R&W and related agreements. Excluded is the $350 million of future net recoveries the Company projects receiving from R&W counterparties in transactions with $2,108 million of net par outstanding as of June 30, 2013 not covered by current agreements and $1,607 million of net par already covered by agreements but for which the Company projects receiving additional amounts.

(2)
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 the Company for 80% of claims on the first lien transactions covered by the agreement that the Company 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, and the Company was projecting in its base case that such collateral losses would eventually reach $5.1 billion.

•
Under the Company's agreement with Deutsche Bank AG and certain of its affiliates (collectively, “Deutsche Bank”), Deutsche Bank agreed to reimburse the Company 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, the Company was projecting in its base case that such aggregate lifetime claims would remain below $319 million. The agreement also requires Deutsche Bank to reimburse the Company 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 the Company 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, the Company was projecting in its base case that such losses would be $146 million. Except for the reimbursement obligation relating to the Uninsured Tranches, the Deutsche Bank Agreement does not include transactions where the Company has provided protection to Deutsche Bank on RMBS transactions in CDS form.

•
Under the Company's agreement with UBS Real Estate Securities Inc. and affiliates ("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

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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 $350 million from breaches of R&W in transactions not covered by agreements with $2,108 million of net par outstanding as of June 30, 2013 and $1,607 million of net par already covered by agreements but for which the Company projects receiving additional amounts. 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 23,500 loan files, representing approximately $6.5 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)
Prime first lien
1

 
1

 
$
40

 
$
44

Alt-A first lien
28

 
26

 
3,904

 
4,173

Option ARM
10

 
10

 
915

 
1,183

Subprime
5

 
5

 
965

 
989

Closed-end second lien
4

 
4

 
175

 
260

HELOC
8

 
7

 
611

 
549

Total
56

 
53

 
$
6,610

 
$
7,198

____________________
(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

 
$
(5
)
 
$
6

 
$
(5
)
Change in recovery assumptions as the result of additional file review and recovery success
6

 
(10
)
 
17

 
70

Estimated increase (decrease) in defaults that will result in additional (lower) breaches
(4
)
 
58

 
(3
)
 
(24
)
Results of settlements
38

 
—

 
180

 
48

Accretion of discount on balance
5

 
3

 
8

 
8

Total
$
51

 
$
46

 
$
208

 
$
97

 
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.
 
“XXX” Life Insurance Transactions
 
The Company’s $3.1 billion net par of XXX life insurance transactions as of June 30, 2013 include $923 million rated BIG. The BIG “XXX” life insurance reserve securitizations are based on discrete blocks of individual life insurance business. In each such transaction the monies raised by the sale of the bonds insured by the Company were used to capitalize a special purpose vehicle that provides reinsurance to a life insurer or reinsurer. The monies are invested at inception in accounts managed by third-party investment managers.
 
The BIG “XXX” life insurance transactions consist of two transactions: Ballantyne Re p.l.c and Orkney Re II p.l.c. These transactions had material amounts of their assets invested in U.S. RMBS transactions. Based on its analysis of the information currently available, including estimates of future investment performance, and projected credit impairments on the invested assets and performance of the blocks of life insurance business at June 30, 2013, the Company’s projected net expected loss to be paid is $115 million. The overall decrease of approximately $13 million in expected loss to be paid during Second Quarter 2013 is due primarily to the higher risk free rates used to discount the long dated projected losses in the transactions.


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Student Loan Transactions
 
The Company has insured or reinsured $2.9 billion net par of student loan securitizations, of which $1.9 billion was issued by private issuers and classified as asset-backed and $1.0 billion was issued by public authorities and classified as public finance. Of these amounts, $212 million and $315 million, respectively, are rated BIG. The Company is projecting approximately $56 million of net expected loss to be paid in these portfolios. In general, the losses are due to: (i) the poor credit performance of private student loan collateral and high loss severities, or (ii) high interest rates on auction rate securities with respect to which the auctions have failed. The largest of these losses was approximately $26 million and related to a transaction backed by a pool of private student loans assumed by AG Re from another monoline insurer. The guaranteed bonds were issued as auction rate securities that now bear a high rate of interest due to the downgrade of the primary insurer’s financial strength rating. Further, the underlying loan collateral has performed below expectations. The overall increase of approximately $1 million in net expected loss during Second Quarter 2013 is primarily due to moderate collateral underperformance.
 
Trust Preferred Securities Collateralized Debt Obligations
 
The Company has insured or reinsured $5.2 billion of net par (71% of which is in CDS form) of collateralized debt obligations (“CDOs”) backed by TruPS and similar debt instruments, or “TruPS CDOs.” Of the $5.2 billion, $2.4 billion is rated BIG. The underlying collateral in the TruPS CDOs consists of subordinated debt instruments such as TruPS issued by bank holding companies and similar instruments issued by insurance companies, real estate investment trusts (“REITs”) and other real estate related issuers.
 
The Company projects losses for TruPS CDOs by projecting the performance of the asset pools across several scenarios (which it weights) and applying the CDO structures to the resulting cash flows. At June 30, 2013, the Company has projected expected losses to be paid for TruPS CDOs of $33 million.The increase of approximately $10 million in net expected loss during Second Quarter 2013 is due primarily to the receipt during the quarter of over $9 million of reimbursements for claims previously paid. The Company last quarter had projected receiving these reimbursements and netted them against expected future losses, so their receipt increased expected future losses by a like amount.

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 $2,154 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 $1.0 billion of sewer revenue bonds and $793 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 $146 million to the City's general obligation bonds (which are secured by a pledge of the unlimited tax, full faith, credit and resources of the City) and $175 million of the City's Certificates of Participation (which are unsecured unconditional contractual obligations of the City), both of which the Company rates below investment grade. The Company paid claims of $2 million in Second Quarter 2013.

The Company has net exposure to Jefferson County, Alabama of $682 million as of June 30, 2013. On November 9, 2011, Jefferson County filed for bankruptcy under Chapter 9 of the U.S. Bankruptcy Code. Most of the Company's net Jefferson County exposure relates to $464 million in sewer revenue exposure, of which $192 million is direct and $272 million is assumed reinsurance 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 special revenues 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

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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 also has assumed exposure of $30 million to warrants that are payable from Jefferson County's general fund on a "subject to appropriation" basis. In 2012 Jefferson County chose not to make payment under its General Obligation bonds, so the Company has established a projected loss for these warrants as well. The Company's remaining net exposure of $188 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 $155 million, consisting of pension obligation and lease revenue bonds. As of June 30, 2013, the Company had paid $12 million in net claims.

The Company has $155 million of net par exposure to The City of Harrisburg, Pennsylvania, of which $92 million is BIG. The Company has paid $17 million in net claims as of June 30, 2013.

The Company has $337 million of net par exposure to the Louisville Arena Authority. The bond proceeds were used to construct the KFC Yum Center, home to the University of Louisville men's and women's basketball teams. Actual revenues available for Debt Service are well below original projections, and under the Company's internal rating scale, the transaction is BIG.

The Company has $26 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, which it expects to fund as claims in September 2013. The Company had paid $89 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 loss across its troubled U.S. public finance credits as of June 30, 2013 will be $71 million. As of March 31, 2013 the Company was projecting a net recovery of $9 million across it 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 €453 million and its exposure net of reinsurance is €329 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 $664 million and its exposure net of insurance is $627 million of which $591 million is rated BIG. The Company estimated net expected losses of $46 million related to these Spanish and Hungarian credits, down from $49 million as of March 31, 2013 largely due to movements in exchange rates, interest rates and timing of 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 or reinsures a total of $278 million net par of securities backed by manufactured housing loans, a total of $193 million rated BIG. The Company has expected loss to be paid of $30 million as of June 30, 2013, down from $33 million as of March 31, 2013, due primarily to the higher risk free rates used to discount losses and higher projected recoveries on certain transactions.
 

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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 $3.8 billion, payable in varying amounts over the next 13 years. Of this liability, as much as approximately $3.0 billion may be payable between 2014 and 2020. As of June 30, 2013, the Company estimates that it may pay claims of approximately $1.4 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 and AGC have 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 and AGC have 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 and AGC to such persons. In addition, in the lawsuits against DLJ Mortgage Capital, Inc. (“DLJ”) and Credit Suisse Securities (USA) LLC (“Credit Suisse”), AGM and AGC have alleged breaches of contract in procuring falsely inflated shadow ratings (a condition to the issuance by AGM and AGC 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. At a hearing held on June 26, 2013, the Bankruptcy Court approved a plan support agreement which has the support of Ally Financial Inc. and a majority of the debtors' largest claimants. On July 4, 2013, the debtors and the official committee of unsecured creditors filed a disclosure statement regarding the Joint Chapter 11 Plan of Residential Capital, LLC et al. A hearing on the disclosure statement is scheduled for August 2013.

•
Credit Suisse: AGM and AGC have sued DLJ and Credit Suisse 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

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Certificates, Series 2006-4; and CMSC Mortgage-Backed Pass Through Certificates, Series 2007-3. The ones insured by AGC are: CSAB Mortgage-Backed Pass Through Certificates, Series 2007-1 and TBW Mortgage-Backed Pass Through Certificates, Series 2007-2. 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 have appealed 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.

In addition, AGC had previously sued JPMorgan Chase & Co.'s affiliate EMC Mortgage LLC ("EMC"), J.P. Morgan Securities Inc. (formerly known as Bear, Stearns & Co. Inc.) (“JPMorgan Securities”) and JPMorgan Chase Bank, N.A. (“JPMorgan Bank”, and together with EMC and JPMorgan Securities, “JPMorgan”) on the SACO I Trust 2005-GP1 second lien transaction and EMC on the Bear Stearns Asset Backed Securities I Trust 2005-AC5 and Bear Stearns Asset Backed Securities I Trust 2005-AC6 first lien transactions. In August 2013, AGC reached a settlement with JPMorgan resolving AGC's claims in respect of those RMBS transactions and AGC has agreed to dismiss these lawsuits upon receipt of the settlement amount.
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.
 
“XXX” Life Insurance Transactions
 
In December 2008, Assured Guaranty (UK) Ltd. (“AGUK”) filed an action against J.P. Morgan Investment Management Inc. (“JPMIM”), the investment manager in the Orkney Re II transaction, in the Supreme Court of the State of New York alleging that JPMIM engaged in breaches of fiduciary duty, gross negligence and breaches of contract based upon its handling of the investments of Orkney Re II. After AGUK’s claims were dismissed with prejudice in January 2010, AGUK was successful in its subsequent motions and appeals and, as of December 2011, all of AGUK’s claims for breaches of fiduciary duty, gross negligence and contract were reinstated in full. Separately, at the trial court level, discovery is ongoing.
 
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

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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 loss adjustment expenses ("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:
 

 
 

 
 

 
 

 
 

 
 

Prime first lien
$
2

 
$
—

 
$
2

 
$
3

 
$
—

 
$
3

Alt-A first lien
78

 
2

 
76

 
93

 
—

 
93

Option ARM
30

 
60

 
(30
)
 
52

 
216

 
(164
)
Subprime
108

 
2

 
106

 
82

 
0

 
82

Total first lien
218

 
64

 
154

 
230

 
216

 
14

Second lien:
 

 
 

 
 

 
 

 
 

 
 

Closed-end second lien
4

 
49

 
(45
)
 
5

 
72

 
(67
)
HELOC
22

 
147

 
(125
)
 
37

 
196

 
(159
)
Total second lien
26

 
196

 
(170
)
 
42

 
268

 
(226
)
Total U.S. RMBS
244

 
260

 
(16
)
 
272

 
484

 
(212
)
TruPS
2

 
—

 
2

 
1

 
—

 
1

Other structured finance
170

 
5

 
165

 
197

 
4

 
193

U.S. public finance
142

 
127

 
15

 
104

 
134

 
(30
)
Non-U.S. public finance
31

 
—

 
31

 
31

 
—

 
31

Total financial guaranty
589

 
392

 
197

 
605

 
622

 
(17
)
Other
2

 
5

 
(3
)
 
2

 
5

 
(3
)
Subtotal
591

 
397

 
194

 
607

 
627

 
(20
)
Effect of consolidating FG VIEs
(87
)
 
(103
)
 
16

 
(64
)
 
(217
)
 
153

Total (1)
$
504

 
$
294

 
$
210

 
$
543

 
$
410

 
$
133

____________________
(1)
See “Components of Net Reserves (Salvage)” table for loss and LAE reserve and salvage and subrogation recoverable components.
 

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Table of Contents

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, 2013
 
As of
December 31, 2012
 
(in millions)
Loss and LAE reserve
$
564

 
$
601

Reinsurance recoverable on unpaid losses
(60
)
 
(58
)
Subtotal
504

 
543

Salvage and subrogation recoverable
(331
)
 
(456
)
Salvage and subrogation payable(1)
37

 
46

Subtotal
(294
)
 
(410
)
Other recoveries(2)
(24
)
 
(30
)
Subtotal
(318
)
 
(440
)
  Total
186

 
103

Less: other (non-financial guaranty business)
(3
)
 
(3
)
Financial guaranty net reserves (salvage)
$
189

 
$
106

____________________
(1)
Recorded as a component of reinsurance balances payable.

(2)
R&W recoveries recorded in other assets on the consolidated balance sheet.
 
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
$
228

 
$
(71
)
 
$
157

 
$
449

 
$
(169
)
 
$
280

Loss and LAE reserve
443

 
(30
)
 
413

 
571

 
(33
)
 
538

____________________
(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
$
561

Less: net expected loss to be paid for FG VIEs
31

Total
530

Contra-paid, net
112

Salvage and subrogation recoverable, net of reinsurance
289

Loss and LAE reserve, net of reinsurance
(502
)
Other recoveries (1)
24

Net expected loss to be expensed (2)
$
453

____________________
(1)
R&W recoveries recorded in other assets on the consolidated balance sheet.
 
(2)
Excludes $105 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)
$
18

2013 (October 1–December 31)
17

Subtotal 2013
35

2014
54

2015
46

2016
40

2017
36

2018 - 2022
129

2023 - 2027
62

2028 - 2032
30

After 2032
21

Total present value basis(1)
453

Discount
411

Total future value
$
864

 
____________________
(1)
Consolidation of FG VIEs resulted in reductions of $105 million in net expected loss to be expensed.



44
Table of Contents

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:
 
 
 
 
 
 
 
Prime first lien
$
0

 
$
1

 
$
0

 
$
1

Alt-A first lien
(9
)
 
29

 
0

 
28

Option ARM
22

 
17

 
(61
)
 
69

Subprime
23

 
16

 
34

 
24

Total first lien
36

 
63

 
(27
)
 
122

Second lien:
 
 
 
 
 
 
 
Closed end second lien
(1
)
 
3

 
19

 
2

HELOC
(19
)
 
4

 
(16
)
 
19

Total second lien
(20
)
 
7

 
3

 
21

Total U.S. RMBS
16

 
70

 
(24
)
 
143

TruPS
(1
)
 
(2
)
 
(1
)
 
(6
)
Other structured finance
(9
)
 
29

 
(21
)
 
1

U.S. public finance
78

 
26

 
74

 
45

Non-U.S. public finance
—

 
5

 
1

 
195

Subtotal
84

 
128

 
29

 
378

Other
—

 
(6
)
 
—

 
(6
)
Total insurance contracts before FG VIE consolidation
84

 
122

 
29

 
372

Effect of consolidating FG VIEs
(22
)
 
(4
)
 
(15
)
 
(12
)
Total loss and LAE
$
62

 
$
118

 
$
14

 
$
360


 

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Table of Contents

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
FG VIEs
 
Total
 
Gross
 
Ceded
 
Gross
 
Ceded
 
Gross
 
Ceded
 
 
 

(dollars in millions)
Number of risks(1)
144

 
(47
)
 
83

 
(27
)
 
148

 
(52
)
 
375

 
—

 
375

Remaining weighted-average contract period (in years)
11.3

 
7.8

 
10.2

 
13.0

 
9.0

 
6.6

 
10.4

 
—

 
10.4

Outstanding exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Principal
$
7,135

 
$
(1,159
)
 
$
3,703

 
$
(394
)
 
$
7,065

 
$
(516
)
 
$
15,834

 
$
—

 
$
15,834

Interest
4,153

 
(463
)
 
1,849

 
(179
)
 
2,387

 
(151
)
 
7,596

 
—

 
7,596

Total(2)
$
11,288

 
$
(1,622
)
 
$
5,552

 
$
(573
)
 
$
9,452

 
$
(667
)
 
$
23,430

 
$
—

 
$
23,430

Expected cash outflows (inflows)
$
1,199

 
$
(435
)
 
$
916

 
$
(104
)
 
$
2,937

 
$
(141
)
 
$
4,372

 
$
(705
)
 
$
3,667

Potential recoveries(3)
(1,247
)
 
441

 
(516
)
 
29

 
(2,181
)
 
119

 
(3,355
)
 
629

 
(2,726
)
Subtotal
(48
)
 
6

 
400

 
(75
)
 
756

 
(22
)
 
1,017

 
(76
)
 
941

Discount
1

 
1

 
(118
)
 
26

 
(371
)
 
5

 
(456
)
 
45

 
(411
)
Present value of expected cash flows
$
(47
)
 
$
7

 
$
282

 
$
(49
)
 
$
385

 
$
(17
)
 
$
561

 
$
(31
)
 
$
530

Deferred premium revenue
$
168

 
$
(36
)
 
$
221

 
$
(30
)
 
$
647

 
$
(80
)
 
$
890

 
$
(202
)
 
$
688

Reserves (salvage)(4)
$
(86
)
 
$
11

 
$
125

 
$
(32
)
 
$
156

 
$
(1
)
 
$
173

 
$
16

 
$
189

 

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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
FG VIEs
 
Total
 
Gross
 
Ceded
 
Gross
 
Ceded
 
Gross
 
Ceded
 
 
(dollars in millions)
Number of risks(1)
153

 
(57
)
 
76

 
(22
)
 
142

 
(51
)
 
371

 
—

 
371

Remaining weighted-average contract period (in years)
11.0

 
9.3

 
11.5

 
15.3

 
8.5

 
5.8

 
10.2

 
—

 
10.2

Outstanding exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Principal
$
8,533

 
$
(1,484
)
 
$
2,741

 
$
(135
)
 
$
7,568

 
$
(540
)
 
$
16,683

 
$
—

 
$
16,683

Interest
4,357

 
(585
)
 
1,813

 
(131
)
 
2,269

 
(137
)
 
7,586

 
—

 
7,586

Total(2)
$
12,890

 
$
(2,069
)
 
$
4,554

 
$
(266
)
 
$
9,837

 
$
(677
)
 
$
24,269

 
$
—

 
$
24,269

Expected cash outflows (inflows)
$
1,582

 
$
(677
)
 
$
863

 
$
(58
)
 
$
3,052

 
$
(156
)
 
$
4,606

 
$
(738
)
 
$
3,868

Potential recoveries(3)
(1,629
)
 
653

 
(509
)
 
18

 
(2,639
)
 
142

 
(3,964
)
 
798

 
(3,166
)
Subtotal
(47
)
 
(24
)
 
354

 
(40
)
 
413

 
(14
)
 
642

 
60

 
702

Discount
(1
)
 
9

 
(107
)
 
14

 
(202
)
 
0

 
(287
)
 
36

 
(251
)
Present value of expected cash flows
$
(48
)
 
$
(15
)
 
$
247

 
$
(26
)
 
$
211

 
$
(14
)
 
$
355

 
$
96

 
$
451

Deferred premium revenue
$
111

 
$
(24
)
 
$
227

 
$
(15
)
 
$
757

 
$
(90
)
 
$
966

 
$
(251
)
 
$
715

Reserves (salvage)(4)
$
(103
)
 
$
(4
)
 
$
102

 
$
(18
)
 
$
(35
)
 
$
11

 
$
(47
)
 
$
153

 
$
106

 ____________________
(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 one of the Company’s 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 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

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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 and AGC had insured approximately $8.2 billion net par of VRDOs, of which approximately $0.4 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.
 
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

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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 37 fixed maturity securities, which was 5.8% or $612 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 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.
 

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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, $61 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 AGC’s CCS (the “AGC CCS Securities”) and AGM’s 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, Long Term Debt and Credit Facilities). The estimated current cost of the Company’s CCS is based 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.
 
 Supplemental Executive Retirement Plans

The Company classifies the fair value measurement of the assets of the Company's various supplemental executive retirement plans as either Level 1 or Level 2. The fair value of these assets is valued based on the observable published daily values of the underlying mutual fund included in the aforementioned plans (Level 1) or based upon the net asset value of the funds if a published daily value is not available (Level 2).
 
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

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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 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 expected premium cash flows.
 
The expected future premium cash flows for the Company’s credit derivatives were discounted at rates ranging from 0.20% to 3.45% at June 30, 2013 and 0.21% to 2.81% at December 31, 2012.
 

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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 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
6
%
 
6
%
Based on market indices
87
%
 
88
%
Provided by the CDS counterparty
7
%
 
6
%
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 closed 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

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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 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 AGC or AGM. For credit spreads on the Company’s name the Company obtains the quoted price of CDS contracts traded on AGC and AGM from market data sources published by third parties. The cost to acquire CDS protection referencing AGC or 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 AGC or AGM increases, the amount of premium the Company retains on a deal generally decreases. As the cost to acquire CDS protection referencing AGC or 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 25% and 71%, 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 and AGC's credit spreads narrowing to levels not seen since 2008. As a result of this, the cost to hedge AGC's and AGM's names 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 AGC and AGM hedged by its counterparties, with independent third parties each reporting period. The current level of AGC’s and AGM’s own credit spread has resulted in the bank or deal originator hedging a significant portion of its exposure to AGC and AGM. This reduces the amount of contractual cash flows AGC and 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.
 

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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
%
 
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 AGC, when the CDS spread on AGC 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 AGC, when the CDS spread on AGC 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 AGC’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 AGC or AGM's name.


54
Table of Contents

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 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.

55
Table of Contents

 
Long-Term Debt
 
The Company’s long-term debt, excluding notes payable, is valued by broker-dealers using third party independent pricing sources and standard market conventions. The market conventions utilize market quotations, market transactions for the Company’s comparable instruments, and to a lesser extent, similar instruments in the broader insurance industry. The fair value measurement was classified as Level 2 in the fair value hierarchy.
 
The fair value of the notes payable that are recorded within long-term debt was determined by calculating the present value of the expected cash flows. The Company determines discounted future cash flows using market driven discount rates and a variety of assumptions, 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 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 Invested Assets
 
The fair value of the other invested assets, which primarily consist of 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 discount rates and a variety of assumptions, including 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.


56
Table of Contents

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
$
741

 
$
—

 
$
741

 
$
—

Obligations of state and political subdivisions
5,334

 
—

 
5,298

 
36

Corporate securities
1,083

 
—

 
1,083

 
—

Mortgage-backed securities:
 

 
 
 
 
 
 
RMBS
1,127

 
—

 
851

 
276

Commercial mortgage-backed securities ("CMBS")
502

 
—

 
502

 
—

Asset-backed securities
483

 
—

 
183

 
300

Foreign government securities
294

 
—

 
294

 
—

Total fixed maturity securities
9,564


—

 
8,952

 
612

Short-term investments
943

 
766

 
177

 
—

Other invested assets (1)
69

 
—

 
61

 
8

Credit derivative assets
101

 
—

 
—

 
101

FG VIEs’ assets, at fair value
2,674

 
—

 
—

 
2,674

Other assets(2)
56

 
23

 
10

 
23

Total assets carried at fair value
$
13,407

 
$
789

 
$
9,200

 
$
3,418

Liabilities:
 

 
 

 
 

 
 

Credit derivative liabilities
$
2,349

 
$
—

 
$
—

 
$
2,349

FG VIEs’ liabilities with recourse, at fair value
1,940

 
—

 
—

 
1,940

FG VIEs’ liabilities without recourse, at fair value
1,134

 
—

 
—

 
1,134

Total liabilities carried at fair value
$
5,423

 
$
—

 
$
—

 
$
5,423

 

57
Table of Contents

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
$
794

 
$
—

 
$
794

 
$
—

Obligations of state and political subdivisions
5,631

 
—

 
5,596

 
35

Corporate securities
1,010

 
—

 
1,010

 
—

Mortgage-backed securities:
 

 
 

 
 

 
 

RMBS
1,266

 
—

 
1,047

 
219

CMBS
520

 
—

 
520

 
—

Asset-backed securities
531

 
—

 
225

 
306

Foreign government securities
304

 
—

 
304

 
—

Total fixed maturity securities
10,056

 
—

 
9,496

 
560

Short-term investments
817

 
446

 
371

 
—

Other invested assets (1)
120

 
—

 
112

 
8

Credit derivative assets
141

 
—

 
—

 
141

FG VIEs’ assets, at fair value
2,688

 
—

 
—

 
2,688

Other assets(2)
65

 
24

 
5

 
36

Total assets carried at fair value
$
13,887

 
$
470

 
$
9,984

 
$
3,433

Liabilities:
 

 
 

 
 

 
 

Credit derivative liabilities
$
1,934

 
$
—

 
$
—

 
$
1,934

FG VIEs’ liabilities with recourse, at fair value
2,090

 
—

 
—

 
2,090

FG VIEs’ liabilities without recourse, at fair value
1,051

 
—

 
—

 
1,051

Total liabilities carried at fair value
$
5,075

 
$
—

 
$
—

 
$
5,075

 ____________________
(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 fair value of $6 million and $7 million, respectively.
 
(2)    Includes fair value of CCS and supplemental executive retirement plan assets.

 

58
Table of Contents

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
$
35

 

$
221

 

$
286

 

$
1

 
$
2,813

 

$
26

 

$
(2,393
)
 
$
(2,071
)
 
$
(1,107
)
 
Total pretax realized and unrealized gains/(losses) recorded in:(1)
 
 

 

 

 

 

 

 
 

 

 

 

 

 

 

 

 

 

Net income (loss)
—

(2
)
6

(2
)
5

(2
)
(1
)
(7
)
341

(3
)
(3
)
(4
)
74

(6
)
(82
)
(3
)
(118
)
(3
)
Other comprehensive income (loss)
1

 

(3
)
 

—

 

2

 
—

 

—

 

—

 

—

 

—

 

Purchases
—

 

67

 

11

 

—

 
—

 

—

 

—

 

—

 

—

 

Settlements
—

 
(15
)
 
(2
)
 
—

 
(302
)
 
—

 

71

 

78

 

44

 

FG VIE consolidations
—

 

—

 

—

 

—

 
—

 

—

 

—

 

—

 
—

 

FG VIE deconsolidations
—

 
—

 
—

 
—

 
(178
)
 
—

 
—

 
135

 
47

 
Fair value as of June 30, 2013
$
36

 

$
276

 

$
300

 

$
2

 
$
2,674

 

$
23

 

$
(2,248
)
 
$
(1,940
)
 
$
(1,134
)
 
Change in unrealized gains/(losses) related to financial instruments held as of June 30, 2013
$
1

 
$
(3
)
 
$
1

 
$
2

 
$
231

 
$
(3
)
 
$
294

 
$
(82
)
 
$
(132
)
 


59
Table of Contents

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
$
9

 
$
136

 

$
258

 

$
2

 
$
2,828

 

$
40

 
$
(1,953
)
 

$
(2,365
)
 
(1,086
)
 
Total pretax realized and unrealized gains/(losses) recorded in:(1)
 
 
 

 

 
 

 
 
 
 

 
 
 
 

 
 

 
 

Net income (loss)
0

 
4

(2
)
8

(2
)
—

 
43

(3
)
4

(4
)
261

(6
)
(13
)
(3
)
(13
)
(3
)
Other comprehensive income (loss)
1

 
(17
)
 

(12
)
 

(1
)
 
—

 

—

 
—

 

—

 

—

 

Purchases
—

 
55

 

22

 

—

 
—

 

—

 
—

 

—

 

—

 

Settlements
—

 
(11
)
 
(2
)
 
—

 
(145
)
 
—

 
26

 

139

 

57

 

FG VIE consolidations
—

 
—

 

—

 

—

 
—

 

—

 
—

 

—

 
—

 

Fair value as of June 30, 2012
$
10

 
$
167

 

$
274

 

$
1

 
$
2,726

 

$
44

 
$
(1,666
)
 

$
(2,239
)
 
(1,042
)
 
Change in unrealized gains/(losses) related to financial instruments held as of June 30, 2012
$
1

 
$
(17
)
 
$
(12
)
 
$
(1
)
 
$
72

 
$
4

 
$
283

 
$
(18
)
 
(37
)
 



60
Table of Contents

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
$
35

 

$
219

 

$
306

 

$
1

 
$
2,688

 

$
36

 

$
(1,793
)
 
$
(2,090
)
 
$
(1,051
)
 
Total pretax realized and unrealized gains/(losses) recorded in:(1)


 



 



 



 


 



 



 



 



 

Net income (loss)
1

(2
)
11

(2
)
9

(2
)
(1
)
(7
)
556

(3
)
(13
)
(4
)
(518
)
(6
)
(163
)
(3
)
(192
)
(3
)
Other comprehensive income (loss)
1

 

4

 

(22
)
 

2

 


 

—

 

—

 

—

 

—

 

Purchases
—

 

70

 

11

 

—

 
—

 

—

 

—

 

—

 

—

 

Settlements
(1
)
 
(28
)
 
(4
)
 
—

 
(440
)
 
—

 

63

 

190

 

99

 

FG VIE consolidations
—

 

—

 

—

 

—

 
48

 

—

 

—

 

(12
)
 
(37
)
 

FG VIE deconsolidations
—

 
—

 
—

 
—

 
(178
)
 
—

 
—

 
135

 
47

 
Fair value as of June 30, 2013
$
36

 

$
276

 

$
300

 

$
2

 
$
2,674

 

$
23

 

$
(2,248
)
 
$
(1,940
)
 
$
(1,134
)
 
Change in unrealized gains/(losses) related to financial instruments held as of June 30, 2013
$
1

 
$
5

 
$
(21
)
 
$
2

 
$
430

 
$
(13
)
 
$
(317
)
 
$
(165
)
 
$
(226
)
 
 


61
Table of Contents

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

 

$
134

 

$
235

 

$
2

 
$
2,819

 

$
54

 

$
(1,304
)
 
$
(2,397
)
 
$
(1,061
)
 
Total pretax realized and unrealized gains/(losses) recorded in:(1)
 
 



 



 



 


 



 



 



 



 

Net income (loss)
0

(2
)
5

(2
)
14

(2
)
0

 
175

(3
)
(10
)
(4
)
(430
)
(6
)
(99
)
(3
)
(93
)
(3
)
Other comprehensive income (loss)
1

 

(7
)
 

(12
)
 

(1
)
 
—

 

—

 

—

 

—

 

—

 

Purchases
—

 

55

 

40

 

—

 
—

 

—

 

—

 

—

 

—

 

Settlements
(1
)
 
(20
)
 
(3
)
 
—

 
(283
)
 
—

 

68

 

277

 

112

 

FG VIE consolidations
—

 

—

 

—

 

—

 
15

 

—

 

—

 

(20
)
 
—

 

Fair value as of June 30, 2012
$
10

 

$
167

 
$
274

 
$
1

 
$
2,726

 
$
44

 
$
(1,666
)
 
$
(2,239
)
 
$
(1,042
)
 
Change in unrealized gains/(losses) related to financial instruments held as of June 30, 2012
$
1

 
$
(7
)
 
$
(12
)
 
$
(1
)
 
$
303

 
$
(10
)
 
$
(352
)
 
$
(125
)
 
$
(155
)
 
______________
(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.

(7)
Reported in other income.
 

62
Table of Contents

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
 
$
36

 
Discounted
 
Rate of inflation
 
1.0
%
-
3.0%
 
 
cash flow
 
Cash flow receipts
4.8
%
-
90.0%
 
 
 
 
Yield
5.2
%
 
9.0%
 
 
 
 
Collateral recovery period
1 month

-
42 years
 
 
 
 
 
 
 
 
 
 
 
RMBS
 
276

 
Discounted
 
CPR
 
1.0
%
-
7.5%
 
 
 cash flow
 
CDR
 
4.4
%
-
27.8%
 
 
 
 
Severity
 
47.9
%
-
102.8%
 
 
 
 
Yield
 
4.1
%
-
10.8%
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%
 
 
 
 
 
 
 
 
 
 
 
XXX life insurance transactions
 
74

 
Discounted
 
Yield
 
10.5%
 
 
 cash flow
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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
 
2,674

 
Discounted
 
CPR
 
0.6
%
-
11.8%
 
 
 cash flow
 
CDR
 
2.8
%
-
27.8%
 
 
 
 
Loss severity
 
38.1
%
-
106.4%
 
 
 
 
Yield
 
2.8
%
-
10.6%


 

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Financial Instrument Description
 
Fair Value at
June 30, 2013
(in millions)
 
Valuation
Technique
 
Significant Unobservable Inputs
 
Range
Other assets
 
23

 
Discounted cash flow
 
Quotes from third party pricing
 
$56
-
$57
 
 
 
 
Term (years)
 
3 years
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 
 
 
 
 
 
 
Credit derivative liabilities, net
 
(2,248
)
 
Discounted
 
Year 1 loss estimates
 
0.0
%
-
61.0%
 
 
 
cash flow
 
Hedge cost (in bps)
 
14.2

-
343.3
 
 
 
 
 
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
 
(3,074
)
 
Discounted
 
CPR
 
0.6
%
-
11.8%
 
 
cash flow
 
CDR
 
2.8
%
-
27.8%
 
 
 
 
Loss severity
 
38.1
%
-
106.4%
 
 
 
 
Yield
 
2.8
%
-
10.6%

 


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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
 
$
35

 
Discounted
 
Rate of inflation
 
1.0
%
-
3.0%
 
 
cash flow
 
Cash flow receipts
4.9
%
-
85.8%
 
 
 
 
Discount rates
4.3
%
 
9.0%
 
 
 
 
Collateral recovery period
1 month

-
43 years
 
 
 
 
 
 
 
 
 
 
 
RMBS
 
219

 
Discounted
 
CPR
 
0.8
%
-
7.5%
 
 
 cash flow
 
CDR
 
4.4
%
-
28.6%
 
 
 
 
Severity
 
48.1
%
-
102.8%
 
 
 
 
Yield
 
3.5
%
-
12.8%
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%
 
 
 
 
 
 
 
 
 
 
 
XXX life insurance transactions
 
57

 
Discounted
 
Yield
 
12.5%
 
 
 cash flow
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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
 
2,688

 
Discounted
 
CPR
 
0.5
%
-
10.9%
 
 
 cash flow
 
CDR
 
3.0
%
-
28.6%
 
 
 
 
Loss severity
 
37.5
%
-
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
 
36

 
Discounted cash flow
 
Quotes from third party pricing
 
$38
-
$51
 
 
 
 
Term (years)
 
3 years
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 
 
 
 
 
 
 
Credit derivative liabilities, net
 
(1,793
)
 
Discounted
 
Year 1 loss estimates
 
0.0
%
-
58.7%
 
 
 
cash flow
 
Hedge cost (in bps)
 
64.2

-
678.4
 
 
 
 
 
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
 
(3,141
)
 
Discounted
 
CPR
 
0.5
%
-
10.9%
 
 
cash flow
 
CDR
 
3.0
%
-
28.6%
 
 
 
 
Loss severity
 
37.5
%
-
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
$
9,564

 
$
9,564

 
$
10,056

 
$
10,056

Short-term investments
943

 
943

 
817

 
817

Other invested assets
102

 
110

 
177

 
182

Credit derivative assets
101

 
101

 
141

 
141

FG VIEs’ assets, at fair value
2,674

 
2,674

 
2,688

 
2,688

Other assets
177

 
177

 
166

 
166

Liabilities:
 

 
 

 
 

 
 

Financial guaranty insurance contracts(1)
3,725

 
5,210

 
3,918

 
6,537

Long-term debt
827

 
1,095

 
836

 
1,091

Credit derivative liabilities
2,349

 
2,349

 
1,934

 
1,934

FG VIEs’ liabilities with recourse, at fair value
1,940

 
1,940

 
2,090

 
2,090

FG VIEs’ liabilities without recourse, at fair value
1,134

 
1,134

 
1,051

 
1,051

Other liabilities
74

 
74

 
47

 
47

____________________
(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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Table of Contents

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 3.9 years at June 30, 2013 and 3.7 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 obligation/collateral bond obligations
 
$
22,954

 
31.9
%
 
34.2
%
 
AAA
 
$
29,142

 
32.8
%
 
33.3
%
 
AAA
Synthetic investment grade pooled corporate
 
9,626

 
21.6

 
19.7

 
AAA
 
9,658

 
21.6

 
19.7

 
AAA
Synthetic high yield pooled corporate
 
2,690

 
47.2

 
41.1

 
AAA
 
3,626

 
35.0

 
30.3

 
AAA
TruPS CDOs
 
3,716

 
46.1

 
33.5

 
BB
 
4,099

 
46.5

 
32.7

 
BB
Market value CDOs of corporate obligations
 
3,111

 
31.2

 
32.7

 
AAA
 
3,595

 
30.1

 
32.0

 
AAA
Total pooled corporate obligations
 
42,097

 
31.7

 
31.1

 
AAA
 
50,120

 
31.7

 
30.4

 
AAA
U.S. RMBS:
 
 

 


 
 

 
 
 
 

 
 

 
 

 
 
Option ARM and Alt-A first lien
 
3,112

 
20.0

 
10.1

 
B+
 
3,381

 
20.2

 
10.4

 
B+
Subprime first lien
 
3,195

 
30.1

 
51.7

 
AA-
 
3,494

 
29.8

 
52.6

 
A+
Prime first lien
 
302

 
10.9

 
5.2

 
B
 
333

 
10.9

 
5.2

 
B
Closed end second lien and HELOCs
 
25

 
—

 
—

 
CCC
 
49

 
—

 
—

 
B-
Total U.S. RMBS
 
6,634

 
24.3

 
29.9

 
BBB
 
7,257

 
24.2

 
30.4

 
BBB
CMBS
 
3,816

 
33.4

 
41.5

 
AAA
 
4,094

 
33.3

 
41.8

 
AAA
Other
 
8,332

 
—

 
—

 
A
 
9,310

 
—

 
—

 
A-
Total
 
$
60,879

 
 

 
 

 
AA+
 
$
70,781

 
 

 
 

 
AA+
____________________
(1)
Represents the sum of subordinate tranches and over-collateralization and does not include any benefit from excess interest collections that may be used to absorb losses.


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Table of Contents

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 Company’s TruPS CDO asset pools are generally less diversified by obligors and industries than the typical CLO asset pool. Also, the underlying collateral in TruPS CDOs consists primarily of subordinated debt instruments such as TruPS issued by bank holding companies and similar instruments issued by insurance companies, REITs and other real estate related issuers while CLOs typically contain primarily senior secured obligations. However, to mitigate these risks TruPS CDOs were typically structured with higher levels of embedded credit enhancement than typical CLOs.
 
The Company’s exposure to “Other” CDS contracts is also highly diversified. It includes $3.0 billion of exposure to three pooled infrastructure transactions comprising diversified pools of international infrastructure project transactions and loans to regulated utilities. These pools were all structured with underlying credit enhancement sufficient for the Company to attach at AAA levels at origination. The remaining $5.3 billion of exposure in “Other” CDS contracts comprises numerous deals across various asset classes, such as commercial receivables, international RMBS, infrastructure, regulated utilities and consumer receivables. Of the total net par outstanding in the "Other" sector, $0.5 million is rated BIG.

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
 
$
43,763

 
71.9
%
 
$
50,918

 
71.9
%
AA
 
3,807

 
6.3

 
3,083

 
4.4

A
 
3,365

 
5.5

 
5,487

 
7.8

BBB
 
4,146

 
6.8

 
4,584

 
6.4

BIG
 
5,798

 
9.5

 
6,709

 
9.5

Total credit derivative net par outstanding
 
$
60,879

 
100.0
%
 
$
70,781

 
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
$
41

 
$
34

 
$
68

 
$
63

Net ceding commissions (paid and payable) received and receivable
0

 
0

 
1

 
0

Realized gains on credit derivatives
41

 
34

 
69

 
63

Terminations
—

 
(1
)
 
—

 
(1
)
Net credit derivative losses (paid and payable) recovered and recoverable
(127
)
 
(56
)
 
(137
)
 
(142
)
Total realized gains (losses) and other settlements on credit derivatives
(86
)
 
(23
)
 
(68
)
 
(80
)
Net unrealized gains (losses) on credit derivatives
160

 
284

 
(450
)
 
(350
)
Net change in fair value of credit derivatives
$
74

 
$
261

 
$
(518
)
 
$
(430
)


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Table of Contents

In Second Quarter 2013 and 2012, CDS contracts totaling $2.0 billion and $0.6 billion in net par were terminated, resulting in accelerations of credit derivative revenues of $14 million in Second Quarter 2013 and $0.7 million in Second Quarter 2012. In Six Months 2013 and 2012, CDS contracts totaling $3.0 billion and $0.8 billion in net par were terminated, resulting in accelerations of credit derivative revenues of $15 million in Six Months 2013 and $1 million in Six Months 2012. In Second Quarter 2013, in addition to the CDS terminations mentioned above, the Company terminated a film securitization CDS for a payment of $120 million which was recorded in realized gains (losses) and other settlements on credit derivatives, with a corresponding release of the unrealized loss recorded in unrealized gains (losses) on credit derivatives of $127 million for a net change in fair value of credit derivatives of $7 million.
 
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.
 
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:
 
$
(34
)
 
$
25

 
$
(139
)
 
$
30

U.S. RMBS
 
14

 
250

 
(443
)
 
(379
)
CMBS
 
(1
)
 
0

 
(4
)
 
0

Other
 
181

 
9

 
136

 
(1
)
Total
 
$
160

 
$
284

 
$
(450
)
 
$
(350
)
 
During Second Quarter 2013, unrealized fair value gains were driven primarily by the termination of a film securitization transaction and price improvement on a XXX life securitization transaction, both in the Other sector. These unrealized gains were slightly offset by wider implied net spreads in the pooled corporate obligations sector. The wider implied net spreads were primarily a result of asset prices on the Company's pooled corporate obligations deteriorating during the period, as well as the decreased cost to buy protection in AGC's name as the market cost of AGC's credit decreased during the period. These transactions were pricing at or above their floor levels (or the minimum rate at which the Company would expect to consider assuming these risks based on historical experience); therefore when the cost of purchasing CDS protection on AGC, which management refers to as the CDS spread on AGC, decreased the implied spreads that the Company would expect to receive on these transactions increased. As indicated below, the credit spread of both the 5 Year and 1 Year CDS spread on AGC decreased in Second Quarter 2013. 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 AGM's current outstanding exposure continue to price at floor levels.

During Six Months 2013, the cost to buy protection on AGC's name declined. This led to U.S. RMBS unrealized fair value losses which were generated primarily in the Alt-A, prime first lien and subprime RMBS sectors due to wider implied net spreads. The wider implied net spreads were primarily a result of the decreased cost to buy protection in AGC's name as the market cost of AGC's credit decreased significantly during the period. These transactions were pricing at or above their floor levels; therefore when the cost of purchasing CDS protection on AGC decreased, the implied spreads that the Company would expect to receive on these transactions increased. As indicated below, the credit spread of both the 5 Year and 1 Year CDS spread on AGC decreased significantly in Six Months 2013. To calculate the fair value of the CDS contracts, the Company matches the tenor of the CDS contracts in the Company's portfolio to the tenor of the CDS spread purchased in AGC's name. The cost of AGM's 5 Year and 1 Year credit protection also decreased during Six Months 2013, but did not lead to significant fair value losses, as the policies which represent the majority of AGM's current outstanding exposure continue to price at floor levels. Six Months 2013 changes in fair value of credit derivatives in the Other category includes a $20 million loss for guaranteed interest rate swaps identified during 2013.

     In Second Quarter 2012, U.S. RMBS unrealized fair value gains were generated primarily in the prime first lien, Alt-A, Option ARM and subprime RMBS sectors due to tighter implied net spreads. The tighter implied net spreads were primarily a result of the increased cost to buy protection in AGC's name as the market cost of AGC's credit protection increased. These transactions were pricing above their floor levels; therefore when the cost of purchasing CDS protection on AGC increased, the

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Table of Contents

implied spreads that the Company would expect to receive on these transactions decreased. The cost of AGM's credit protection also increased during the quarter, but did not lead to significant fair value gains, as the majority of AGM policies continue to price at floor levels. In addition, Second Quarter 2012 included an $85 million unrealized gain relating to R&W benefits from the Deutsche Bank Agreement.

During Six Months 2012, the cost to buy protection on AGC's name declined. This led to U.S. RMBS unrealized fair value losses which were generated primarily in the prime first lien, Alt-A and Option ARM RMBS sectors due to wider implied net spreads. The wider implied net spreads were primarily a result of the decreased cost to buy protection in AGC's name as the market cost of AGC's credit protection decreased. These transactions were pricing above their floor levels; therefore when the cost of purchasing CDS protection on AGC decreased, the implied spreads that the Company would expect to receive on these transactions increased. The cost of AGM's credit protection also decreased during Six Months 2012, but did not lead to significant fair value losses, as the majority of AGM policies continue to price at floor levels.

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 AGC and AGM. The Company determines its own credit risk based on quoted CDS prices traded on the Company at each balance sheet date. Generally, a widening of the CDS prices traded on AGC and AGM has an effect of offsetting unrealized losses that result from widening general market credit spreads, while a narrowing of the CDS prices traded on AGC and AGM has an effect of offsetting unrealized gains that result from narrowing general market credit spreads.
 
Five-Year CDS Spread on AGC and 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):
 

 
 
 
 

 
 
 
 
 
 
AGC
343

 
397

 
678

 
904

 
743

 
1,140

AGM
365

 
380

 
536

 
652

 
555

 
778

 
One-Year CDS Spread on AGC and 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):
 

 
 
 
 

 
 
 
 
 
 
AGC
57

 
59

 
270

 
629

 
594

 
965

AGM
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 AGC and AGM credit spreads
$
(3,961
)
 
$
(4,809
)
Plus: Effect of AGC and AGM credit spreads
1,713

 
3,016

Net fair value of credit derivatives
$
(2,248
)
 
$
(1,793
)
 
The fair value of CDS contracts at June 30, 2013, before considering the implications of AGC’s and AGM’s credit spreads, is a direct result of continued wide credit spreads in the fixed income security markets and ratings downgrades. The asset classes that remain most affected are 2005-2007 vintages of prime first lien, Alt-A, Option ARM, subprime RMBS deals as well as trust-preferred and pooled corporate securities. Comparing June 30, 2013 with December 31, 2012, there was a narrowing of spreads primarily related to Alt-A first lien, Option ARM, and subprime RMBS transactions, as well as the Company's pooled corporate obligations. This narrowing of spreads combined with the run-off of par outstanding and

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termination of securities, resulted in a gain of approximately $848 million, before taking into account AGC’s or AGM’s credit spreads.
 
Management believes that the trading level of AGC’s and AGM’s credit spreads over the past several years has been due to the correlation between AGC’s and AGM’s risk profile and the current risk profile of the broader financial markets and to increased demand for credit protection against AGC and 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 AGC’s and 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, TruPS 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
 
$
(135
)
 
$
6

 
$
(19
)
 
$
(16
)
U.S. RMBS
 
(1,679
)
 
(1,237
)
 
(197
)
 
(181
)
CMBS
 
(7
)
 
(2
)
 
—

 
—

Other
 
(427
)
 
(560
)
 
43

 
(85
)
Total
 
$
(2,248
)
 
$
(1,793
)
 
$
(173
)
 
$
(282
)
 ____________________
(1) 
Represents amount in excess of the present value of future installment fees to be received of $43 million as of June 30, 2013 and $43 million as of December 31, 2012. Includes R&W benefit of $204 million as of June 30, 2013 and $237 million as of December 31, 2012.

Ratings Sensitivities of Credit Derivative Contracts
 
Within the Company’s insured CDS portfolio, the transaction documentation for approximately $1.8 billion in CDS gross par insured as of June 30, 2013 provides that a downgrade of AGC's financial strength rating below BBB- or Baa3 would constitute a termination event that would allow the CDS counterparty to terminate the affected transactions. If the CDS counterparty elected to terminate the affected transactions, AGC could be required to make a termination payment (or may be entitled to receive a termination payment from the CDS counterparty). The Company does not believe that it can accurately estimate the termination payments AGC could be required to make if, as a result of any such downgrade, the CDS counterparty terminated the affected transactions. These payments could have an adverse effect on the Company’s liquidity and financial condition.
 
The transaction documentation for approximately $11.6 billion in CDS gross par insured as of June 30, 2013 requires certain of the Company's insurance subsidiaries to post eligible collateral to secure its obligation to make payments under such contracts. Eligible collateral is generally cash or U.S. government or agency securities; eligible collateral other than cash is valued at a discount to the face amount. For approximately $11.3 billion of such contracts, AGC has negotiated caps such that the posting requirement cannot exceed a certain fixed amount, regardless of the mark-to-market valuation of the exposure or the financial strength ratings of AGC. For such contracts, AGC need not post on a cash basis more than $675 million, which amount is already being posted by AGC and is part of the approximately $680 million posted by the Company's insurance subsidiaries. For the remaining approximately $381 million of such contracts, the Company could be required from time to time to post additional collateral based on movements in the mark-to-market valuation of the underlying exposure. Of the $680 million being posted by the Company's insurance subsidiaries, approximately $64 million relate to such $381 million of notional.


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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 AGC and AGM and on the risks that they both assume.
 
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
 
$
(4,558
)
 
$
(2,310
)
50% widening in spreads
 
(3,403
)
 
(1,155
)
25% widening in spreads
 
(2,826
)
 
(578
)
10% widening in spreads
 
(2,479
)
 
(231
)
Base Scenario
 
(2,248
)
 
—

10% narrowing in spreads
 
(2,037
)
 
211

25% narrowing in spreads
 
(1,720
)
 
528

50% narrowing in spreads
 
(1,192
)
 
1,056

 ____________________
(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. AGC and AGM do not sponsor any VIEs when underwriting third party financial guaranty insurance or credit derivative transactions, nor has either of them acted 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.
 
AGC and AGM are 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. AGL’s and its Subsidiaries’ 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 AGC or 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 1,100 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
33

 
33

Consolidated(1)
11

 
2

Deconsolidated(1)
(2
)
 
—

Matured
(1
)
 
(2
)
End of the period
41

 
33

____________________
(1)
Net loss on consolidation and deconsolidation was $7 million in Six Months 2013 and $6 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 $820 million at June 30, 2013. The aggregate unpaid principal of the FG VIEs’ assets was approximately $2,169 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 2013 were gains of $97 million and $168 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 $84 million and $170 million, respectively.
 
The aggregate unpaid principal balance was approximately $1,739 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 lien
25

 
$
653

 
$
849

 
14

 
$
618

 
$
825

Second lien
14

 
492

 
731

 
16

 
633

 
915

Other
2

 
360

 
360

 
3

 
350

 
350

Total with recourse
41

 
1,505

 
1,940

 
33

 
1,601

 
2,090

Without recourse
—

 
1,169

 
1,134

 
—

 
1,087

 
1,051

Total
41

 
$
2,674

 
$
3,074

 
33

 
$
2,688

 
$
3,141


 

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Table of Contents

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)
$
2,481

 
$
2,808

____________________ 
(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 AGC and AGM FG VIE liabilities with recourse and (3) the elimination of investment balances related to the Company’s purchase of AGC and 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 Shareholders’ Equity
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
 
 
 
 
Net earned premiums
$
(15
)
 
$
(16
)
 
$
(33
)
 
$
(33
)
Net investment income
(4
)
 
(3
)
 
(7
)
 
(6
)
Net realized investment gains (losses)
1

 
3

 
2

 
4

Fair value gains (losses) on FG VIEs
143

 
168

 
213

 
127

Loss and LAE
22

 
4

 
15

 
12

Total pretax effect on net income
147

 
156

 
190

 
104

Less: tax provision (benefit)
51

 
55

 
66

 
37

Total effect on net income (loss)
$
96

 
$
101

 
$
124

 
$
67

 

 
As of
June 30, 2013
 
As of
December 31, 2012
 
(in millions)
Total (decrease) increase on shareholders’ equity
$
(226
)
 
$
(348
)


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 $143 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 $213 million pre-tax fair value gain of consolidated FG VIEs during Six Months 2013. The additional gain of $64 million for Six Months 2013 was also a result of an 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 $168 million. The majority of this gain, $161 million, is a result of a R&W settlement with Deutsche Bank during the period. This was also the primary driver of the $127 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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Table of Contents

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 investment income on fixed maturity securities, short-term investments and assets acquired in refinancing transactions was $94 million and $97 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
$
81

 
$
88

 
$
160

 
$
175

Income from fixed maturity securities purchased or obtained for loss mitigation purposes
12

 
15

 
28

 
27

Other (1)
2

 
1

 
3

 
2

Gross investment income
95

 
104

 
191

 
204

Investment expenses
(2
)
 
(3
)
 
(4
)
 
(5
)
Net investment income
$
93

 
$
101

 
$
187

 
$
199

____________________
(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
$
16

 
$
17

 
$
55

 
$
26

Gross realized losses on investment portfolio
(7
)
 
(18
)
 
(13
)
 
(21
)
Other-than-temporary impairment ("OTTI")
(7
)
 
(2
)
 
(12
)
 
(7
)
Net realized investment gains (losses)
$
2


$
(3
)
 
$
30

 
$
(2
)
 

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Table of Contents

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").
 
Roll Forward of Credit Losses in the Investment Portfolio

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Balance, beginning of period
$
69

 
$
51

 
$
64

 
$
47

Additions for credit losses on securities for which an OTTI was not previously recognized
—

 
—

 
1

 
2

Additions for credit losses on securities for which an OTTI was previously recognized
3

 
2

 
7

 
4

Balance, end of period
$
72

 
$
53

 
$
72

 
$
53

 
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
 
7
%
 
$
706

 
$
40

 
$
(5
)
 
$
741

 
$
—

 
AA+
Obligations of state and political subdivisions
 
50

 
5,101

 
273

 
(40
)
 
5,334

 
5

 
AA
Corporate securities
 
10

 
1,055

 
42

 
(14
)
 
1,083

 
0

 
A+
Mortgage-backed securities(4):
 
0

 
 
 
 
 
 

 
 
 
 

 

RMBS
 
11

 
1,172

 
35

 
(80
)
 
1,127

 
(61
)
 
A+
CMBS
 
5

 
483

 
22

 
(3
)
 
502

 
—

 
AAA
Asset-backed securities
 
4

 
459

 
31

 
(7
)
 
483

 
17

 
BIG
Foreign government securities
 
4

 
291

 
7

 
(4
)
 
294

 
0

 
AA+
Total fixed maturity securities
 
91

 
9,267

 
450

 
(153
)
 
9,564

 
(39
)
 
AA-
Short-term investments
 
9

 
943

 
0

 
0

 
943

 
—

 
AAA
Total investment portfolio
 
100
%
 
$
10,210

 
$
450

 
$
(153
)
 
$
10,507

 
$
(39
)
 
AA-


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Table of Contents

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
 
7
%
 
$
732

 
$
62

 
$
0

 
$
794

 
$
—

 
AA+
Obligations of state and political subdivisions
 
51

 
5,153

 
489

 
(11
)
 
5,631

 
9

 
AA
Corporate securities
 
9

 
930

 
80

 
0

 
1,010

 
0

 
AA-
Mortgage-backed securities(4):
 
 

 
 

 
 

 
 

 
 

 
 

 
 
RMBS
 
13

 
1,281

 
62

 
(77
)
 
1,266

 
(59
)
 
A+
CMBS
 
5

 
482

 
38

 
0

 
520

 
—

 
AAA
Asset-backed securities
 
5

 
482

 
59

 
(10
)
 
531

 
43

 
BIG
Foreign government securities
 
2

 
286

 
18

 
0

 
304

 
0

 
AAA
Total fixed maturity securities
 
92

 
9,346

 
808

 
(98
)
 
10,056

 
(7
)
 
AA-
Short-term investments
 
8

 
817

 
0

 
0

 
817

 
—

 
AAA
Total investment portfolio
 
100
%
 
$
10,163

 
$
808

 
$
(98
)
 
$
10,873

 
$
(7
)
 
AA-
____________________
(1)
Based on amortized cost.
 
(2)
Accumulated OCI ("AOCI"). See also Note 17.
 
(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 55% of mortgage backed securities as of June 30, 2013 and 61% 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.
 

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Table of Contents

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.
 
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
$
175

 
$
(5
)
 
$
—

 
$
—

 
$
175

 
$
(5
)
Obligations of state and political subdivisions
629

 
(40
)
 
—

 
—

 
629

 
(40
)
Corporate securities
319

 
(14
)
 
—

 
—

 
319

 
(14
)
Mortgage-backed securities:
 
 
 
 
 
 
 

 


 


RMBS
427

 
(19
)
 
143

 
(61
)
 
570

 
(80
)
CMBS
59

 
(3
)
 
—

 
—

 
59

 
(3
)
Asset-backed securities
54

 
(5
)
 
10

 
(2
)
 
64

 
(7
)
Foreign government securities
155

 
(4
)
 
—

 
—

 
155

 
(4
)
Total
$
1,818

 
$
(90
)
 
$
153

 
$
(63
)
 
$
1,971

 
$
(153
)
Number of securities
 

 
365

 
 

 
18

 
 

 
383

Number of securities with OTTI
 

 
6

 
 

 
8

 
 

 
14

 
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
$
62

 
$
0

 
$
—

 
$
—

 
$
62

 
$
0

Obligations of state and political subdivisions
79

 
(11
)
 
—

 
—

 
79

 
(11
)
Corporate securities
25

 
0

 
—

 
—

 
25

 
0

Mortgage-backed securities:
 

 
 

 
 

 
 

 


 


RMBS
108

 
(19
)
 
121

 
(58
)
 
229

 
(77
)
CMBS
5

 
0

 
—

 
—

 
5

 
0

Asset-backed securities
16

 
0

 
35

 
(10
)
 
51

 
(10
)
Foreign government securities
8

 
0

 
—

 
—

 
8

 
0

Total
$
303

 
$
(30
)
 
$
156

 
$
(68
)
 
$
459

 
$
(98
)
Number of securities
 

 
58

 
 

 
16

 
 

 
74

Number of securities with OTTI
 

 
5

 
 

 
6

 
 

 
11

 
Of the securities in an unrealized loss position for 12 months or more as of June 30, 2013, ten securities had unrealized losses greater than 10% of book value. The total unrealized loss for these securities as of June 30, 2013 was $63 million. The Company has determined that the unrealized losses recorded as of June 30, 2013 are yield related and not the result of OTTI.
 

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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.
 
Distribution of Fixed-Maturity Securities
by Contractual Maturity
As of June 30, 2013
 
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Due within one year
$
260

 
$
264

Due after one year through five years
1,477

 
1,539

Due after five years through 10 years
2,346

 
2,446

Due after 10 years
3,529

 
3,686

Mortgage-backed securities:
 

 
 

RMBS
1,172

 
1,127

CMBS
483

 
502

Total
$
9,267

 
$
9,564

 
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 $359 million and $368 million as of June 30, 2013 and December 31, 2012, respectively. In addition, to fulfill state licensing requirements the Company has placed on deposit eligible securities of $22 million and $27 million as of June 30, 2013 and December 31, 2012, respectively. To provide collateral for a letter of credit, the Company holds a fixed maturity investment in a segregated account equal to 120% of the letter of credit, which amounted to $3.5 million and $3.5 million as of June 30, 2013 and December 31, 2012, respectively.

Under certain derivative contracts, the Company is required to post eligible securities as collateral. The need to post collateral under these transactions is generally based on fair value assessments in excess of contractual thresholds. The fair value of the Company’s pledged securities totaled $680 million and $660 million as of June 30, 2013 and December 31, 2012, respectively. See Note 8, Financial Guaranty Contracts Accounted for as Credit Derivatives, for the effect of the downgrade on collateral posted.
 
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 AGC, or assets may be obtained as part of a negotiated agreement.


79
Table of Contents

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
$
36

 
$
35

   RMBS
256

 
215

   Asset-backed securities
300

 
306

Other invested assets:
 
 
 
   Assets acquired in refinancing transactions
61

 
72

   Other
24

 
42

Total
$
677

 
$
670

 

11.
Insurance Company Regulatory Requirements
 
Dividend Restrictions and Capital Requirements
 
AGC is a Maryland domiciled insurance company. Under Maryland's insurance law, AGC may, with prior notice to the Maryland Insurance Commissioner, pay an ordinary dividend that, together with all dividends paid in the prior 12 months, does not exceed 10% of its policyholders' surplus (as of the prior December 31) or 100% of its adjusted net investment income during that period. As of June 30, 2013, approximately $73 million was available for distribution of dividends, after giving effect to dividends paid in the prior 12 months of approximately $17 million. This amount does not take into account a series of transactions that Assured Guaranty completed in July 2013 in order to capitalize its subsidiary MAC, including AGC contributing cash and marketable securities to Municipal Assurance Holdings Inc. (“MAC Holdings”), a holding company newly formed to own 100% of MAC's outstanding common stock, ceding a portfolio of policies covering U.S. municipal bonds to MAC, and paying MAC unearned premium for such cession.
 
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, ceding a portfolio of policies covering U.S. municipal bonds to MAC, and paying MAC unearned premium for such cession.

As of July 31, 2013, AG Re had unencumbered assets of approximately $280 million. AG Re maintains unencumbered assets for general corporate purposes, including placing additional assets in trust for the benefit of cedants to reflect declines in the market value of previously posted assets or additional ceded reserves. We expect unencumbered assets to decline in third quarter 2013 due to collateral posting requirements related to Detroit exposures. AG Re is an insurance company registered and licensed under the Insurance Act 1978 of Bermuda, amendments thereto and related regulations. Based on regulatory capital requirements AG Re currently has $600 million of excess capital and surplus. As a Class 3B insurer, AG Re is restricted from distributing capital or paying dividends by the following regulatory requirements:

•
Dividends shall not exceed outstanding statutory surplus or $440 million.

•
Dividends on annual basis shall not exceed 25% of its total statutory capital and surplus (as set out in its previous year's financial statements) or $321 million unless it files (at least seven days before payment of such dividends) with the Bermuda Monetary Authority an affidavit stating that it will continue to meet the required margins.

•
Capital distributions on an annual basis shall not exceed 15% of its total statutory capital (as set out in its previous year's financial statements) or $126 million, unless approval is granted by the Bermuda Monetary Authority.

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•
Dividends are limited by requirements that the subject company must at all times (i) maintain the minimum solvency margin and the Company's applicable enhanced capital requirements required under the Insurance Act of 1978 and (ii) have relevant assets in an amount at least equal to 75% of relevant liabilities, both as defined under the Insurance Act of 1978.
 
Dividends Paid and Repayment of Surplus Note
By Insurance Company Subsidiaries

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Dividends paid by AGC to AGUS
$
17

 
$
40

 
$
17

 
$
55

Dividends paid by AGM to AGMH
38

 
—

 
38

 
30

Dividends paid by AG Re to AGL
60

 
40

 
100

 
70

Repayment of surplus note by AGM to AGMH
—

 
50

 
25

 
50

 
12.
Income Taxes

Provision for Income Taxes
 
AGL and its Bermuda Subsidiaries, which include AG Re, Assured Guaranty Re Overseas Ltd. (“AGRO”), Assured Guaranty (Bermuda) Ltd. and Cedar Personnel Ltd., are 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, AGL and its Bermuda Subsidiaries will be exempt from taxation in Bermuda until March 31, 2035. The Company’s U.S. and U.K. subsidiaries are subject to income taxes imposed by U.S. and U.K. authorities, respectively, and file applicable tax returns. In addition, AGRO, a Bermuda domiciled company and Assured Guaranty (Europe) Ltd., a U.K. domiciled company, have elected under Section 953(d) of the U.S. Internal Revenue Code to be taxed as a U.S. domestic corporation.
 
In conjunction with the acquisition of AGMH on July 1, 2009 ("AGMH Acquisition"), AGMH has joined the consolidated federal tax group of AGUS, AGC, and AG Financial Products Inc. (“AGFP”). In conjunction with the acquisition of MAC (formerly Municipal and Infrastructure Assurance Corporation) on May 31, 2012 (the "MAC Acquisition"), MAC has joined the consolidated federal tax group. For the periods beginning on July 1, 2009 and forward, AGMH files a consolidated federal income tax return with AGUS, AGC, AGFP and AG Analytics Inc. (“AGUS consolidated tax group”). Assured Guaranty Overseas US Holdings Inc. and its subsidiaries AGRO, Assured Guaranty Mortgage Insurance Company and AG Intermediary Inc., have historically filed their own consolidated federal income tax return.

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.
    
The effective tax rates reflect the proportion of income recognized by each of the Company’s operating subsidiaries, with U.S. subsidiaries taxed at the U.S. marginal corporate income tax rate of 35%, U.K. subsidiaries taxed at the U.K. blended marginal corporate tax rate of 23.25% unless subject to U.S. tax by election or as a U.S. controlled foreign corporation, and no taxes for the Company’s Bermuda holding company and Bermuda subsidiaries unless subject to U.S. tax by election or as a U.S. controlled foreign corporation. 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.
 
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.


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Effective Tax Rate Reconciliation
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Expected tax provision (benefit) at statutory rates in taxable jurisdictions
$
124

 
$
191

 
$
76

 
$
(8
)
Tax-exempt interest
(15
)
 
(16
)
 
(29
)
 
(31
)
Change in liability for uncertain tax positions
1

 
1

 
(7
)
 
1

Other
0

 
1

 
2

 
2

Total provision (benefit) for income taxes
$
110

 
$
177

 
$
42

 
$
(36
)
Effective tax rate
33.5
%
 
32.0
%
 
36.4
%
 
25.0
%

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. Where there is a pretax loss in one jurisdiction and pretax income in another, the total combined expected tax rate may be higher or lower than any of the individual statutory rates.
 
The following table presents pretax income and revenue by jurisdiction.
 
Pretax Income (Loss) by Tax Jurisdiction

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
United States
$
353

 
$
546

 
$
219

 
$
(22
)
Bermuda
(24
)
 
8

 
(102
)
 
(120
)
UK
0

 
0

 
0

 
0

Total
$
329

 
$
554

 
$
117

 
$
(142
)
 
Revenue by Tax Jurisdiction

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
United States
$
425

 
$
676

 
$
298

 
$
391

Bermuda
40

 
79

 
(9
)
 
2

UK
0

 
0

 
0

 
0

Total
$
465

 
$
755

 
$
289

 
$
393

 
Pretax income by jurisdiction may be disproportionate to revenue by jurisdiction to the extent that insurance losses incurred are disproportionate.

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 the Company 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.

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Uncertain Tax Positions
    
The following table provides a reconciliation of the beginning and ending balances of the total liability for unrecognized tax benefits. The balance of unrecognized tax benefits has been reduced due to the closing of an IRS audit.

 
As of June 30, 2013
 
As of December 31, 2012
 
(in millions)
Balance at the beginning of the period
$
22

 
$
20

Decrease due to closing of IRS audit
(9
)
 
—

Increase in unrecognized tax benefits as a result of position taken during the current period
2

 
2

Balance, end of period
$
15

 
$
22


The Company's policy is to recognize interest and penalties related to uncertain tax positions in income tax expense. As of June 30, 2013, the Company has accrued $3 million of interest.

AGUS has open tax years with the U.S. Internal Revenue Service (“IRS”) for 2009 forward and is currently under audit for the 2009 tax year. The IRS concluded its field work with respect to tax years 2006 through 2008 without adjustment.  On February 20, 2013 the IRS notified AGUS that the Joint Committee on Taxation completed its review and has accepted the results of the IRS examination without exception.

13.
Reinsurance and Other Monoline Exposures
 
The Company 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. The Company has historically entered into ceded reinsurance contracts in order to obtain greater business diversification and reduce the net potential loss from large risks.
 
Assumed and Ceded Business
 
The Company is party to reinsurance agreements as a reinsurer to other monoline financial guaranty companies. Under these relationships, the Company assumes a portion of the ceding company’s insured risk in exchange for a premium. The Company may be exposed to risk in this portfolio in that the Company may be required to pay losses without a corresponding premium in circumstances where the ceding company is experiencing financial distress and is unable to pay premiums. The Company’s facultative and treaty agreements are generally subject to termination at the option of the ceding company:
 
•
if the Company fails to meet certain financial and regulatory criteria and to maintain a specified minimum financial strength rating, or

•
upon certain changes of control of the Company.
 
Upon termination under these conditions, the Company may be required (under some of its reinsurance agreements) to return to the ceding company unearned premiums (net of ceding commissions) and loss reserves calculated on a statutory basis of accounting, attributable to reinsurance ceded pursuant to such agreements after which the Company would be released from liability with respect to the Assumed Business.

Upon the occurrence of the conditions set forth in the first bullet above, whether or not an agreement is terminated, the Company may be required to obtain a letter of credit or alternative form of security to collateralize its obligation to perform under such agreement or it may be obligated to increase the level of ceding commission paid.
 
With respect to a significant portion of the Company’s in-force financial guaranty Assumed Business, based on AG Re's and AGC's current ratings and subject to the terms of each reinsurance agreement, the ceding company may have the right to recapture Assumed Business ceded to AG Re or AGC, respectively, and in most cases, assets representing the statutory unearned premium (net of ceding commissions) and loss reserves (if any), plus in certain cases to receive an additional ceding commission, associated with that business. As of June 30, 2013, AG Re had posted $310 million of collateral in trust accounts for the benefit of third party ceding companies to secure its obligations under its reinsurance agreements, excluding

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contingency reserves. The equivalent amount for AGC is $135 million; AGC is not required to post collateral. On February 14, 2013, AG Re posted an additional $27 million of collateral due to the January 2013 downgrade by Moody's of its financial strength rating to Baa1. As of June 30, 2013, the amount of additional ceding commission for AG Re was $8 million.

The Company has Ceded Business to 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.

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
$
1

 
$
45

 
$
20

 
$
107

Assumed(1)
21

 
(14
)
 
19

 
12

Ceded(2)
1

 
1

 
(1
)
 
88

Net
$
23

 
$
32

 
$
38

 
$
207

Premiums Earned:
 
 
 
 
 
 
 
Direct
$
187

 
$
245

 
$
454

 
$
451

Assumed
1

 
12

 
14

 
26

Ceded
(25
)
 
(38
)
 
(57
)
 
(64
)
Net
$
163

 
$
219

 
$
411

 
$
413

Loss and LAE:
 
 
 
 
 
 
 
Direct
$
20

 
$
87

 
$
(7
)
 
$
391

Assumed
49

 
46

 
35

 
63

Ceded
(7
)
 
(15
)
 
(14
)
 
(94
)
Net
$
62

 
$
118

 
$
14

 
$
360

____________________
(1)
Negative assumed premiums written were due to changes in expected Debt Service schedules.

(2)
Positive ceded premiums written were due to commutations and changes in expected Debt Service schedules.
 

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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 $557 million of fixed maturity securities in its investment portfolio wrapped by National Public Finance Guarantee Corporation, $479 million by Ambac Assurance Corporation ("Ambac") and $28 million by other guarantors.
 
Exposure by Reinsurer
 
 
 
Ratings at
 
Par Outstanding
 
 
August 6, 2013
 
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)
American Overseas Reinsurance Company Limited (f/k/a Ram Re)
 
WR (2)
 
WR
 
$
8,971

 
$
—

 
$
30

Tokio Marine & Nichido Fire Insurance Co., Ltd.
 
Aa3
 
AA-
 
7,634

 
—

 
—

Radian Asset Assurance Inc.
 
Ba1
 
B+
 
4,897

 
42

 
1,273

Syncora Guarantee Inc.
 
WR
 
WR
 
4,031

 
1,789

 
162

Mitsui Sumitomo Insurance Co. Ltd.
 
A1
 
A+ (3)
 
2,176

 
—

 
—

ACA Financial Guaranty Corp.
 
NR
 
WR
 
819

 
6

 
10

Swiss Reinsurance Co.
 
A1
 
AA-
 
425

 
—

 
—

Ambac Assurance Corporation
 
WR
 
WR
 
85

 
6,489

 
19,596

CIFG Assurance North America Inc.
 
WR
 
WR
 
61

 
255

 
5,331

MBIA Inc.
 
(4)
 
(4)
 
—

 
10,498

 
7,726

Financial Guaranty Insurance Co.
 
WR
 
WR
 
—

 
2,634

 
1,766

Other
 
Various
 
Various
 
993

 
1,933

 
46

Total
 
 
 
 
 
$
30,092

 
$
23,646

 
$
35,940

____________________
(1)
Includes $3,415 million in ceded par outstanding related to insured credit derivatives.
  
(2)    Represents “Withdrawn Rating.”
 
(3)    The Company has structural collateral agreements satisfying the triple-A credit requirement of S&P and/or Moody’s.

(4)
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
 
 
Assumed
Premium, net
of Commissions
 
Ceded
Premium, net
of Commissions
 
Assumed
Expected
Loss and LAE
 
Ceded
Expected
Loss and LAE
 
(in millions)
American Overseas Reinsurance Company Limited
$
—

 
$
(11
)
 
$
—

 
$
8

Tokio Marine & Nichido Fire Insurance Co., Ltd.
—

 
(23
)
 
—

 
37

Radian Asset Assurance Inc.
—

 
(18
)
 
—

 
1

Syncora Guarantee Inc.
—

 
(40
)
 
22

 
1

Mitsui Sumitomo Insurance Co. Ltd.
—

 
(4
)
 
—

 
8

Swiss Reinsurance Co.
—

 
(3
)
 
—

 
2

Ambac
71

 
—

 
(71
)
 
—

CIFG Assurance North America Inc.
—

 
—

 
—

 
5

MBIA Inc.
14

 
—

 
(18
)
 
—

Financial Guaranty Insurance Co.
8

 
—

 
(91
)
 
—

Other
—

 
(42
)
 
—

 
—

Total
$
93

 
$
(141
)
 
$
(158
)
 
$
62

 
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 their respective businesses, certain of the Company’s subsidiaries assert claims in legal proceedings against third parties to recover losses paid in prior periods. For example, as described in Note 5, Expected Loss to be Paid "Recovery Litigation", as of the date of this filing, AGC and AGM have filed complaints against certain sponsors and underwriters of RMBS securities that AGC or 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
 
The Company receives 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 of the County’s debt. The complaint in this lawsuit seeks equitable relief, unspecified monetary damages, interest, attorneys’

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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 2103, 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 April 8, 2011, AG Re and AGC filed a Petition to Compel Arbitration with the Supreme Court of the State of New York, requesting an order compelling Ambac to arbitrate Ambac’s disputes with AG Re and AGC concerning their obligations under reinsurance agreements with Ambac. In March 2010, Ambac placed a number of insurance policies that it had issued, including policies reinsured by AG Re and AGC pursuant to the reinsurance agreements, into a segregated account. The Wisconsin state court has approved a rehabilitation plan whereby permitted claims under the policies in the segregated account will be paid 25% in cash and 75% in surplus notes issued by the segregated account. Ambac has advised AG Re and AGC that it has and intends to continue to enter into commutation agreements with holders of policies issued by Ambac, and reinsured by AG Re and AGC, pursuant to which Ambac will pay a combination of cash and surplus notes to the policyholder. AG Re and AGC have informed Ambac that they believe their only current payment obligation with respect to the commutations arises from the cash payment, and that there is no obligation to pay any amounts in respect of the surplus notes until payments of principal or interest are made on such notes. Ambac has disputed this position on one commutation and may take a similar position on subsequent commutations. On April 15, 2011, attorneys for the Wisconsin Insurance Commissioner, as Rehabilitator of Ambac’s segregated account, and for Ambac filed a motion with Lafayette County, Wisconsin, Circuit Court Judge William Johnston, asking him to find AG Re and AGC to be in violation of an injunction protecting the interests of the segregated account by their seeking to compel arbitration on this matter and failing to pay in full all amounts with respect to Ambac’s payments in the form of surplus notes. On June 14, 2011, Judge Johnston issued an order granting the Rehabilitator’s and Ambac’s motion to enforce the injunction against AGC and AG Re and the parties filed a stipulation dismissing the Petition to Compel Arbitration without prejudice. AGC and AG Re have appealed Judge Johnston’s order to the Wisconsin Court of Appeals.
 
On November 28, 2011, Lehman Brothers International (Europe) (in administration) (“LBIE”) sued AGFP, an affiliate of AGC which in the past had provided credit protection to counterparties under credit default swaps. AGC acts as the credit support provider of AGFP under these credit default swaps. LBIE’s complaint, which was filed in the Supreme Court of the State of New York, alleged that AGFP improperly terminated nine credit derivative transactions between LBIE and AGFP and improperly calculated the termination payment in connection with the termination of 28 other credit derivative transactions between LBIE and AGFP. With respect to the 28 credit derivative transactions, AGFP calculated that LBIE owes AGFP approximately $25 million, whereas LBIE asserted in the complaint that AGFP owes LBIE a termination payment of approximately $1.4 billion. LBIE is seeking unspecified damages. On February 3, 2012, AGFP filed a motion to dismiss certain of the counts in the complaint, and on March 15, 2013, the court granted AGFP's motion to dismiss the count relating to

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improper termination of the nine credit derivative transactions and denied AGFP's motion to dismiss the count relating to the remaining transactions. The decision is subject to appeal. The Company cannot reasonably estimate the possible loss, if any, that may arise from this lawsuit.
 
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 the Company 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 the Company did acquire. While Dexia SA and Dexia Crédit Local S.A. (“DCL”), jointly and severally, have agreed to indemnify the Company 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 be sufficient to fully hold the Company 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 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.
 

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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 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);

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(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.
 
15.
Long-Term Debt and Credit Facilities
 
The principal and carrying values of the Company’s long-term debt are presented in the table below.
 
Principal and Carrying Amounts of Debt 

 
As of June 30, 2013
 
As of December 31, 2012
 
Principal

Carrying
Value

Principal

Carrying
Value
 
(in millions)
AGUS:
 


 


 


 

7.0% Senior Notes
$
200

 
$
197


$
200

 
$
197

Series A Enhanced Junior Subordinated Debentures
150

 
150


150

 
150

Total AGUS
350

 
347


350

 
347

AGMH:
 

 
 


 

 
 

67/8% QUIBS
100

 
68


100

 
68

6.25% Notes
230

 
138


230

 
137

5.60% Notes
100

 
54


100

 
54

Junior Subordinated Debentures
300

 
167


300

 
164

Total AGMH
730

 
427


730

 
423

AGM:
 

 
 


 

 
 

Notes Payable
48

 
53


61

 
66

Total AGM
48

 
53


61

 
66

Total
$
1,128

 
$
827


$
1,141

 
$
836




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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.
 
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.

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Limited Recourse Credit Facilities
  
AG Re had a $200 million limited recourse credit facility for the payment of losses in respect of cumulative municipal losses (net of any recoveries) in excess of the greater of $260 million or the average annual Debt Service of the covered portfolio multiplied by 4.5%. The obligation to repay loans under this agreement is a limited recourse obligation payable solely from, and collateralized by, a pledge of recoveries realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. AG Re terminated this credit facility effective March 5, 2013.
 
Letters of Credit
 
AGC entered into a letter of credit agreement in December 2011 with Bank of New York Mellon totaling approximately $2.9 million in connection with a 2008 lease for office space, which space was subsequently sublet. As of June 30, 2013, $2.9 million was outstanding under this letter of credit. This letter of credit expires in November 2013.
 
Committed Capital Securities
 
On April 8, 2005, AGC entered into separate agreements (the “Put Agreements”) with four custodial trusts (each, a “Custodial Trust”) pursuant to which AGC may, at its option, cause each of the Custodial Trusts to purchase up to $50 million of perpetual preferred stock of AGC (the “AGC Preferred Stock”). The custodial trusts were created as vehicles for providing capital support to AGC by allowing AGC to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option. If the put options were exercised, AGC would receive $200 million in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose, including the payment of claims. The put options have not been exercised through the date of this filing. Initially, all of AGC CCS were issued to a special purpose pass-through trust (the “Pass-Through Trust”). The Pass-Through Trust was dissolved in April 2008 and the AGC CCS were distributed to the holders of the Pass-Through Trust’s securities. Neither the Pass-Through Trust nor the custodial trusts are consolidated in the Company’s financial statements.
 
Income distributions on the Pass-Through Trust securities and AGC CCS were equal to an annualized rate of one-month LIBOR plus 110 basis points for all periods ending on or prior to April 8, 2008. Following dissolution of the Pass-Through Trust, distributions on the AGC CCS Securities are determined pursuant to an auction process. On April 7, 2008 this auction process failed, thereby increasing the annualized rate on the AGC CCS to one-month LIBOR plus 250 basis points. Distributions on the AGC preferred stock will be determined pursuant to the same process.
 
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.
Earnings Per Share
 
Computation of Earnings Per Share 

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions, except per share amounts)
Basic earnings per share ("EPS"):
 
 
 
 
 
 
 
Net income (loss) attributable to AGL
$
219

 
$
377

 
$
75

 
$
(106
)
Less: Distributed and undistributed income (loss) available to nonvested shareholders
0

 
1

 
0

 
0

Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic
$
219

 
$
376

 
$
75

 
$
(106
)
Basic shares
187.8

 
186.3

 
190.8

 
184.4

Basic EPS
$
1.17

 
$
2.02

 
$
0.39

 
$
(0.58
)
 
 
 
 
 
 
 
 
Diluted EPS:
 
 
 
 
 
 
 
Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic
$
219

 
$
376

 
$
75

 
$
(106
)
Plus: Re-allocation of undistributed income (loss) available to nonvested shareholders of AGL and subsidiaries
0

 
—

 
0

 
—

Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, diluted
$
219

 
$
376

 
$
75

 
$
(106
)
 
 
 
 
 
 
 
 
Basic shares
187.8

 
186.3

 
190.8

 
184.4

Effect of dilutive securities:
 
 
 
 
 
 
 
Options and restricted stock awards
1.0

 
0.7

 
0.9

 
—

Equity units
—

 
—

 
—

 
—

Diluted shares
188.8

 
187.0

 
191.7

 
184.4

Diluted EPS
$
1.16

 
$
2.01

 
$
0.39

 
$
(0.58
)
Potentially dilutive securities excluded from computation of EPS because of antidilutive effect
2.0

 
13.0

 
3.6

 
15.9

 


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17.
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
 
Cumulative
Translation
Adjustment
 
Cash Flow Hedge
 
Total Accumulated
Other
Comprehensive
Income
 
(in millions)
Balance, March 31, 2013
$
466

 
$
(17
)
 
$
(11
)
 
$
9

 
$
447

Other comprehensive income (loss) before reclassifications
(219
)
 
(16
)
 
(1
)
 
—

 
(236
)
Amounts reclassified from AOCI to:
 
 
 
 
 
 
 
 
 
Other net realized investment gains (losses)
(13
)
 
11

 
—

 
—

 
(2
)
Interest expense
—

 
—

 
—

 
(1
)
 
(1
)
Total before tax
(13
)
 
11

 
—

 
(1
)
 
(3
)
Tax (provision) benefit
3

 
(3
)
 
—

 
1

 
1

Total amounts reclassified from AOCI, net of tax
(10
)
 
8

 
—

 
0

 
(2
)
Net current period other comprehensive income
(229
)
 
(8
)
 
(1
)
 
0

 
(238
)
Balance, June 30, 2013
$
237

 
$
(25
)
 
$
(12
)
 
$
9

 
$
209



Second Quarter 2012

 
Net Unrealized
Gains (Losses) on
Investments with no OTTI
 
Net Unrealized
Gains (Losses) on
Investments with OTTI
 
Cumulative
Translation
Adjustment
 
Cash Flow Hedge
 
Total Accumulated
Other
Comprehensive
Income
 
(in millions)
Balance, March 31, 2012
$
408

 
$
(12
)
 
$
(6
)
 
$
9

 
$
399

Other comprehensive income (loss)
37

 
(4
)
 
(2
)
 
0

 
31

Balance, June 30, 2012
$
445

 
$
(16
)
 
$
(8
)
 
$
9

 
$
430





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Six Months 2013

 
Net Unrealized
Gains (Losses) on
Investments with no OTTI
 
Net Unrealized
Gains (Losses) on
Investments with OTTI
 
Cumulative
Translation
Adjustment
 
Cash Flow Hedge
 
Total Accumulated
Other
Comprehensive
Income
 
(in millions)
Balance, December 31, 2012
$
517

 
$
(5
)
 
$
(6
)
 
$
9

 
$
515

Other comprehensive income (loss) before reclassifications
(269
)
 
(32
)
 
(6
)
 
—

 
(307
)
Amounts reclassified from AOCI to:


 


 


 


 
 
Other net realized investment gains (losses)
(14
)
 
17

 
—

 
—

 
3

Interest expense
—

 
—

 
—

 
(1
)
 
(1
)
Total before tax
(14
)
 
17

 
—

 
(1
)
 
2

Tax (provision) benefit
3

 
(5
)
 
—

 
1

 
(1
)
Total amounts reclassified from AOCI, net of tax
(11
)
 
12

 
—

 
0

 
1

Net current period other comprehensive income
(280
)
 
(20
)
 
(6
)
 
0

 
(306
)
Balance, June 30, 2013
$
237

 
$
(25
)
 
$
(12
)
 
$
9

 
$
209



Six Months 2012

 
Net Unrealized
Gains (Losses) on
Investments with no OTTI
 
Net Unrealized
Gains (Losses) on
Investments with OTTI
 
Cumulative
Translation
Adjustment
 
Cash Flow Hedge
 
Total Accumulated
Other
Comprehensive
Income
 
(in millions)
Balance, December 31, 2011
$
365

 
$
2

 
$
(8
)
 
$
9

 
$
368

Other comprehensive income (loss)
80

 
(18
)
 
0

 
0

 
62

Balance, June 30, 2012
$
445

 
$
(16
)
 
$
(8
)
 
$
9

 
$
430



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18.
Subsidiary Information
 
The following tables present the condensed consolidating financial information for AGUS and AGMH, wholly-owned subsidiaries of AGL, which have issued publicly traded debt securities (see Note 15, Long-Term Debt and Credit Facilities) as of June 30, 2013 and December 31, 2012 and for the three and six months ended June 30, 2013 and 2012. The information for AGUS and AGMH presents its subsidiaries on the equity method of accounting.
 
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF JUNE 30, 2013
(in millions)
 
 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
ASSETS
 

 
 

 
 

 
 

 
 

 
 

Total investment portfolio and cash
$
48

 
$
58

 
$
31

 
$
10,943

 
$
(300
)
 
$
10,780

Investment in subsidiaries
4,414

 
3,867

 
3,417

 
—

 
(11,698
)
 
—

Premiums receivable, net of ceding commissions payable
—

 
—

 
—

 
1,044

 
(129
)
 
915

Ceded unearned premium reserve
—

 
—

 
—

 
1,441

 
(931
)
 
510

Deferred acquisition costs
—

 
—

 
—

 
206

 
(81
)
 
125

Reinsurance recoverable on unpaid losses
—

 
—

 
—

 
201

 
(141
)
 
60

Credit derivative assets
—

 
—

 
—

 
595

 
(494
)
 
101

Deferred tax asset, net
—

 
48

 
(91
)
 
916

 
(23
)
 
850

Intercompany receivable
—

 
—

 
—

 
173

 
(173
)
 
—

Financial guaranty variable interest entities’ assets, at fair value
—

 
—

 
—

 
2,674

 
—

 
2,674

Other
28

 
34

 
34

 
669

 
(172
)
 
593

TOTAL ASSETS
$
4,490

 
$
4,007

 
$
3,391

 
$
18,862

 
$
(14,142
)
 
$
16,608

LIABILITIES AND SHAREHOLDERS’ EQUITY
 

 
 

 
 

 
 

 
 

 
 

Unearned premium reserves
$
—

 
$
—

 
$
—

 
$
5,718

 
$
(906
)
 
$
4,812

Loss and LAE reserve
—

 
—

 
—

 
721

 
(157
)
 
564

Long-term debt
—

 
347

 
427

 
53

 
—

 
827

Intercompany payable
—

 
173

 
—

 
300

 
(473
)
 
—

Credit derivative liabilities
—

 
—

 
—

 
2,843

 
(494
)
 
2,349

Financial guaranty variable interest entities’ liabilities, at fair value
—

 
—

 
—

 
3,074

 
—

 
3,074

Other
6

 
9

 
15

 
764

 
(296
)
 
498

TOTAL LIABILITIES
6

 
529

 
442

 
13,473

 
(2,326
)
 
12,124

TOTAL SHAREHOLDERS’ EQUITY
4,484

 
3,478

 
2,949

 
5,389

 
(11,816
)
 
4,484

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
4,490

 
$
4,007

 
$
3,391

 
$
18,862

 
$
(14,142
)
 
$
16,608

 

96
Table of Contents

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2012
(in millions)
 
 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
ASSETS
 

 
 

 
 

 
 

 
 

 
 

Total investment portfolio and cash
$
245

 
$
15

 
$
30

 
$
11,233

 
$
(300
)
 
$
11,223

Investment in subsidiaries
4,734

 
3,958

 
3,225

 
3,524

 
(15,441
)
 
—

Premiums receivable, net of ceding commissions payable
—

 
—

 
—

 
1,147

 
(142
)
 
1,005

Ceded unearned premium reserve
—

 
—

 
—

 
1,550

 
(989
)
 
561

Deferred acquisition costs
—

 
—

 
—

 
190

 
(74
)
 
116

Reinsurance recoverable on unpaid losses
—

 
—

 
—

 
223

 
(165
)
 
58

Credit derivative assets
—

 
—

 
—

 
553

 
(412
)
 
141

Deferred tax asset, net
—

 
48

 
(94
)
 
789

 
(22
)
 
721

Intercompany receivable
—

 
—

 
—

 
173

 
(173
)
 
—

Financial guaranty variable interest entities’ assets, at fair value
—

 
—

 
—

 
2,688

 
—

 
2,688

Other
23

 
29

 
26

 
816

 
(165
)
 
729

TOTAL ASSETS
$
5,002

 
$
4,050

 
$
3,187

 
$
22,886

 
$
(17,883
)
 
$
17,242

LIABILITIES AND SHAREHOLDERS’ EQUITY
 

 
 

 
 

 
 

 
 

 
 

Unearned premium reserves
$
—

 
$
—

 
$
—

 
$
6,168

 
$
(961
)
 
$
5,207

Loss and LAE reserve
—

 
—

 
—

 
778

 
(177
)
 
601

Long-term debt
—

 
347

 
423

 
66

 
—

 
836

Intercompany payable
—

 
173

 
—

 
300

 
(473
)
 
—

Credit derivative liabilities
—

 
—

 
—

 
2,346

 
(412
)
 
1,934

Financial guaranty variable interest entities’ liabilities, at fair value
—

 
—

 
—

 
3,141

 
—

 
3,141

Other
8

 
6

 
15

 
803

 
(303
)
 
529

TOTAL LIABILITIES
8

 
526

 
438

 
13,602

 
(2,326
)
 
12,248

TOTAL SHAREHOLDERS’ EQUITY
4,994

 
3,524

 
2,749

 
9,284

 
(15,557
)
 
4,994

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
5,002

 
$
4,050

 
$
3,187

 
$
22,886

 
$
(17,883
)
 
$
17,242

 

 

 

97
Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED JUNE 30, 2013
(in millions)
 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
REVENUES
 

 
 

 
 

 
 

 
 

 
 

Net earned premiums
$
—

 
$
—

 
$
—

 
$
161

 
$
2

 
$
163

Net investment income
—

 
—

 
—

 
98

 
(5
)
 
93

Net realized investment gains (losses)
—

 
—

 
1

 
(3
)
 
4

 
2

Net change in fair value of credit derivatives:
 

 
 

 
 

 
 

 
 

 
 
Realized gains (losses) and other settlements
—

 
—

 
—

 
(86
)
 
—

 
(86
)
Net unrealized gains (losses)
—

 
—

 
—

 
160

 
—

 
160

Net change in fair value of credit derivatives
—

 
—

 
—

 
74

 
—

 
74

Other
—

 
—

 
—

 
132

 
1

 
133

TOTAL REVENUES
—

 
—

 
1

 
462

 
2

 
465

EXPENSES
 

 
 

 
 

 
 

 
 

 
 

Loss and LAE
—

 
—

 
—

 
61

 
1

 
62

Amortization of deferred acquisition costs
—

 
—

 
—

 
(11
)
 
12

 
1

Interest expense
—

 
8

 
14

 
5

 
(6
)
 
21

Other operating expenses
7

 
0

 
0

 
44

 
1

 
52

TOTAL EXPENSES
7

 
8

 
14

 
99

 
8

 
136

INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN NET EARNINGS OF SUBSIDIARIES
(7
)
 
(8
)
 
(13
)
 
363

 
(6
)
 
329

Total provision (benefit) for income taxes
—

 
2

 
4

 
(119
)
 
3

 
(110
)
Equity in net earnings of subsidiaries
226

 
252

 
220

 
—

 
(698
)
 
—

NET INCOME (LOSS)
$
219

 
$
246

 
$
211

 
$
244

 
$
(701
)
 
$
219

 
 
 
 
 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME (LOSS)
$
(19
)
 
$
92

 
$
122

 
$
(142
)
 
$
(72
)
 
$
(19
)



98
Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED JUNE 30, 2012
(in millions)

 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
REVENUES
 

 
 

 
 

 
 

 
 

 
 

Net earned premiums
$
—

 
$
—

 
$
—

 
$
217

 
$
2

 
$
219

Net investment income
—

 
—

 
1

 
105

 
(5
)
 
101

Net realized investment gains (losses)
—

 
—

 
—

 
(3
)
 
—

 
(3
)
Net change in fair value of credit derivatives:
 

 
 

 
 

 
 

 
 

 
 
Realized gains (losses) and other settlements
—

 
—

 
—

 
(22
)
 
(1
)
 
(23
)
Net unrealized gains (losses)
—

 
—

 
—

 
284

 
—

 
284

Net change in fair value of credit derivatives
—

 
—

 
—

 
262

 
(1
)
 
261

Other
—

 
—

 


 
178

 
(1
)
 
177

TOTAL REVENUES
—

 
—

 
1

 
759

 
(5
)
 
755

EXPENSES
 

 
 

 
 

 
 

 
 

 
 

Loss and LAE
—

 
—

 
—

 
118

 
—

 
118

Amortization of deferred acquisition costs
—

 
—

 
—

 
9

 
(4
)
 
5

Interest expense
—

 
10

 
14

 
6

 
(5
)
 
25

Other operating expenses
5

 
0

 
0

 
50

 
(2
)
 
53

TOTAL EXPENSES
5

 
10

 
14

 
183

 
(11
)
 
201

INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN NET EARNINGS OF SUBSIDIARIES
(5
)
 
(10
)
 
(13
)
 
576

 
6

 
554

Total provision (benefit) for income taxes
—

 
3

 
(3
)
 
(183
)
 
6

 
(177
)
Equity in net earnings of subsidiaries
382

 
360

 
169

 
354

 
(1,265
)
 
—

NET INCOME (LOSS)
$
377

 
$
353

 
$
153

 
$
747

 
$
(1,253
)
 
$
377

 
 
 
 
 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME (LOSS)
$
408

 
$
372

 
$
165

 
$
797

 
$
(1,334
)
 
$
408



99
Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 2013
(in millions)

 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
REVENUES
 

 
 

 
 

 
 

 
 

 
 

Net earned premiums
$
—

 
$
—

 
$
—

 
$
407

 
$
4

 
$
411

Net investment income
0

 
0

 
0

 
197

 
(10
)
 
187

Net realized investment gains (losses)
0

 
—

 
1

 
25

 
4

 
30

Net change in fair value of credit derivatives:
 
 
 
 
 
 
 
 
 
 
 
Realized gains (losses) and other settlements
—

 
—

 
—

 
(68
)
 
—

 
(68
)
Net unrealized gains (losses)
—

 
—

 
—

 
(450
)
 
—

 
(450
)
Net change in fair value of credit derivatives
—

 
—

 
—

 
(518
)
 
—

 
(518
)
Other
—

 
—

 
—

 
179

 
—

 
179

TOTAL REVENUES
—

 
—

 
1

 
290

 
(2
)
 
289

EXPENSES
 

 
 

 
 

 
 

 
 

 
 

Loss and LAE
—

 
—

 
—

 
17

 
(3
)
 
14

Amortization of deferred acquisition costs
—

 
—

 
—

 
(3
)
 
7

 
4

Interest expense
—

 
15

 
27

 
11

 
(11
)
 
42

Other operating expenses
12

 
0

 
0

 
102

 
(2
)
 
112

TOTAL EXPENSES
12

 
15

 
27

 
127

 
(9
)
 
172

INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN NET EARNINGS OF SUBSIDIARIES
(12
)
 
(15
)
 
(26
)
 
163

 
7

 
117

Total provision (benefit) for income taxes
—

 
5

 
9

 
(54
)
 
(2
)
 
(42
)
Equity in net earnings of subsidiaries
87

 
170

 
382

 
—

 
(639
)
 
—

NET INCOME (LOSS)
$
75

 
$
160

 
$
365

 
$
109

 
$
(634
)
 
$
75

 
 
 
 
 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME (LOSS)
$
(231
)
 
$
(45
)
 
$
239

 
$
(395
)
 
$
201

 
$
(231
)

100
Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 2012
(in millions)

 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
REVENUES
 

 
 

 
 

 
 

 
 

 
 

Net earned premiums
$
—

 
$
—

 
$
—

 
$
406

 
$
7

 
$
413

Net investment income
0

 
0

 
1

 
206

 
(8
)
 
199

Net realized investment gains (losses)
0

 
—

 
0

 
(2
)
 
—

 
(2
)
Net change in fair value of credit derivatives:
 
 
 
 
 
 
 
 
 
 
 
Realized gains (losses) and other settlements
—

 
—

 
—

 
(79
)
 
(1
)
 
(80
)
Net unrealized gains (losses)
—

 
—

 
—

 
(350
)
 
—

 
(350
)
Net change in fair value of credit derivatives
—

 
—

 
—

 
(429
)
 
(1
)
 
(430
)
Other
—

 
—

 
—

 
214

 
(1
)
 
213

TOTAL REVENUES
—

 
—

 
1

 
395

 
(3
)
 
393

EXPENSES
 

 
 

 
 

 
 

 
 

 
 

Loss and LAE
—

 
—

 
—

 
362

 
(2
)
 
360

Amortization of deferred acquisition costs
—

 
—

 
—

 
18

 
(8
)
 
10

Interest expense
—

 
20

 
27

 
11

 
(8
)
 
50

Other operating expenses
12

 
1

 
0

 
105

 
(3
)
 
115

TOTAL EXPENSES
12

 
21

 
27

 
496

 
(21
)
 
535

INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN NET EARNINGS OF SUBSIDIARIES
(12
)
 
(21
)
 
(26
)
 
(101
)
 
18

 
(142
)
Total provision (benefit) for income taxes
—

 
7

 
9

 
25

 
(5
)
 
36

Equity in net earnings of subsidiaries
(94
)
 
7

 
162

 
(6
)
 
(69
)
 
—

NET INCOME (LOSS)
$
(106
)
 
$
(7
)
 
$
145

 
$
(82
)
 
$
(56
)
 
$
(106
)
 
 
 
 
 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME (LOSS)
$
(44
)
 
$
37

 
$
174

 
$
24

 
$
(235
)
 
$
(44
)


101
Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2013
(in millions)
 
 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
Net cash flows provided by (used in) operating activities
$
86

 
$
43

 
$
14

 
$
172

 
$
(193
)
 
$
122

Cash flows from investing activities
 

 
 

 
 

 
 

 
 

 
 

Fixed maturity securities:
 

 
 

 
 

 
 

 
 

 
 

Purchases
—

 
—

 
(23
)
 
(1,029
)
 
65

 
(987
)
Sales
171

 
1

 
19

 
506

 
(65
)
 
632

Maturities
21

 
—

 
2

 
423

 
—

 
446

Sales (purchases) of short-term investments, net
5

 
(56
)
 
1

 
(76
)
 
—

 
(126
)
Net proceeds from financial guaranty variable entities’ assets
—

 
—

 
—

 
440

 
—

 
440

Investment in subsidiary
—

 
—

 
25

 
—

 
(25
)
 
—

Other
—

 
—

 
—

 
67

 
—

 
67

Net cash flows provided by (used in) investing activities
197

 
(55
)
 
24

 
331

 
(25
)
 
472

Cash flows from financing activities
 

 
 

 
 

 
 

 
 

 
 

Return of capital
—

 
—

 
—

 
(25
)
 
25

 
—

Dividends paid
(38
)
 
—

 
(38
)
 
(155
)
 
193

 
(38
)
Repurchases of common stock
(244
)
 
—

 
—

 
—

 
—

 
(244
)
Share activity under option and incentive plans
(1
)
 
—

 
—

 
—

 
—

 
(1
)
Net paydowns of financial guaranty variable entities’ liabilities
—

 
—

 
—

 
(289
)
 
—

 
(289
)
Payment of long-term debt
—

 
—

 
—

 
(13
)
 
—

 
(13
)
Net cash flows provided by (used in) financing activities
(283
)
 
—

 
(38
)
 
(482
)
 
218

 
(585
)
Effect of exchange rate changes
—

 
—

 
—

 
(4
)
 
—

 
(4
)
Increase (decrease) in cash
—

 
(12
)
 
—

 
17

 
—

 
5

Cash at beginning of period
—

 
13

 
—

 
125

 
—

 
138

Cash at end of period
$
—

 
$
1

 
$
0

 
$
142

 
$
—

 
$
143

 

102
Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2012
(in millions)
 
 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
Net cash flows provided by (used in) operating activities
$
56

 
$
24

 
$
21

 
$
296

 
$
(235
)
 
$
162

Cash flows from investing activities
 

 
 

 
 

 
 

 
 

 
 

Fixed maturity securities:
 

 
 

 
 

 
 

 
 

 
 

Purchases
(92
)
 
(1
)
 
(11
)
 
(820
)
 
—

 
(924
)
Sales
—

 
—

 
1

 
525

 
—

 
526

Maturities
—

 
—

 
2

 
513

 
—

 
515

Sales (purchases) of short-term investments, net
(78
)
 
27

 
17

 
(74
)
 
—

 
(108
)
Net proceeds from financial guaranty variable entities’ assets
—

 
—

 
—

 
283

 
—

 
283

Acquisition of MAC, net of cash acquired
—

 
(91
)
 
—

 
—

 
—

 
(91
)
Intercompany debt
—

 
—

 
—

 
(173
)
 
173

 
—

Investment in subsidiary
—

 
—

 
50

 
—

 
(50
)
 
—

Other
—

 
—

 
—

 
72

 
—

 
72

Net cash flows provided by (used in) investing activities
(170
)
 
(65
)
 
59

 
326

 
123

 
273

Cash flows from financing activities
 

 
 

 
 

 
 

 
 

 
 
Issuance of common stock
173

 
—

 
—

 
—

 
—

 
173

Return of capital
—

 
—

 
—

 
(50
)
 
50

 
—

Dividends paid
(33
)
 
—

 
(80
)
 
(155
)
 
235

 
(33
)
Repurchases of common stock
(24
)
 
—

 
—

 
—

 
—

 
(24
)
Share activity under option and incentive plans
(2
)
 
—

 
—

 
—

 
—

 
(2
)
Net paydowns of financial guaranty variable entities’ liabilities
—

 
—

 
—

 
(389
)
 
—

 
(389
)
Payment of long-term debt
—

 
(173
)
 
—

 
(23
)
 
—

 
(196
)
Intercompany debt
—

 
173

 
—

 
—

 
(173
)
 
—

Net cash flows provided by (used in) financing activities
114

 
—

 
(80
)
 
(617
)
 
112

 
(471
)
Effect of exchange rate changes
—

 
—

 
—

—

(4
)
—

—

 
(4
)
Increase (decrease) in cash
—

 
(41
)
 
—

 
1

 
—

 
(40
)
Cash at beginning of period
0

 
72

 
—

 
143

 
—

 
215

Cash at end of period
$
0

 
$
31

 
$
—

 
$
144

 
$
—

 
$
175




103
Table of Contents

ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward Looking Statements  

This Form 10-Q contains information that includes or is based upon forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward looking statements give the expectations or forecasts of future events of Assured Guaranty Ltd. (“AGL” and, together with its subsidiaries, “Assured Guaranty” or the “Company”). These statements can be identified by the fact that they do not relate strictly to historical or current facts and relate to future operating or financial performance.
 
Any or all of Assured Guaranty’s forward looking statements herein are based on current expectations and the current economic environment and may turn out to be incorrect. Assured Guaranty’s actual results may vary materially. Among factors that could cause actual results to differ materially are:
 
·                  rating agency action, including a ratings downgrade, a change in outlook, the placement of ratings on watch for downgrade, or a change in rating criteria, at any time, of Assured Guaranty or any of its subsidiaries and/or of transactions that Assured Guaranty’s subsidiaries have insured;
 
·                  developments in the world’s financial and capital markets, including changes in interest and foreign exchange rates, that adversely affect the demand for the Company's insurance, issuers’ payment rates, Assured Guaranty’s loss experience, its exposure to refinancing risk in transactions (which could result in substantial liquidity claims on its guarantees), its access to capital, its unrealized (losses) gains on derivative financial instruments or its investment returns;

·                  changes in the world’s credit markets, segments thereof or general economic conditions;
 
·                  the impact of rating agency action with respect to sovereign debt and the resulting effect on the value of securities in the Company’s investment portfolio and collateral posted by and to the Company;
 
·                  more severe or frequent losses impacting the adequacy of Assured Guaranty’s expected loss estimates;
 
·                  the impact of market volatility on the mark-to-market of Assured Guaranty’s contracts written in credit default swap form;
 
·                  reduction in the amount of insurance opportunities available to Assured Guaranty;
 
·                  deterioration in the financial condition of Assured Guaranty’s reinsurers, the amount and timing of reinsurance recoverables actually received and the risk that reinsurers may dispute amounts owed to Assured Guaranty under its reinsurance agreements;
 
·                  the failure of Assured Guaranty to realize insurance loss recoveries or damages expected from originators, sellers, sponsors, underwriters or servicers of residential mortgage-backed securities transactions through loan putbacks, settlement negotiations or litigation;
 
·                  the possibility that budget shortfalls or other factors will result in credit losses or impairments on obligations of state and local governments that the Company insures or reinsures;
 
·                  increased competition, including from new entrants into the financial guaranty industry;
 
·                  changes in applicable accounting policies or practices;
 
·                  changes in applicable laws or regulations, including insurance and tax laws;
 
·                  other governmental actions;
 
·                  difficulties with the execution of Assured Guaranty’s business strategy;
 

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·                  contract cancellations;
 
·                  loss of key personnel;

·                  adverse technological developments;
 
·                  the effects of mergers, acquisitions and divestitures;
 
·                  natural or man-made catastrophes;
 
·                  other risks and uncertainties that have not been identified at this time;
 
·                  management’s response to these factors; and
 
·                  other risk factors identified in Assured Guaranty’s filings with the U.S. Securities and Exchange Commission (the “SEC”).
 
The foregoing review of important factors should not be construed as exhaustive, and should be read in conjunction with the other cautionary statements that are included in this Form 10-Q. The Company undertakes no obligation to update publicly or review any forward looking statement, whether as a result of new information, future developments or otherwise, except as required by law. Investors are advised, however, to consult any further disclosures the Company makes on related subjects in the Company’s reports filed with the SEC.
 
If one or more of these or other risks or uncertainties materialize, or if the Company’s underlying assumptions prove to be incorrect, actual results may vary materially from what the Company projected. Any forward looking statements in this Form 10-Q reflect the Company’s current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to its operations, results of operations, growth strategy and liquidity.
 
For these statements, the Company claims the protection of the safe harbor for forward looking statements contained in Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).



Introduction
 
The Company provides credit protection products in 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 securities insured by the Company include taxable and tax-exempt obligations issued by U.S. state or municipal governmental authorities, utility districts or facilities; notes or bonds issued to finance international infrastructure projects; and asset-backed securities issued by special purpose entities. The Company markets its credit protection products directly to issuers and underwriters of public finance, infrastructure and structured finance securities as well as to investors in such obligations. The Company guarantees obligations issued in many countries, although its principal focus is on the U.S., as well as Europe and Australia.
 
 
Available Information
 
The Company maintains an Internet web site at www.assuredguaranty.com. The Company makes available, free of charge, on its web site (at www.assuredguaranty.com/investor-information/by-company/assured-guaranty-ltd/sec-filings) the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13 (a) or 15 (d) of the Exchange Act as soon as reasonably practicable after the Company files such material with, or furnishes it to, the SEC. The Company also makes available, free of charge, through its web site (at www.assuredguaranty.com/governance) links to the Company’s Corporate Governance Guidelines, its Code of Conduct and the charters for its Board Committees.
 
The Company routinely posts important information for investors on its web site (at www.assuredguaranty.com/about-us/company-statements). The Company uses this web site as a means of disclosing material, non-public information and for

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complying with its disclosure obligations under SEC Regulation FD. Accordingly, investors should monitor the Investor Information portion of the Company’s web site, in addition to following the Company’s press releases, SEC filings, public conference calls, presentations and webcasts.
 
The information contained on, or that may be accessed through, the Company’s web site is not incorporated by reference into, and is not a part of, this report.


Executive Summary
  
This executive summary of management’s discussion and analysis highlights selected information and may not contain all of the information that is important to readers of this Quarterly Report. For a more detailed description of events, trends and uncertainties, as well as the capital, liquidity, credit, operational and market risks and the critical accounting policies and estimates affecting the Company, this Quarterly Report should be read in its entirety and in addition to Assured Guaranty's 2012 Annual Report on Form 10-K and Assured Guaranty's Quarterly Report on 10-Q for the quarter ended March 31, 2013.

Economic Environment
 
The Company continued to be the most active provider of financial guaranty insurance in the three-months ended June 30, 2013 ("Second Quarter 2013") and six-months ended June 30, 2013 ("Six Months 2013") as a result of its financial strength and its ability to attract investors through its default protection, credit selection, underwriting and surveillance. All of the Company's pre-2008 financial guaranty competitors have had their financial strength ratings downgraded by rating agencies to below investment grade levels or are no longer rated, severely impairing their ability to underwrite new business. Only two other industry participants have investment grade financial strength ratings today: National Public Finance Guarantee Corporation, which recently resolved litigation challenging its separation from MBIA Insurance Corporation and appears not to have financial strength ratings adequate to issue new financial guaranty policies on public finance obligations at this time, and Build America Mutual Assurance Company, which is a new entrant to the industry that commenced operations during 2012 and significantly increased its business during Six Months 2013. Business conditions have been difficult for the entire financial guaranty insurance industry since mid-2007, and the Company continues to face challenges in maintaining its market penetration today. The industry's ability to generate new business in the current environment of sustained low interest rates and tight credit spreads is constrained. These conditions suppress demand for bond insurance as the potential savings for issuers are diminished and some investors prefer to forgo insurance in favor of greater yield. However, the Company believes this indicates potential for growth in insured penetration once interest rates rise and credit spreads widen. The Company cannot assure whether or when these changes will occur.
 
The overall economic environment in the U.S. has improved over the last few years and indicators such as lower mortgage delinquency rates, more stable housing prices and record stock market valuations point toward further improvement. However, unemployment rates remain high, and the economy is continuing to experience the economic impact of the Federal budget sequestration mandated by congressional legislation.
 
Although few municipalities have fully rebuilt reserves to pre-recession levels, the vast majority have been taking steps to address the ongoing fiscal challenges they have experienced since the recent credit crisis and the ensuing recession, including,in many cases, significant unfunded pension and retiree health care liabilities. Revenues at the state level have been rebounding in general, and while the strength of the housing recovery varies from region to region, property tax and other revenues have stabilized for most local governments. Although municipal defaults remain rare, a small number of municipal credits have sought bankruptcy protection. This is an area of law that has not been tested due to the relatively low frequency of such cases. The Company has been active with respect to the municipal bankruptcy cases involving Jefferson County, Alabama, the City of Stockton, California and the City of Detroit, Michigan. It has also been closely monitoring legal proceedings in other municipal bankruptcy cases. In addition, the Company has been involved with efforts of the city receiver for the City of Harrisburg, Pennsylvania to develop and implement a fiscal recovery plan for the city. The publicity surrounding high-profile defaults and bankruptcy filings, such as Detroit's, especially those few where bond insurers are paying claims, provides evidence of the value of bond insurance, which we believe may stimulate demand, especially at the retail level.
 
In the international arena, troubled Eurozone countries continue to be a source of stress in global equity and debt markets. Following the 2011 restructuring of the sovereign debt of Greece, debt costs in Portugal, Spain and Italy remain elevated, although they have declined substantially since the announcement on August 2, 2012 by the European Central Bank that it would undertake outright monetary transactions in support of Eurozone sovereign bonds. Successful execution of structural reforms is necessary to avert further fiscal stress in those and other European Union ("EU") countries. Fiscal austerity programs initiated to address the problems have constrained economic growth, and a number of countries are in or near

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recession. The rating agencies have downgraded many European sovereign credits. The Company's exposure to troubled Eurozone countries is described in “–Results of Operations–Consolidated Results of Operations–Losses in the Insured Portfolio” and “–Insured Portfolio-Selected European Exposures.”
 
The economic environment since 2008 has had a significant negative impact on the demand by investors for financial guaranty policies, and it is uncertain when or if demand for financial guaranties will return to their pre-credit crisis level. In particular, there has been limited new issue activity and also limited demand for financial guaranties in both the global structured finance and international infrastructure finance markets for several years. The Company expects that global structured finance and international infrastructure opportunities will increase in the future as the global economy recovers, issuers return to the capital markets for financings and institutional investors again utilize financial guaranties. The Company has recently seen an increase in UK infrastructure opportunities, although the Company cannot assure that this will continue.
 
In Second Quarter 2013, the Company continued to be affected by a negative perception of financial guaranty insurers arising from the financial distress suffered by other companies in the industry during the financial crisis. On January 17, 2013, after a ten month review, Moody's Investors Service, Inc. ("Moody's") assigned the following lower financial strength ratings: A2 (Stable) for Assured Guaranty Municipal Corp. ("AGM"), A3 (Stable) for Assured Guaranty Corp. ("AGC"), and Baa1 (Stable) for Assured Guaranty Re Ltd. ("AG Re"). The Company believes the Moody's rating action during first quarter 2013 caused an interruption in demand for its municipal bond insurance as the market evaluated the action's implications. Historically, production has decreased in the periods immediately before and after an unfavorable rating agency action but subsequently increased from those lower levels.
 
In a sign that the impact of the Moody's downgrade is limited, AGC's and AGM's credit spreads tightened 49% and 32%, respectively, during Six Months 2013. Credit spreads reflect the risk that investors perceive in the Company, among other factors. The higher the Company's credit spread, the lower the benefit of the Company's guaranty is to certain investors. If investors view the Company as being only marginally less risky, or perhaps even as risky, as the uninsured security, the coupon on a security insured by the Company may not be much lower, or may be the same as, an uninsured security offered by the same issuer. Accordingly, issuers may be unwilling to pay a premium for the Company to insure their securities if the insurance does not lower the costs of issuance. Although high compared with their pre-2007 levels, both AGC's and AGM's credit spreads were less than 12% of their March 2009 peaks as of June 30, 2013.

Financial Performance of Assured Guaranty

 Financial Results 

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions, except per share amounts)
Selected income statement data
 

 
 
 
 
 
 
Net earned premiums
$
163

 
$
219

 
$
411

 
$
413

Net investment income
93

 
101

 
187

 
199

Realized gains (losses) and other settlements on credit derivatives
(86
)
 
(23
)
 
(68
)
 
(80
)
Net unrealized gains (losses) on credit derivatives
160

 
284

 
(450
)
 
(350
)
Fair value gains (losses) on financial guaranty variable interest entities
143

 
168

 
213

 
127

Loss and loss adjustment (expenses) benefit
(62
)
 
(118
)
 
(14
)
 
(360
)
Other operating expenses
(52
)
 
(53
)
 
(112
)
 
(115
)
Net income (loss)
219

 
377

 
75

 
(106
)
Diluted income (loss) per share
$
1.16

 
$
2.01

 
$
0.39

 
$
(0.58
)
Selected non-GAAP measures(1)
 
 
 
 
 
 
 
Operating income
$
98

 
$
114

 
$
358

 
$
185

Operating income per share
$
0.52

 
$
0.61

 
$
1.87

 
$
0.99

Present value of new business production (“PVP”)
$
16

 
$
50

 
$
34

 
$
106

____________________
(1)
Please refer to “—Non-GAAP Financial Measures.”

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Net Income (Loss)

There are several primary drivers of volatility in reported net income or loss that are not necessarily indicative of credit impairment or improvement, or ultimate economic gains or losses: changes in credit spreads of insured credit derivative obligations and financial guaranty variable interest entities' ("FG VIEs") assets and liabilities, changes in the Company's own credit spreads, and changes in risk-free rates used to discount expected losses. Changes in credit spreads have the most significant effect on changes in fair value of credit derivatives and FG VIE assets and liabilities. In addition to these factors, changes in expected losses, the timing of refundings and terminations, realized gains and losses on the investment portfolio (including other-than-temporary impairments), the effects of large settlements or transactions, and the effects of the Company's various loss mitigation strategies, among other factors, may also have a significant effect on reported net income or loss in a given reporting period. 

Net income for Second Quarter 2013 was $219 million compared to net income of $377 million in the three-month period ended June 30, 2012 ("Second Quarter 2012"). Second Quarter 2013 net earned premiums were lower than Second Quarter 2012 due primarily to the scheduled amortization of the insurance portfolio, and fewer negotiated terminations and refundings, coupled with low new business originations. Credit spreads affecting the fair value of credit derivatives declined more significantly in Second Quarter 2012 than Second Quarter 2013, resulting in lower fair value gains in Second Quarter of 2013. Loss and loss adjustment expenses were lower in Second Quarter 2013 than Second Quarter 2012 due primarily to increased representations and warranties ("R&W") benefits, offset in part by higher losses in U.S. public finance primarily due to Detroit.

Net income for Six Months 2013 was $75 million compared to net loss of $106 million in the six-month period ended June 30, 2012 ("Six Months 2012"). Loss and loss adjustment expenses in Six Months 2013 were significantly lower than Six Months 2012 primarily due to the loss in the prior year related to Greek sovereign exposures, and the benefit taken in 2013 related to R&W settlement agreements, including the UBS settlement. Net change in fair value of FG VIEs was higher in Six Months 2013 due to the benefit of several R&W settlements related to such consolidated FG VIEs. Other income in Six Months 2012 included commutation gains recognized on previously ceded reinsurance contracts from Radian Asset Assurance Inc. ("Radian") and Tokio Marine & Nichido Fire Insurance Co., Ltd. ("Tokio"). This was offset in part by higher fair value losses in Six Months 2013 related to credit derivatives as a result of credit spread tightening, which was more significant in 2013 than 2012.

Non-GAAP Financial Measures 

Non-GAAP operating income in Second Quarter 2013 was $98 million, compared with $114 million in Second Quarter 2012. The decrease in operating income was primarily driven by the scheduled amortization of the insurance portfolio and lower refundings and negotiated terminations, partially offset by lower loss expense. Non-GAAP operating income in Six Months 2013 was $358 million, compared with $185 million in Six Months 2012. The increase in operating income was primarily driven by lower losses, partially offset by the decrease in other income, as indicated above. The increase in pretax operating income in U.S. taxable jurisdictions resulted in a higher effective tax rate in Six Months 2013.

Adjusted book value per share was $49.06 as of June 30, 2013 as compared to $47.17 per share as of December 31, 2012. Adjusted book value value per share increased primarily due to the benefit of the settlement agreements, including the UBS Agreement, and the share repurchases in Six Months 2013.

See "–Non-GAAP Financial Measures" for a description of these non-GAAP financial measures.

Key Business Strategies
 
While continuing its focus on loss mitigation, commutations and capital improvement strategies, the Company has also devoted significant resources to launching its subsidiary, Municipal Assurance Corp. ("MAC"), formerly known as Municipal and Infrastructure Assurance Corporation.

Municipal Assurance Corp.

MAC was acquired by the Company in May 2012 and is licensed to provide financial guaranty insurance and reinsurance in 38 U.S. jurisdictions, including the District of Columbia. MAC is a new financial guaranty insurer that provides insurance only on high quality debt obligations in the U.S. public finance markets. In July, it was capitalized with $700 million in equity and a $100 million surplus note issued to AGM. MAC started operations in July 2013 with an assumed book of

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business totaling $111 billion in par, which was ceded to MAC from its affiliates, AGC and AGM. The Company was established in order to increase the Company's insurance penetration in the U.S. public finance sector and starts with a seasoned book of business and a future stream of investment income and premiums earnings which is unlike other start up financial guarantors. MAC received a AA+ (stable outlook) financial strength rating from Kroll Bond Rating Agency and a AA- (stable outlook) financial strength rating from Standard and Poor’s Ratings Services ("S&P").

Loss Mitigation
    
The Company continued its risk remediation strategies in 2013, which lowered losses and improved rating agency capital. In an effort to recover U.S. residential mortgage-backed security ("RMBS") losses the Company experienced in its insured U.S. RMBS portfolio resulting from breaches of R&W, the Company has pursued R&W providers by enforcing R&W provisions in contracts, negotiating agreements with R&W providers relating to those provisions and, where indicated, initiating litigation against R&W providers.

On May 6, 2013, the Company entered into the UBS Agreement to settle R&W claims with UBS for a cash payment of $358 million plus 85% of future losses on certain transactions under a loss-sharing agreement. In the proceeding AGM brought against Flagstar Bank in the United States District Court for the Southern District of New York, the court granted judgment in favor of AGM awarding AGM damages of $90.7 million and pre-judgment interest of $15.9 million, for a total of $106.5 million. In Second Quarter 2013, Flagstar and AGM settled out of court for $105 million. See Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of R&W settlements.

In addition, in August 2013, AGC entered into a settlement agreement with an R&W provider that resolved AGC’s claims relating to specified RMBS transactions that AGC had insured and AGM reached an agreement in principle with a servicer of certain RMBS transactions that AGM had insured.

All together these efforts have resulted in the Company causing R&W providers to pay or agree to pay $3.5 billion (gross of reinsurance) in respect of R&W. The Company believes these results, including settlement agreements and trial decisions, are significant and will help it as it continues to pursue R&W providers for U.S. RMBS transactions it has insured. The Company continues to enforce contractual provisions and pursue litigation and is in discussions with other R&W providers regarding potential agreements. See “Recovery Litigation” in Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of the litigation proceedings the Company has initiated against other R&W providers.
 
The Company is also continuing to purchase attractively priced below-investment-grade ("BIG") obligations that it insured. These purchases resulted in a reduction to net expected loss to be paid of $535 million as of June 30, 2013. As of June 30, 2013, the fair value of assets purchased or obtained for loss mitigation purposes (excluding the value of the Company's insurance) was $685 million, with a par of $1,905 million (including bonds related to FG VIEs of $92 million in fair value and $700 million in par).
 
The quality of servicing of the mortgage loans underlying an RMBS transaction influences collateral performance and ultimately the amount (if any) of the Company's insured losses. The Company has established a group to mitigate RMBS losses by influencing mortgage servicing, including, if possible, causing the transfer of servicing or establishing special servicing arrangements. “Special servicing” is an industry term referencing more intense servicing applied to delinquent loans aimed at mitigating losses. Special servicing arrangements provide incentives to a servicer to achieve better performance on the mortgage loans it services. As a result of the Company’s efforts, as of June 30, 2013, the servicing of approximately $2.8 billion of mortgage loans had been transferred to a new servicer and another $1.7 billion of mortgage loans were subject to special servicing arrangements. The June 30, 2013 net insured par of the transactions subject to a servicing transfer was $2.4 billion and the net insured par of the transactions subject to a special servicing arrangement was $0.9 billion.

New Business Production and Commutations
 
Management believes that the Company is able to provide value not only by insuring the timely payment of scheduled interest and principal amounts when due, but also through its underwriting, surveillance and loss mitigation capabilities. Few individual or even institutional investors have the analytic resources to cover the tens of thousands of municipal credits in the market. For those exposures that the Company guarantees, it undertakes the tasks of credit selection, analysis, negotiation of terms, surveillance and, if necessary, loss mitigation. Management believes this allows retail investors to participate more widely, institutional investors to operate more efficiently, and smaller, less well-known issuers to gain market access on a more cost-effective basis. The following tables present summarized information about the U.S. municipal market's new debt issuance volume and the Company's share of that market.


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U.S. Municipal Market Data
Based on Sale Date
 
 
Six Months 2013
 
Year Ended December 31, 2012
 
Par
 
Number of
issues
 
Par
 
Number of
issues
 
(dollars in billions, except number of issues)
New municipal bonds issued
$
170.1

 
6,139

 
$
366.7

 
12,544

Insured by AGC and AGM(1)
3.4

 
270

 
13.2

 
1,157

____________________
(1)
Represents 60.3% for Six Months 2013 and 99.8% for 2012 of market share of bonds, based on par issued with insurance.
 
Penetration Rates for the
U.S. Municipal Market

 
Six Months
 
Year Ended December 31,
 
2013
 
2012
 
2012
Market penetration par
3.3%
 
4.0%
 
3.6%
Market penetration based on number of issues
9.1
 
10.3
 
9.2
% of single A par sold
11.0
 
12.9
 
11.9
% of single A transactions sold
29.6
 
32.2
 
29.5
% of under $25 million par sold
10.3
 
13.4
 
11.7
% of under $25 million transactions sold
10.3
 
11.6
 
10.3
 
New Business Production
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
PVP (1):
 
 
 
 
 
 
 
Public Finance—U.S.
 
 
 
 
 
 
 
Assumed from Radian (2)
$
—

 
$
—

 
$
—

 
$
22

Direct
15

 
47

 
31

 
77

Public Finance—non-U.S.
—

 
1

 
—

 
1

Structured Finance—U.S.
1

 
2

 
3

 
6

Total PVP
$
16

 
$
50

 
$
34

 
$
106

Gross Par Written:
 
 
 
 
 
 
 
Public Finance—U.S.
 
 
 
 
 
 
 
Assumed from Radian
$
—

 
$
—

 
$
—

 
$
1,797

Direct
2,276

 
4,670

 
3,856

 
7,716

Public Finance—non-U.S.
—

 
35

 
—

 
35

Structured Finance—U.S.
—

 
—

 
14

 
38

Total gross par written
$
2,276

 
$
4,705

 
$
3,870

 
$
9,586

____________________
(1)
PVP represents the present value of estimated future earnings primarily on new financial guaranty contracts written in the period, before consideration of cessions to reinsurers. See “—Non-GAAP Measures—PVP or Present Value of New Business Production.”

(2)
Represents assumed public finance business from Radian, the Company's first third party assumed reinsurance treaty written since 2009.

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Public finance PVP declined in Second Quarter 2013 from its Second Quarter 2012 level primarily due to the continued low interest rate environment and tight credit spreads, and the decline in new issuance volume. Despite the challenging interest rate and market environment, the Company maintained average new business credit ratings in the single-A category.

The Company continues to evaluate opportunities for commutations of previously ceded books of business similar to the agreements reached in the first quarter 2012 with Radian and Tokio.

Capital Improvement Strategies
    
In order to reduce leverage and possibly, rating agency capital charges, the Company has mutually agreed with beneficiaries to terminate selected financial guaranty insurance and credit derivative contracts. In particular, the Company has targeted investment grade securities for which claims are not expected but which carry a disproportionate rating agency capital charge. The Company terminated $2.6 billion and $4.2 billion in net par in Second Quarter 2013 and Six Months 2013, respectively, and $1.4 billion and $1.6 billion in net par in Second Quarter 2012 and Six Months 2012, respectively.

Share Repurchase Program

On May 8, 2013, the Company's board of directors authorized an additional $115 million of repurchases of the Company’s common shares, adding to the January 2013 authorization of $200 million and bringing the total authorization in 2013 to $315 million, of which the Company had repurchased a total of 11.5 million common shares, from March 5, 2013 through June 30, 2013, for approximately $244 million at an average price of $21.26 per share, including 5.0 million common shares from funds associated with WL Ross & Co. LLC and its affiliates and Wilbur L. Ross, Jr., a director of the Company, for $109.7 million.

Results of Operations
 
Estimates and Assumptions
 
The Company’s consolidated financial statements include amounts that are determined using estimates and assumptions. The actual amounts realized could ultimately be materially different from the amounts currently provided for in the Company’s consolidated financial statements. Management believes the most significant items requiring inherently subjective and complex estimates are expected losses, including assumptions for breaches of R&W, fair value estimates, other-than-temporary impairment (“OTTI”), deferred income taxes, and premium revenue recognition. The following discussion of the results of operations includes information regarding the estimates and assumptions used for these items and should be read in conjunction with the notes to the Company’s consolidated financial statements.
 
An understanding of the Company’s accounting policies for these items is of critical importance to understanding its consolidated financial statements. See Part II, Item 8. “Financial Statements and Supplementary Data” of the Company's Annual Report on Form 10-K for a discussion of significant accounting policies and fair value methodologies. The following discussion of the results of operations includes information regarding the estimates and assumptions used for these items and should be read in conjunction with the notes to the Company’s consolidated financial statements.


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Consolidated Results of Operations

Consolidated Results of Operations
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Revenues:
 
 
 
 
 
 
 
Net earned premiums
$
163

 
$
219

 
$
411

 
$
413

Net investment income
93

 
101

 
187

 
199

Net realized investment gains (losses)
2

 
(3
)
 
30

 
(2
)
Net change in fair value of credit derivatives:
 
 
 
 
 
 
 
Realized gains (losses) and other settlements
(86
)
 
(23
)
 
(68
)
 
(80
)
Net unrealized gains
160

 
284

 
(450
)
 
(350
)
     Net change in fair value of credit derivatives
74

 
261

 
(518
)
 
(430
)
Fair value gains (losses) on committed capital securities ("CCS")
(3
)
 
4

 
(13
)
 
(10
)
Fair value gains (losses) on FG VIEs
143

 
168

 
213

 
127

Other income
(7
)
 
5

 
(21
)
 
96

Total revenues
465

 
755

 
289

 
393

Expenses:
 
 
 
 
 
 
 
Loss and loss adjustment expenses ("LAE")
62

 
118

 
14

 
360

Amortization of deferred acquisition costs
1

 
5

 
4

 
10

Interest expense
21

 
25

 
42

 
50

Other operating expenses
52

 
53

 
112

 
115

Total expenses
136

 
201

 
172

 
535

Income (loss) before provision for income taxes
329

 
554

 
117

 
(142
)
Provision (benefit) for income taxes
110

 
177

 
42

 
(36
)
Net income (loss)
$
219

 
$
377

 
$
75

 
$
(106
)


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Net Earned Premiums
 
Net earned premiums are recognized over the remaining contractual lives, or in the case of homogeneous pools of insured obligations, the remaining expected lives, of financial guaranty insurance contracts.
 
Net Earned Premiums
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Financial guaranty:
 
 
 
 
 
 
 
Public finance
 
 
—

 
 
 
 
Scheduled net earned premiums and accretion
$
70

 
$
86

 
$
147

 
$
169

Accelerations(1)
46

 
68

 
112

 
105

Total public finance
116

 
154

 
259

 
274

Structured finance(2)
 
 
 
 
 
 
 
Scheduled net earned premiums and accretion
46

 
65

 
104

 
139

Accelerations(1)
—

 
—

 
47

 
—

Total structured finance
46

 
65

 
151

 
139

Other
1

 
—

 
1

 
—

Total net earned premiums
$
163

 
$
219

 
$
411

 
$
413

____________________
(1)
Reflects the unscheduled refunding or early termination of underlying insured obligations.
 
(2)
Excludes $15 million and $16 million for Second Quarter 2013 and 2012, respectively, and $33 million and $33 million for Six Months 2013 and 2012, respectively, related to consolidated FG VIEs.

Net earned premiums decreased in Second Quarter 2013 and Six Months 2013 compared with Second Quarter 2012 and Six Months 2012, primarily due to decline in scheduled net earned premium corresponding to the decline in the par outstanding, particularly in the structured finance insured portfolio, offset in part by increase in accelerations in Six Months 2013. Included in accelerations in the table above are accelerations related to the negotiated terminations of financial guaranty insurance contracts of $17 million for the Second Quarter 2013, $22 million for the Second Quarter 2012, $32 million for the Six Months 2013, and $22 million of the Six Months 2012.

At June 30, 2013, $4.4 billion of net deferred premium revenue remained to be earned over the life of the insurance contracts. Due to the scheduled amortization of deferred premium revenue, which includes acquisition accounting adjustments, scheduled net earned premiums are expected to decrease each year unless replaced by new business or the Company reassumes previously ceded business.

Net Investment Income
 
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 investment portfolio, excluding loss mitigation bonds, declined due to a lower fixed maturity balance and lower reinvestment rates. The overall pre-tax book yield was 3.81% at June 30, 2013 and 3.88% at June 30, 2012, respectively. Excluding bonds purchased or obtained for loss mitigation purposes, pre-tax yield was 3.42% as of June 30, 2013 compared with 3.54% as of June 30, 2012.


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Net Realized Investment Gains (Losses)

The table below presents the components of net realized investment gains (losses).

Net Realized Investment Gains (Losses)(1)
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Realized investment gains (losses) on sales of investments
$
9

 
$
(1
)
 
$
42

 
$
5

OTTl
(7
)
 
(2
)
 
(12
)
 
(7
)
Net realized investment gains (losses)
$
2

 
$
(3
)
 
$
30

 
$
(2
)
____________________
(1)
Net realized investment gains (losses) exclude $1 million OTTI for Second Quarter 2013 and $3 million OTTI for Second Quarter 2012 related to consolidated FG VIEs. Net realized investment gains (losses) exclude $2 million OTTI for Six Months 2013 and $4 million OTTI for Six Months 2012 related to consolidated FG VIEs.

The increase in realized investment gains in Six Months 2013 was primarily due to the gains on sales of certain other invested assets.

Other Income
 
Other income is comprised of recurring items such as foreign exchange remeasurement gains and losses, ancillary fees on financial guaranty policies such as commitment, consent and processing fees, and other revenue items on financial guaranty insurance and reinsurance contracts such as commutation gains on re-assumptions of previously ceded business.
 
Other Income

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Foreign exchange gain (loss) on remeasurement of premium receivable and loss reserves
$
(3
)
 
$
5

 
$
(19
)
 
$
15

Commutation gains (losses)
—

 
—

 
—

 
83

Other
(4
)
 
—

 
(2
)
 
(2
)
Total other income
$
(7
)
 
$
5

 
$
(21
)
 
$
96

 
In Six Months 2012, the Company reassumed two large previously ceded reinsurance contracts from Radian and Tokio resulting in commutation gains of $83 million. There was no reassumption of any previously ceded reinsurance in Six Months 2013.

Losses in the Insured Portfolio
 
The insured portfolio includes policies accounted for under three separate accounting models depending on the characteristics of the contract and the Company’s control rights. Please refer to Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of the assumptions and methodologies used in calculating the expected loss to be paid for all contracts. See the following in Item 1, Financial Statements:

•Notes 4 and 6 for financial guaranty insurance;
•Note 7 for fair value methodologies for credit derivatives and FG VIE assets and liabilities;
•Note 8 for financial guaranty contracts accounted for credit derivatives; and
•Note 9 for consolidated FG VIE.
    

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The discussion of losses that follows encompasses losses on all contracts in the insured portfolio regardless of accounting model, unless otherwise specified. In order to effectively evaluate and manage the economics of the entire insured portfolio, management compiles and analyzes expected loss information for all policies on a consistent basis. That is, management monitors and assigns ratings and calculates expected losses in the same manner for all its exposures. Management also considers contract specific characteristics that affect the estimates of expected loss.

The surveillance process for identifying transactions with expected losses is described in the the notes to the consolidated financial statements. 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.
 
Net Par Outstanding and Number of Risks
By BIG Category

 
 
Net Par Outstanding
as of
 
Number of Risks (1)
as of
Description
 
June 30, 2013
 
December 31, 2012
 
June 30, 2013
 
December 31, 2012
 
 
(dollars in millions)
BIG:
 
 

 
 

 
 

 
 

Category 1
 
$
7,481

 
$
9,254

 
171

 
183

Category 2
 
5,811

 
5,107

 
108

 
103

Category 3
 
8,340

 
9,031

 
179

 
174

Total BIG
 
$
21,632

 
$
23,392

 
458

 
460

____________________
(1)
A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making debt service payments.
 
U.S. RMBS:

The Company projects losses on its insured U.S. RMBS on a transaction-by-transaction basis by projecting the performance of the underlying pool of mortgages over time and then applying the structural features (i.e., payment priorities or tranching) of the RMBS to the projected performance of the collateral over time. The resulting projected claim payments or reimbursements are then discounted using risk-free rates. For transactions where the Company projects it will receive recoveries from providers of R&W, it projects the amount of recoveries and either establishes a recovery for claims already paid or reduces its projected claim payments accordingly.
 
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

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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 $3.5 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

$
2.3

Agreement amounts projected to be received in the future
0.6

Repurchase amounts paid into the relevant RMBS prior to settlement (1)
0.6

Total R&W payments, gross of reinsurance

$
3.5

____________________
(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 $964 million, which includes $614 million from agreements (and pending agreements) with R&W providers and $350 million in transactions where the Company does not yet have such an agreement, all net of reinsurance.

The Company assumes that recoveries on transactions backed by second lien loans that were not subject to the largest settlement agreements will occur, depending on scenarios, in two to four years from the balance sheet date, 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. See Note 5, Expected loss to be Paid, of the Financial Statements, for a discussion of the significant terms of the Company's R&W settlement agreements to date.

Net expected loss to be paid consists primarily of the present value of future: expected claim payments, expected recoveries of excess spread in the transaction structures, cessions to reinsurers, and expected recoveries for breaches of R&W and other loss mitigation strategies. Current risk free rates are used to discount expected losses at the end of each reporting period and therefore changes in such rates from period to period affect the expected loss estimates reported. The effect of changes in discount rates are included in net economic loss development, however, economic loss development attributable to changes in discount rates is not indicative of credit impairment or improvement. Assumptions used in the determination of the net expected loss to be paid such as delinquency, severity, and discount rates and expected timeframes to recovery in the mortgage market were consistent by sector regardless of the accounting model used. The primary drivers of changes in expected loss to be paid are discussed below.

The primary difference between net economic loss development and loss expense included in operating income relates to the consideration of deferred premium revenue in the calculation of loss reserves and loss expense. For financial guaranty insurance contracts, a loss is generally recorded only when expected losses exceed deferred premium revenue. Therefore, the timing of loss recognition does not necessarily coincide with the timing of the actual credit impairment or improvement reported in net economic loss development. AGM's U.S. RMBS transactions generally have the largest deferred premium revenue balances because of the purchase accounting adjustments that were made in 2009 in connection with Assured Guaranty's purchase of AGM, and therefore the largest differences between net economic loss development and loss expense is this sector. See "–Losses Incurred."


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Economic Loss Development and (Paid) Recovered Losses

 
Economic Loss Development(1)
 
(Paid) Recovered Losses
 
Second Quarter
 
Second Quarter
 
2013
 
2012
 
2013
 
2012
 
(in millions)
U.S. RMBS before benefit for recoveries for breaches of R&W
$
70

 
$
97

 
$
(212
)
 
$
(296
)
Net benefit for recoveries for breaches of R&W
(51
)
 
(46
)
 
525

 
223

U.S. RMBS after benefit for recoveries for breaches of R&W
19

 
51

 
313

 
(73
)
Other structured finance
(23
)
 
25

 
(116
)
 
(9
)
Public finance
91

 
19

 
(7
)
 
6

Other
—

 
(6
)
 
10

 
—

Total
$
87

 
$
89

 
$
200

 
$
(76
)

 
Economic Loss Development(1)
 
(Paid) Recovered Losses
 
Six Months
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
U.S. RMBS before benefit for recoveries for breaches of R&W
$
127

 
$
165

 
$
(366
)
 
$
(521
)
Net benefit for recoveries for breaches of R&W
(208
)
 
(97
)
 
614

 
293

U.S. RMBS after benefit for recoveries for breaches of R&W
(81
)
 
68

 
248

 
(228
)
Other structured finance
(28
)
 
(1
)
 
(120
)
 
(35
)
Public finance
108

 
240

 
(30
)
 
54

Other
(10
)
 
(6
)
 
10

 
—

Total
$
(11
)
 
$
301

 
$
108

 
$
(209
)
____________________
(1)
Economic loss development includes the effects of changes in assumptions based on observed market trends, changes in discount rates, accretion of discount and the economic effects of loss mitigation efforts.

Net Expected Loss to be Paid
 
 
As of
June 30, 2013
 
As of
December 31, 2012
 
(in millions)
U.S. RMBS before benefit for recoveries for breaches of R&W
$
1,413

 
$
1,652

Net benefit for recoveries for breaches of R&W
(964
)
 
(1,370
)
U.S. RMBS after benefit for recoveries for breaches of R&W
449

 
282

Other structured finance
191

 
339

Public finance
137

 
59

Other
(3
)
 
(3
)
Total
$
774

 
$
677


Second Quarter 2013 Net Economic Loss Development

Total economic loss development in Second Quarter 2013 was $87 million ($79 million after tax), which was primarily driven by loss development in U.S. public finance, Detroit in particular, and RMBS development, offset in part by positive developments in other sectors. In the RMBS sector, loss development was partially offset by an increase in the benefit

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for R&W attributable to settlement agreements. The risk-free rates used to discount expected losses ranged from 0.0% to 4.03% as of June 30, 2013 compared with 0.0% to 3.28% as of December 31, 2012.

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 it chose 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 the Company uses to project RMBS losses and the scenarios it employs are described in more detail in Note 5, Expected Loss to be Paid, of the Financial Statements.

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 2013
 
(in millions)
Inclusion (removal) of deals with breaches of R&W during period
$
6

Change in recovery assumptions as the result of additional file review and recovery success
6

Estimated increase (decrease) in defaults that will result in additional (lower) breaches
(4
)
Results of settlements
38

Accretion of discount on balance
5

Total
$
51

 
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 net par outstanding for these and all other BIG rated U.S. public finance obligations was $4.9 billion as of June 30, 2013 and $4.6 billion as of December 31, 2012. The Company projects that its total future expected net loss across its troubled U.S. public finance credits as of June 30, 2013 will be $71 million. As of March 31, 2013 the Company was projecting a net recovery of $9 million across it 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.
        

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Second Quarter 2012 Net Economic Loss Development

Net economic loss development in Second Quarter 2012 was $89 million ($73 million after tax) which was driven primarily by the effects of declines in risk-free rates and additional expected losses on certain public finance transactions. U.S. RMBS development was $51 million, which reflects the effect of discount rates and higher losses in the underlying collateral, largely offset by a higher R&W benefit. Increases in loss development due to declines in the risk-free rates do not reflect credit impairment in the underlying collateral. The Company recorded $16 million in gains in Second Quarter 2012 due to changes in foreign exchange rates on Greece reserves, which was recorded in other income. In Second Quarter 2012, the Company also recorded a $6 million estimated recovery on a legacy life reinsurance transaction. Changes in discount rates had a significant effect on the economic loss development in Second Quarter 2012 as the rates ranged from 0% to 3.04% as of June 30, 2012 compared with 0.0% to 3.27% as of December 31, 2011.

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 2012
 
(in millions)
Inclusion (removal) of deals with breaches of R&W during period
$
(5
)
Change in recovery assumptions as the result of additional file review and recovery success
(10
)
Estimated increase (decrease) in defaults that will result in additional (lower) breaches
58

Results of settlements
—

Accretion of discount on balance
3

Total
$
46


Losses Incurred
 
For transactions accounted for as financial guaranty insurance under generally accepted accounting principles in the United States of America ("GAAP"), each transaction’s expected loss to be expensed, net of estimated R&W recoveries, is compared with the deferred premium revenue of that transaction. Generally, when the expected loss to be expensed exceeds the deferred premium revenue, a loss is recognized in the income statement for the amount of such excess.

When the Company measures operating income, a non-GAAP financial measure, it calculates the credit derivative and FG VIE losses incurred in a similar manner. Changes in fair value in excess of expected loss that are not indicative of economic deterioration or improvement are not included in operating income.
 
Expected loss to be paid as discussed above under "Losses in the Insured Portfolio" is an important liquidity measure in that it provides the present value of amounts that the Company expects to pay or recover in future periods. Expected loss to be expensed is important because it presents the Company’s projection of incurred losses that will be recognized in future periods as deferred premium revenue amortizes into income on financial guaranty insurance policies. Expected loss to be paid for FG VIEs pursuant to AGC’s and AGM’s financial guaranty policies is calculated in a manner consistent with financial guaranty insurance contracts, but eliminated in consolidation under GAAP.


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 The following tables present the loss and LAE recorded in the consolidated statements of operations by sector for non-derivative contracts and the loss expense recorded under non-GAAP operating income respectively. 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
$
16

 
$
70

 
$
(24
)
 
$
143

Other structured finance
(10
)
 
27

 
(22
)
 
(5
)
Public finance
78

 
31

 
75

 
240

Other
—

 
(6
)
 
—

 
(6
)
Total insurance contracts before FG VIE consolidation
84

 
122

 
29

 
372

Effect of consolidating FG VIEs
(22
)
 
(4
)
 
(15
)
 
(12
)
Total loss and LAE
$
62

 
$
118

 
$
14

 
$
360



Loss Expense Non-GAAP Operating

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
U.S. RMBS
$
37

 
$
73

 
$
21

 
$
148

Other structured finance
(20
)
 
25

 
(36
)
 
(12
)
Public finance
79

 
30

 
76

 
239

Other
—

 
(6
)
 
(10
)
 
(6
)
Total
$
96

 
$
122

 
$
51

 
$
369



Reconciliation of Loss and LAE to Non-GAAP Loss Expense

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Loss and LAE
$
62

 
$
118

 
$
14

 
$
360

Credit derivative loss expense
12

 
0

 
22

 
(2
)
FG VIE loss expense
22

 
4

 
15

 
11

Loss expense included in operating income
$
96

 
$
122

 
$
51

 
$
369


In 2012, the U.S. RMBS sector and non-U.S. public finance sector have generated the majority of the losses incurred. In 2012, the Company fully settled its exposure to Greek sovereign debt. In 2013, U.S. RMBS losses were lower due primarily to the settlement of several R&W claims, however U.S. public finance sector experienced economic loss development due in part to the Company's exposure to Detroit. Changes in risk-free rates used to discount losses also affected loss expense in the Second Quarter 2013 and Second Quarter 2012 for long-dated transactions, however this component of loss expense does not reflect actual credit impairment or improvement in the period.

For financial guaranty contracts accounted for as insurance, the amounts reported in the GAAP financial statements may only reflect a portion of the current period’s economic development and may also include a portion of prior-period economic development. The difference between economic loss development on financial guaranty insurance contracts and loss

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and LAE recognized in GAAP income is essentially loss development and accretion for financial guaranty insurance contracts that is, or was previously, absorbed in unearned premium reserve. Such amounts have not yet been recognized in income.

The table below presents the expected timing of loss recognition for insurance contracts on both a reported GAAP and non-GAAP operating income basis.

Financial Guaranty Insurance
Net Expected Loss to be Expensed
As of June 30, 2013
 
 
Net Expected Loss to be Expensed(1)
 
In GAAP
Reported
Income
 
In Non-GAAP
Operating
Income
 
(in millions)
2013 (July 1 - September 30)
$
18

 
$
20

2013 (October 1 - December 31)
17

 
18

Subtotal 2013
35

 
38

2014
54

 
64

2015
46

 
59

2016
40

 
52

2017
36

 
45

2018-2022
129

 
156

2023-2027
62

 
75

2028-2032
30

 
38

After 2032
21

 
31

Total expected PV of net expected loss to be expensed
453

 
558

Discount
411

 
456

Total future value
$
864

 
$
1,014

____________________
(1)
Net expected loss to be expensed for GAAP reported income is different than non-GAAP operating income by the amount related to consolidated FG VIEs.

Net Change in Fair Value of Credit Derivatives
  
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 and credit spreads, and other market factors. With considerable volatility continuing in the market, unrealized gains (losses) on credit derivatives may fluctuate significantly in future periods.

Except for net estimated credit impairments (i.e., net expected payments), the unrealized gains and losses on credit derivatives are expected to reduce to zero as the exposure approaches its maturity date. Changes in the fair value of the Company’s credit derivatives that do not reflect actual or expected claims or credit losses have no impact on the Company’s statutory claims paying resources, rating agency capital or regulatory capital positions. Expected losses to be paid in respect of contracts accounted for as credit derivatives are included in the discussion above: “—Losses in the Insured Portfolio.”
  
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 AGC and AGM. The Company determines its own credit risk based on quoted credit default swap ("CDS") prices traded on the Company at each balance sheet date. Generally, a widening of the CDS prices traded on AGC and AGM has an effect of offsetting unrealized losses that result from widening general market credit spreads, while a narrowing of the CDS prices traded on AGC and AGM has an effect of offsetting unrealized gains that result from narrowing general market credit spreads.
 

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There are typically no quoted prices for the Company's instruments or similar instruments as financial guaranty contracts do not typically trade in active markets. Observable inputs other than quoted market prices exist; however, these inputs reflect contracts that do not contain terms and conditions similar to those in the credit derivatives issued by the Company. Therefore, the valuation of the Company’s credit derivative contracts requires the use of models that contain significant, unobservable inputs, and are classified as Level 3 in the fair value hierarchy. See Note 7, Fair Value Measurement, of the Financial Statements.
 
The fair value of the Company's credit derivative contracts represents the difference between the present value of remaining net 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, interest rates, the credit ratings of referenced entities, the Company’s own credit risk and remaining contractual cash flows.

The models used to determine fair value are primarily developed internally based on market conventions for similar transactions that the Company observed in the past. There has been very limited new issuance activity in this market over the past three years and as of June 30, 2013, and market prices for the Company’s credit derivative contracts were generally not available. Inputs to the estimate of fair value include various market indices, credit spreads, the Company’s own credit spread, and estimated contractual payments.
 
Management considers the non-standard terms of its credit derivative contracts in determining the fair value of these contracts. These terms differ from more standardized credit derivatives sold by companies outside of the financial guaranty industry. The non-standard terms include the absence of collateral support agreements or immediate settlement provisions. In addition, the Company employs relatively high attachment points. Because of these terms and conditions, the fair value of the Company’s credit derivatives may not reflect the same prices observed in an actively traded market of CDS that do not contain terms and conditions similar to those observed in the financial guaranty market. The Company considers R&W claim recoveries in determining the fair value of its CDS contracts.
 
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.
 
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
$
41

 
$
34

 
$
68

 
$
63

Net ceding commissions (paid and payable) received and receivable
0

 
0

 
1

 
0

Realized gains on credit derivatives
41

 
34

 
69

 
63

Terminations
—

 
(1
)
 
—

 
(1
)
Net credit derivative losses (paid and payable) recovered and recoverable
(127
)
 
(56
)
 
(137
)
 
(142
)
Total realized gains (losses) and other settlements on credit derivatives
(86
)
 
(23
)
 
(68
)
 
(80
)
Net unrealized gains (losses) on credit derivatives
160

 
284

 
(450
)
 
(350
)
Net change in fair value of credit derivatives
$
74

 
$
261

 
$
(518
)
 
$
(430
)
 
Net credit derivative premiums have increased in Second Quarter 2013 and Six Months 2013 due primarily to the accelerations of premium earnings due to negotiated terminations, offset in part by the decline in scheduled earnings due to decline in net par outstanding to $60.9 billion at June 30, 2013 from $78.4 billion at June 30, 2012. In Second Quarter 2013 and

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2012, CDS contracts totaling $2.0 billion and $0.6 billion in net par were terminated, resulting in accelerations of credit derivative revenues of $14 million in Second Quarter 2013 and $0.7 million in Second Quarter 2012. In Six Months 2013 and 2012, CDS contracts totaling $3.0 billion and $0.8 billion in net par were terminated, resulting in accelerations of credit derivative revenues of $15 million in Six Months 2013 and $1 million in Six Months 2012. In Second Quarter 2013, in addition to the CDS terminations mentioned above, the Company terminated a film securitization CDS for a payment of $120 million which was recorded in realized gains (losses) and other settlements on credit derivatives, with a corresponding release of the unrealized loss recorded in unrealized gains (losses) on credit derivatives of $127 million for a net change in fair value of credit derivatives of $7 million.
 

Net Change in Unrealized Gains (Losses) on Credit Derivatives By Sector
 
 
 
Second Quarter
 
Six Months
Asset Type
 
2013
 
2012
 
2013
 
2012
 
 
(in millions)
U.S. RMBS
 
$
14

 
$
250

 
$
(443
)
 
$
(379
)
Pooled corporate obligations
 
(34
)
 
25

 
(139
)
 
30

Commercial mortgage-backed securities ("CMBS")
 
(1
)
 
0

 
(4
)
 
0

Other(1)
 
181

 
9

 
136

 
(1
)
Total
 
$
160

 
$
284

 
$
(450
)
 
$
(350
)
____________________
(1)
“Other” includes all other U.S. and international asset classes, such as commercial receivables, international infrastructure, international RMBS securities, and pooled infrastructure securities.
 
During Second Quarter 2013, unrealized fair value gains were driven primarily by the termination of a film securitization transaction and price improvement on a XXX life securitization transaction, both in the Other sector. These unrealized gains were slightly offset by wider implied net spreads in the pooled corporate obligations sector. The wider implied net spreads were primarily a result of asset prices on the Company's pooled corporate obligations deteriorating during the period, as well as the decreased cost to buy protection in AGC's name as the market cost of AGC's credit decreased during the period. These transactions were pricing at or above their floor levels (or the minimum rate at which the Company would expect to consider assuming these risks based on historical experience); therefore when the cost of purchasing CDS protection on AGC, which management refers to as the CDS spread on AGC, decreased the implied spreads that the Company would expect to receive on these transactions increased. As indicated below, the credit spread of both the 5 Year and 1 Year CDS spread on AGC decreased in Second Quarter 2013. 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 AGM's current outstanding exposure continue to price at floor levels.

During Six Months 2013, the cost to buy protection on AGC's name declined. This led to U.S. RMBS unrealized fair value losses which were generated primarily in the Alt-A, prime first lien and subprime RMBS sectors due to wider implied net spreads. The wider implied net spreads were primarily a result of the decreased cost to buy protection in AGC's name as the market cost of AGC's credit decreased significantly during the period. These transactions were pricing at or above their floor levels; therefore when the cost of purchasing CDS protection on AGC decreased, the implied spreads that the Company would expect to receive on these transactions increased. As indicated below, the credit spread of both the 5 Year and 1 Year CDS spread on AGC decreased significantly in Six Months 2013. To calculate the fair value of the CDS contracts, the Company matches the tenor of the CDS contracts in the Company's portfolio to the tenor of the CDS spread purchased in AGC's name. The cost of AGM's 5 Year and 1 Year credit protection also decreased during Six Months 2013, but did not lead to significant fair value losses, as the policies which represent the majority of AGM's current outstanding exposure continue to price at floor levels. Six Months 2013 changes in fair value of credit derivatives in the Other category includes a $20 million loss for guaranteed interest rate swaps identified during 2013.

     In Second Quarter 2012, U.S. RMBS unrealized fair value gains were generated primarily in the prime first lien, Alt-A, Option ARM and subprime RMBS sectors due to tighter implied net spreads. The tighter implied net spreads were primarily a result of the increased cost to buy protection in AGC's name as the market cost of AGC's credit protection increased. These transactions were pricing above their floor levels; therefore when the cost of purchasing CDS protection on AGC increased, the implied spreads that the Company would expect to receive on these transactions decreased. The cost of AGM's credit protection also increased during the quarter, but did not lead to significant fair value gains, as the majority of AGM policies continue to

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price at floor levels. In addition, Second Quarter 2012 included an $85 million unrealized gain relating to R&W benefits from the Deutsche Bank Agreement.

During Six Months 2012, the cost to buy protection on AGC's name declined. This led to U.S. RMBS unrealized fair value losses which were generated primarily in the prime first lien, Alt-A and Option ARM RMBS sectors due to wider implied net spreads. The wider implied net spreads were primarily a result of the decreased cost to buy protection in AGC's name as the market cost of AGC's credit protection decreased. These transactions were pricing above their floor levels; therefore when the cost of purchasing CDS protection on AGC decreased, the implied spreads that the Company would expect to receive on these transactions increased. The cost of AGM's credit protection also decreased during Six Months 2012, but did not lead to significant fair value losses, as the majority of AGM policies continue to price at floor levels.
.

Five-Year CDS Spread on AGC and 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):
 

 
 
 
 

 
 
 
 
 
 
AGC
343

 
397

 
678

 
904

 
743

 
1,140

AGM
365

 
380

 
536

 
652

 
555

 
778

 
One-Year CDS Spread on AGC and 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):
 

 
 
 
 

 
 
 
 
 
 
AGC
57

 
59

 
270

 
629

 
594

 
965

AGM
72

 
60

 
257

 
416

 
378

 
538


 
Effect of Changes in the Company’s Credit Spread on
Unrealized Gains (Losses) on Credit Derivatives
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Change in unrealized gains (losses) of credit derivatives:
 
 
 
 
 
 
 
Before considering implication of the Company’s credit spreads
$
350

 
$
(855
)
 
$
854

 
$
(142
)
Resulting from change in the Company’s credit spreads
(190
)
 
1,139

 
(1,304
)
 
(208
)
After considering implication of the Company’s credit spreads
$
160

 
$
284

 
$
(450
)
 
$
(350
)
 
Management believes that the trading level of AGC’s and AGM’s credit spreads is due to the correlation between AGC’s and AGM’s risk profile and the current risk profile of the broader financial markets and to increased demand for credit protection against AGC and 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 AGC’s and AGM’s credit spread were higher credit spreads in the fixed income security markets relative to pre-financial crisis levels. The higher credit spreads in the fixed income security market are due to the lack of liquidity in the high-yield collateralized debt obligations ("CDO"), trust preferred securities CDO ("TruPS CDOs"), and collateralized loan obligation ("CLO") markets as well as continuing market concerns over the most recent vintages of RMBS.


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Provision for Income Tax
 
Deferred income tax assets and liabilities are established for the temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted rates in effect for the year in which the differences are expected to reverse. Such temporary differences relate principally to unrealized gains and losses on investments and credit derivatives, FG VIE fair value adjustments, loss and LAE reserve, unearned premium reserve and tax attributes for net operating losses, alternative minimum tax (“AMT”) credits and foreign tax credits. As of June 30, 2013 and December 31, 2012, the Company had a net deferred income tax asset of $850 million and $721 million, respectively. The increase in the deferred tax asset related primarily to fair value losses on credit derivatives. As of June 30, 2013, the Company has foreign tax credits carried forward of $30 million which expire in 2018 through 2021 and AMT credits of $58 million which do not expire. Foreign tax credits of $22 million are from its acquisition of Assured Guaranty Municipal Holdings Inc. (“AGMH”) on July 1, 2009 (“AGMH Acquisition”). The Internal Revenue Code limits the amount of credits the Company may utilize each year.

Provision for Income Taxes and Effective Tax Rates
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Total provision (benefit) for income taxes
$
110

 
$
177

 
$
42

 
$
(36
)
Effective tax rate
33.5
%
 
32.0
%
 
36.4
%
 
25.0
%
 
The Company’s effective tax rates reflect the proportion of income recognized by each of the Company’s operating subsidiaries, with U.S. subsidiaries taxed at the U.S. marginal corporate income tax rate of 35%, United Kingdom (“U.K.”) subsidiaries taxed at the U.K. blended marginal corporate tax rate of 23.25% unless subject to U.S. tax by election or as a U.S. controlled foreign corporation, and no taxes for the Company’s Bermuda holding company and subsidiaries unless subject to U.S tax by election or as a U.S. controlled foreign corporation. 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. Accordingly, the Company’s overall corporate effective tax rate fluctuates based on the distribution of taxable income across these jurisdictions. Second Quarter 2013 and Second Quarter 2012 had disproportionate losses and income across jurisdictions, offset by tax-exempt interest, and are the primary reasons for the 33.5% and 32.0% effective tax rates, respectively. Six Months 2013 and Six Months 2012 had disproportionate losses and income across jurisdictions, offset by tax-exempt interest, and are the primary reasons for the 36.4% and 25.0% effective tax rates, respectively.

Financial Guaranty Variable Interest Entities
 
Pursuant to GAAP, the Company evaluated 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 that could potentially be significant to the VIE. As of June 30, 2013, the Company determined that, based on the assessment of its control rights over servicer or collateral manager replacement, given that servicing/managing collateral were deemed to be the VIEs’ most significant activities, 41 VIEs required consolidation.

The table below presents the effects on reported GAAP income resulting from consolidating these FG VIEs and eliminating their related insurance and investment accounting entries and, in total, represents a difference between GAAP reported net income and non-GAAP operating income attributable to FG VIEs. The consolidation of FG VIEs has a significant effect on net income and shareholders' equity due to (1) changes in fair value gains (losses) on FG VIE assets and liabilities, (2) the eliminations of premiums and losses related to the AGC and AGM FG VIE liabilities with recourse and (3) the elimination of investment balances related to the Company’s purchase of AGC and AGM insured FG VIE debt. Upon consolidation of an FG VIE, the related insurance and, if applicable, the related investment balances, are considered intercompany transactions and therefore eliminated. See “—Non-GAAP Financial Measures—Operating Income” below.
 

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Effect of Consolidating FG VIEs on Net Income (Loss) 

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Net earned premiums
$
(15
)
 
$
(16
)
 
$
(33
)
 
$
(33
)
Net investment income
(4
)
 
(3
)
 
(7
)
 
(6
)
Net realized investment gains (losses)
1

 
3

 
2

 
4

Fair value gains (losses) on FG VIEs
143

 
168

 
213

 
127

Loss and LAE
22

 
4

 
15

 
12

Total pretax effect on net income
147

 
156

 
190

 
104

Less: tax provision (benefit)
51

 
55

 
66

 
37

Total effect on net income (loss)
$
96

 
$
101

 
$
124

 
$
67

 
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 $143 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 $213 million pre-tax fair value gain of consolidated FG VIEs during Six Months 2013. The additional gain of $64 million for Six Months 2013 was also a result of an R&W benefit related to the Flagstar policies referenced above.
 
During Second Quarter 2012, the Company recorded a pre-tax net fair value gain of consolidated FG VIEs of $168 million. The majority of this gain, $161 million, is a result of a R&W settlement with Deutsche Bank during the period. This was also the primary driver of the $127 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.

Expected losses to be paid (recovered) in respect of consolidated FG VIEs, which were $31 million paid as June 30, 2013 and $96 million recovered as of December 31, 2012, are included in the discussion of “—Losses in the Insured Portfolio.” 

Non-GAAP Financial Measures
 
To reflect the key financial measures management analyzes in evaluating the Company’s operations and progress towards long-term goals, the Company discusses both measures promulgated in accordance with GAAP and measures not promulgated in accordance with GAAP (“non-GAAP financial measures”). Although the financial measures identified as non-GAAP should not be considered substitutes for GAAP measures, management considers them key performance indicators and employs them as well as other factors in determining compensation. Non-GAAP financial measures, therefore, provide investors with important information about the key financial measures management utilizes in measuring its business. The primary limitation of non-GAAP financial measures is the potential lack of comparability to those of other companies, which may define non-GAAP measures differently because there is limited literature with respect to such measures. Three of the primary non-GAAP financial measures analyzed by the Company’s senior management are: operating income, adjusted book value and PVP.
 
Management and the board of directors utilize non-GAAP financial measures in evaluating the Company’s financial performance and as a basis for determining senior management incentive compensation. By providing these non-GAAP financial measures, investors, analysts and financial news reporters have access to the same information that management reviews internally. In addition, Assured Guaranty’s presentation of non-GAAP financial measures is consistent with how analysts calculate their estimates of Assured Guaranty’s financial results in their research reports on Assured Guaranty and with how investors, analysts and the financial news media evaluate Assured Guaranty’s financial results.
 
The following paragraphs define each non-GAAP financial measure and describe why it is useful. A reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure, if available, is also presented below.
 

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Operating Income
 
Reconciliation of Net Income (Loss) to Operating Income
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
 
 
 
 
 
Net income (loss)
$
219

 
$
377

 
$
75

 
$
(106
)
Less after-tax adjustments:
 
 
 
 
 
 
 
Realized gains (losses) on investments
2

 
(4
)
 
21

 
(5
)
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
28

 
160

 
(406
)
 
(357
)
Fair value gains (losses) on CCS
(2
)
 
3

 
(8
)
 
(6
)
Foreign exchange gains (losses) on remeasurement of premiums receivable and loss and LAE reserves
(3
)
 
3

 
(14
)
 
10

Effect of consolidating FG VIEs
96

 
101

 
124

 
67

Operating income
$
98


$
114

 
$
358

 
$
185

 
 
 
 
 
 
 
 
Effective tax rate on operating income
29.4
%
 
29.9
%
 
26.8
%
 
25.7
%
 
Management believes that operating income is a useful measure because it clarifies the understanding of the underwriting results of the Company’s financial guaranty business, and also includes financing costs and net investment income, and enables investors and analysts to evaluate the Company’s financial results as compared with the consensus analyst estimates distributed publicly by financial databases. Operating income is defined as net income (loss) attributable to AGL, as reported under GAAP, adjusted for the following:
 
1)            Elimination of the after-tax realized gains (losses) on the Company’s investments, except for gains and losses on securities classified as trading. The timing of realized gains and losses, which depends largely on market credit cycles, can vary considerably across periods. The timing of sales is largely subject to the Company’s discretion and influenced by market opportunities, as well as the Company’s tax and capital profile. Trends in the underlying profitability of the Company’s business can be more clearly identified without the fluctuating effects of these transactions.

2)            Elimination of the after-tax non-credit impairment unrealized fair value gains (losses) on credit derivatives, which is the amount in excess of the present value of the expected estimated economic credit losses, and non-economic payments. Such fair value adjustments are heavily affected by, and in part fluctuate with, changes in market interest rates, credit spreads and other market factors and are not expected to result in an economic gain or loss. Additionally, such adjustments present all financial guaranty contracts on a more consistent basis of accounting, whether or not they are subject to derivative accounting rules.
 
3)            Elimination of the after-tax fair value gains (losses) on the Company’s CCS. Such amounts are heavily affected by, and in part fluctuate with, changes in market interest rates, credit spreads and other market factors and are not expected to result in an economic gain or loss.
 
4)            Elimination of the after-tax foreign exchange gains (losses) on remeasurement of net premium receivables and loss and LAE reserves. Long-dated receivables constitute a significant portion of the net premium receivable balance and represent the present value of future contractual or expected collections. Therefore, the current period’s foreign exchange remeasurement gains (losses) are not necessarily indicative of the total foreign exchange gains (losses) that the Company will ultimately recognize.
 
5)            Elimination of the effects of consolidating FG VIEs in order to present all financial guaranty contracts on a more consistent basis of accounting, whether or not GAAP requires consolidation. GAAP requires the Company to consolidate certain VIEs that have issued debt obligations insured by the Company even though the Company does not own such VIEs.
 

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Adjusted Book Value and Operating Shareholders’ Equity
 
Management also uses adjusted book value in order to measure the intrinsic value of the Company, excluding franchise value. Growth in adjusted book value is one of the key financial measures used in determining the amount of certain long term compensation to management and employees and used by rating agencies and investors.
 
Reconciliation of Shareholders’ Equity
to Adjusted Book Value
 
 
As of June 30, 2013
 
As of December 31, 2012
 
Total
 
Per Share
 
Total
 
Per Share
 
(dollars in millions, except
per share amounts)
Shareholders’ equity
$
4,484

 
$
24.52

 
$
4,994

 
$
25.74

Less after-tax adjustments:
 
 
 
 
 
 
 
Effect of consolidating FG VIEs
(226
)
 
(1.23
)
 
(348
)
 
(1.79
)
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(1,424
)
 
(7.78
)
 
(988
)
 
(5.09
)
Fair value gains (losses) on CCS
15

 
0.08

 
23

 
0.12

Unrealized gain (loss) on investment portfolio excluding foreign exchange effect
183

 
1.00

 
477

 
2.45

Operating shareholders’ equity
5,936

 
32.45

 
5,830

 
30.05

After-tax adjustments:
 
 
 

 
 

 
 

Less: Deferred acquisition costs
163

 
0.89

 
165

 
0.85

Plus: Net present value of estimated net future credit derivative revenue
178

 
0.97

 
220

 
1.14

Plus: Net unearned premium reserve on financial guaranty contracts in excess of expected loss to be expensed
3,022

 
16.53

 
3,266

 
16.83

Adjusted book value
$
8,973

 
$
49.06

 
$
9,151

 
$
47.17

 
As of June 30, 2013, shareholders’ equity decreased to $4.5 billion from $5.0 billion at December 31, 2012 due to share repurchases, decline in unrealized gains on the available for sale portfolio and dividends, which were partially offset by net income in Six Months 2013. Operating shareholders' equity increased due primarily to positive operating income in Six Months 2013, which was partially offset by the share repurchases. Adjusted book value decreased mainly due to share repurchases, dividends and economic loss development. Adjusted book value per share increased due to the reduction in shares outstanding as of June 30, 2013 due to share repurchases. Shares outstanding decreased by 11.1 million primarily due to the repurchase of 11.5 million common shares, partially offset by the vesting of restricted stock units of 0.4 million in Six Months 2013.
 
Management believes that operating shareholders’ equity is a useful measure because it presents the equity of the Company with all financial guaranty contracts accounted for on a more consistent basis and excludes fair value adjustments that are not expected to result in economic loss. Many investors, analysts and financial news reporters use operating shareholders’ equity as the principal financial measure for valuing AGL’s current share price or projected share price and also as the basis of their decision to recommend, buy or sell AGL’s common shares. Many of the Company’s fixed income investors also use operating shareholders’ equity to evaluate the Company’s capital adequacy. Operating shareholders’ equity is the basis of the calculation of adjusted book value (see below). Operating shareholders’ equity is defined as shareholders’ equity attributable to Assured Guaranty Ltd., as reported under GAAP, adjusted for the following:
 
1)            Elimination of the effects of consolidating FG VIEs in order to present all financial guaranty contracts on a more consistent basis of accounting, whether or not GAAP requires consolidation. GAAP requires the Company to consolidate certain VIEs that have issued debt obligations insured by the Company even though the Company does not own such VIEs.
 

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2)            Elimination of the after-tax non-credit impairment unrealized fair value gains (losses) on credit derivatives, which is the amount in excess of the present value of the expected estimated economic credit losses, and non-economic payments. Such fair value adjustments are heavily affected by, and in part fluctuate with, changes in market interest rates, credit spreads and other market factors and are not expected to result in an economic gain or loss.
 
3)            Elimination of the after-tax fair value gains (losses) on the Company’s CCS. Such amounts are heavily affected by, and in part fluctuate with, changes in market interest rates, credit spreads and other market factors and are not expected to result in an economic gain or loss.
 
4)            Elimination of the after-tax unrealized gains (losses) on the Company’s investments that are recorded as a component of accumulated other comprehensive income (“AOCI”) (excluding foreign exchange remeasurement). The AOCI component of the fair value adjustment on the investment portfolio is not deemed economic because the Company generally holds these investments to maturity and therefore should not recognize an economic gain or loss.
 
Management believes that adjusted book value is a useful measure because it enables an evaluation of the net present value of the Company’s in-force premiums and revenues in addition to operating shareholders’ equity. The premiums and revenues included in adjusted book value will be earned in future periods, but actual earnings may differ materially from the estimated amounts used in determining current adjusted book value due to changes in foreign exchange rates, prepayment speeds, terminations, credit defaults and other factors. Many investors, analysts and financial news reporters use adjusted book value to evaluate AGL’s share price and as the basis of their decision to recommend, buy or sell the AGL common shares. Adjusted book value is operating shareholders’ equity, as defined above, further adjusted for the following:
 
1)            Elimination of after-tax deferred acquisition costs, net. These amounts represent net deferred expenses that have already been paid or accrued and will be expensed in future accounting periods.
 
2)            Addition of the after-tax net present value of estimated net future credit derivative revenue. See below.
 
3)            Addition of the after-tax value of the unearned premium reserve on financial guaranty contracts in excess of expected loss to be expensed, net of reinsurance. This amount represents the expected future net earned premiums, net of expected losses to be expensed, which are not reflected in GAAP equity.

Net Present Value of Estimated Net Future Credit Derivative Revenue
 
Management believes that this amount is a useful measure because it enables an evaluation of the value of future estimated credit derivative revenue. There is no corresponding GAAP financial measure. This amount represents the present value of estimated future revenue from the Company’s credit derivative in-force book of business, net of reinsurance, ceding commissions and premium taxes, for contracts without expected economic losses, and is discounted at 6%. Estimated net future credit derivative revenue may change from period to period due to changes in foreign exchange rates, prepayment speeds, terminations, credit defaults or other factors that affect par outstanding or the ultimate maturity of an obligation.

PVP or Present Value of New Business Production
 
Reconciliation of PVP to Gross Written Premiums
 
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Total PVP
$
16

 
$
50

 
$
34

 
$
106

Less: Financial guaranty installment premium PVP
—

 
3

 
1

 
7

Total: Financial guaranty upfront gross written premiums
16

 
47

 
33

 
99

Plus: Financial guaranty installment gross written premiums
6

 
(16
)
 
6

 
20

Total gross written premiums
$
22

 
$
31

 
$
39

 
$
119

 

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Management believes that PVP is a useful measure because it enables the evaluation of the value of new business production for the Company by taking into account the value of estimated future installment premiums on all new contracts underwritten in a reporting period as well as premium supplements and additional installment premium on existing contracts as to which the issuer has the right to call the insured obligation but has not exercised such right, whether in insurance or credit derivative contract form, which GAAP gross premiums written and the net credit derivative premiums received and receivable portion of net realized gains and other settlements on credit derivatives (“Credit Derivative Revenues”) do not adequately measure. PVP in respect of financial guaranty contracts written in a specified period is defined as gross upfront and installment premiums received and the present value of gross estimated future installment premiums, in each case, discounted at 6%. For purposes of the PVP calculation, management discounts estimated future installment premiums on insurance contracts at 6%, while under GAAP, these amounts are discounted at a risk free rate. Additionally, under GAAP, management records future installment premiums on financial guaranty insurance contracts covering non-homogeneous pools of assets based on the contractual term of the transaction, whereas for PVP purposes, management records an estimate of the future installment premiums the Company expects to receive, which may be based upon a shorter period of time than the contractual term of the transaction. Actual future net earned or written premiums and Credit Derivative Revenues may differ from PVP due to factors including, but not limited to, changes in foreign exchange rates, prepayment speeds, terminations, credit defaults, or other factors that affect par outstanding or the ultimate maturity of an obligation.
 
Insured Portfolio
 
The following tables present the insured portfolio by asset class net of cessions to reinsurers. It includes all financial guaranty contracts outstanding as of the dates presented, regardless of the form written (i.e. credit derivative form or traditional financial guaranty insurance form) or the applicable accounting model (i.e. insurance, derivative or VIE consolidation).
 

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Net Par Outstanding and Average Internal Rating by Asset Class
 
 
As of June 30, 2013
 
As of December 31, 2012
Sector
 
Net Par
Outstanding
 
Avg.
Rating
 
Net Par
Outstanding
 
Avg.
Rating
 
 
(dollars in millions)
Public finance:
 
 

 
 
 
 

 
 
U.S.:
 
 

 
 
 
 

 
 
General obligation
 
$
163,218

 
A+
 
$
169,985

 
A+
Tax backed
 
70,775

 
A+
 
73,787

 
A+
Municipal utilities
 
59,864

 
A
 
62,116

 
A
Transportation
 
31,892

 
A
 
33,799

 
A
Healthcare
 
17,084

 
A
 
17,838

 
A
Higher education
 
14,576

 
A
 
15,770

 
A+
Infrastructure finance
 
4,042

 
BBB
 
4,210

 
BBB
Housing
 
4,035

 
A+
 
4,633

 
AA-
Investor-owned utilities
 
1,042

 
A-
 
1,069

 
A-
Other public finance—U.S.
 
4,527

 
A
 
4,760

 
A
Total public finance—U.S.
 
371,055

 
A
 
387,967

 
A+
Non-U.S.:
 
 

 
 
 
 

 
 
Infrastructure finance
 
14,360

 
BBB
 
15,812

 
BBB
Regulated utilities
 
10,726

 
BBB+
 
12,494

 
BBB+
Pooled infrastructure
 
3,005

 
AA-
 
3,200

 
AA-
Other public finance—non-U.S.
 
5,609

 
A
 
6,034

 
A
Total public finance—non-U.S.
 
33,700

 
BBB+
 
37,540

 
BBB+
Total public finance
 
404,755

 
A
 
425,507

 
A
Structured finance:
 
 

 
 
 
 

 
 
U.S.:
 
 

 
 
 
 

 
 
Pooled corporate obligations
 
35,319

 
AAA
 
41,886

 
AAA
RMBS
 
16,268

 
BB+
 
17,827

 
BB+
CMBS and other commercial real estate related exposures
 
4,036

 
AAA
 
4,247

 
AAA
Financial products
 
3,030

 
AA-
 
3,653

 
AA-
Insurance securitizations
 
2,440

 
AA-
 
2,190

 
A+
Consumer receivables
 
2,270

 
BBB
 
2,369

 
BBB+
Commercial receivables
 
791

 
BBB+
 
1,025

 
BBB+
Structured credit
 
184

 
B+
 
319

 
CCC+
Other structured finance—U.S.
 
1,058

 
A-
 
1,179

 
BBB+
Total structured finance—U.S.
 
65,396

 
AA-
 
74,695

 
AA-
Non-U.S.:
 
 

 
 
 
 

 
 
Pooled corporate obligations
 
12,523

 
AAA
 
14,813

 
AAA
RMBS
 
1,309

 
AA-
 
1,424

 
AA-
Commercial receivables
 
1,305

 
A-
 
1,463

 
A-
Insurance securitizations
 
923

 
CCC-
 
923

 
CCC-
Structured credit
 
401

 
BBB
 
591

 
BBB
CMBS and other commercial real estate related exposures
 
—

 
—
 
100

 
AAA
Other structured finance—non-U.S.
 
377

 
AAA
 
377

 
AAA
Total structured finance—non-U.S.
 
16,838

 
AA
 
19,691

 
AA
Total structured finance
 
82,234

 
AA-
 
94,386

 
AA-
Total net par outstanding
 
$
486,989

 
A+
 
$
519,893

 
A+


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The June 30, 2013 and December 31, 2012 amounts above include $41.9 billion and $48.1 billion, respectively, of AGM structured finance net par outstanding. AGM has not insured a mortgage-backed transaction since January 2008 and announced its complete withdrawal from the structured finance market in August 2008. The structured finance transactions that remain in AGM’s insured portfolio are of double-A average underlying credit quality, according to the Company’s internal rating system. Management expects AGM’s structured finance portfolio to run-off rapidly: 10% by year-end 2013, 59% by year end 2015, and 82% by year-end 2017.
 
The following tables set forth the Company’s net financial guaranty portfolio by internal rating.
 
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
 
$
4,311

 
1.2
%
 
$
1,657

 
4.9
%
 
$
36,292

 
55.5
%
 
$
11,079

 
65.8
%
 
$
53,339

 
11.0
%
AA
 
115,820

 
31.2

 
487

 
1.4

 
9,808

 
15.0

 
669

 
4.0

 
126,784

 
26.0

A
 
202,440

 
54.6

 
8,965

 
26.6

 
2,872

 
4.4

 
863

 
5.1

 
215,140

 
44.2

BBB
 
43,554

 
11.7

 
20,701

 
61.5

 
3,526

 
5.4

 
2,313

 
13.7

 
70,094

 
14.4

BIG
 
4,930

 
1.3

 
1,890

 
5.6

 
12,898

 
19.7

 
1,914

 
11.4

 
21,632

 
4.4

Total net par outstanding
 
$
371,055

 
100.0
%
 
$
33,700

 
100.0
%
 
$
65,396

 
100.0
%
 
$
16,838

 
100.0
%
 
$
486,989

 
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
 
$
4,502

 
1.2
%
 
$
1,706

 
4.5
%
 
$
42,187

 
56.5
%
 
$
13,169

 
66.8
%
 
$
61,564

 
11.9
%
AA
 
124,525

 
32.1

 
875

 
2.3

 
9,589

 
12.8

 
722

 
3.7

 
135,711

 
26.1

A
 
210,124

 
54.1

 
9,781

 
26.1

 
4,670

 
6.2

 
1,409

 
7.2

 
225,984

 
43.4

BBB
 
44,213

 
11.4

 
22,885

 
61.0

 
3,717

 
5.0

 
2,427

 
12.3

 
73,242

 
14.1

BIG
 
4,603

 
1.2

 
2,293

 
6.1

 
14,532

 
19.5

 
1,964

 
10.0

 
23,392

 
4.5

Total net par outstanding
 
$
387,967

 
100.0
%
 
$
37,540

 
100.0
%
 
$
74,695

 
100.0
%
 
$
19,691

 
100.0
%
 
$
519,893

 
100.0
%
 
Securities purchased for loss mitigation purposes represented $1,193 million and $1,133 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 $219 million and $220 million in gross par outstanding as of June 30, 2013 and December 31, 2012, respectively.

Selected European Exposure

 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 Company has identified those European countries where it has exposure and where it believes heightened uncertainties exist to be: Greece, Hungary, Ireland, Italy, Portugal and Spain (the “Selected European Countries”). The Company selected these European countries based on its view that their credit fundamentals are deteriorating, as well as on published reports identifying countries that may be experiencing reduced demand for their sovereign debt in the current environment. See “—Selected European Countries” below for an explanation of the circumstances in each country leading the Company to select that country for further discussion.
 

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Economic Exposure to the Selected European Countries
 
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 tables, both gross and net of ceded reinsurance:
 
Gross Economic Exposure to Selected European Countries(1)
June 30, 2013
 
 
Greece
 
Hungary
 
Ireland
 
Italy
 
Portugal
 
Spain
 
Total
 
(in millions)
Sovereign and sub-sovereign exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

Public finance
$
—

 
$
—

 
$
—

 
$
1,315

 
$
120

 
$
420

 
$
1,855

Infrastructure finance
—

 
440

 
23

 
84

 
97

 
169

 
813

Sub-total
—

 
440

 
23

 
1,399

 
217

 
589

 
2,668

Non-sovereign exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

Regulated utilities
—

 
—

 
—

 
233

 
—

 
0

 
233

RMBS
—

 
224

 
137

 
546

 
—

 
—

 
907

Commercial receivables
—

 
1

 
12

 
62

 
15

 
3

 
93

Pooled corporate
23

 
—

 
198

 
245

 
15

 
550

 
1,031

Sub-total
23

 
225

 
347

 
1,086

 
30

 
553

 
2,264

Total
$
23

 
$
665

 
$
370

 
$
2,485

 
$
247

 
$
1,142

 
$
4,932

Total BIG
$
—

 
$
627

 
$
8

 
$
2

 
$
136

 
$
573

 
$
1,346

 
Net Economic Exposure to Selected European Countries(1)
June 30, 2013

 
Greece
 
Hungary
 
Ireland
 
Italy
 
Portugal
 
Spain
 
Total
 
(in millions)
Sovereign and sub-sovereign exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

Public finance
$
—

 
$
—

 
$
—

 
$
981

 
$
102

 
$
261

 
$
1,344

Infrastructure finance
—

 
413

 
23

 
83

 
97

 
167

 
783

Sub-total
—

 
413

 
23

 
1,064

 
199

 
428

 
2,127

Non-sovereign exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

Regulated utilities
—

 
—

 
—

 
215

 
—

 
0

 
215

RMBS
—

 
214

 
137

 
479

 
—

 
—

 
830

Commercial receivables
—

 
1

 
12

 
59

 
14

 
3

 
89

Pooled corporate
22

 
—

 
172

 
224

 
15

 
499

 
932

Sub-total
22

 
215

 
321

 
977

 
29

 
502

 
2,066

Total
$
22

 
$
628

 
$
344

 
$
2,041

 
$
228

 
$
930

 
$
4,193

Total BIG
$
—

 
$
591

 
$
7

 
$
2

 
$
118

 
$
412

 
$
1,130

____________________
(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. Included in both tables above is $137 million of reinsurance assumed on a 2004 - 2006 pool of Irish residential mortgages that is part of the Company’s remaining legacy mortgage reinsurance business. One of the residential mortgage-backed securities 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 tables.

As of June 30, 2013, the Company does not guarantee any sovereign bonds of the Selected European Countries, although the payments for many of the public finance and infrastructure finance credits originate with sovereigns or sub-

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sovereigns. The exposure shown in the “Public Finance” Category is from transactions backed by receivable payments from sub-sovereigns in Italy, Spain and Portugal. The Company understands that Moody's recently had undertaken a review of redenomination risk in selected countries in the Eurozone, including some of the Selected European Countries. No redenomination from the Euro to another currency has yet occurred and it may never occur. Therefore, it is not possible to be certain at this point how a redenomination of an issuer’s obligations might be implemented in the future and, in particular, whether any redenomination would extend to the Company's obligations under a related financial guarantee.
 
The tables above include the par amount of financial guaranty contracts accounted for as derivatives. The Company’s credit derivative transactions are governed by International Swaps and Derivatives Association, Inc. ("ISDA") documentation, and the Company is required to make a loss payment on them only upon the occurrence of one or more defined credit events with respect to the referenced securities or loans. For those financial guaranty contracts included in the tables above and accounted for as derivatives, the tables below show their fair value, net of reinsurance:
 
Fair Value Gain (Loss) of Financial Guaranty Contracts Accounted for as Derivatives,
With Exposure to Selected European Countries, Net of Reinsurance
June 30, 2013
 
Greece
 
Hungary
 
Ireland
 
Italy
 
Portugal
 
Spain
 
(in millions)
Sovereign and sub-sovereign exposure:
 

 
 

 
 

 
 

 
 

 
 

Public finance
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Infrastructure finance
—

 
(1
)
 
0

 
(1
)
 
(2
)
 
0

Total sovereign exposure
—

 
(1
)
 
0

 
(1
)
 
(2
)
 
0

Non-sovereign exposure:
 

 
 

 
 

 
 

 
 

 
 

Regulated utilities
—

 
—

 
—

 
—

 
—

 
—

RMBS
—

 
(7
)
 
—

 
—

 
—

 
—

Total non-sovereign exposure
—

 
(7
)
 
—

 
—

 
—

 
—

Total
$
—

 
$
(8
)
 
$
0

 
$
(1
)
 
$
(2
)
 
$
0

 
The Company purchases reinsurance in the ordinary course to cover both its financial guaranty insurance and credit derivative exposures. Aside from this type of coverage the Company does not purchase credit default protection to manage the risk in its financial guaranty business. Rather, the Company has reduced its risks by ceding a portion of its business (including its financial guaranty contracts accounted for as derivatives) to third-party reinsurers that are generally required to pay their proportionate share of claims paid by the Company, and the net amounts shown above are net of such third-party reinsurance (reinsurance of financial guaranty contracts accounted for as derivatives is accounted for as a purchased derivative). See Note 13, Reinsurance and Other Monoline Exposures, of the Financial Statements.
 
Indirect Exposure to Selected European Countries
 
The Company has included in the exposure tables above its indirect economic exposure to the Selected European Countries through insurance it provides on (a) pooled corporate and (b) commercial receivables transactions. The Company considers economic exposure to a Selected European Country to be indirect when that exposure relates to only a small portion of an insured transaction that otherwise is not related to that Selected European Country.
 
The Company’s pooled corporate obligations are highly diversified in terms of obligors and, except in the case of TruPS CDOs or transactions backed by perpetual preferred securities (“Perps”), highly diversified in terms of industry. Most pooled corporate obligations are structured to limit exposure to any given obligor and any given non-U.S. country or region. The insured pooled corporate transactions generally benefit from embedded credit enhancement which allows a transaction a certain level of losses in the underlying collateral without causing the Company to pay a claim. Some pooled corporate obligations include investments in companies with a nexus to the Selected European Countries.
 
The Company’s commercial receivable transactions included in the exposure tables above are rail car lease transactions and aircraft lease transactions where some of the lessees have a nexus with the Selected European Countries. Like the pooled corporate transactions, the commercial receivable transactions generally benefit from embedded credit enhancement which allows a transaction a certain level of losses in the underlying collateral without causing the Company to pay a claim.


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The following table shows the Company’s indirect economic exposure (net of reinsurance) to the Selected European Countries in pooled corporate obligations and commercial receivable transactions. The amount shown in the table is calculated by multiplying the amount insured by the Company (based on par for financial guaranty contracts and notional amount for financial guaranty contracts accounted for as derivatives) times the percent of the relevant collateral pool reported as having a nexus to the Selected European Countries:
 
Net Indirect Exposure to Selected European Countries
June 30, 2013
 
 
Greece
 
Hungary
 
Ireland
 
Italy
 
Portugal
 
Spain
 
Total
 
(dollars in millions)
Pooled corporate
 

 
 

 
 

 
 

 
 

 
 

 
 

$ millions
$
22

 
$
—

 
$
172

 
$
224

 
$
15

 
$
499

 
$
932

Average proportion
1.9
%
 
—

 
2.3
%
 
3.1
%
 
1.0
%
 
4.4
%
 
3.3
%
Commercial receivables
 

 
 

 
 

 
 

 
 

 
 

 
 

$ millions
$
—

 
$
1

 
$
12

 
$
59

 
$
14

 
$
3

 
$
89

Average proportion
—

 
0.6
%
 
9.1
%
 
9.2
%
 
2.4
%
 
1.8
%
 
5.1
%
Total $ millions
$
22

 
$
1

 
$
184

 
$
283

 
$
29

 
$
502

 
$
1,021

 
The table above includes, in the pooled corporate category, exposure from primarily non-U.S. pooled corporate transactions insured by the Company. Many primarily U.S. pooled corporate obligations permit investments of up to 10% or 15% (or occasionally 20%) of the pool in non-U.S. (or non-U.S. or -Canadian) collateral. Given the relatively low level of permitted international investments in these transactions and their generally high current credit quality, they are excluded from the table above.
 
Selected European Countries
 
The Company follows and analyzes public information regarding developments in countries to which the Company has exposure, including the Selected European Countries, and utilizes this information to evaluate risks in its financial guaranty portfolio. Because the Company guarantees payments under its financial guaranty contracts, its analysis is focused primarily on the risk of payment defaults by these countries or obligors in these countries. However, dramatic developments with respect to the Selected European Countries would also impact the fair value of insurance contracts accounted for as derivatives and with a nexus to those countries.
 
The Republic of Hungary is rated ”BB" and "Ba1" by S&P and Moody's, respectively. In October 2008 Hungary requested and later received financial assistance from the EU and the International Monetary Fund (“IMF”). Hungary again requested financial assistance in November 2011 but negotiations were later indefinitely suspended. In common with most European Union countries, the IMF expects Hungary’s economic growth to be subdued in 2013, despite an expansionary monetary policy. The Company’s sovereign and sub-sovereign exposure to Hungarian credits includes an infrastructure financing dependent on payments by government agencies. The Company rates this exposure ($377 million net par) below investment grade. The Company is closely monitoring developments with respect to the ability and willingness of these entities to meet their payment obligations. The Company’s non-sovereign exposure to Hungary comprises primarily covered mortgage bonds issued by Hungarian banks. The Company rates the covered bonds ($214 million net par) below investment grade.
 
The Kingdom of Spain's financial profile and credit ratings have deteriorated over the past few years, partly as a result of large borrowing needs in the context of a challenging funding environment. The weakening of the country's real estate sector has resulted in the deterioration of the banking system's financial profile, in particular that of the savings and loans. The regional finances are also a source of concern, given the fiscal slippage exhibited by some of the regions. The Kingdom of Spain is rated “BBB-” and “Baa3” by S&P and Moody’s, respectively. The September 6, 2012 announcement of a European Central Bank program to purchase unlimited amounts of secondary market debt of euro area sovereigns that apply for a full macroeconomic adjustment or precautionary program from the EFSF/ESM has helped in the reduction of Spanish sovereign bond yields. The Company’s sovereign and sub-sovereign exposure to Spanish credits includes infrastructure financings dependent on payments by sub-sovereigns and government agencies, financings dependent on lease and other payments by sub-sovereigns and government agencies, and an issuance by a regulated utility. The Company rates most ($412 million aggregate net par) of its exposure to sovereign and sub-sovereign credits in Spain below investment grade. The Company is closely monitoring developments with respect to the ability and willingness of these entities to meet their payment obligations.
 

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The Republic of Portugal is rated “BB” and “Ba3” by S&P and Moody's, respectively. Over the past few years, the Republic of Portugal’s economy and credit ratings have been adversely affected by fiscal imbalances, high indebtedness and the difficult macroeconomic situation generally facing the countries in the euro area. In order to stabilize its debt position, in April 2011 Portugal requested and subsequently received financial assistance from the EU and the IMF. In return, Portugal agreed to a set of deficit reduction and debt targets. The meeting of these targets will likely represent a significant burden on the Portuguese economy in an environment of slow economic activity and volatile bank and sovereign credit markets. The Company’s exposure to sovereign and sub-sovereign Portuguese credits includes infrastructure financings dependent on payments by sub-sovereigns and government agencies and financings dependent on lease payments by sub-sovereigns and government agencies. The Company rates four of these transactions ($118 million aggregate net par) below investment grade. The Company is closely monitoring developments with respect to the ability and willingness of these entities to meet their payment obligations.
 
The Republic of Ireland, currently rated “BBB+” and “Ba1” by S&P and Moody’s, respectively, has been adversely affected over the past few years by the weakening global economic environment and the need to provide wide-ranging support to its banking sector, which resulted in a rapid deterioration of the country’s public finances. In November 2010, the Republic of Ireland applied for and subsequently received a financial assistance package from the EU and the IMF. The package included an allocation to support the Irish banking system. Ireland’s fiscal consolidation plan is being implemented in the context of slow economic growth and restricted availability of credit. The Company’s exposure to Irish credits includes exposure in a pool of infrastructure financings dependent on payments by a sub-sovereign and mortgage reinsurance on a pool of Irish residential mortgages originated in 2004-2006 left from its legacy mortgage reinsurance business. Only $7 million of the Company’s exposure to Ireland is below investment grade, and it is indirect in non-sovereign pooled corporate transactions.

The Republic of Italy was downgraded to “BBB” from “BBB+” by S&P on July 9, 2013, reflecting the agency’s view of the effects of further weakening growth on the country’s economic structure and resilience, and its impaired monetary transmission mechanism. Moody’s continues to rate the country at “Baa2". The September 6, 2012 announcement of a European Central Bank program to purchase unlimited amounts of secondary market debt of euro area sovereigns that apply for a full macroeconomic adjustment or precautionary program from the European Financial Stability Facility/European Stability Mechanism ("EFSF/ESM") has helped in the reduction of Italian sovereign bond yields. The Company’s sovereign and sub-sovereign exposure to Italy depends on payments by Italian governmental entities in connection with infrastructure financings or for services already rendered. The Company internally rates one of the infrastructure transactions ($2 million net par) below investment grade. The Company’s non-sovereign Italian exposure is comprised primarily of securities backed by Italian residential mortgages or in one case a government-sponsored water utility. The Company is closely monitoring the ability and willingness of these obligors to make timely payments on their obligations.

The Hellenic Republic of Greece is rated “B-” and “C” by S&P and Moody’s, respectively. As evidenced by its low ratings, the country still faces significant economic, social and political challenges. As of June 30, 2013 the Company no longer had any direct economic exposure to Greece, although it does still have small, indirect exposures as described above under "Indirect Exposure to Selected European Countries".

Identifying Exposure to Selected European Countries
 
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 most exposures 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 as it has, for example, in a residential mortgage backed security backed by residential mortgage loans in both Germany and Italy. The Company may also have exposures to the Selected European Countries in business assumed from other monoline insurance companies. See Note 13, Reinsurance and Other Monoline Exposure, of the Financial Statements. In the case of assumed business, the Company depends upon geographic information provided by the primary insurer.
 
The Company also has indirect exposure to the Selected European Countries through structured finance transactions backed by pools of corporate obligations or receivables, such as lease payments, with a nexus to such countries. In most instances, the trustees and/or servicers for such transactions provide reports that identify the domicile of the underlying obligors in the pool (and the Company relies on such reports), although occasionally such information is not 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 may also have indirect exposures to Selected European Countries in business assumed from other monoline insurance companies. However, in the

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case of assumed business, the primary insurer generally does not provide information to the Company permitting it to geographically allocate the exposure proportionally to the domicile of the underlying obligors.

Exposures by Reinsurer
 
Ceded par outstanding represents the portion of insured risk ceded to other reinsurers. 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 as a result been downgraded by the rating agencies. In addition, state insurance regulators have intervened with respect to some of these insurers.
 
Assumed par outstanding represents the amount of par assumed by the Company from other monolines. Under these relationships, the Company assumes a portion of the ceding company’s insured risk in exchange for a premium. The Company may be exposed to risk in this portfolio in that the Company may be required to pay losses without a corresponding premium in circumstances where the ceding company is experiencing financial distress and is unable to pay premiums.
 
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.
 

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Exposure by Reinsurer
 
 
 
Ratings at
 
Par Outstanding
 
 
August 6, 2013
 
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)
American Overseas Reinsurance Company Limited (f/k/a Ram Re)
 
WR (2)
 
WR
 
$
8,971

 
$
—

 
$
30

Tokio
 
Aa3
 
AA-
 
7,634

 
—

 
—

Radian
 
Ba1
 
B+
 
4,897

 
42

 
1,273

Syncora Guarantee Inc.
 
WR
 
WR
 
4,031

 
1,789

 
162

Mitsui Sumitomo Insurance Co. Ltd.
 
A1
 
A+(3)
 
2,176

 
—

 
—

ACA Financial Guaranty Corp.
 
NR
 
WR
 
819

 
6

 
10

Swiss Reinsurance Co.
 
A1
 
AA-
 
425

 
—

 
—

Ambac Assurance Corporation ("Ambac")
 
WR
 
WR
 
85

 
6,489

 
19,596

CIFG Assurance North America Inc. ("CIFG")
 
WR
 
WR
 
61

 
255

 
5,331

MBIA Inc.
 
(4)
 
(4)
 
—

 
10,498

 
7,726

Financial Guaranty Insurance Co.
 
WR
 
WR
 
—

 
2,634

 
1,766

Other
 
Various
 
Various
 
993

 
1,933

 
46

Total
 
 
 
 
 
$
30,092

 
$
23,646

 
$
35,940

____________________
(1)
Includes $3,415 million in ceded par outstanding related to insured credit derivatives.
  
(2)    Represents “Withdrawn Rating.”
 
(3)    The Company has structural collateral agreements satisfying the triple-A credit requirement of S&P and/or Moody’s.

(4)    MBIA Inc. includes various subsidiaries which are rated A and B by S&P and Baa1, B1, B3, WR and NR by Moody’s.


Ceded Par Outstanding by Reinsurer and Credit Rating
As of June 30, 2013

 
Internal Credit Rating
 
 
Reinsurer
 
AAA
 
AA
 
A
 
BBB
 
BIG
 
Total
 
(in millions)
American Overseas Reinsurance Company Limited (f/k/a Ram Re)
$
1,174

 
$
3,046

 
$
2,753

 
$
1,537

 
$
461

 
$
8,971

Tokio
1,221

 
1,184

 
2,322

 
2,241

 
666

 
7,634

Radian
243

 
290

 
2,472

 
1,537

 
355

 
4,897

Syncora Guarantee Inc.
—

 
241

 
739

 
2,387

 
664

 
4,031

Mitsui Sumitomo Insurance Co. Ltd.
147

 
683

 
888

 
404

 
54

 
2,176

ACA Financial Guaranty Corp
—

 
474

 
324

 
21

 
—

 
819

Swiss Reinsurance Co.
7

 
6

 
269

 
104

 
39

 
425

Ambac
—

 
—

 
85

 
—

 
—

 
85

CIFG
—

 
—

 
—

 
—

 
61

 
61

Other
—

 
101

 
819

 
73

 
—

 
993

Total
$
2,792

 
$
6,025

 
$
10,671

 
$
8,304

 
$
2,300

 
$
30,092



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Table of Contents

In accordance with U.S. statutory accounting requirements and U.S. insurance laws and regulations, in order for the Company to receive credit for liabilities ceded to reinsurers domiciled outside of the U.S., such reinsurers must secure their liabilities to the Company. All of the unauthorized reinsurers in the table above post collateral for the benefit of the Company in an amount at least equal to the sum of their ceded unearned premium reserve, loss reserves and contingency reserves all calculated on a statutory basis of accounting. CIFG and Radian are authorized reinsurers. Radian's collateral equals or exceeds its ceded statutory loss reserves and CIFG's collateral covers a substantial portion of its ceded statutory loss reserves. Collateral may be in the form of letters of credit or trust accounts. The total collateral posted by all non-affiliated reinsurers as of June 30, 2013 is approximately $1.2 billion.

Second-to-Pay
Insured Par Outstanding by Internal Rating
As of June 30, 2013(1)
 
 
Public Finance
 
Structured Finance
 
 
 
AAA
 
AA
 
A
 
BBB
 
BIG
 
AAA
 
AA
 
A
 
BBB
 
BIG
 
Total
 
(in millions)
Radian
$
—

 
$
—

 
$
13

 
$
18

 
$
11

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
42

Syncora Guarantee Inc.
—

 
25

 
378

 
728

 
293

 
110

 
66

 
1

 
—

 
188

 
1,789

ACA Financial Guaranty Corp.
—

 
3

 
—

 
3

 
—

 
—

 
—

 
—

 
—

 
—

 
6

Ambac
0

 
1,396

 
3,270

 
1,118

 
81

 
11

 
49

 
1

 
298

 
265

 
6,489

CIFG
—

 
11

 
69

 
130

 
45

 
—

 
—

 
—

 
—

 
—

 
255

MBIA Inc.
162

 
2,448

 
4,108

 
1,820

 
—

 
—

 
1,507

 
24

 
204

 
225

 
10,498

Financial Guaranty Insurance Co.
—

 
117

 
1,066

 
312

 
318

 
689

 
—

 
82

 
—

 
50

 
2,634

Other
—

 
—

 
1,933

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
1,933

Total
$
162

 
$
4,000

 
$
10,837

 
$
4,129

 
$
748

 
$
810

 
$
1,622

 
$
108

 
$
502

 
$
728

 
$
23,646

____________________
(1)
Assured Guaranty’s internal rating.

Exposure to Residential Mortgage-Backed Securities
 
The tables below provide information on the risk ratings and certain other risk characteristics of the Company’s financial guaranty insurance and credit derivative RMBS exposures as of June 30, 2013. U.S. RMBS exposures represent 3% of the total net par outstanding, and BIG U.S. RMBS represent 44% of total BIG net par outstanding. The tables presented provide information with respect to the underlying performance indicators of this book of business. See Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of expected losses to be paid on U.S. RMBS exposures.
 
Net par outstanding in the following tables are based on values as of June 30, 2013. All performance information such as pool factor, subordination, cumulative losses and delinquency is based on June 30, 2013 information obtained from third parties and/or provided by the trustee.
 
Pool factor in the following tables is the percentage of the current collateral balance divided by the original collateral balance of the transactions at inception.
 
Subordination in the following tables represents the sum of subordinate tranches and overcollateralization, expressed as a percentage of total transaction size and does not include any benefit from excess spread collections that may be used to absorb losses. Many of the closed-end-second lien RMBS transactions insured by the Company have unique structures whereby the collateral may be written down for losses without a corresponding write-down of the obligations insured by the Company. Many of these transactions are currently undercollateralized, with the principal amount of collateral being less than the principal amount of the obligation insured by the Company. The Company is not required to pay principal shortfalls until legal maturity (rather than making timely principal payments), and takes the undercollateralization into account when estimating expected losses for these transactions.
 

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Cumulative losses in the following tables are defined as net charge-offs on the underlying loan collateral divided by the original collateral balance.
 
60+ day delinquencies in the following tables are defined as loans that are greater than 60 days delinquent and all loans that are in foreclosure, bankruptcy or real estate owned divided by current collateral balance.
 
U.S. Prime First Lien in the tables below includes primarily prime first lien plus an insignificant amount of other miscellaneous RMBS transactions.
 
Distribution of U.S. RMBS by Internal Rating and Type of Exposure as of June 30, 2013
 
Ratings:
 
Prime
First
Lien
 
Closed
End
Second
Lien
 
Home Equity Lines of Credit ("HELOC")
 
Alt-A
First Lien
 
Option
ARM
 
Subprime
First
Lien
 
Total Net
Par
Outstanding
 
 
(in millions)
AAA
 
$
4

 
$
0

 
$
47

 
$
241

 
$
5

 
$
2,283

 
$
2,580

AA
 
107

 
106

 
119

 
432

 
456

 
1,851

 
3,070

A
 
1

 
0

 
228

 
7

 
27

 
118

 
383

BBB
 
41

 
—

 
6

 
257

 
24

 
289

 
617

BIG
 
442

 
321

 
2,480

 
3,322

 
700

 
2,353

 
9,618

Total exposures
 
$
595

 
$
428

 
$
2,881

 
$
4,259

 
$
1,212

 
$
6,894

 
$
16,268

 
Distribution of U.S. RMBS by Year Insured and Type of Exposure as of June 30, 2013
 
Year
insured:
 
Prime
First
Lien
 
Closed
End
Second
Lien
 
HELOC
 
Alt-A
First Lien
 
Option
ARM
 
Subprime
First
Lien
 
Total Net
Par
Outstanding
 
 
(in millions)
2004 and prior
 
$
29

 
$
1

 
$
210

 
$
92

 
$
32

 
$
1,307

 
$
1,671

2005
 
165

 
—

 
649

 
553

 
47

 
209

 
1,622

2006
 
99

 
192

 
846

 
362

 
119

 
2,709

 
4,327

2007
 
302

 
235

 
1,176

 
2,138

 
949

 
2,593

 
7,393

2008
 
—

 
—

 
—

 
1,114

 
65

 
76

 
1,255

Total exposures
 
$
595

 
$
428

 
$
2,881

 
$
4,259

 
$
1,212

 
$
6,894

 
$
16,268


Distribution of U.S. RMBS by Internal Rating and Year Insured as of June 30, 2013
 
Year
insured:
 
AAA
Rated
 
AA
Rated
 
A
Rated
 
BBB
Rated
 
BIG
Rated
 
Total
 
 
(dollars in millions)
2004 and prior
 
$
1,036

 
$
136

 
$
45

 
$
108

 
$
346

 
$
1,671

2005
 
129

 
185

 
2

 
34

 
1,273

 
1,622

2006
 
1,319

 
1,386

 
64

 
114

 
1,445

 
4,327

2007
 
10

 
1,298

 
272

 
362

 
5,450

 
7,393

2008
 
87

 
65

 
—

 
—

 
1,103

 
1,255

Total exposures
 
$
2,580

 
$
3,070

 
$
383

 
$
617

 
$
9,618

 
$
16,268

% of total
 
15.9
%
 
18.9
%
 
2.3
%
 
3.8
%
 
59.1
%
 
100.0
%
 

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Table of Contents

Distribution of Financial Guaranty Direct U.S. RMBS
Insured January 1, 2005 or Later by Exposure Type, Average Pool Factor, Subordination,
Cumulative Losses and 60+ Day Delinquencies as of June 30, 2013
 
U.S. Prime First Lien
 
Year
insured:
 
Net Par
Outstanding
 
Pool
Factor
 
Subordination
 
Cumulative
Losses
 
60+ Day
Delinquencies
 
Number of
Transactions
 
 
(dollars in millions)
2005
 
$
162

 
26.1
%
 
4.8
%
 
2.5
%
 
11.6
%
 
6

2006
 
99

 
48.7
%
 
8.4
%
 
0.7
%
 
17.3
%
 
1

2007
 
302

 
38.0
%
 
4.3
%
 
6.1
%
 
21.1
%
 
1

2008
 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—

  Total
 
$
563

 
36.5
%
 
5.1
%
 
4.1
%
 
17.7
%
 
8

 
U.S. Closed End Second Lien
 
Year
insured:
 
Net Par
Outstanding
 
Pool
Factor
 
Subordination
 
Cumulative
Losses
 
60+ Day
Delinquencies
 
Number of
Transactions
 
 
(dollars in millions)
2005
 
$
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—

2006
 
183

 
11.5
%
 
—
%
 
60.3
%
 
5.7
%
 
1

2007
 
235

 
13.7
%
 
—
%
 
70.1
%
 
6.1
%
 
8

2008
 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—

  Total
 
$
418

 
12.8
%
 
—
%
 
65.8
%
 
5.9
%
 
9

 
U.S. HELOC
 
Year
insured:
 
Net Par
Outstanding
 
Pool
Factor
 
Subordination
 
Cumulative
Losses
 
60+ Day
Delinquencies
 
Number of
Transactions
 
 
(dollars in millions)
2005
 
$
606

 
13.2
%
 
3.1
%
 
17.5
%
 
9.2
%
 
6

2006
 
829

 
21.2
%
 
3.6
%
 
37.5
%
 
6.4
%
 
7

2007
 
1,176

 
34.8
%
 
2.5
%
 
32.8
%
 
5.3
%
 
9

2008
 
—

 
—
%
 
—
%
 
—
%
 
—
%
 
—

  Total
 
$
2,612

 
25.5
%
 
3.0
%
 
30.8
%
 
6.6
%
 
22


U.S. Alt-A First Lien
 
Year
insured:
 
Net Par
Outstanding
 
Pool
Factor
 
Subordination
 
Cumulative
Losses
 
60+ Day
Delinquencies
 
Number of
Transactions
 
 
(dollars in millions)
2005
 
$
551

 
25.9
%
 
8.5
%
 
7.4
%
 
18.7
%
 
21

2006
 
362

 
31.8
%
 
0.0
%
 
21.3
%
 
38.0
%
 
7

2007
 
2,138

 
39.5
%
 
1.2
%
 
17.0
%
 
28.7
%
 
12

2008
 
1,114

 
37.6
%
 
15.1
%
 
16.4
%
 
26.3
%
 
5

  Total
 
$
4,164

 
36.5
%
 
5.8
%
 
16.0
%
 
27.5
%
 
45

 

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Table of Contents

U.S. Option ARMs
 
Year
insured:
 
Net Par
Outstanding
 
Pool
Factor
 
Subordination
 
Cumulative
Losses
 
60+ Day
Delinquencies
 
Number of
Transactions
 
 
(dollars in millions)
2005
 
$
41

 
15.8
%
 
11.6
%
 
10.3
%
 
14.8
%
 
2

2006
 
113

 
31.6
%
 
—
%
 
20.4
%
 
36.0
%
 
5

2007
 
949

 
38.6
%
 
0.9
%
 
22.3
%
 
32.8
%
 
11

2008
 
65

 
41.2
%
 
48.3
%
 
16.9
%
 
26.2
%
 
1

  Total
 
$
1,168

 
37.2
%
 
3.8
%
 
21.4
%
 
32.1
%
 
19

 
U.S. Subprime First Lien
 
Year
insured:
 
Net Par
Outstanding
 
Pool
Factor
 
Subordination
 
Cumulative
Losses
 
60+ Day
Delinquencies
 
Number of
Transactions
 
 
(dollars in millions)
2005
 
$
200

 
34.8
%
 
18.7
%
 
8.8
%
 
28.6
%
 
4

2006
 
2,704

 
18.5
%
 
61.4
%
 
19.7
%
 
33.2
%
 
4

2007
 
2,593

 
42.2
%
 
11.3
%
 
26.4
%
 
41.5
%
 
13

2008
 
76

 
54.1
%
 
17.4
%
 
21.6
%
 
30.8
%
 
1

  Total
 
$
5,573

 
30.6
%
 
35.9
%
 
22.4
%
 
36.8
%
 
22

 

Liquidity and Capital Resources
 
Liquidity Requirements and Sources
 
AGL and its Holding Company Subsidiaries
 
The liquidity of AGL and its subsidiaries that are intermediate holding companies is largely dependent on dividends from their operating subsidiaries and their access to external financing. Liquidity requirements include the payment of operating expenses, interest on debt of Assured Guaranty US Holdings Inc. ("AGUS") and AGMH, and dividends on common shares. AGL and its holding company subsidiaries may also require liquidity to make periodic capital investments in their operating subsidiaries. In the ordinary course of business, the Company evaluates its liquidity needs and capital resources in light of holding company expenses and dividend policy, as well as rating agency considerations. The Company also subjects its cash flow projections and its assets to a stress test, maintaining a liquid asset balance of one time its stressed operating company net cash flows. Management believes that AGL will have sufficient liquidity to satisfy its needs over the next twelve months, including the ability to pay dividends on AGL common shares. See “—Insurance Company Regulatory Restrictions” below for a discussion of the dividend restrictions of its insurance company subsidiaries.
 
The Company anticipates that for the next twelve months, amounts paid by AGL’s operating subsidiaries as dividends will be a major source of its liquidity. It is possible that, in the future, AGL or its subsidiaries may need to seek additional external debt or equity financing in order to meet their obligations. External sources of financing may or may not be available to the Company, and if available, the cost of such financing may not be acceptable to the Company. As of June 30, 2013, AGL had $35 million in short term investments and $13 million in fixed maturity securities with weighted average duration of 0.1 years. AGUS and AGMH had a total of $59 million in cash, short term investments and common stock and $30 million in fixed maturity securities with weighted average duration of 2.1 years. See also "—Insurance Company Regulatory Restrictions" below.
 

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Table of Contents

AGL and Holding Company Subsidiaries
Significant Cash Flow Items
 
 
Six Months
 
2013
 
2012
 
(in millions)
Dividends and return of capital from subsidiaries
$
180

 
$
205

Proceeds from issuance of common shares
—

 
173

Dividends paid to AGL shareholders
(38
)
 
(33
)
Repurchases of common shares
(244
)
 
(24
)
Interest paid
(35
)
 
(42
)
Loans from subsidiaries
—

 
173

Payment of long-term debt
—

 
(173
)
 
Insurance Company Subsidiaries
 
Liquidity of the insurance company subsidiaries is primarily used to pay for:

•
claims on the insured portfolio,
•
operating expenses,
•
purchase of loss mitigation bonds
•
collateral postings in connection with credit derivatives and reinsurance transactions,
•
reinsurance premiums,
•
dividends to AGUS, AGMH and AGL, as applicable, for debt service and dividends,
•
principal paydown on surplus notes issued, and
•
capital investments in their own subsidiaries, where appropriate.

Management believes that its subsidiaries’ liquidity needs for the next twelve months can be met from current cash, short-term investments and operating cash flow, including premium collections and coupon payments as well as scheduled maturities and paydowns from their respective investment portfolios. The Company targets a balance of its most liquid assets including cash and short term securities, Treasuries, agency RMBS and pre-refunded municipal bonds equal to 1.5 times its projected operating company cash flow needs over the next four quarters. The Company intends to hold and has the ability to hold temporarily impaired debt securities until the date of anticipated recovery.
 
Beyond the next twelve months, the ability of the operating subsidiaries to declare and pay dividends may be influenced by a variety of factors, including market conditions, insurance regulations and rating agency capital requirements and general economic conditions.
 
Insurance policies issued provide, in general, that payments of principal, interest and other amounts insured may not be accelerated by the holder of the obligation. Amounts paid by the Company therefore are typically in accordance with the obligation’s original payment schedule, unless the Company accelerates such payment schedule, at its sole option. CDS may provide for acceleration of amounts due upon the occurrence of certain credit events, subject to single-risk limits specified in the insurance laws of the State of New York (the “New York Insurance Law”). These constraints prohibit or limit acceleration of certain claims according to Article 69 of the New York Insurance Law and serve to reduce the Company’s liquidity requirements.
 
 Payments made in settlement of the Company’s obligations arising from its insured portfolio may, and often do, vary significantly from year-to-year, depending primarily on the frequency and severity of payment defaults and whether the Company chooses to accelerate its payment obligations in order to mitigate future losses.
 

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Table of Contents

Claims Paid (Recovered)

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Claims paid before R&W recoveries, net of reinsurance
$
325

 
$
299

 
$
506

 
$
502

R&W recoveries
(525
)
 
(223
)
 
(614
)
 
(293
)
Claims paid (recovered), net of reinsurance(1)
$
(200
)
 
$
76

 
$
(108
)
 
$
209

____________________
(1)
Includes $168 million and $117 million recovered for consolidated FG VIEs for Second Quarter 2013 and 2012, respectively, and $159 million and $80 million recovered for consolidated FG VIEs for Six Months 2013 and 2012, respectively.
 
The terms of the Company’s CDS contracts generally are modified from standard CDS contract forms approved by ISDA in order to provide for payments on a scheduled basis and to replicate the terms of a traditional financial guaranty insurance policy. Some contracts the Company entered into as the credit protection seller, however, utilize standard ISDA settlement mechanics of cash settlement (i.e., a process to value the loss of market value of a reference obligation) or physical settlement (i.e., delivery of the reference obligation against payment of principal by the protection seller) in the event of a “credit event,” as defined in the relevant contract. Cash settlement or physical settlement generally requires the payment of a larger amount, prior to the maturity of the reference obligation, than would settlement on a “pay-as-you-go” basis, under which the Company would be required to pay scheduled interest shortfalls during the term of the reference obligation and scheduled principal shortfall only at the final maturity of the reference obligation. The Company’s CDS contracts also generally provide that if events of default or termination events specified in the CDS 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 the CDS contract prior to maturity. The Company may be required to make a termination payment to its swap counterparty upon such termination. In addition, under certain of the Company's CDS, the Company may be obligated to collateralize its obligations under the CDS if it does not maintain financial strength ratings above the negotiated rating level specified in the CDS documentation.

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 $3.8 billion, payable in varying amounts over the next 13 years. Of this liability, as much as approximately $3.0 billion may be payable between 2014 and 2020. As of June 30, 2013, the Company estimates that it may pay claims of approximately $1.4 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.
    
 Insurance Company Regulatory Restrictions
 
The insurance company subsidiaries’ ability to pay dividends depends, among other things, upon their financial condition, results of operations, cash requirements, and compliance with rating agency requirements, and is also subject to restrictions contained in the insurance laws and related regulations of their states of domicile. Dividends paid by a U.S. company to a Bermuda holding company presently are subject to a 30% withholding tax.
 
AGC is a Maryland domiciled insurance company. Under Maryland's insurance law, AGC may, with prior notice to the Maryland Insurance Commissioner, pay an ordinary dividend that, together with all dividends paid in the prior 12 months, does

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not exceed 10% of its policyholders' surplus (as of the prior December 31) or 100% of its adjusted net investment income during that period. As of June 30, 2013, approximately $73 million was available for distribution of dividends, after giving effect to dividends paid in the prior 12 months of approximately $17 million. This amount does not take into account a series of transactions that Assured Guaranty completed in July 2013 in order to capitalize its subsidiary MAC, including AGC contributing cash and marketable securities to Municipal Assurance Holdings Inc. (“MAC Holdings”), a holding company newly formed to own 100% of MAC's outstanding common stock, ceding a portfolio of policies covering U.S. municipal bonds to MAC, and paying MAC unearned premium for such cession.
 
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, ceding a portfolio of policies covering U.S. municipal bonds to MAC, and paying MAC unearned premium for such cession.

As of July 31, 2013, AG Re had unencumbered assets of approximately $280 million. AG Re maintains unencumbered assets for general corporate purposes, including placing additional assets in trust for the benefit of cedants to reflect declines in the market value of previously posted assets or additional ceded reserves. We expect unencumbered assets to decline in third quarter 2013 due to collateral posting requirements related to Detroit exposures. AG Re is an insurance company registered and licensed under the Insurance Act 1978 of Bermuda, amendments thereto and related regulations. Based on regulatory capital requirements AG Re currently has $600 million of excess capital and surplus. As a Class 3B insurer, AG Re is restricted from distributing capital or paying dividends by the following regulatory requirements:

•
Dividends shall not exceed outstanding statutory surplus or $440 million.

•
Dividends on annual basis shall not exceed 25% of its total statutory capital and surplus (as set out in its previous year's financial statements) or $321 million unless it files (at least seven days before payment of such dividends) with the Bermuda Monetary Authority an affidavit stating that it will continue to meet the required margins.

•
Capital distributions on an annual basis shall not exceed 15% of its total statutory capital (as set out in its previous year's financial statements) or $126 million, unless approval is granted by the Bermuda Monetary Authority.

•
Dividends are limited by requirements that the subject company must at all times (i) maintain the minimum solvency margin and the Company's applicable enhanced capital requirements required under the Insurance Act of 1978 and (ii) have relevant assets in an amount at least equal to 75% of relevant liabilities, both as defined under the Insurance Act of 1978.

Dividends Paid and Repayment of Surplus Note
By Insurance Company Subsidiaries

 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Dividends paid by AGC to AGUS
$
17

 
$
40

 
$
17

 
$
55

Dividends paid by AGM to AGMH
38

 
—

 
38

 
30

Dividends paid by AG Re to AGL
60

 
40

 
100

 
70

Repayment of surplus note by AGM to AGMH
—

 
50

 
25

 
50



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Consolidated Cash Flows
 
Consolidated Cash Flow Summary
 
 
Three Months
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
(in millions)
Net cash flows provided by (used in) operating activities
$
136

 
$
87

 
$
122

 
$
162

Net cash flows provided by (used in) investing activities
235

 
166

 
472

 
273

Net cash flows provided by (used in) financing activities
(352
)
 
(254
)
 
(585
)
 
(471
)
Effect of exchange rate changes
(1
)
 
(6
)
 
(4
)
 
(4
)
Cash at beginning of period
125

 
182

 
138

 
215

Total cash at the end of the period
$
143

 
$
175

 
$
143

 
$
175

 
Operating cash flows in Six Months 2013 and Six Months 2012 include cash flows from FG VIEs. Claims paid on consolidated FG VIEs are presented in the consolidated cash flow statements as a component of paydowns on FG VIE liabilities in financing activities as opposed to operating activities. Excluding consolidated FG VIEs, the cash flows from operating activities increased for Six Months 2013 compared to Six Months 2012 and were mainly related to proceeds from R&W settlements and sales of trading securities, which were partially offset by claim payments and higher tax payments in Six Months 2013 and $210 million in cash received on two commutations in Six Months 2012.
 
Investing activities were primarily net sales (purchases) of fixed maturity and short-term investment securities. Investing cash flows in Six Months 2013 and 2012 include inflows of $440 million and $283 million for FG VIEs, respectively. Six Months 2013 included proceeds from sales of third party surplus notes and other invested assets. Six Months 2012 included a $91 million payment to acquire MAC and proceeds from a paydown of notes receivable from PFC LLC, which were used to offset the Company’s payments under its CDS contract.
 
Financing activities consisted primarily of paydowns of FG VIE liabilities and share repurchases. Financing cash flows in Six Months 2013 and 2012 include outflows of $289 million and $389 million for FG VIEs, respectively.

On January 18, 2013, the Company's Board of Directors authorized a $200 million share repurchase program. This latest repurchase program replaces the November 14, 2011 authorization to repurchase up to 5.0 million common shares. On May 8, 2013, the Company's board of directors authorized an additional $115 million of repurchases of the Company’s common shares, bringing the total authorization in 2013 to $315 million. In Six Months 2013 the Company had repurchased 11.5 million common shares for $244 million, including 5.0 million common shares from funds associated with WL Ross & Co. LLC and its affiliates and Wilbur L. Ross, Jr., a director of the Company, for $109.7 million, pursuant to the January and May 2013 authorizations. In Six Months 2012 the Company had repurchased 2.1 million common shares for $24 million.

Commitments and Contingencies
 
Leases
 
AGL and its subsidiaries are party to various lease agreements. Future cash payments associated with contractual obligations pursuant to operating leases for office space have not materially changed since December 31, 2012.


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Long-Term Debt Obligations
 
The principal of and interest paid on long-term debt issued by AGUS and AGMH were as follows:

Principal Outstanding
and Interest Paid on Long-Term Debt
 
 
Principal Amount
 
Interest Paid
 
As of June 30,
 
As of December 31,
 
Second Quarter
 
Six Months
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
 
(in millions)
 
 
 
 
AGUS:
 

 
 

 
 

 
 

 
 
 
 
7.0% Senior Notes
$
200

 
$
200

 
$
7

 
$
7

 
$
7

 
$
7

8.5% Senior Notes
—

 
—

 
—

 
4

 
—

 
7

Series A Enhanced Junior Subordinated Debentures
150

 
150

 
5

 
5

 
5

 
5

Total AGUS
350

 
350

 
12

 
16

 
12

 
19

AGMH:
 

 
 

 
 

 
 

 
 
 
 
67/8% QUIBS
100

 
100

 
1

 
1

 
3

 
3

6.25% Notes
230

 
230

 
3

 
3

 
7

 
7

5.60% Notes
100

 
100

 
2

 
2

 
3

 
3

Junior Subordinated Debentures
300

 
300

 
10

 
10

 
10

 
10

Total AGMH
730

 
730

 
16

 
16

 
23

 
23

AGM:
 

 
 

 
 

 
 

 
 
 
 
Notes Payable
48

 
61

 
1

 
3

 
3

 
5

Total AGM
48

 
61

 
1

 
3

 
3

 
5

Total
$
1,128

 
$
1,141

 
$
29

 
$
35

 
$
38

 
$
47



AGL fully and unconditionally guarantees the following obligations:

•
7.0% Senior Notes issued by AGUS
•
6 7/8% Quarterly Income Bonds Securities (“QUIBS”) issued by AGMH
•
6.25% Notes issued by AGMH
•
5.60% Notes issued by AGMH

In addition, AGL guarantees, on a junior subordinated basis, AGUS’s Series A, Enhanced Junior Subordinated Debentures and the $300 million of AGMH’s outstanding Junior Subordinated Debentures.
 
Debt Issued by AGUS
 
7.0% Senior Notes.  On May 18, 2004, AGUS issued $200 million of 7.0% senior notes due 2034 (“7.0% Senior Notes”) for net proceeds of $197 million. Although the coupon on the Senior Notes is 7.0%, the effective rate is approximately 6.4%, taking into account the effect of a cash flow hedge.
 
8.5% Senior Notes. On June 24, 2009, AGL issued 3,450,000 equity units for net proceeds of approximately $167 million in a registered public offering. The net proceeds of the offering were used to pay a portion of the consideration for the AGMH Acquisition. Each equity unit consisted of (i) a 5% undivided beneficial ownership interest in $1,000 principal amount of 8.5% senior notes due 2014 issued by AGUS and (ii) a forward purchase contract obligating the holders to purchase $50 of AGL common shares in June 2012. On June 1, 2012, the Company completed the remarketing of the $173 million aggregate principal amount of 8.5% Senior Notes; AGUS purchased all of the Senior Notes in the remarketing at a price of 100% of the principal amount thereof, and retired all of such notes on June 1, 2012. The proceeds from the remarketing were used to satisfy the obligations of the holders of the Equity Units to purchase AGL common shares pursuant to the forward purchase contract.

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Accordingly, on June 1, 2012, AGL issued 3.8924 common shares to holders of each Equity Unit, which represented a settlement rate of 3.8685 common shares plus certain anti-dilution adjustments, or an aggregate of 13,428,770 common shares at approximately $12.85 per share. The Equity Units ceased to exist when the forward purchase contracts were settled on June 1, 2012.

Series A Enhanced Junior Subordinated Debentures.  On December 20, 2006, AGUS issued $150 million of the Debentures due 2066. The Debentures pay a fixed 6.40% rate of interest until December 15, 2016, and thereafter pay a floating rate of interest, reset quarterly, at a rate equal to three month London Interbank Offered Rate ("LIBOR") plus a margin equal to 2.38%. AGUS may select at 1.0 or more times to defer payment of interest for 1.0 or more consecutive periods for up to ten years. Any unpaid interest bears interest at the then applicable rate. AGUS may not defer interest past the maturity date.
 
Debt Issued by AGMH
 
6 7/8% QUIBS.  On December 19, 2001, AGMH issued $100 million face amount of 6 7/8% QUIBS due December 15, 2101, which are callable without premium or penalty.
 
6.25% Notes.  On November 26, 2002, AGMH issued $230 million face amount of 6.25% Notes due November 1, 2102, which are callable without premium or penalty in whole or in part.
 
5.60% Notes.  On July 31, 2003, AGMH issued $100 million face amount of 5.60% Notes due July 15, 2103, which are callable without premium or penalty in whole or in part.
 
Junior Subordinated Debentures.  On November 22, 2006, AGMH issued $300 million face amount of Junior Subordinated Debentures with a scheduled maturity date of December 15, 2036 and a final repayment date of December 15, 2066. The final repayment date of December 15, 2066 may be automatically extended up to four times in five-year increments provided certain conditions are met. The debentures are redeemable, in whole or in part, at any time prior to December 15, 2036 at their principal amount plus accrued and unpaid interest to the date of redemption or, if greater, the make-whole redemption price. Interest on the debentures will accrue from November 22, 2006 to December 15, 2036 at the annual rate of 6.40%. If any amount of the debentures remains outstanding after December 15, 2036, then the principal amount of the outstanding debentures will bear interest at a floating interest rate equal to one-month LIBOR plus 2.215% until repaid. AGMH may elect at one or more times to defer payment of interest on the debentures for one or more consecutive interest periods that do not exceed ten years. In connection with the completion of this offering, AGMH entered into a replacement capital covenant for the benefit of persons that buy, hold or sell a specified series of AGMH long-term indebtedness ranking senior to the debentures. Under the covenant, the debentures will not be repaid, redeemed, repurchased or defeased by AGMH or any of its subsidiaries on or before the date that is twenty years prior to the final repayment date, except to the extent that AGMH has received proceeds from the sale of replacement capital securities. The proceeds from this offering were used to pay a dividend to the shareholders of AGMH.
 
Debt Issued by AGM
 
Notes Payable represent debt, issued by special purpose entities consolidated by AGM, to the former AGMH subsidiaries that conducted AGMH’s Financial Products Business (the “Financial Products Companies”) transferred to Dexia Holdings Inc. ("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 term of the notes payable matches the terms of the assets.

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

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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 Dexia Crédit Local S.A. (“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.
 
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.
 
Limited-Recourse Credit Facilities
 
AG Re had a $200 million limited recourse credit facility for the payment of losses in respect of cumulative municipal losses (net of any recoveries) in excess of the greater of $260 million or the average annual debt service of the covered portfolio multiplied by 4.5%. The obligation to repay loans under this agreement is a limited recourse obligation payable solely from, and collateralized by, a pledge of recoveries realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. AG Re terminated such credit facility effective March 5, 2013.

Letters of Credit
 
AGC entered into a letter of credit agreement in December 2011 with Bank of New York Mellon totaling approximately $2.9 million in connection with a 2008 lease for office space, which space was subsequently sublet. As of June 30, 2013, $2.9 million was outstanding under this letter of credit. This letter of credit expires in November 2013.

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Committed Capital Securities

Each of AGC and AGM have issued $200 million of committed capital securities pursuant to transactions in which AGC CCS Securities or AGM CPS Securities, as applicable, were issued by custodial trusts created for the primary purpose of issuing such securities, investing the proceeds in high-quality assets and providing put options to AGC or AGM, as applicable. The put options allow AGC and AGM to issue non-cumulative redeemable perpetual preferred to the trusts in exchange for cash. For both AGC and AGM, four initial trusts were created, each with an initial aggregate face amount of $50 million. The Company does not consider itself to be the primary beneficiary of the trusts for either the AGC or AGM committed capital securities and the trusts are not consolidated in Assured Guaranty's financial statements.

The trusts provide AGC and AGM access to new capital at their respective sole discretion through the exercise of the put options. Upon AGC's or AGM's exercise of its put option, the relevant trust will liquidate its portfolio of eligible assets and use the proceeds to purchase the AGC or AGM preferred stock, as applicable. AGC or AGM may use the proceeds from such sale of its preferred stock to the trusts for any purpose, including the payment of claims. The put agreements have no scheduled termination date or maturity. However, each put agreement will terminate if (subject to certain grace periods) in the event specified events occur.

     AGC Committed Capital Securities. AGC entered into separate put agreements with four custodial trusts with respect to its committed capital securities in April 2005. The AGC put options have not been exercised through the date of this filing. Initially, all of AGC committed capital securities were issued to a special purpose pass-through trust (the “Pass-Through Trust”). The Pass-Through Trust was dissolved in April 2008 and the AGC committed capital securities were distributed to the holders of the Pass-Through Trust's securities. Neither the Pass-Through Trust nor the custodial trusts are consolidated in the Company's financial statements.  Income distributions on the Pass-Through Trust securities and committed capital securities were equal to an annualized rate of one-month LIBOR plus 110 basis points for all periods ending on or prior to April 8, 2008. Following dissolution of the Pass-Through Trust, distributions on the AGC committed capital securities are determined pursuant to an auction process. On April 7, 2008 this auction process failed, thereby increasing the annualized rate on the AGC committed capital securities to one-month LIBOR plus 250 basis points. Distributions on the AGC preferred stock will be determined pursuant to the same process. AGC continues to have the ability to exercise its put option and cause the related trusts to purchase AGC Preferred Stock.
 
AGM Committed Capital Securities. AGM entered into separate put agreements with four custodial trusts trusts with respect to its committed capital securities in June 2003. The AGM put options have not been exercised through the date of this filing. 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 committed capital 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.

Investment Portfolio
 
The Company’s principal objectives in managing its investment portfolio are to preserve the highest possible ratings for each operating company; to manage investment risk within the context of the underlying portfolio of insurance risk; to maintain sufficient liquidity to cover unexpected stress in the insurance portfolio; and to maximize after-tax net investment income.
 
Fixed Maturity Securities and Short-Term Investments

The Company’s fixed maturity securities and short-term investments had a duration of 4.9 years as of June 30, 2013 and 4.3 years as of December 31, 2012. Generally, the Company’s fixed maturity securities are designated as available-for-sale. Fixed maturity securities designated as available for sale are reported at their fair value, and the change in fair value is reported as part of AOCI except for the credit component of the unrealized loss for securities deemed to be OTTI. If management believes the decline in fair value is “other-than-temporary,” the Company writes down the carrying value of the investment and records a realized loss in the consolidated statements of operations for an amount equal to the credit component of the unrealized loss.

Fair value of fixed maturity securities is based upon market prices provided by either independent pricing services or, when such prices are not available, by reference to broker or underwriter bid indications. The Company’s fixed maturity and

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short term portfolio is primarily invested in publicly traded securities. For more information about the Investment Portfolio and a detailed description of the Company’s valuation of investments see Note 10, Investments and Cash, of the Financial Statements.

Fixed Maturity Securities and Short Term Investments
by Security Type 

 
As of June 30, 2013
 
As of December 31, 2012
 
Amortized
Cost
 
Estimated
Fair Value
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Fixed maturity securities:
 

 
 

 
 

 
 

U.S. government and agencies
$
706

 
$
741

 
$
732

 
$
794

Obligations of state and political subdivisions
5,101

 
5,334

 
5,153

 
5,631

Corporate securities
1,055

 
1,083

 
930

 
1,010

Mortgage-backed securities(1):
 
 
 
 
 
 
 

RMBS
1,172

 
1,127

 
1,281

 
1,266

CMBS
483

 
502

 
482

 
520

Asset-backed securities
459

 
483

 
482

 
531

Foreign government securities
291

 
294

 
286

 
304

Total fixed maturity securities
9,267

 
9,564

 
9,346

 
10,056

Short-term investments
943

 
943

 
817

 
817

Total fixed maturity and short-term investments
$
10,210

 
$
10,507

 
$
10,163

 
$
10,873

 ____________________
(1)
Government-agency obligations were approximately 55% of mortgage backed securities as of June 30, 2013 and 61% as of December 31, 2012, based on fair value.
 
The following tables summarize, for all fixed maturity securities in an unrealized loss position as of June 30, 2013 and December 31, 2012, the aggregate fair value and gross unrealized loss by length of time the amounts have continuously been in an unrealized loss position.

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
$
175

 
$
(5
)
 
$
—

 
$
—

 
$
175

 
$
(5
)
Obligations of state and political subdivisions
629

 
(40
)
 
—

 
—

 
629

 
(40
)
Corporate securities
319

 
(14
)
 
—

 
—

 
319

 
(14
)
Mortgage-backed securities:
 
 
 
 
 
 
 

 
 
 
 
RMBS
427

 
(19
)
 
143

 
(61
)
 
570

 
(80
)
CMBS
59

 
(3
)
 
—

 
—

 
59

 
(3
)
Asset-backed securities
54

 
(5
)
 
10

 
(2
)
 
64

 
(7
)
Foreign government securities
155

 
(4
)
 
—

 
—

 
155

 
(4
)
Total
$
1,818

 
$
(90
)
 
$
153

 
$
(63
)
 
$
1,971

 
$
(153
)
Number of securities
 

 
365

 
 

 
18

 
 

 
383

Number of securities with OTTI
 

 
6

 
 

 
8

 
 

 
14


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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
$
62

 
$
0

 
$
—

 
$
—

 
$
62

 
$
0

Obligations of state and political subdivisions
79

 
(11
)
 
—

 
—

 
79

 
(11
)
Corporate securities
25

 
0

 
—

 
—

 
25

 
$
0

Mortgage-backed securities:
 

 
 

 
 

 
 

 
—

 
—

RMBS
108

 
(19
)
 
121

 
(58
)
 
229

 
(77
)
CMBS
5

 
0

 
—

 
—

 
5

 
0

Asset-backed securities
16

 
0

 
35

 
(10
)
 
51

 
(10
)
Foreign government securities
8

 
0

 
—

 
—

 
8

 
0

Total
$
303

 
$
(30
)
 
$
156

 
$
(68
)
 
$
459

 
$
(98
)
Number of securities
 

 
58

 
 

 
16

 
 

 
74

Number of securities with OTTI
 

 
5

 
 

 
6

 
 

 
11

 
Of the securities in an unrealized loss position for 12 months or more as of June 30, 2013, ten securities had an unrealized loss greater than 10% of book value. The total unrealized loss for these securities as of June 30, 2013 was $63 million. The Company has determined that the unrealized losses recorded as of June 30, 2013 are yield related and not the result of other-than-temporary impairments.
 
Changes in interest rates affect the value of the Company’s fixed maturity portfolio. As interest rates fall, the fair value of fixed maturity securities increases and as interest rates rise, the fair value of fixed maturity securities decreases. The Company’s portfolio of fixed maturity securities consists primarily of high-quality, liquid instruments. The Company continues to receive sufficient information to value its investments and has not had to modify its approach due to the current market conditions.
 
The amortized cost and estimated fair value of the Company’s available-for-sale fixed maturity securities, by contractual maturity, 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.

Distribution of Fixed Maturity Securities by Contractual Maturity
As of June 30, 2013
 
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Due within one year
$
260

 
$
264

Due after one year through five years
1,477

 
1,539

Due after five years through 10 years
2,346

 
2,446

Due after 10 years
3,529

 
3,686

Mortgage-backed securities:
 

 
 

RMBS
1,172

 
1,127

CMBS
483

 
502

Total
$
9,267

 
$
9,564

 

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The following table summarizes the ratings distributions of the Company’s investment portfolio as of June 30, 2013 and December 31, 2012. Ratings reflect the lower of the Moody’s and S&P classifications, except for bonds purchased for loss mitigation or risk management strategies, which use Assured Guaranty’s internal ratings classifications.
 
Distribution of Fixed Maturity Securities by Rating
 
Rating
 
As of
June 30, 2013
 
As of
December 31, 2012
AAA
 
13.9
%
 
18.5
%
AA
 
61.6

 
61.3

A
 
17.4

 
14.3

BBB
 
0.9

 
0.4

BIG(1)
 
6.2

 
5.5

Total
 
100.0
%
 
100.0
%
____________________
(1)
Includes securities purchased or obtained as part of loss mitigation or other risk management strategies of $1,205 million in par with carrying value of $592 million or 6.2% of fixed maturity securities as of June 30, 2013 and of $1,160 million in par with carrying value of $556 million or 5.5% of fixed maturity securities as of December 31, 2012.
 
The following table presents the fair value of securities with third-party guaranties.
 
Summary of Investments with Third-Party Guarantors (1)
at Fair Value
 
Guarantor
 
As of
June 30, 2013
 
 
(in millions)
National Public Finance Guarantee Corporation
 
$
557

Ambac
 
479

CIFG
 
20

Berkshire Hathaway Assurance Corporation
 
5

Syncora Guarantee Inc.
 
3

Total
 
$
1,064

___________________
(1)
99% of these securities had investment grade ratings based on the lower of Moody’s and S&P.

Short-term investments include securities with maturity dates equal to or less than one year at the time of purchase. The Company’s short-term investments consist of money market funds, discount notes and certain time deposits for foreign cash portfolios. Short-term investments are reported at fair value.
 
In connection with its assumed business, under agreements with its ceding companies and in accordance with statutory requirements, the Company maintains fixed maturity securities in trust accounts for the benefit of the ceding companies, which amounted to $359 million and $368 million as of June 30, 2013 and December 31, 2012, respectively. In addition, to fulfill state licensing requirements the Company has placed on deposit eligible securities of $22 million and $27 million as of June 30, 2013 and December 31, 2012, respectively, for the protection of the policyholders. To provide collateral for a letter of credit, the Company holds a fixed maturity investment in a segregated account equal to 120% of the letter of credit, which amounted to $3.5 million as of June 30, 2013 and December 31, 2012. 
 
Under certain derivative contracts, the Company is required to post eligible securities as collateral. The need to post collateral under these transactions is generally based on mark-to-market valuations in excess of contractual thresholds. The fair market value of the Company’s pledged securities totaled $680 million and $660 million as of June 30, 2013 and December 31, 2012, respectively. See Note 8, Financial Guaranty Contracts Accounted for as Credit Derivatives, of the Financial Statements, for the effect of the downgrade on collateral posted.

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Other Invested Assets

Assets Acquired in Refinancing Transactions
 
The Company has rights under certain of its financial guaranty insurance policies and indentures that allow it to accelerate the insured notes and pay claims under its insurance policies upon the occurrence of predefined events of default. To mitigate financial guaranty insurance losses, the Company elected to purchase certain outstanding insured obligations or its underlying collateral, primarily franchise loans. The refinancing vehicles obtained their funds from the proceeds of AGM-insured guaranteed investment contracts ("GICs"), issued in the ordinary course of business by the Financial Products Companies (See “—Liquidity Arrangements with respect to AGMH’s former Financial Products Business—The GIC Business” below). The refinancing vehicles are consolidated with the Company.
 
Investment in Portfolio Funding Company LLC I
 
In the third quarter of 2010, as part of loss mitigation efforts under a CDS contract, the Company acquired a 50% interest in Portfolio Funding Company LLC I (“PFC”). PFC owns the distribution rights of a motion picture film library. The Company accounts for its interest in PFC as an equity investment. The Company’s equity earnings in PFC are included in net change in fair value of credit derivatives, as any proceeds from the investment are used to offset the Company’s payments under its CDS contract. During Six Months 2013 and Six Months 2012, the Company received $9 million and $49 million, respectively, in payments of notes receivable from PFC. The Company and the CDS counterparty mutually agreed to terminate the CDS on April 25, 2013.
 
Liquidity Arrangements with respect to AGMH’s former Financial Products Business
 
AGMH’s former financial products segment had been in the business of borrowing funds through the issuance of GICs and medium term notes and reinvesting the proceeds in investments that met AGMH’s investment criteria. The financial products business also included the equity payment undertaking agreement portion of the leveraged lease business, as described further below in “—Strip Coverage Facility for the Leveraged Lease Business.”
 
The GIC Business
 
AGM continues to have exposure to the GIC business formerly conducted by AGMH through its non-insurance subsidiaries (the “GIC Issuers”) FSA Capital Management Services LLC, FSA Capital Markets Services LLC and FSA Capital Markets Services (Caymans) Ltd. Prior to the completion of the AGMH Acquisition, AGMH sold its ownership interest in the GIC Issuers and FSA Asset Management LLC (“FSAM”) to Dexia Holdings. Even though AGMH no longer owns the GIC Issuers or FSAM, AGM's guarantees of the GICs remain in place, and must remain in place until each GIC is terminated.

Through a series of transactions and intercompany financing arrangements put in place substantially contemporaneously with the AGMH Acquisition, AGM has sought to mitigate its exposure to the GICs. The key forms of protection consist of guarantees, committed financing arrangements, and collateralized put contracts entered into by Dexia Holdings and certain related and formerly-related entities. The nature and scope of those arrangements is more fully described in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of the Company's Form 10‑K for the year ended December 31, 2012 and its Form 10-Q for the quarter ended March 31, 2013.

In the most recent quarter, no substantive modifications were made to those arrangements, and accordingly AGM's risks in its exposure to the GICs remains the same. The overall exposure has declined as a result of terminations and amortization of GICs. As of June 30, 2013, the aggregate accreted GIC balance was approximately $2.9 billion. As of the same date and with respect to the FSAM assets that are covered by the primary put contract, the aggregate accreted principal was approximately $4.4 billion, the aggregate market value was approximately $4.2 billion and the aggregate market value after agreed reductions was approximately $3.2 billion. Cash and net derivative value constituted another $0.4 billion of assets. Accordingly, as of June 30, 2013, the aggregate fair value (after agreed reductions) of the assets supporting the GIC business exceeded the aggregate principal amount of all outstanding GICs and certain other business and hedging costs of the GIC business. Therefore, no posting of collateral was required under the credit support annex applicable to the primary put contract. Under the terms of that credit support annex, the collateral posting is recalculated on a weekly basis according to the formula set forth in the credit support annex, and a collateral posting is required whenever the collateralization levels tested by the formula are not satisfied, subject to a threshold of $5 million.


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Despite the execution of the transaction referred to above, and the significant portion of FSAM assets comprised of highly liquid securities backed by the full faith and credit of the United States, AGM remains subject to the risk that Dexia may not make payments or securities available (i) on a timely basis, which is referred to as “liquidity risk,” or (ii) at all, which is referred to as “credit risk,” because of the risk of default. Even if Dexia has sufficient assets to pay all amounts when due, concerns regarding Dexia's financial condition or willingness to comply with their obligations could cause one or more rating agencies to view negatively the ability or willingness of Dexia and its affiliates to perform under their various agreements and could negatively affect AGM's ratings.
 
If Dexia or its affiliates do not fulfill the contractual obligations, the GIC issuers may not have the financial ability to pay upon the withdrawal of GIC funds or post collateral or make other payments in respect of the GICs, thereby resulting in claims upon the AGM financial guaranty insurance policies. If AGM is required to pay a claim due to a failure of the GIC issuers to pay amounts in respect of the GICs, AGM is subject to the risk that the GICs will not be paid from funds received from Dexia before it is required to make payment under its financial guaranty policies or that it will not receive the guaranty payment at all.
 
The Medium Term Notes Business
 
In connection with the AGMH Acquisition, DCL agreed to fund, on behalf of AGM and Assured Guaranty (Bermuda) Ltd., 100% of all policy claims made under financial guaranty insurance policies issued by AGM and Assured Guaranty (Bermuda) in relation to the medium term notes issuance program of FSA Global Funding Limited. Such agreement is set out in a Separation Agreement, dated as of July 1, 2009, between DCL, AGM, Assured Guaranty (Bermuda), FSA Global Funding and Premier International Funding Co., and in a funding guaranty and a reimbursement guaranty that DCL issued for the benefit of AGM and Assured Guaranty (Bermuda). Under the funding guaranty, DCL guarantees to pay to or on behalf of AGM or Assured Guaranty (Bermuda) amounts equal to the payments required to be made under policies issued by AGM or Assured Guaranty (Bermuda) relating to the medium term notes business. Under the reimbursement guaranty, DCL guarantees to pay reimbursement amounts to AGM or Assured Guaranty (Bermuda) for payments they make following a claim for payment under an obligation insured by a policy they have issued. Notwithstanding DCL’s obligation to fund 100% of all policy claims under those policies, AGM and Assured Guaranty (Bermuda) have a separate obligation to remit to DCL a certain percentage (ranging from 0% to 25%) of those policy claims. AGM, the Company and related parties are also protected against losses arising out of or as a result of the medium term note business through an indemnification agreement with DCL.
 
The Leveraged Lease Business
 
Under the Strip Coverage Facility entered into in connection with the AGMH Acquisition, Dexia Credit Local (NY) agreed to make loans to AGM to finance all draws made by lessors on certain AGM strip policies issued in connection with the leveraged lease business. AGM may request advances under the Strip Coverage Facility without any explicit limit on the number of loan requests, provided that the aggregate principal amount of loans outstanding as of any date may not initially exceed the commitment amount. The leveraged lease business, the AGM strip policies and the Strip Coverage Facility are described further under “Commitments and Contingencies—Recourse Credit Facilities—2009 Strip Coverage Facility” under this Liquidity and Capital Resources section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for an updated sensitivity analysis for credit derivatives and expected losses on contracts accounted for as insurance. There were no material changes in market risk since December 31, 2012.


ITEM 4.
CONTROLS AND PROCEDURES

Assured Guaranty’s management, with the participation of AGL’s President and Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) that are effective in recording, processing, summarizing and reporting, within the time periods specified in the Commission’s rules and forms, information required to be disclosed by AGL in the reports that it files or submits under the Exchange Act and ensuring that such information is accumulated and communicated to management, including the President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
 

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Management of the Company, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of June 30, 2013. Based on their evaluation as of June 30, 2013 covered by this Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective.
 
There have been no changes in the Company’s internal controls over financial reporting during the Company’s quarter ended June 30, 2013, that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II.
OTHER INFORMATION

ITEM 1.
LEGAL PROCEEDINGS
 
The Company is subject to legal proceedings and claims, as described in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 and in the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2013. Material developments to such proceedings during the three months ended June 30, 2013 are described below and in the "Recovery Litigation—RMBS Transactions," section of Note 5, Expected Loss to be Paid, of the Financial Statements.
 
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 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 2103, 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.





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ITEM 1A.
RISK FACTORS

Refer to “Risk Factors" under Part I, “Item 1A. Risk Factors” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. There have been no material changes to the risk factors disclosed in such Annual Report on Form 10-K.


ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Issuer’s Purchases of Equity Securities
 
The following table reflects purchases of AGL common shares made by the Company during Second Quarter 2013.
 
Period
 
Total
Number of
Shares
Purchased
 
Average
Price Paid
Per Share
 
Total Number of
Shares Purchased as
Part of Publicly
Announced Program (1)
 
Maximum Number (or Approximate Dollar Value)
of Shares that
May Yet Be
Purchased
Under the Program(2)
April 1 - April 30
 
2,895,035

 
$
20.00

 
2,895,035

 
$
102,947,913

May 1 - May 31
 
1,679,928

 
$
22.31

 
1,679,928

 
$
180,467,734

June 1 - June 30
 
5,000,000

 
$
21.94

 
5,000,000

 
$
70,767,734

Total
 
9,574,963

 
$
21.42

 
9,574,963

 
 

____________________
(1)
On January 18, 2013, the Company's Board of Directors authorized a $200 million share repurchase program. On May 8, 2013, the Company's Board of Directors authorized an additional $115 million of repurchases of the Company’s common shares, bringing the total authorization in 2013 to $315 million.

(2)
Excludes commissions.


ITEM 6.
EXHIBITS.
 
See Exhibit Index for a list of exhibits filed with this report.


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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
ASSURED GUARANTY LTD.
(Registrant)
 
 
Dated August 9, 2013
By:
/s/ ROBERT A. BAILENSON
 
 
 
 
 
Robert A. Bailenson
Chief Financial Officer (Principal Financial and
Accounting Officer and Duly Authorized Officer)


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EXHIBIT INDEX
 
Exhibit
Number
 
Description of Document
10.1

 
Share Purchase Agreement, dated May 31, 2013, among Assured Guaranty Ltd., WLR Recovery Fund IV, L.P., WLR Recovery Funds III, L.P., WLR AGO Co-Invest, L.P., WLR/GS Master Co-Investments, L.P., WLR IV Parallel ESC, L.P and Wilbur L. Ross, Jr. (Incorporated by reference to Exhibit 10.1 to Form 8-K filed on June 3, 2013)
31.1

 
Certification of CEO Pursuant to Exchange Act Rules 13A-14 and 15D-14, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2

 
Certification of CFO Pursuant to Exchange Act Rules 13A-14 and 15D-14, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1

 
Certification of CEO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002
32.2

 
Certification of CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002
101.1

 
The following financial information from Assured Guaranty Ltd.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 formatted in XBRL: (i) Consolidated Balance Sheets at June 30, 2013 and December 31, 2012; (ii) Consolidated Statements of Operations for the Three and Six Months ended June 30, 2013 and 2012; (iii) Consolidated Statements of Comprehensive Income for the Three and Six Months ended June 30, 2013 and 2012 (iv) Consolidated Statement of Shareholders’ Equity for the Six Months ended June 30, 2013; (v) Consolidated Statements of Cash Flows for the Six Months ended June 30, 2013 and 2012; and (vi) Notes to Consolidated Financial Statements.
 



159