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ASSURED GUARANTY LTD - Quarter Report: 2017 March (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 March 31, 2017
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, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth 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)
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
The number of registrant’s Common Shares ($0.01 par value) outstanding as of May 2, 2017 was 121,818,250 (includes 58,858 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
March 31, 2017
 
As of
December 31, 2016
Assets
 

 
 

Investment portfolio:
 

 
 

Fixed-maturity securities, available-for-sale, at fair value (amortized cost of $10,135 and $9,974)
$
10,479

 
$
10,233

Short-term investments, at fair value
689

 
590

Other invested assets
173

 
162

Total investment portfolio
11,341

 
10,985

Cash
147

 
118

Premiums receivable, net of commissions payable
876

 
576

Ceded unearned premium reserve
180

 
206

Deferred acquisition costs
106

 
106

Reinsurance recoverable on unpaid losses
74

 
80

Salvage and subrogation recoverable
405

 
365

Credit derivative assets
9

 
13

Deferred tax asset, net
438

 
497

Current income tax receivable
—

 
12

Financial guaranty variable interest entities’ assets, at fair value
781

 
876

Other assets
318

 
317

Total assets
$
14,675

 
$
14,151

Liabilities and shareholders’ equity
 

 
 

Unearned premium reserve
$
3,827

 
$
3,511

Loss and loss adjustment expense reserve
1,193

 
1,127

Reinsurance balances payable, net
52

 
64

Long-term debt
1,307

 
1,306

Credit derivative liabilities
359

 
402

Current income tax payable
63

 
—

Financial guaranty variable interest entities’ liabilities with recourse, at fair value
721

 
807

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

 
151

Other liabilities
382

 
279

Total liabilities
8,038

 
7,647

Commitments and contingencies (See Note 14)

 

Common stock ($0.01 par value, 500,000,000 shares authorized; 123,028,528 and 127,988,230 shares issued and outstanding)
1

 
1

Additional paid-in capital
841

 
1,060

Retained earnings
5,588

 
5,289

Accumulated other comprehensive income, net of tax of $101 and $70
206

 
149

Deferred equity compensation
1

 
5

Total shareholders’ equity
6,637

 
6,504

Total liabilities and shareholders’ equity
$
14,675

 
$
14,151


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 March 31,
 
2017
 
2016
Revenues
 
 
 
Net earned premiums
$
164

 
$
183

Net investment income
122

 
99

Net realized investment gains (losses):
 
 
 
Other-than-temporary impairment losses
(1
)
 
(20
)
Less: portion of other-than-temporary impairment loss recognized in other comprehensive income
8

 
(4
)
Net impairment loss
(9
)
 
(16
)
Other net realized investment gains (losses)
41

 
3

Net realized investment gains (losses)
32

 
(13
)
Net change in fair value of credit derivatives:
 
 
 
Realized gains (losses) and other settlements
15

 
8

Net unrealized gains (losses)
39

 
(68
)
Net change in fair value of credit derivatives
54

 
(60
)
Fair value gains (losses) on committed capital securities
(2
)
 
(16
)
Fair value gains (losses) on financial guaranty variable interest entities
10

 
18

Bargain purchase gain and settlement of pre-existing relationships
58

 
—

Other income (loss)
89

 
34

Total revenues
527

 
245

Expenses
 
 
 
Loss and loss adjustment expenses
59

 
90

Amortization of deferred acquisition costs
4

 
4

Interest expense
24

 
26

Other operating expenses
68

 
60

Total expenses
155

 
180

Income (loss) before income taxes
372

 
65

Provision (benefit) for income taxes
 
 
 
Current
51

 
30

Deferred
4

 
(24
)
Total provision (benefit) for income taxes
55

 
6

Net income (loss)
$
317

 
$
59

 
 
 
 
Earnings per share:
 
 
 
Basic
$
2.53

 
$
0.43

Diluted
$
2.49

 
$
0.43

Dividends per share
$
0.1425

 
$
0.13

 
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 Comprehensive Income (unaudited)
 
(in millions)
 
 
Three Months Ended March 31,
 
2017
 
2016
Net income (loss)
$
317

 
$
59

Unrealized holding gains (losses) arising during the period on:
 
 
 
Investments with no other-than-temporary impairment, net of tax provision (benefit) of $23 and $31
44

 
95

Investments with other-than-temporary impairment, net of tax provision (benefit) of $28 and $(10)
50

 
(17
)
Unrealized holding gains (losses) arising during the period, net of tax
94

 
78

Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $21 and $(4)
39

 
(6
)
Change in net unrealized gains (losses) on investments
55

 
84

Other, net of tax provision
2

 
(2
)
Other comprehensive income (loss)
$
57

 
$
82

Comprehensive income (loss)
$
374

 
$
141

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

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Assured Guaranty Ltd.

Consolidated Statement of Shareholders’ Equity (unaudited)
 
For the Three Months Ended March 31, 2017
 
(dollars in millions, except share data)

 
Common Shares Outstanding
 
 
Common Stock Par Value
 
Additional
Paid-in
Capital
 
Retained Earnings
 
Accumulated
Other
Comprehensive Income
 
Deferred
Equity Compensation
 
Total
Shareholders’ Equity
Balance at December 31, 2016
127,988,230

 
 
$
1

 
$
1,060

 
$
5,289

 
$
149

 
$
5

 
$
6,504

Net income
—

 
 
—

 
—

 
317

 
—

 
—

 
317

Dividends ($0.1425 per share)
—

 
 
—

 
—

 
(18
)
 
—

 
—

 
(18
)
Common stock repurchases
(5,430,041
)
 
 
0

 
(216
)
 
—

 
—

 
—

 
(216
)
Share-based compensation and other
470,339

 
 
0

 
(3
)
 
—

 
—

 
(4
)
 
(7
)
Other comprehensive income
—

 
 
—

 
—

 
—

 
57

 
—

 
57

Balance at March 31, 2017
123,028,528

 
 
$
1

 
$
841

 
$
5,588

 
$
206

 
$
1

 
$
6,637

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

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Assured Guaranty Ltd.

Consolidated Statements of Cash Flows (unaudited)
 
(in millions)
 
 
Three Months Ended March 31,
 
2017
 
2016
Net cash flows provided by (used in) operating activities
$
102

 
$
(90
)
Investing activities
 

 
 

Fixed-maturity securities:
 

 
 

Purchases
(517
)
 
(296
)
Sales
323

 
162

Maturities
265

 
301

Net sales (purchases) of short-term investments
12

 
(63
)
Net proceeds from paydowns on financial guaranty variable interest entities’ assets
46

 
66

Acquisition of MBIA UK, net of cash acquired (see Note 2)
95

 
—

Other
(13
)
 
2

Net cash flows provided by (used in) investing activities
211

 
172

Financing activities
 

 
 

Dividends paid
(19
)

(18
)
Repurchases of common stock
(216
)

(75
)
Repurchases of common stock to pay withholding taxes
(12
)
 
(2
)
Net paydowns of financial guaranty variable interest entities’ liabilities
(48
)
 
(42
)
Repayment of long-term debt
(1
)
 
0

Proceeds from options exercises
2

 
1

Net cash flows provided by (used in) financing activities
(294
)
 
(136
)
Effect of foreign exchange rate changes
2

 
0

Increase (decrease) in cash and restricted cash
21

 
(54
)
Cash and restricted cash at beginning of period (see Note 10)
127

 
166

Cash and restricted cash at end of period (see Note 10)
$
148

 
$
112

Supplemental cash flow information
 

 
 

Cash paid (received) during the period for:
 

 
 

Income taxes
$
(5
)
 
$
1

Interest
$
8

 
$
7


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)
 
March 31, 2017

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 primarily to offer financial guaranty insurance that protects holders of debt instruments and other monetary obligations from defaults in scheduled payments. If an obligor defaults on a scheduled payment due on an obligation, including a scheduled principal or interest payment (debt service), the Company is required under its unconditional and irrevocable financial guaranty to pay the amount of the shortfall to the holder of the obligation. The Company markets its financial guaranty insurance 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 principally in the U.S. and the United Kingdom (U.K.), and also guarantees obligations issued in other countries and regions, including Australia and Western Europe. The Company also provides other forms of insurance that are in line with its risk profile and benefit from its underwriting experience.

In the past, the Company sold credit protection by issuing policies that guaranteed payment obligations under credit derivatives, primarily credit default swaps (CDS). 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. 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 in the U.S. 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 also contributed to the Company not entering into such new CDS in the U.S. since 2009. 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 variable interest entities (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 March 31, 2017 and cover the three-month period ended March 31, 2017 (First Quarter 2017), and the three-month period ended March 31, 2016 (First Quarter 2016). 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, its direct and indirect subsidiaries (collectively, the Subsidiaries), and its consolidated 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, 2016, filed with the U.S. Securities and Exchange Commission (the SEC).


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The Company's principal insurance company subsidiaries are:

•
Assured Guaranty Municipal Corp. (AGM), domiciled in New York;
•
Municipal Assurance Corp. (MAC), domiciled in New York;
•
Assured Guaranty Corp. (AGC), domiciled in Maryland;
•
Assured Guaranty (Europe) Ltd. (AGE), organized in the U.K.; and
•
Assured Guaranty Re Ltd. (AG Re) and Assured Guaranty Re Overseas Ltd (AGRO), domiciled in Bermuda.

The Company’s organizational structure includes various holding companies, two of which - Assured Guaranty U.S. Holdings Inc. (AGUS) and Assured Guaranty Municipal Holdings Inc. (AGMH) - have public debt outstanding. See Note 15, Long-Term Debt and Credit Facilities and Note 18, Subsidiary Information.

Adopted Accounting Standards

Statement of Cash Flows

In November 2016, the FASB issued Accounting Standards Update (ASU) 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the Emerging Issues Task Force), which addresses the presentation of changes in restricted cash and restricted cash equivalents in the statement of cash flows with the objective of reducing the existing diversity in practice. Under the ASU, entities are required to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows.  As a result, entities will no longer present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents in the statement of cash flows.  When cash, cash equivalents, restricted cash and restricted cash equivalents are presented in more than one line item on the balance sheet, the ASU requires a reconciliation be presented either on the face of the statement of cash flows or in the notes to the financial statements showing the totals in the statement of cash flows to the related captions in the balance sheet. The ASU was adopted on January 1, 2017 and was applied retrospectively. The required reconciliation is shown in Note 10, Investments and Cash.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force), which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This ASU did not have an effect on the Company’s consolidated statements of cash flows for the periods presented.

Share-Based Payments

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment, which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows.  The new guidance requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also allows an employer to repurchase more of an employee’s shares than it previously could for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur. The ASU was adopted January 1, 2017. This ASU did not have a material effect on the consolidated financial statements.

Future Application of Accounting Standards

Premium Amortization on Purchased Callable Debt Securities

In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Topic 310-20) - Premium Amortization on Purchased Callable Debt Securities.  This ASU shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date.  Currently, entities generally amortize the premium as a yield adjustment over the contractual life of the security.  This ASU has no effect on the accounting for purchased callable debt securities held at a discount.  ASU 2017-08 is to be applied using a modified retrospective approach through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption.  The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  Early adoption is permitted.  The Company is evaluating the effect that this ASU will have on its consolidated financial statements.


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Table of Contents

Income Taxes

In October 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-16, Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory, which removes the current prohibition against immediate recognition of the current and deferred income tax effects of intra-entity transfers of assets other than inventory.  Under the ASU, the selling (transferring) entity is required to recognize a current income tax expense or benefit upon transfer of the asset.  Similarly, the purchasing (receiving) entity is required to recognize a deferred tax asset or deferred tax liability, as well as the related deferred tax benefit or expense, upon receipt of the asset.  The ASU is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods, and early adoption is permitted.  The ASU’s amendments are to be applied on a modified retrospective basis recognizing the effects in retained earnings as of the beginning of the year of adoption.   This ASU is not expected to have a material effect on the Company’s consolidated financial statements.

Credit Losses on Financial Instruments

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.  The amendments in this ASU are intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions will use forward-looking information to better inform their credit loss estimates as a result of the ASU. While many of the loss estimation techniques applied today will still be permitted, the inputs to those techniques will change to reflect the full amount of expected credit losses. The ASU requires enhanced disclosures to help investors and other financial statement users to better understand significant estimates and judgments used in estimating credit losses, as well as credit quality and underwriting standards of an organization’s portfolio. 

In addition, the ASU amends the accounting for credit losses on available-for-sale securities and purchased financial assets with credit deterioration. The ASU also eliminates the concept of “other than temporary” from the impairment model for certain available-for-sale securities. Accordingly, the ASU states that an entity must use an allowance approach, must limit the allowance to an amount at which the security’s fair value is less than its amortized cost basis, may not consider the length of time fair value has been less than amortized cost, and may not consider recoveries in fair value after the balance sheet date when assessing whether a credit loss exists. For purchased financial assets with credit deterioration, the ASU requires an entity’s method for measuring credit losses to be consistent with its method for measuring expected losses for originated and purchased non-credit-deteriorated assets.

The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. For most debt instruments, entities will be required to record a cumulative-effect adjustment to the statement of financial position as of the beginning of the first reporting period in which the guidance is adopted.  The changes to the impairment model for available-for-sale securities and changes to purchased financial assets with credit deterioration are to be applied prospectively.  For the Company, this would be as of January 1, 2020.  Early adoption is permitted for fiscal years, and interim periods with those fiscal years, beginning after December 15, 2018.  The Company is evaluating the effect that this ASU will have on its consolidated financial statements.

Leases
    
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU requires lessees to present right-of-use assets and lease liabilities on the balance sheet. ASU 2016-02 is to be applied using a modified retrospective approach at the beginning of the earliest comparative period in the financial statements. The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is evaluating the effect that this ASU will have on its consolidated financial statements.

Financial Instruments
    
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities.  The amendments in this ASU are intended to make targeted improvements to GAAP by addressing certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Under the ASU, certain equity securities will need to be accounted for at fair value with changes in fair value recognized through net income.  Currently, the Company recognizes unrealized gains and losses for these securities in OCI. Another amendment pertains to liabilities that an entity has elected to measure at fair value in accordance with the fair value option for financial instruments. For these liabilities, the portion of fair value change related to credit risk will be separately

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presented in OCI.  Currently, the entire change in the fair value of these liabilities is reflected in the income statement. The Company elected the fair value option to account for its consolidated FG VIEs. FG VIE financial liabilities with recourse are sensitive to changes in the Company’s implied credit worthiness and will be impacted by the ASU. 
           
The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Entities will be required to record a cumulative-effect adjustment to the statement of financial position as of the beginning of the fiscal year in which the guidance is adopted.  For the Company, this would be as of January 1, 2018.  Early adoption is permitted only for the amendment related to the change in presentation of financial liabilities that are fair valued using the fair value option. The Company does not expect that the amendment related to certain equity securities will have a material effect on its consolidated financial statements. Upon the adoption date, the Company will present the total change in credit risk for FG VIEs’ financial liabilities with recourse separately in OCI.

2.
Acquisitions

MBIA UK Insurance Limited

On January 10, 2017 (the MBIA UK Acquisition Date), AGC completed its acquisition of MBIA UK Insurance Limited (MBIA UK), the U.K. operating subsidiary of MBIA Insurance Corporation (MBIA) (the MBIA UK Acquisition). As consideration for the outstanding shares of MBIA UK plus $23 million in cash, AGC exchanged all its holdings of notes issued in the Zohar II 2005-1 transaction (Zohar II Notes), which were insured by MBIA. AGC’s Zohar II Notes had total outstanding principal of approximately $347 million and fair value of $334 million as of the MBIA UK Acquisition Date. The MBIA UK Acquisition added approximately $12 billion of net par insured on January 10, 2017.

MBIA UK has been renamed Assured Guaranty (London) Ltd. (AGLN). Assured Guaranty currently maintains AGLN as a stand-alone entity, but is actively working to combine AGLN with its other affiliated European insurance companies. Any such combination will be subject to regulatory and court approvals; as a result, Assured Guaranty cannot predict when, or if, such a combination will be completed.

The MBIA UK Acquisition was accounted for under the acquisition method of accounting which requires that the assets and liabilities acquired be recorded at fair value. The Company exercised significant judgment to determine the fair value of the assets it acquired and liabilities it assumed in the MBIA UK Acquisition. The most significant of these determinations related to the valuation of MBIA UK's financial guaranty insurance contracts. On an aggregate basis, MBIA UK's contractual premiums for financial guaranty insurance contracts were less than the premiums a market participant of similar credit quality would demand to acquire those contracts on the MBIA UK Acquisition Date, particularly for below-investment-grade (BIG) transactions, resulting in a significant amount of the purchase price being allocated to these contracts. For information on the methodology used to measure the fair value of assets acquired and liabilities assumed in the MBIA UK Acquisition, please refer to Note 7, Fair Value Measurement.

The fair value of the Company's stand-ready obligation on the MBIA UK Acquisition Date is recorded in unearned premium reserve. After the MBIA UK Acquisition Date, loss reserves and loss and loss adjustment expenses (LAE) will be recorded when the expected losses for each contract exceeds the remaining unearned premium reserve, in accordance with the Company's accounting policy described in the Annual Report on Form 10-K. The expected losses acquired by the Company as part of the MBIA UK Acquisition are included in Note 5, Expected Losses to be Paid.

The excess of the fair value of net assets acquired over the consideration transferred was recorded as a bargain purchase gain in "bargain purchase gain and settlement of pre-existing relationships" in net income. In addition, the Company and MBIA UK had pre-existing reinsurance relationships, which were also effectively settled at fair value on the MBIA UK Acquisition Date. The gain on settlement of these pre-existing reinsurance relationships represents the net difference between the historical assumed balances that were recorded by the Company and the fair value of ceded balances acquired from MBIA UK. The Company believes the bargain purchase gain resulted from MBIA's strategy to address its insurance obligations with regards to the Zohar II Notes, the issuers of which MBIA did not expect would have sufficient funds to repay such notes in full on the scheduled maturity date of such notes in January 2017.

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The following table shows the net effect of the MBIA UK Acquisition, including the effects of the settlement of pre-existing relationships.

 
Fair Value of Net Assets Acquired, before Settlement of Pre-existing Relationships
 
Net effect of Settlement of Pre-existing Relationships
 
Net Effect of
MBIA UK Acquisition
 
(in millions)
Purchase price (1)
$
334

 
$
—

 
$
334

 
 
 
 
 
 
Identifiable assets acquired:
 
 
 
 
 
Investments
459

 
—

 
459

Cash
72

 
—

 
72

Premiums receivable, net of commissions payable
274

 
(4
)
 
270

Other assets
16

 
(6
)
 
10

Total assets
821

 
(10
)
 
811

 
 

 
 
 
 
Liabilities assumed:
 
 
 
 
 
Unearned premium reserves
389

 
(6
)
 
383

Current tax payable
25

 
—

 
25

Other liabilities
4

 
(5
)
 
(1
)
Total liabilities
418

 
(11
)
 
407

Net assets of MBIA UK
403

 
1

 
404

Cash acquired from MBIA Holdings
23

 
—

 
23

Deferred tax liability
(36
)
 
—

 
(36
)
Net asset effect of MBIA UK Acquisition
390

 
1

 
391

Bargain purchase gain and settlement of pre-existing relationships resulting from MBIA UK Acquisition, after-tax
56

 
1

 
57

Deferred tax
—

 
1

 
1

Bargain purchase gain and settlement of pre-existing relationships resulting from MBIA UK Acquisition, pre-tax
$
56

 
$
2

 
$
58

_____________________
(1)
The purchase price of $334 million was allocated as follows: (1) $329 million for the purchase of net assets of $385 million, and (2) the settlement of pre-existing relationships between MBIA UK and Assured Guaranty at a fair value of $5 million.
    
Revenue and net income related to MBIA UK from the MBIA UK Acquisition Date through March 31, 2017 included in the consolidated statement of operations were approximately $118 million and $92 million, respectively, including the bargain purchase gain, settlement of pre-existing relationships, quarterly activity and realized gain on the disposition of AGC's Zohar II Notes. For First Quarter 2017, the Company recognized transaction expenses related to the MBIA UK Acquisition of $6 million comprising primarily legal and financial advisors fees.

Unaudited Pro Forma Results of Operations

The following unaudited pro forma information presents the combined results of operations of Assured Guaranty and MBIA UK as if the acquisition had been completed on January 1, 2016, as required under GAAP. The pro forma accounts include the estimated historical results of the Company and MBIA UK and pro forma adjustments primarily comprising the earning of the unearned premium reserve and the expected losses that would be recognized in net income for each prior period presented, as well as the accounting for bargain purchase gain, settlement of pre-existing relationships, the realized gain on the disposition of the Zohar II Notes and MBIA UK acquisition related expenses, all net of tax at the applicable statutory rate.


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The unaudited pro forma combined financial information is presented for illustrative purposes only and does not indicate the financial results of the combined company had the companies actually been combined as of January 1, 2016, nor is it indicative of the results of operations in future periods. The Company did not include any pro forma combined financial information for 2017 as substantially all of MBIA UK's results of operations for the first quarter 2017 are included in the First Quarter 2017 Statements of Operations.

Unaudited Pro Forma Results of Operations

 
 
First Quarter 2016
 
 
(in millions, except per share amounts)
Pro forma revenues
 
$
361

Pro forma net income
 
152

Pro forma earnings per share (EPS):
 
 
  Basic
 
1.12

  Diluted
 
1.11


Please refer to Note 2, Acquisitions, in Part II, Item 8. “Financial Statements and Supplementary Data” of AGL’s Annual Report on Form 10-K for the year ended December 31, 2016 for additional information on other recent acquisitions.

3.    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 the rating agencies 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 strong financial strength ratings. However, the methodologies and models used by rating agencies differ, presenting conflicting goals that may make it inefficient or impractical to reach the highest rating level. The methodologies and models are not fully transparent, contain subjective elements and data (such as assumptions about future market demand for the Company’s products) and may change. Ratings are subject to continuous review and revision or withdrawal at any time. If the financial strength ratings of one (or more) of the Company’s insurance subsidiaries were reduced below current levels, the Company expects it could have adverse effects on the impacted subsidiary's future business opportunities as well as the premiums the impacted subsidiary could charge for its insurance policies.

The Company periodically assesses the value of each rating assigned to each of its companies, and as a result of such assessment may request that a rating agency add or drop a rating from certain of its companies. For example, the Kroll Bond Rating Agency (KBRA) ratings were first assigned to MAC in 2013, to AGM in 2014, and to AGC in 2016, while the A.M. Best Company, Inc. (Best) rating was first assigned to Assured Guaranty Re Overseas Ltd. (AGRO) in 2015, and a Moody's Investors Service, Inc. (Moody's) rating was never requested for MAC and was dropped from AG Re and AGRO in 2015. On January 13, 2017, AGC announced that it had requested that Moody's withdraw its financial strength rating of AGC. Moody's declined that initial request, but AGC is renewing its request.

In the last several years, S&P Global Ratings, a division of Standard & Poor's Financial Services LLC (S&P) and Moody's have changed, multiple times, their financial strength ratings of AGL's insurance subsidiaries, or changed the outlook on such ratings. More recently, KBRA and Best have assigned financial strength ratings to some of AGL's insurance subsidiaries. The rating agencies' most recent actions related to AGL's insurance subsidiaries are:

•
On September 20, 2016, KBRA assigned a financial strength rating of AA (stable outlook) to AGC. On December 14, 2016 and July 8, 2016, KBRA affirmed the AA+ (stable outlook) financial strength ratings of AGM and MAC, respectively.

•
On August 8, 2016, Moody's affirmed the A2 (stable outlook) on AGM and AGE and the A3 insurance financial strength rating on AGC and AGC's subsidiary Assured Guaranty (UK) Ltd. (AGUK), raising the outlook to stable from negative. As noted above, AGC is requesting that Moody's withdraw its rating of AGC and AGUK. On January 13, 2017, Moody's upgraded AGLN to Baa2 from Ba2, reflecting its acquisition by AGC. Effective April 8, 2015, at the Company's request, Moody’s withdrew the financial strength ratings it had assigned to AG Re and AGRO.

11
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•
On July 27, 2016, S&P affirmed the AA (stable) financial strength ratings of AGL's insurance subsidiaries other than AGLN. On January 12, 2017, S&P placed the BB rating of AGLN on credit watch positive in anticipation of the potential combination of AGLN with the Company's other European subsidiaries.

•
On May 27, 2016, Best affirmed the A+ (stable) financial strength rating, which is their second highest rating, of AGRO.

There can be no assurance that any of the rating agencies will not take negative action on their financial strength ratings of AGL's insurance subsidiaries in the future.

For a discussion of the effects of rating actions on the Company, see the following:

•
Note 6, Contracts Accounted for as Insurance
•
Note 13, Reinsurance and Other Monoline Exposures

4.
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 it views as investment grade at inception, although, as part of its loss mitigation strategy for existing troubled credits, it may underwrite new issuances that it views as below-investment-grade. The Company diversifies its insured portfolio across asset classes and, in the structured finance portfolio, requires rigorous subordination or collateralization requirements. Reinsurance may be used in order to reduce net exposure to certain insured transactions.

     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. The Company also includes within public finance similar obligations issued by territorial and non-U.S. sovereign and sub-sovereign issuers and governmental authorities.

Structured finance obligations insured by the Company are generally issued by special purpose entities, including VIEs, and backed by pools of assets having an ascertainable cash flow or market value or other specialized financial obligations. Some of these VIEs are consolidated as described in Note 9, Consolidated Variable Interest Entities. Unless otherwise specified, the outstanding par and debt service amounts presented in this note include outstanding exposures on VIEs whether or not they are consolidated.

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, except that the Company's internal credit ratings focus on future performance rather than lifetime performance.
 
The Company monitors its investment grade credits to determine whether any need to be internally downgraded to BIG and 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 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 ratings of the transactions are used.
 
Credits identified as BIG are subjected to further review to determine the probability of a loss. See Note 5, Expected Loss to be Paid, for additional information. Surveillance personnel then assign each BIG transaction to the appropriate BIG

12
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surveillance category based upon whether a future loss is expected and whether a claim has been paid. For surveillance purposes, the Company calculates present value using a discount rate of 4% or 5% depending on the insurance subsidiary. (Risk-free rates are used for calculating the expected loss for financial statement measurement purposes.)
 
More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly. The Company expects “future 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 in the future of that transaction than it will have reimbursed. The three BIG categories are:
 
•
BIG Category 1: Below-investment-grade transactions showing sufficient deterioration to make future losses possible, but for which none are currently expected.
 
•
BIG Category 2: Below-investment-grade transactions for which future losses are expected but for which no claims (other than liquidity claims, which are claims that the Company expects to be reimbursed within one year) have yet been paid.
 
•
BIG Category 3: Below-investment-grade transactions for which future losses are expected and on which claims (other than liquidity claims) have been paid.

Components of Outstanding Exposure

Unless otherwise noted, ratings disclosed herein on the Company's insured portfolio reflect its internal ratings. The Company classifies those portions of risks benefiting from reimbursement obligations collateralized by eligible assets held in trust in acceptable reimbursement structures as the higher of 'AA' or their current internal rating.

The Company purchases securities that it has insured, and for which it has expected losses to be paid, in order to
mitigate the economic effect of insured losses (loss mitigation securities). The Company excludes amounts attributable to loss mitigation securities (unless otherwise indicated) from par and debt service outstanding, because it manages such securities as investments and not insurance exposure. As of March 31, 2017 and December 31, 2016, the Company excluded $2.1 billion and $2.1 billion, respectively, of net par as a result of loss mitigation strategies, including loss mitigation securities held in the investment portfolio, which are primarily BIG. The following table presents the gross and net debt service for financial guaranty contracts.

Financial Guaranty
Debt Service Outstanding

 
Gross Debt Service
Outstanding
 
Net Debt Service
Outstanding
 
March 31,
2017
 
December 31,
2016
 
March 31,
2017
 
December 31,
2016
 
(in millions)
Public finance
$
436,426

 
$
425,849

 
$
422,496

 
$
409,447

Structured finance
24,506

 
29,151

 
23,690

 
28,088

Total financial guaranty
$
460,932

 
$
455,000

 
$
446,186

 
$
437,535


In addition to amounts shown in the tables above, the Company had outstanding commitments to provide guaranties of $8 million for structured finance and $561 million for public finance obligations as of March 31, 2017. The expiration dates for the public finance commitments range between April 1, 2017 and May 17, 2017, with $438 million expiring prior to the date of this filing. 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.


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Financial Guaranty Portfolio by Internal Rating
As of March 31, 2017

 
 
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
 
$
1,816

 
0.8
%
 
$
2,156

 
5.5
%
 
$
6,765

 
36.7
%
 
$
1,032

 
42.9
%
 
$
11,769

 
3.9
%
AA
 
42,529

 
17.9

 
204

 
0.5

 
5,408

 
29.3

 
99

 
4.1

 
48,240

 
16.2

A
 
132,212

 
55.5

 
12,711

 
32.3

 
1,698

 
9.2

 
264

 
11.0

 
146,885

 
49.3

BBB
 
54,294

 
22.8

 
22,199

 
56.4

 
868

 
4.7

 
760

 
31.6

 
78,121

 
26.2

BIG
 
7,199

 
3.0

 
2,073

 
5.3

 
3,707

 
20.1

 
249

 
10.4

 
13,228

 
4.4

Total net par outstanding (1)
 
$
238,050

 
100.0
%

$
39,343


100.0
%

$
18,446


100.0
%

$
2,404


100.0
%

$
298,243


100.0
%
_____________________
(1)
The March 31, 2017 amounts include $12.2 billion of net par from the MBIA UK Acquisition.


Financial Guaranty Portfolio by Internal Rating
As of December 31, 2016 

 
 
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
 
$
2,066

 
0.8
%
 
$
2,221

 
8.4
%
 
$
9,757

 
44.2
%
 
$
1,447

 
47.0
%
 
$
15,491

 
5.2
%
AA
 
46,420

 
19.0

 
170

 
0.6

 
5,773

 
26.2

 
127

 
4.1

 
52,490

 
17.7

A
 
133,829

 
54.7

 
6,270

 
23.8

 
1,589

 
7.2

 
456

 
14.8

 
142,144

 
48.0

BBB
 
55,103

 
22.5

 
16,378

 
62.1

 
879

 
4.0

 
759

 
24.6

 
73,119

 
24.7

BIG
 
7,380

 
3.0

 
1,342

 
5.1

 
4,059

 
18.4

 
293

 
9.5

 
13,074

 
4.4

Total net par outstanding
 
$
244,798

 
100.0
%
 
$
26,381

 
100.0
%
 
$
22,057

 
100.0
%
 
$
3,082

 
100.0
%
 
$
296,318

 
100.0
%


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Components of BIG Portfolio

Components of BIG Net Par Outstanding
(Insurance and Credit Derivative Form)
As of March 31, 2017

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
2,424

 
$
2,901

 
$
1,874

 
$
7,199

 
$
238,050

Non-U.S. public finance
1,810

 
263

 
—

 
2,073

 
39,343

Public finance
4,234

 
3,164

 
1,874

 
9,272

 
277,393

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. Residential mortgage-backed securities (RMBS)
190

 
412

 
2,407

 
3,009

 
5,357

Triple-X life insurance transactions
—

 
—

 
126

 
126

 
2,057

Trust preferred securities (TruPS)
192

 
62

 
—

 
254

 
1,616

Other structured finance
298

 
193

 
76

 
567

 
11,820

Structured finance
680

 
667

 
2,609

 
3,956

 
20,850

Total
$
4,914

 
$
3,831

 
$
4,483

 
$
13,228

 
$
298,243



Components of BIG Net Par Outstanding
(Insurance and Credit Derivative Form)
As of December 31, 2016

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
2,402

 
$
3,123

 
$
1,855

 
$
7,380

 
$
244,798

Non-U.S. public finance
1,288

 
54

 
—

 
1,342

 
26,381

Public finance
3,690

 
3,177

 
1,855

 
8,722

 
271,179

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. RMBS
197

 
493

 
2,461

 
3,151

 
5,637

Triple-X life insurance transactions
—

 
—

 
126

 
126

 
2,057

TruPS
304

 
126

 
—

 
430

 
1,892

Other structured finance
304

 
263

 
78

 
645

 
15,553

Structured finance
$
805

 
$
882

 
$
2,665

 
$
4,352

 
$
25,139

Total
$
4,495

 
$
4,059

 
$
4,520

 
$
13,074

 
$
296,318



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Table of Contents

BIG Net Par Outstanding
and Number of Risks
As of March 31, 2017

 
 
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
 
$
4,427

 
$
487

 
$
4,914

 
159

 
8

 
167

Category 2
 
3,698

 
133

 
3,831

 
71

 
5

 
76

Category 3
 
4,351

 
132

 
4,483

 
149

 
9

 
158

Total BIG
 
$
12,476

 
$
752

 
$
13,228

 
379

 
22

 
401



 BIG Net Par Outstanding
and Number of Risks
As of December 31, 2016

 
 
Net Par Outstanding
 
Number of Risks(2)
Description
 
Financial
Guaranty
Insurance(1)
 
Credit
Derivative
 
Total
 
Financial
Guaranty
Insurance(1)
 
Credit
Derivative
 
Total
 
 
(dollars in millions)
BIG:
 
 

 
 

 
 

 
 

 
 

 
 

Category 1
 
$
3,861

 
$
634

 
$
4,495

 
165

 
10

 
175

Category 2
 
3,857

 
202

 
4,059

 
79

 
6

 
85

Category 3
 
4,383

 
137

 
4,520

 
148

 
9

 
157

Total BIG
 
$
12,101

 
$
973

 
$
13,074

 
392

 
25

 
417

_____________________
(1)    Includes net par outstanding for 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.        

Exposure to Puerto Rico
    
The Company has insured exposure to general obligation bonds of the Commonwealth of Puerto Rico (Puerto Rico or the Commonwealth) and various obligations of its related authorities and public corporations aggregating $4.9 billion net par as of March 31, 2017, all of which are rated BIG. Puerto Rico has experienced significant general fund budget deficits in recent years and a challenging economic environment. Beginning on January 1, 2016, a number of Puerto Rico credits have defaulted on bond payments, and the Company has now paid claims on several Puerto Rico credits as shown in the table "Puerto Rico Net Par Outstanding" below.

On November 30, 2015 and December 8, 2015, Governor García Padilla of Puerto Rico (the Former Governor) issued executive orders (Clawback Orders) directing the Puerto Rico Department of Treasury and the Puerto Rico Tourism Company to retain or transfer certain taxes pledged to secure the payment of bonds issued by the Puerto Rico Highways and Transportation Authority (PRHTA), Puerto Rico Infrastructure Financing Authority (PRIFA), and Puerto Rico Convention Center District Authority (PRCCDA). On January 7, 2016, the Company sued various Puerto Rico governmental officials in the United States District Court, District of Puerto Rico, asserting that this attempt to “claw back” pledged taxes is unconstitutional, and demanding declaratory and injunctive relief. The Puerto Rico credits insured by the Company subject to the Clawback Orders are shown in the table “Puerto Rico Net Par Outstanding” below.


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On April 6, 2016, the Former Governor signed into law the Puerto Rico Emergency Moratorium & Financial Rehabilitation Act (the Moratorium Act). The Moratorium Act purportedly empowers the governor to declare, entity by entity, states of emergency and moratoriums on debt service payments on obligations of the Commonwealth and its related authorities and public corporations, as well as instituting a stay against related litigation, among other things. The Former Governor used the authority of the Moratorium Act to take a number of actions related to issuers of obligations the Company insures. National Public Finance Guarantee Corporation (National) (another financial guarantor), holders of certain Commonwealth general obligation bonds and certain Puerto Rico residents (the National Plaintiffs) have filed suits to invalidate the Moratorium Act, and after the passage of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), the National Plaintiffs sought a relief from the stay of litigation imposed by PROMESA to pursue the action. On July 21, 2016, the Company filed a motion and form of complaint in the U.S. District Court for the District of Puerto Rico seeking relief from the stay of litigation imposed by PROMESA to seek a declaration that the Moratorium Act is preempted by Federal bankruptcy law. In November 2016 that court denied both the Company's and the National Plaintiffs' motions for relief from stay in the respective actions. The PROMESA stay expired on May 1, 2017.

On June 30, 2016, PROMESA was signed into law by the President of the United States. PROMESA establishes a seven-member federal financial oversight board (Oversight Board) with authority to require that balanced budgets and fiscal plans be adopted and implemented by Puerto Rico. PROMESA provides a legal framework under which the debt of the Commonwealth and its related authorities and public corporations may be voluntarily restructured, and grants the Oversight Board the sole authority to file restructuring petitions in a federal court to restructure the debt of the Commonwealth and its related authorities and public corporations if voluntary negotiations fail, provided that any such restructuring must be in accordance with an Oversight Board approved fiscal plan that respects the liens and priorities provided under Puerto Rico law. PROMESA also appears to preempt at least portions of the Moratorium Act and to stay debt-related litigation, including the Company’s litigation regarding the Clawback Orders, until May 1, 2017. On August 31, 2016, the President of the United States appointed the seven members of the Oversight Board.

On January 2, 2017, Ricardo Antonio Rosselló Nevares (the Governor) took office, replacing the Former Governor. On January 29, 2017, the Governor signed the Puerto Rico Emergency and Fiscal Responsibility Act (Emergency Act) that, among other things, repealed portions of the Moratorium Act, defined an emergency period that lasted until May 1, 2017, continued diversion of collateral away from bonds the Company insures, and defined the powers and duties of the Fiscal Agency and Financial Advisory Authority (FAFAA). The emergency period has been extended through August 1, 2017.

In mid-March 2017, the Oversight Board certified Puerto Rico’s fiscal plan, dated March 13, 2017 (Fiscal Plan). The Fiscal Plan provides only approximately $7.9 billion for Commonwealth debt service over the next ten years, an amount less than scheduled debt service for such period. The Fiscal Plan itself acknowledges that there are a number of legal and contractual issues not addressed by the Fiscal Plan. On May 3, 2017, AGM and AGC filed in the Federal District Court in Puerto Rico an adversary complaint seeking a judgment that the Fiscal Plan violates various sections of PROMESA and the U.S. Constitution, an injunction enjoining the Commonwealth and Oversight Board from presenting or proceeding with confirmation of any plan of adjustment based on the Fiscal Plan, and a stay on the confirmation of any plan of adjustment based on the Fiscal Plan pending development of a fiscal plan that complies with PROMESA and the U.S. Constitution.

On April 28, 2017, the Oversight Board approved fiscal plans for PREPA and PRHTA, and directed PRASA to amend its proposed plan in several ways. The PREPA plan appears to be consistent with the Restructuring Support Agreement (RSA) described below. The PRHTA plan assumes that PRHTA will not pay any debt service at least through 2026. The PRASA plan assumes it will pay only approximately 65% of its debt service through 2026. Because PRASA has several categories of debt outstanding and the Company insures only PRASA debt with a senior lien on gross revenues of PRASA, it is unclear whether (or to what extent, if any) the payment of only 65% of debt service through 2026 would result in a reduction in PRASA payments of Company-insured debt. The Company does not believe the fiscal plans of PRHTA or PRASA in their current forms comply with certain mandatory requirements of PROMESA.
On May 3, 2017, the Oversight Board filed a petition with the Federal District Court of Puerto Rico for the Commonwealth under Title III of PROMESA. Title III of PROMESA provides for a process analogous to a voluntary bankruptcy process under chapter 9 of the federal bankruptcy code. The Oversight Board has not, as of May 4, 2017, filed such a petition with respect to any of its instrumentalities.
The final shape, timing and validity of responses to Puerto Rico’s distress eventually enacted or implemented under the auspices of PROMESA and the Oversight Board or otherwise, and the final impact, after resolution of legal challenges, of any such responses on obligations insured by the Company, are uncertain.

The Company groups its Puerto Rico exposure into three categories:

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•
Constitutionally Guaranteed. The Company includes in this category public debt benefiting from Article VI of the Constitution of the Commonwealth, which expressly provides that interest and principal payments on the public debt are to be paid before other disbursements are made.

•
Public Corporations – Certain Revenues Potentially Subject to Clawback. The Company includes in this category the debt of public corporations for which applicable law permits the Commonwealth to claw back, subject to certain conditions and for the payment of public debt, at least a portion of the revenues supporting the bonds the Company insures. As a constitutional condition to clawback, available Commonwealth revenues for any fiscal year must be insufficient to pay Commonwealth debt service before the payment of any appropriations for that year. The Company believes that this condition has not been satisfied to date, and accordingly that the Commonwealth has not to date been entitled to claw back revenues supporting debt insured by the Company. As noted above, the Company sued various Puerto Rico governmental officials in the United States District Court, District of Puerto Rico asserting that Puerto Rico's attempt to “claw back” pledged taxes is unconstitutional, and demanding declaratory and injunctive relief.

•
Other Public Corporations. The Company includes in this category the debt of public corporations that are supported by revenues it does not believe are subject to clawback.

Constitutionally Guaranteed

General Obligation. As of March 31, 2017, the Company had $1,495 million insured net par outstanding of the general obligations of Puerto Rico, which are supported by the good faith, credit and taxing power of the Commonwealth. On July 1, 2016, despite the requirements of Article VI of its Constitution but pursuant to an executive order issued by the Former Governor under the Moratorium Act, the Commonwealth defaulted on most of the debt service payment due that day, and the Company made its first claim payments on these bonds, and has continued to make claim payments on these bonds. As noted above, the Oversight Board filed a petition under Title III of PROMESA with respect o the Commonwealth.

Puerto Rico Public Buildings Authority (PBA). As of March 31, 2017, the Company had $169 million insured net par outstanding of PBA bonds, which are supported by a pledge of the rents due under leases of government facilities to departments, agencies, instrumentalities and municipalities of the Commonwealth, and that benefit from a Commonwealth guaranty supported by a pledge of the Commonwealth’s good faith, credit and taxing power. On July 1, 2016, despite the requirements of Article VI of its Constitution but pursuant to an executive order issued by the Former Governor under the Moratorium Act, the PBA defaulted on most of the debt service payment due that day, and the Company made its first claim payments on these bonds, and has continued to make claim payments on these bonds.

Public Corporations - Certain Revenues Potentially Subject to Clawback

PRHTA. As of March 31, 2017, the Company had $918 million insured net par outstanding of PRHTA (Transportation revenue) bonds and $409 million insured net par of PRHTA (Highways revenue) bonds. The transportation revenue bonds are secured by a subordinate gross pledge of gasoline and gas oil and diesel oil taxes, motor vehicle license fees and certain tolls, plus a first lien on up to $120 million annually of taxes on crude oil, unfinished oil and derivative products. The highways revenue bonds are secured by a gross pledge of gasoline and gas oil and diesel oil taxes, motor vehicle license fees and certain tolls. The Clawback Orders cover Commonwealth-derived taxes that are allocated to PRHTA. The Company believes that such sources represented a substantial majority of PRHTA’s revenues in 2015. The PRHTA bonds are subject to executive orders issued pursuant to the Moratorium Act. As noted above, the Company filed a motion and form of complaint in the U.S. District Court for the District of Puerto Rico seeking relief from the PROMESA stay to seek a declaration that the Moratorium Act is preempted by Federal bankruptcy law and that certain gubernatorial executive orders diverting PRHTA pledged toll revenues (which are not subject to the Clawback Orders) are preempted by PROMESA and violate the U.S. Constitution, and also seeking damages and injunctive relief. That motion was denied on November 2, 2016, on procedural grounds. The PROMESA stay expired on May 1, 2017. There were sufficient funds in the PRHTA bond accounts to make the July 1, 2016 and January 1, 2017 PRHTA debt service payments guaranteed by the Company on a primary basis, and those payments were made in full. As noted above, on April 28, 2017, the Oversight Board approved a fiscal plan for PRHTA that PRHTA will not pay any debt service at least through 2026. The Company does not believe the PRHTA fiscal plan in its current form complies with certain mandatory requirements of PROMESA.


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PRCCDA. As of March 31, 2017, the Company had $152 million insured net par outstanding of PRCCDA bonds, which are secured by certain hotel tax revenues. These revenues are sensitive to the level of economic activity in the area and are subject to the Clawback Orders, and the bonds are subject to an executive order issued pursuant to the Moratorium Act. There were sufficient funds in the PRCCDA bond accounts to make the July 1, 2016 and January 1, 2017 PRCCDA bond payments guaranteed by the Company, and those payments were made in full.

PRIFA. As of March 31, 2017, the Company had $18 million insured net par outstanding of PRIFA bonds, which are secured primarily by the return to Puerto Rico of federal excise taxes paid on rum. These revenues are subject to the Clawback Orders and the bonds are subject to an executive order issued pursuant to the Moratorium Act. The Company made its first claim payment on PRIFA bonds in January 2016, and has continued to make claim payments on PRIFA bonds.

Other Public Corporations

Puerto Rico Electric Power Authority (PREPA). As of March 31, 2017, the Company had $777 million insured net par outstanding of PREPA obligations, which are payable from a pledge of net revenues of the electric system.

On December 24, 2015, AGM and AGC entered into a RSA with PREPA, an ad hoc group of uninsured bondholders and a group of fuel-line lenders that would, subject to certain conditions, result in, among other things, modernization of the utility and a restructuring of current debt. Upon finalization of the contemplated restructuring transaction, insured PREPA revenue bonds (with no reduction to par or stated interest rate) will be supported by securitization bonds issued by a special purpose corporation and secured by a transition charge assessed on ratepayers. To facilitate the securitization transaction and in exchange for a market premium, Assured Guaranty will issue surety insurance policies to support a portion of the reserve fund for the securitization bonds. Certain of the creditors also agreed, subject to certain conditions, to participate in a relending financing, which was closed in two tranches on May 19, 2016 and June 22, 2016. AGM's and AGC's share of the relending financing was approximately $15 million ($2 million for AGC and $13 million for AGM). Legislation meeting the requirements of the original RSA was enacted on February 16, 2016, and a transition charge to be paid by PREPA rate payers for debt service on the securitization bonds as contemplated by the RSA was approved by the Puerto Rico Energy Commission on June 20, 2016.

On July 1, 2016, PREPA made full payment of the $41 million of principal and interest due on PREPA revenue bonds insured by AGM and AGC. That payment was funded in part by relending financing provided by AGM in the form of $26 million of PREPA bonds.

On January 1, 2017, PREPA made full payment of the $18 million of interest due on PREPA revenue bonds insured by
AGM and AGC.

In March 2017, the Governor indicated a desire to modify certain aspects of the RSA. On April 6, 2017, the Governor announced that the Commonwealth, acting on behalf of PREPA, had reached an agreement in principle with the other parties to the RSA (including AGM and AGC) to supplement the RSA. As supplemented, the RSA calls for AGM and AGC to provide surety insurance policies aggregating approximately $113 million ($14 million for AGC and $99 million for AGM) to support the securitization bonds contemplated by the RSA, to extend the maturity of all of the relending financing provided in 2016, to provide approximately $18 million of relending financing in July 2017, and to provide $120 million of principal payment deferrals in 2018 through 2023. The agreement also provides that, upon the finalization of the transactions contemplated by the RSA, the approximately $41 million of relending bonds purchased in 2016, and the $18 million of bonds to be purchased in July 2017, all will be supported by, or exchanged into, securitization bonds contemplated by the RSA. In addition, the RSA now provides for a consensual restructuring under Title VI of PROMESA.

There can be no assurance that the conditions in the modified RSA will be met or that, if the conditions are met, the modified RSA's other provisions, including those related to the insured PREPA revenue bonds, will be implemented as currently contemplated. In addition, the impact of PROMESA, any action taken by the Oversight Board, the Moratorium Act and Emergency Act or any attempt to exercise the power purportedly granted by the Moratorium Act or the Emergency Act on the implementation of the RSA is uncertain. PREPA, during the pendency of the agreements, has suspended deposits into its debt service fund.

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Puerto Rico Aqueduct and Sewer Authority (PRASA). As of March 31, 2017, the Company had $373 million of insured net par outstanding to PRASA bonds, which are secured by the gross revenues of the water and sewer system. On September 15, 2015, PRASA entered into a settlement with the U.S. Department of Justice and the U.S. Environmental Protection Agency that requires it to spend $1.6 billion to upgrade and improve its sewer system island-wide. According to a material event notice PRASA filed on March 4, 2016, PRASA owed its contractors $140 million. The PRASA Revitalization Act, which establishes a securitization mechanism that could facilitate debt issuance, was signed into law on July 13, 2016. While certain bonds benefiting from a guarantee by the Commonwealth are subject to an executive order issued under the Moratorium Act, bonds insured by the Company are not subject to that order. There were sufficient funds in the PRASA bond accounts to make the July 1, 2016 and January 1, 2017 PRASA bond payments guaranteed by the Company, and those payments were made in full. As noted above, on April 28, 2017, the Oversight Board considered a fiscal plan for PRASA that assumes PRASA will pay only approximately 65% of its debt service through 2026. Because PRASA has several categories of debt outstanding and the Company insures only PRASA debt with a senior lien on gross revenues of PRASA, it is unclear whether (or to what extent, if any) the payment of only 65% of debt service through 2026 would result in a reduction in PRASA payments of Company-insured debt. The Company does not believe the PRASA fiscal plan in its current form complies with certain mandatory requirements of PROMESA.
    
Municipal Finance Agency (MFA). As of March 31, 2017, the Company had $354 million net par outstanding of bonds issued by MFA secured by a pledge of local property tax revenues. There were sufficient funds in the MFA bond accounts to make the July 1, 2016 and January 1, 2017 MFA bond payments guaranteed by the Company, and those payments were made in full.

Puerto Rico Sales Tax Financing Corporation (COFINA). As of March 31, 2017, the Company had $271 million insured net par outstanding of junior COFINA bonds, which are secured primarily by a second lien on certain sales and use taxes. As of the date of this filing, all payments on Company-insured COFINA bonds had been made. As noted above, the Oversight Board filed a petition on behalf of the Commonwealth under Title III of PROMESA. That petition may have a material adverse effect on COFINA’s ability to make the timely payment of the Company-insured COFINA bonds.
  
University of Puerto Rico (U of PR). As of March 31, 2017, the Company had $1 million insured net par outstanding of U of PR bonds, which are general obligations of the university and are secured by a subordinate lien on the proceeds, profits and other income of the University, subject to a senior pledge and lien for the benefit of outstanding university system revenue bonds. The U of PR bonds are subject to an executive order issued under the Moratorium Act. As of the date of this filing, all payments on Company-insured U of PR bonds had been made.

All Puerto Rico exposures are internally rated BIG. The following tables show the Company’s insured exposure to general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations.

Puerto Rico
Gross Par and Gross Debt Service Outstanding

 
Gross Par Outstanding
 
Gross Debt Service Outstanding
 
March 31,
2017
 
December 31,
2016
 
March 31,
2017
 
December 31,
2016
 
(in millions)
Exposure to Puerto Rico
$
5,435

 
$
5,435

 
$
8,903

 
$
9,038




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Puerto Rico
Net Par Outstanding (1)

 
As of
March 31, 2017
 
As of
December 31, 2016
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds (2)
$
1,495

 
$
1,476

PBA (2)
169

 
169

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
PRHTA (Transportation revenue) (2)
918

 
918

PRHTA (Highways revenue)
409

 
350

PRCCDA
152

 
152

PRIFA (2)
18

 
18

Other Public Corporations
 
 
 
PREPA
777

 
724

PRASA
373

 
373

MFA
354

 
334

COFINA
271

 
271

U of PR
1

 
1

Total net exposure to Puerto Rico
$
4,937

 
$
4,786

____________________
(1)
The March 31, 2017 amounts include $150 million related to the commutation of previously ceded business. See Note 13, Reinsurance and Other Monoline Exposures, for more information.

(2)    As of the date of this filing, the Company has paid claims on these credits.

The following table shows the scheduled amortization of the insured general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations. The Company guarantees payments of interest and principal when those amounts are scheduled to be paid and cannot be required to pay on an accelerated basis. In the event that obligors default on their obligations, the Company would only be required to pay the shortfall between the principal and interest due in any given period and the amount paid by the obligors.


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     Amortization Schedule of Puerto Rico Net Par Outstanding
and Net Debt Service Outstanding
As of March 31, 2017

 
Scheduled Net Par Amortization
 
Scheduled Net Debt Service Amortization
 
(in millions)
2017 (April 1 - June 30)
$
0

 
$
2

2017 (July 1 - September 30)
224

 
346

2017 (October 1 - December 31)
0

 
2

Subtotal 2017
224

 
350

2018
178

 
419

2019
210

 
440

2020
270

 
490

2021
129

 
336

2022-2026
900

 
1,819

2027-2031
942

 
1,609

2032-2036
1,249

 
1,669

2037-2041
417

 
588

2042-2047
418

 
492

Total
$
4,937

 
$
8,212



Exposure to the Selected European Countries

The European countries where the Company has exposure and believes heightened uncertainties exist are: Hungary, Italy, Portugal, Spain and Turkey (collectively, the Selected European Countries). The Company’s direct 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 Direct Economic Exposure to Selected European Countries(1)
As of March 31, 2017

 
Hungary
 
Italy
 
Portugal
 
Spain
 
Turkey
 
Total
 
(in millions)
Sub-sovereign exposure(2)
$
204

 
$
912

 
$
75

 
$
345

 
$
—

 
$
1,536

Non-sovereign exposure(3)
114

 
400

 
—

 
—

 
202

 
716

Total
$
318

 
$
1,312

 
$
75

 
$
345

 
$
202

 
$
2,252

Total BIG (See Note 5)
$
248

 
$
—

 
$
75

 
$
345

 
$
—

 
$
668

____________________
(1)
While exposures are shown in U.S. dollars, the obligations are in various currencies, primarily euros.
 
(2)
Sub-sovereign exposure in Selected European Countries includes transactions backed by receivables from, or supported by, sub-sovereigns, which are governmental or government-backed entities other than the ultimate governing body of the country.

(3)
Non-sovereign exposure in Selected European Countries includes debt of regulated utilities, RMBS and diversified payment rights (DPR) securitizations.


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Table of Contents

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. The Company may also have direct exposures to the Selected European Countries in business assumed from unaffiliated monoline insurance companies, in which case the Company depends upon geographic information provided by the primary insurer.

The Company's $202 million net insured par exposure in Turkey is to DPR securitizations sponsored by a major Turkish bank. These DPR securitizations were established outside of Turkey and involve payment orders in U.S. dollars, pounds sterling and Euros from persons outside of Turkey to beneficiaries in Turkey who are customers of the sponsoring bank. The sponsoring bank's correspondent banks have agreed to remit all such payments to a trustee-controlled account outside Turkey, where debt service payments for the DPR securitization are given priority over payments to the sponsoring bank.

The Company has excluded from the exposure tables above its indirect economic exposure to the Selected European Countries through policies it provides on pooled corporate and commercial receivables transactions. The Company calculates indirect exposure to a country by multiplying the par amount of a transaction insured by the Company times the percent of the relevant collateral pool reported as having a nexus to the country. On that basis, the Company has calculated exposure of $78 million to Selected European Countries (plus Greece) in transactions with $1.6 billion of net par outstanding. The indirect exposure to credits with a nexus to Greece is $2 million across several highly rated pooled corporate obligations with net par outstanding of $73 million.

Non-Financial Guaranty Insurance

The Company provided capital relief triple-X excess of loss life reinsurance on approximately $444 million of exposure as of March 31, 2017 and $390 million as of December 31, 2016, which is expected to increase to approximately $1.3 billion prior to September 30, 2036. This non-financial guaranty exposure has a similar risk profile to the Company's other investment grade exposure written in financial guaranty form. The Company also has legacy mortgage guaranty reinsurance related to loans originated in Ireland on debt service of approximately $36 million as of March 31, 2017, and $36 million as of December 31, 2016. In addition, the Company started providing reinsurance on aircraft residual value insurance policies in the First Quarter of 2017 and had net exposure of $14 million as of March 31, 2017. These transactions are all rated investment grade internally. The Company had outstanding commitments to provide reinsurance on aircraft residual value insurance policies of approximately $28 million as of March 31, 2017. The expiration dates for these commitments range between April 1, 2017 and September 30, 2017. 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.

5.
Expected Loss to be Paid
 
Loss Estimation Process

This note provides information regarding expected claim payments to be made under all contracts in the insured portfolio, regardless of the accounting model. The Company’s loss reserve committees estimate expected loss to be paid for all contracts by reviewing analyses that consider various scenarios with corresponding probabilities assigned to them. Depending upon the nature of the risk, the Company’s view of the potential size of any loss and the information available to the Company, that analysis may be based upon individually developed cash flow models, internal credit rating assessments and sector-driven loss severity assumptions or judgmental assessments. In the case of its assumed business, the Company may conduct its own analysis as just described or, depending on the Company’s view of the potential size of any loss and the information available to the Company, the Company may use loss estimates provided by ceding insurers. The Company monitors the performance of its transactions with expected losses and each quarter the Company’s loss reserve committees review and refresh their loss projection assumptions and scenarios and the probabilities they assign to those scenarios based on actual developments during the quarter and their view of future performance.
 
The financial guaranties issued by the Company insure the credit performance of the guaranteed obligations over an extended period of time, in some cases over 30 years, and in most circumstances, the Company has no right to cancel such financial guaranties. As a result, the Company's estimate of ultimate losses on a policy is subject to significant uncertainty over the life of the insured transaction. Credit performance can be adversely affected by economic, fiscal and financial market variability over the long life of most contracts.


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Table of Contents

The determination of expected loss to be paid is an inherently subjective process involving numerous estimates, assumptions and judgments by management, using both internal and external data sources with regard to frequency, severity of loss, economic projections, governmental actions, negotiations and other factors that affect credit performance. These estimates, assumptions and judgments, and the factors on which they are based, may change materially over a reporting period, and as a result the Company’s loss estimates may change materially over that same period.

The Company does not use traditional actuarial approaches to determine its estimates of expected losses. Actual losses will ultimately depend on future events or transaction performance and may be influenced by many interrelated factors that are difficult to predict. As a result, the Company's current projections of probable and estimable losses may be subject to considerable volatility and may not reflect the Company's ultimate claims paid. For information on the Company's loss estimation process, please refer to Note 5, Expected Loss to be Paid, of Part II, Item 8, Financial Statements and Supplementary Data in AGL's Annual Report on Form 10-K for the year ended December 31, 2016.

The following tables present 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 financial guaranty (FG) VIEs, by sector, after the expected recoveries/ (payables) for breaches of representations and warranties (R&W) and other expected recoveries. The Company used risk-free rates for U.S. dollar denominated obligations that ranged from 0.0% to 3.14% with a weighted average of 2.65% as of March 31, 2017 and 0.0% to 3.23% with a weighted average of 2.73% as of December 31, 2016.

Net Expected Loss to be Paid
Roll Forward

 
First Quarter
 
2017
 
2016
 
(in millions)
Net expected loss to be paid, beginning of period
$
1,198

 
$
1,391

Net expected loss to be paid on the MBIA UK portfolio as of January 10, 2017
21

 
—

Economic loss development due to:
 
 
 
Accretion of discount
8

 
9

Changes in discount rates
11

 
63

Changes in timing and assumptions
28

 
(13
)
Total economic loss development
47

 
59

Net paid losses
(22
)
 
(113
)
Net expected loss to be paid, end of period
$
1,244

 
$
1,337


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Table of Contents

Net Expected Loss to be Paid
Roll Forward by Sector
First Quarter 2017

 
Net Expected
Loss to be
Paid 
(Recovered)
as of
December 31, 2016
 
Net Expected
Loss to be
Paid
on MBIA UK
as of
January 10, 2017
 
Economic Loss
Development
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be
Paid 
(Recovered)
as of
March 31, 2017 (2)
 
(in millions)
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
871

 
$
—

 
$
124

 
$
(25
)
 
$
970

Non-U.S. public finance
33

 
13

 
(5
)
 
—

 
41

Public finance
904

 
13

 
119

 
(25
)
 
1,011

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. RMBS
206

 
—

 
(22
)
 
13

 
197

Triple-X life insurance transactions
54

 
—

 
(53
)
 
0

 
1

Other structured finance
34

 
8

 
3

 
(10
)
 
35

Structured finance
294

 
8

 
(72
)
 
3

 
233

Total
$
1,198

 
$
21

 
$
47

 
$
(22
)
 
$
1,244



Net Expected Loss to be Paid
Roll Forward by Sector
First Quarter 2016

 
Net Expected
Loss to be
Paid 
(Recovered)
as of
December 31, 2015
 
Economic Loss
Development
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be
Paid (Recovered)
as of
March 31, 2016
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
771

 
$
98

 
$
(5
)
 
$
864

Non-U.S. public finance
38

 
1

 
—

 
39

Public finance
809

 
99

 
(5
)
 
903

Structured finance:
 

 
 

 
 

 
 

U.S. RMBS
409

 
(31
)
 
(85
)
 
293

Triple-X life insurance transactions
99

 
4

 
(1
)
 
102

Other structured finance
74

 
(13
)
 
(22
)
 
39

Structured finance
582

 
(40
)
 
(108
)
 
434

Total
$
1,391

 
$
59

 
$
(113
)
 
$
1,337

____________________
(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. The Company paid $2 million and $2 million in LAE for First Quarter 2017 and 2016, respectively.

(2)
Includes expected LAE to be paid of $19 million as of March 31, 2017 and $12 million as of December 31, 2016.


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Table of Contents

The following table presents the present value of net expected loss to be paid and the net economic loss development for all contracts by accounting model.

Net Expected Loss to be Paid (Recovered) and
Net Economic Loss Development (Benefit)
By Accounting Model

 
Net Expected Loss to be Paid (Recovered)
 
Net Economic Loss Development (Benefit)
 
As of March 31, 2017
 
As of December 31, 2016
 
First Quarter 2017
 
First Quarter 2016
 
(in millions)
Financial guaranty insurance
$
1,141

 
$
1,083

 
$
66

 
$
61

FG VIEs (1) and other
99

 
105

 
(4
)
 
4

Credit derivatives (2)
4

 
10

 
(15
)
 
(6
)
Total
$
1,244

 
$
1,198

 
$
47

 
$
59

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

(2)    Refer to Note 8, Contracts Accounted for as Credit Derivatives.

Selected U.S. Public Finance Transactions
 
The Company insures general obligation bonds of the Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations aggregating $4.9 billion net par as of March 31, 2017, all of which are BIG. For additional information regarding the Company's exposure to general obligations of Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations, please refer to "Exposure to Puerto Rico" in Note 4, Outstanding Exposure.
On February 25, 2015, a plan of adjustment resolving the bankruptcy filing of the City of Stockton, California under chapter 9 of the U.S. Bankruptcy Code became effective. As of March 31, 2017, the Company’s net par subject to the plan consists of $113 million of pension obligation bonds. As part of the plan settlement, the City will repay the pension obligation bonds from certain fixed payments and certain variable payments contingent on the City's revenue growth. 

The Company projects that its total net expected loss across its troubled U.S. public finance credits as of March 31, 2017 including those mentioned above, which incorporated the likelihood of the various outcomes, will be $970 million, compared with a net expected loss of $871 million as of December 31, 2016. Economic loss development in First Quarter 2017 was $124 million which was primarily attributable to Puerto Rico exposures.

Selected Non - U.S. Public Finance Transactions

The Company insures and reinsures credits with sub-sovereign exposure to various Spanish and Portuguese issuers where a Spanish and Portuguese sovereign default may cause the sub-sovereigns also to default. The Company's exposure net of reinsurance to these Spanish and Portuguese credits is $345 million and $75 million, respectively. The Company rates all of these issuers BIG due to the financial condition of Spain and Portugal and their dependence on the sovereign. The Company's Hungary exposure is to infrastructure bonds dependent on payments from Hungarian governmental entities. The Company's exposure net of reinsurance to these Hungarian credits is $204 million, all of which is rated BIG.
 
As part of the MBIA UK Acquisition, the Company now also insures an obligation backed by the availability and toll revenues of a major arterial road into a city in the U.K. with $210 million of net par outstanding as of March 31, 2017. This transaction has been underperforming due to lower traffic volume and higher costs compared with expectations at underwriting.

These transactions, together with other non-U.S. public finance insured obligations, had expected loss to be paid of $41 million as of March 31, 2017, compared with $33 million as of December 31, 2016. The MBIA UK Acquisition added $13 million of net expected loss as of January 2017. The economic benefit of approximately $5 million during the First Quarter 2017 was due mainly to the improved internal outlook of certain European sovereigns and sub-sovereign entities.

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Table of Contents


Approach to Projecting Losses in 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 and tranching) of the RMBS and any R&W agreements to the projected performance of the collateral over time. The resulting projected claim payments or reimbursements are then discounted using risk-free rates.

First Quarter 2017 U.S. RMBS Loss Projections
 
Based on its observation during the period of the performance of its insured transactions (including early stage delinquencies, late stage delinquencies and loss severity) as well as the residential property market and economy in general, the Company chose to use the same general assumptions to project RMBS losses as of March 31, 2017 as it used as of December 31, 2016, except that it reduced the liquidation rates for certain Alt-A, prime and adjustable rate mortgage (Option ARM) delinquency categories and increased the loss severity for subprime transactions of 2007+ vintages.

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 or in the past twelve months have been two or more payments behind, have been modified, are in foreclosure, or have been foreclosed upon). 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 non-performing categories. The Company arrived at its liquidation rates based on data purchased from a third party provider and assumptions about how delays in the foreclosure process and loan modifications may ultimately affect the rate at which loans are liquidated. Each quarter the Company reviews the most recent twelve months of this data and (if necessary) adjusts its liquidation rates based on its observations. The following table shows liquidation assumptions for various non-performing categories.


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Table of Contents

First Lien Liquidation Rates

 
March 31, 2017
 
December 31, 2016
Current Loans Modified in the Previous 12 Months
 
 
 
Alt A and Prime
25%
 
25%
Option ARM
25
 
25
Subprime
25
 
25
Current Loans Delinquent in the Previous 12 Months
 
 
 
Alt A and Prime
25
 
25
Option ARM
25
 
25
Subprime
25
 
25
30 – 59 Days Delinquent
 
 
 
Alt A and Prime
30
 
35
Option ARM
35
 
35
Subprime
40
 
40
60 – 89 Days Delinquent
 
 
 
Alt A and Prime
45
 
45
Option ARM
45
 
50
Subprime
50
 
50
90+ Days Delinquent
 
 
 
Alt A and Prime
55
 
55
Option ARM
55
 
55
Subprime
55
 
55
Bankruptcy
 
 
 
Alt A and Prime
45
 
45
Option ARM
50
 
50
Subprime
40
 
40
Foreclosure
 
 
 
Alt A and Prime
65
 
65
Option ARM
65
 
65
Subprime
65
 
65
Real Estate Owned
 
 
 
All
100
 
100

While the Company uses liquidation rates as described above to project defaults of non-performing loans (including current loans modified or delinquent within the last 12 months), it projects defaults on presently current loans by applying a conditional default rate (CDR) trend. The start of that CDR trend is based on the defaults the Company projects will emerge from currently nonperforming, recently nonperforming and modified 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 36 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 36-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. In the base case, the Company assumes the final CDR will be reached 6.25 years after the initial 36-month CDR plateau period. Under the Company’s methodology, defaults projected to occur in the first 36 months represent defaults that can be attributed to loans that were modified or delinquent in the last 12 months or that are currently delinquent or in foreclosure, while the defaults projected to occur using

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the projected CDR trend after the first 36 month period represent defaults attributable to borrowers that are currently performing or are projected to reperform.

     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 historically high levels, and the Company is assuming in the base case that these high levels generally will continue for another 18 months. The Company determines its initial loss severity based on actual recent experience. As a result, the Company updated loss severities for specific asset classes and vintages based on observed data, as shown in the tables below. The Company then assumes that loss severities begin returning to levels consistent with underwriting assumptions beginning after the initial 18 month period, declining to 40% in the base case over 2.5 years.
 
The following table shows the range as well as the average, weighted by outstanding net insured par, for 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
March 31, 2017
 
As of
December 31, 2016
 
Range
 
Weighted Average
 
Range
 
Weighted Average
Alt A and Prime
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
1.0
%
-
12.8%
 
5.6%
 
1.0
%
–
13.5%
 
5.7%
Final CDR
0.0
%
-
0.6%
 
0.3%
 
0.0
%
–
0.7%
 
0.3%
Initial loss severity:
 
 
 
 
 
 
 
2005 and prior
60%
 
 
 
60%
 
 
2006
80%
 
 
 
80%
 
 
2007+
70%
 
 
 
70%
 
 
Option ARM
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
3.2
%
-
7.1%
 
5.6%
 
3.2
%
–
7.0%
 
5.6%
Final CDR
0.2
%
-
0.4%
 
0.3%
 
0.2
%
–
0.3%
 
0.3%
Initial loss severity:
 
 
 
 
 
 
 
2005 and prior
60%
 
 
 
60%
 
 
2006
70%
 
 
 
70%
 
 
2007+
75%
 
 
 
75%
 
 
Subprime
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
3.8
%
-
14.5%
 
8.3%
 
2.8
%
–
14.1%
 
8.1%
Final CDR
0.2
%
-
0.7%
 
0.4%
 
0.1
%
–
0.7%
 
0.4%
Initial loss severity:
 
 
 
 
 
 
 
2005 and prior
80%
 
 
 
80%
 
 
2006
90%
 
 
 
90%
 
 
2007+
95%
 
 
 
90%
 
 
____________________
(1)                                Represents variables for most heavily weighted scenario (the base case).

 
The rate at which the principal amount of loans is voluntarily prepaid may impact both the amount of losses projected (since that amount is a function of the CDR, 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 voluntary conditional prepayment rate (CPR) follows a similar pattern to that of the CDR. 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 15% in the base case. For transactions where the initial CPR is higher than the final CPR, the initial CPR is held constant and the final CPR is not used. These CPR assumptions are the same as those the Company used for December 31, 2016.

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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 CDR returned to its modeled equilibrium, which was defined as 5% of the initial CDR. The Company also stressed CPR and the speed of recovery of loss severity rates. The Company probability weighted a total of five scenarios as of March 31, 2017. The Company used a similar approach to establish its pessimistic and optimistic scenarios as of March 31, 2017 as it used as of December 31, 2016, increasing and decreasing the periods of stress from those used in the base case.
 
In the Company's most stressful scenario where loss severities were assumed to rise and then recover over nine years and the initial ramp-down of the CDR was assumed to occur over 15 months, expected loss to be paid would increase from current projections by approximately $26 million for Alt-A first liens, $8 million for Option ARM, $33 million for subprime and $1 million for prime transactions.

In the Company's least stressful scenario where the CDR plateau was six months shorter (30 months, effectively assuming that liquidation rates would improve) and the CDR 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 $11 million for Alt-A first liens, $21 million for Option ARM, $31 million for subprime and $0.1 million for prime transactions.

U.S. Second Lien RMBS Loss Projections
 
Second lien RMBS transactions include both home equity lines of credit (HELOC) and closed end second lien. The Company believes the primary variable affecting its expected losses in second lien RMBS transactions is the amount and timing of future losses in the collateral pool supporting the transactions. Expected losses are also a function of the structure of the transaction; the voluntary prepayment rate (typically also referred to as CPR of the collateral); the interest rate environment; and assumptions about the draw rate and loss severity.
 
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. The Company estimates the amount of loans that will default over the next six months by calculating current representative liquidation rates. A liquidation rate is the percent of loans in a given cohort (in this instance, delinquency category) that ultimately default. Similar to first liens, the Company then calculates a CDR for six months, which is the period over which the currently delinquent collateral is expected to be liquidated. That CDR is then used as the basis for the plateau CDR period that follows the embedded plateau losses.

For the base case scenario, the CDR (the plateau CDR) was held constant for six months. 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. (The long-term steady state CDR is calculated as the constant CDR that would have yielded the amount of losses originally expected at underwriting.) 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 six months of delinquent data and 28 months of decrease to the steady state CDR, the same as of December 31, 2016.

HELOC loans generally permit the borrower to pay only interest for an initial period (often ten years) and, after that period, require the borrower to make both the monthly interest payment and a monthly principal payment, and so increase the borrower's aggregate monthly payment. Some of the HELOC loans underlying the Company's insured HELOC transactions have reached their principal amortization period. The Company has observed that the increase in monthly payments occurring when a loan reaches its principal amortization period, even if mitigated by borrower relief offered by the servicer, is associated with increased borrower defaults. Thus, most of the Company's HELOC projections incorporate an assumption that a percentage of loans reaching their amortization periods will default around the time of the payment increase. These projected defaults are in addition to those generated using the CDR curve as described above. This assumption is similar to the one used as of December 31, 2016.

When a second lien loan defaults, there is generally a very low recovery. The Company assumed as of March 31, 2017 that it will generally recover only 2% of the collateral defaulting in the future and declining additional amounts of post-default receipts on previously defaulted collateral. This is the same assumption used as of December 31, 2016.
 
The rate at which the principal amount of loans is prepaid may impact both the amount of losses projected as well as the amount of excess spread. In the base case, an average CPR (based on experience of the past year) is assumed to continue until the end of the plateau before gradually increasing to the final CPR over the same period the CDR decreases. The final CPR is assumed to be 15% for second lien transactions (in the base case), which is lower than the historical average but reflects

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the Company’s continued uncertainty about the projected performance of the borrowers in these transactions. For transactions where the initial CPR is higher than the final CPR, the initial CPR is held constant and the final CPR is not used. This pattern is generally consistent with how the Company modeled the CPR as of December 31, 2016. 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. These variables have been relatively stable and have less impact on the projection results than the variables discussed above. However, in a number of HELOC transactions the servicers have been modifying poorly performing loans from floating to fixed rates, and, as a result, rising interest rates would negatively impact the excess spread available from these modified loans to support the transactions.  The Company incorporated these modifications in its assumptions.

In estimating expected losses, the Company modeled and probability weighted five possible CDR curves applicable to the period preceding the return to the long-term steady state CDR. The Company used five scenarios at March 31, 2017 and December 31, 2016. The Company believes that the level of the elevated CDR and the length of time it will persist, the ultimate prepayment rate, and the amount of additional defaults because of the expiry of the interest only period, are the primary drivers behind the likely amount of losses the collateral will suffer. The Company continues to evaluate the assumptions affecting its modeling results.

The Company believes the most important driver of its projected second lien RMBS losses is the performance of its HELOC transactions. The following table shows the range as well as the average, weighted by outstanding net insured par, for key assumptions for the calculation of expected loss to be paid for individual transactions for direct vintage 2004 - 2008 HELOCs.

Key Assumptions in Base Case Expected Loss Estimates
HELOCs (1)

 
As of
March 31, 2017
 
As of
December 31, 2016
 
Range
 
Weighted Average
 
Range
 
Weighted Average
Plateau CDR
3.8
%
–
23.9%
 
14.1%
 
3.5
%
–
24.8%
 
13.6%
Final CDR trended down to
0.5
%
–
3.2%
 
1.3%
 
0.5
%
–
3.2%
 
1.3%
Liquidation rates:
 
 
 
 
 
 
 
 
 
 
 
Current Loans Modified in the Previous 12 Months
25%
 
 
 
25%
 
 
Current Loans Delinquent in the Previous 12 Months
25
 
 
 
25
 
 
30 – 59 Days Delinquent
50
 
 
 
50
 
 
60 – 89 Days Delinquent
65
 
 
 
65
 
 
90+ Days Delinquent
80
 
 
 
80
 
 
Bankruptcy
55
 
 
 
55
 
 
Foreclosure
75
 
 
 
75
 
 
Real Estate Owned
100
 
 
 
100
 
 
Loss severity
98%
 
 
 
98%
 
 
____________________
(1)
Represents variables for most heavily weighted scenario (the base case).

The Company’s base case assumed a six 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. Increasing the CDR plateau to eight months and increasing the ramp-down by three months to 31 months (for a total stress period of 39 months), and doubling the defaults relating to the end of the interest only period would increase the expected loss by approximately $34 million for HELOC transactions. On the other hand, reducing the CDR plateau to four months and decreasing the length of the CDR ramp-down to 25 months (for a total stress period of 29 months), and lowering the ultimate prepayment rate to 10% would decrease the expected loss by approximately $22 million for HELOC transactions.


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Breaches of Representations and Warranties

As of March 31, 2017, the Company had a net R&W payable of $19 million to R&W counterparties, compared to an R&W payable of $6 million as of December 31, 2016. The increase in the payable is related primarily to higher expected recoveries in a transaction where an interpleader proceeding has been dismissed in the Company's favor (and thus higher R&W payable) .

Triple-X Life Insurance Transactions
 
The Company had $2.1 billion of net par exposure to financial guaranty triple-X life insurance transactions as of March 31, 2017. Two of these transactions, with $126 million of net par outstanding, are rated BIG. The triple-X life insurance transactions are based on discrete blocks of individual life insurance business. In older vintage triple-X life insurance transactions, which include the two BIG-rated transactions, the amounts raised by the sale of the notes insured by the Company were used to capitalize a special purpose vehicle that provides reinsurance to a life insurer or reinsurer. The amounts have been invested since inception in accounts managed by third-party investment managers. In the case of the two BIG-rated transactions, material amounts of their assets were invested in U.S. RMBS. Based on its analysis of the information 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 March 31, 2017, the Company’s projected net expected loss to be paid is $1 million. The economic benefit during First Quarter 2017 was approximately $53 million, which was due primarily to a settlement with the former investment manager of the two BIG transactions.

Student Loan Transactions
 
The Company has insured or reinsured $1.4 billion net par of student loan securitizations issued by private issuers and that it classifies as structured finance. Of this amount, $118 million is rated BIG. The Company is projecting approximately $34 million of net expected loss to be paid on these transactions. 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 economic loss development during First Quarter 2017 was approximately $2 million, which was driven primarily by changes in the discount rates and certain assumption updates.

Recovery Litigation
 
Public Finance Transactions

On January 7, 2016, AGM, AGC and Ambac Assurance Corporation (Ambac) commenced an action for declaratory judgment and injunctive relief in the U.S. District Court for the District of Puerto Rico to invalidate the executive orders issued by the Governor on November 30, 2015 and December 8, 2015 directing that the Secretary of the Treasury of the Commonwealth of Puerto Rico and the Puerto Rico Tourism Company retain or transfer (in other words, claw back) certain taxes and revenues pledged to secure the payment of bonds issued by the PRHTA, the PRCCDA and the PRIFA. The Commonwealth defendants filed a motion to dismiss the action for lack of subject matter jurisdiction, which the Court denied on October 4, 2016. On October 14, 2016, the Commonwealth defendants filed a notice of PROMESA automatic stay, which has now expired.

On July 21, 2016, AGC and AGM filed a motion and form of complaint in the U.S. District Court for the District of Puerto Rico seeking relief from the stay provided by PROMESA. Upon a grant of relief from the PROMESA stay, the lawsuit further seeks a declaration that the Moratorium Act is preempted by Federal bankruptcy law and that certain gubernatorial executive orders diverting PRHTA pledged toll revenues (which are not subject to the Clawback) are preempted by PROMESA and violate the U.S. Constitution. Additionally, it seeks damages for the value of the PRHTA toll revenues diverted and injunctive relief prohibiting the defendants from taking any further action under these executive orders. On October 28, 2016, the Oversight Board filed a motion seeking leave to intervene in the action, which motion was denied on November 1, 2016, without prejudice, on procedural grounds. On November 2, 2016, the Court denied AGC’s and AGM’s motion for relief from the PROMESA stay on procedural grounds, but the stay has now expired.

On May 3, 2017, AGM and AGC filed in the Federal District Court in Puerto Rico an adversary complaint seeking a judgment that the Commonwealth's Fiscal Plan violates various sections of PROMESA and the Contracts, Takings and Due Process Clauses of the U.S. Constitution, an injunction enjoining the Commonwealth and Oversight Board from presenting or proceeding with confirmation of any plan of adjustment based on the Fiscal Plan, and a stay on the confirmation of any plan of adjustment based on the Fiscal Plan pending development of a fiscal plan that complies with PROMESA and the U.S. Constitution.

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For a discussion of the Company's exposure to Puerto Rico related to the litigation described above, please see Note 4, Outstanding Exposure.

On November 1, 2013, Radian Asset Assurance Inc. (Radian Asset) commenced a declaratory judgment action in the U.S. District Court for the Southern District of Mississippi against Madison County, Mississippi and the Parkway East Public Improvement District to establish its rights under a contribution agreement from the County supporting certain special assessment bonds issued by the District and insured by Radian Asset (now AGC). As of March 31, 2017, $20 million of such bonds were outstanding. The County maintained that its payment obligation is limited to two years of annual debt service, while AGC contended the County’s obligations under the contribution agreement continue so long as the bonds remain outstanding. On April 27, 2016, the Court granted AGC's motion for summary judgment, agreeing with AGC's interpretation of the County's obligations. Oral argument on the County's appeal of that ruling was heard by the United States Court of Appeals for the Fifth Circuit on April 5, 2017.

Triple-X Life Insurance Transactions
 
In December 2008 AGUK filed an action in the Supreme Court of the State of New York against J.P. Morgan Investment Management Inc. (JPMIM), the investment manager for a triple-X life insurance transaction, Orkney Re II plc (Orkney), involving securities guaranteed by AGUK. The action alleged that JPMIM engaged in breaches of fiduciary duty, gross negligence and breaches of contract based upon its handling of the Orkney investments. The trial commenced on March 13, 2017. During a court-ordered mediation session on March 25, 2017, the parties agreed to settle the litigation and subsequently filed a stipulation of discontinuance of the court proceedings with prejudice. The parties have agreed to keep the terms of the settlement confidential.

RMBS Transactions

On February 5, 2009, U.S. Bank National Association, as indenture trustee (U.S. Bank), CIFG Assurance North America Inc. (CIFGNA), as insurer of the Class Ac Notes, and Syncora Guarantee Inc. (Syncora), as insurer of the Class Ax Notes, filed a complaint in the Supreme Court of the State of New York against GreenPoint Mortgage Funding, Inc. (GreenPoint) alleging GreenPoint breached its R&W with respect to the underlying mortgage loans in the GreenPoint Mortgage Funding Trust 2006-HE1 transaction.  On March 3, 2010, the court dismissed CIFGNA's and Syncora’s causes of action on standing grounds. On December 16, 2013, GreenPoint moved to dismiss the remaining claims of U.S. Bank on the grounds that it too lacked standing. U.S. Bank cross-moved for partial summary judgment striking GreenPoint’s defense that U.S. Bank lacked standing to directly pursue claims against GreenPoint. On January 28, 2016, the court denied GreenPoint’s motion for summary judgment and granted U.S. Bank’s cross-motion for partial summary judgment, finding that as a matter of law U.S. Bank has standing to directly assert claims against GreenPoint. Oral argument on GreenPoint's appeal was heard by the New York Appellate Division, First Department, on May 2, 2017. CIFGNA originally had $500 million insured net par exposure to this transaction; $22 million insured net par remains outstanding at March 31, 2017.

On November 26, 2012, CIFGNA filed a complaint in the Supreme Court of the State of New York against JP Morgan Securities LLC (JP Morgan) for material misrepresentation in the inducement of insurance and common law fraud, alleging that JP Morgan fraudulently induced CIFGNA to insure $400 million of securities issued by ACA ABS CDO 2006-2 Ltd. and $325 million of securities issued by Libertas Preferred Funding II, Ltd. On June 26, 2015, the Court dismissed with prejudice CIFGNA’s material misrepresentation in the inducement of insurance claim and dismissed without prejudice CIFGNA’s common law fraud claim. On September 24, 2015, the Court denied CIFGNA’s motion to amend but allowed CIFGNA to re-plead a cause of action for common law fraud. On November 20, 2015, CIFGNA filed a motion for leave to amend its complaint to re-plead common law fraud. On April 29, 2016, CIFGNA filed an appeal to reverse the Court’s decision dismissing CIFGNA’s material misrepresentation in the inducement of insurance claim. On November 29, 2016, the Appellate Division of the Supreme Court of the State of New York ruled that the Court’s decision dismissing with prejudice CIFGNA’s material misrepresentation in the inducement of insurance claim should be modified to grant CIFGNA leave to re-plead such claim. On February 27, 2017, AGC (as successor to CIFGNA) filed an amended complaint which includes a claim for material misrepresentation in the inducement of insurance.


33
Table of Contents

6.
Contracts Accounted for as Insurance

Financial Guaranty Insurance Premiums

The portfolio of outstanding exposures discussed in Note 4, Outstanding Exposure, includes financial guaranty contracts that meet the definition of insurance contracts, contracts that meet the definition of a derivative under GAAP, and contracts that are accounted for as consolidated FG VIEs. Amounts presented in this note relate to financial guaranty insurance contracts, unless otherwise noted. See Note 8, Contracts Accounted for as Credit Derivatives for amounts that relate to CDS and Note 9, Consolidated Variable Interest Entities for amounts that relate to FG VIEs.

Net Earned Premiums
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Scheduled net earned premiums
$
103

 
$
91

Accelerations:
 
 
 
Refundings
56

 
79

Terminations
2

 
10

Total Accelerations
58

 
89

Accretion of discount on net premiums receivable
3

 
3

  Financial guaranty insurance net earned premiums
164

 
183

Other
0

 
0

  Net earned premiums (1)
$
164

 
$
183

 ___________________
(1)
Excludes $4 million and $5 million for First Quarter 2017 and 2016, respectively, related to consolidated FG VIEs.


Components of Unearned Premium Reserve
 
 
As of March 31, 2017
 
As of December 31, 2016
 
Gross
 
Ceded
 
Net(1)
 
Gross
 
Ceded
 
Net(1)
 
(in millions)
Deferred premium revenue(2)
3,874

 
180

 
3,694

 
3,548

 
206

 
3,342

Contra-paid (3)
(47
)
 
0

 
(47
)
 
(37
)
 
0

 
(37
)
Unearned premium reserve
$
3,827

 
$
180

 
$
3,647

 
$
3,511

 
$
206

 
$
3,305

 ____________________
(1)
Excludes $86 million and $90 million of deferred premium revenue, and $20 million and $25 million of contra-paid related to FG VIEs as of March 31, 2017 and December 31, 2016, respectively.

(2)
Includes $1 million of other as of March 31, 2017. As of December 31, 2016, other deferred premium revenue was de minimis.

(3)
See "Financial Guaranty Insurance Losses– Insurance Contracts' Loss Information" below for an explanation of "contra-paid".
 


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Table of Contents

Gross Premium Receivable,
Net of Commissions on Assumed Business
Roll Forward
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Beginning of period, December 31
$
576

 
$
693

Premiums receivable from acquisitions (see Note 2)
270

 
—

Gross written premiums on new business, net of commissions on assumed business
110

 
41

Gross premiums received, net of commissions on assumed business
(92
)
 
(49
)
Adjustments:
 
 
 
Changes in the expected term
(1
)
 
(22
)
Accretion of discount, net of commissions on assumed business
4

 
0

Foreign exchange translation
9

 
(1
)
End of period, March 31 (1)
$
876

 
$
662

____________________
(1)
Excludes $11 million and $16 million as of March 31, 2017 and March 31, 2016, respectively, related to consolidated FG VIEs.

Foreign exchange translation relates to installment premiums receivable denominated in currencies other than the U.S. dollar. Approximately 68%, 50% and 55% of installment premiums at March 31, 2017, December 31, 2016 and March 31, 2016, respectively, are denominated in currencies other than the U.S. dollar, primarily the euro and 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.
 
Expected Collections of
Financial Guaranty Insurance Gross Premiums Receivable,
Net of Commissions on Assumed Business
(Undiscounted)
 
 
As of March 31, 2017
 
(in millions)
2017 (April 1 – June 30)
$
29

2017 (July 1 – September 30)
26

2017 (October 1 – December 31)
19

2018
85

2019
78

2020
75

2021
73

2022-2026
283

2027-2031
195

2032-2036
109

After 2036
102

Total(1)
$
1,074

 ____________________
(1)
Excludes expected cash collections on FG VIEs of $13 million.



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Table of Contents

Scheduled Financial Guaranty Insurance Net Earned Premiums

 
As of March 31, 2017
 
(in millions)
2017 (April 1 – June 30)
$
98

2017 (July 1 – September 30)
93

2017 (October 1 – December 31)
90

2018
342

2019
299

2020
271

2021
250

2022-2026
967

2027-2031
621

2032-2036
367

After 2036
295

Net deferred premium revenue(1)
3,693

Future accretion
189

Total future net earned premiums
$
3,882

 ____________________
(1)
Excludes scheduled net earned premiums on consolidated FG VIEs of $86 million.


Selected Information for Financial Guaranty Insurance
Policies Paid in Installments

 
As of
March 31, 2017
 
As of
December 31, 2016
 
(dollars in millions)
Premiums receivable, net of commission payable
$
876

 
$
576

Gross deferred premium revenue
1,290

 
1,041

Weighted-average risk-free rate used to discount premiums
3.0
%
 
3.0
%
Weighted-average period of premiums receivable (in years)
9.2

 
9.1


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Table of Contents

Financial Guaranty Insurance Losses

Insurance Contracts' Loss Information

The following table provides information on loss and LAE reserves and salvage and subrogation recoverable, net of reinsurance. The Company used risk-free rates for U.S. dollar denominated financial guaranty insurance obligations that ranged from 0.0% to 3.14% with a weighted average of 2.67% as of March 31, 2017 and 0.0% to 3.23% with a weighted average of 2.74% as of December 31, 2016.

Loss and LAE Reserve and Salvage and Subrogation Recoverable
Net of Reinsurance
Insurance Contracts 

 
As of March 31, 2017
 
As of December 31, 2016
 
Loss and
LAE
Reserve, net
 
Salvage and
Subrogation
Recoverable, net 
 
Net Reserve (Recoverable)
 
Loss and
LAE
Reserve, net
 
Salvage and
Subrogation
Recoverable, net 
 
Net Reserve (Recoverable)
 
(in millions)
Public finance:
 
 
 
 
 
 
 
 
 
 
 
U.S. public finance
$
809

 
$
96

 
$
713

 
$
711

 
$
86

 
$
625

Non-U.S. public finance
16

 
—

 
16

 
21

 
—

 
21

Public finance
825

 
96

 
729

 
732

 
86

 
646

Structured finance:
 
 
 
 
 
 
 
 
 
 
 
U.S. RMBS
273

 
260

 
13

 
283

 
262

 
21

Triple-X life insurance transactions
20

 
29

 
(9
)
 
36

 
—

 
36

Other structured finance
59

 
—

 
59

 
60

 
—

 
60

Structured finance
352

 
289

 
63

 
379

 
262

 
117

Subtotal
1,177

 
385

 
792

 
1,111

 
348

 
763

Other recoverable (payable)
—

 
2

 
(2
)
 
—

 
(1
)
 
1

Subtotal
1,177

 
387

 
790

 
1,111

 
347

 
764

Elimination of losses attributable to FG VIEs
(58
)
 
—

 
(58
)
 
(64
)
 
—

 
(64
)
Total (1)
$
1,119

 
$
387

 
$
732

 
$
1,047

 
$
347

 
$
700

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



37
Table of Contents

Components of Net Reserves (Salvage)
 
 
As of
March 31, 2017
 
As of
December 31, 2016
 
(in millions)
Loss and LAE reserve
$
1,193

 
$
1,127

Reinsurance recoverable on unpaid losses
(74
)
 
(80
)
Loss and LAE reserve, net
1,119

 
1,047

Salvage and subrogation recoverable
(405
)
 
(365
)
Salvage and subrogation payable(1)
20

 
17

Other payable (recoverable)
(2
)
 
1

Salvage and subrogation recoverable, net, and other recoverable
(387
)
 
(347
)
Net reserves (salvage)
$
732

 
$
700

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

    
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: (i) the contra-paid which represent the claim payments made and recoveries received that have not yet been recognized in the statement of operations, (ii) salvage and subrogation recoverable for transactions that are in a net recovery position where the Company has not yet received recoveries on claims previously paid (having the effect of reducing net expected loss to be paid by the amount of the previously paid claim and the expected recovery), but will have no future income effect (because the previously paid claims and the corresponding recovery of those claims will offset in income in future periods), and (iii) loss reserves that have already been established (and therefore expensed but not yet paid).

Reconciliation of Net Expected Loss to be Paid and
Net Expected Loss to be Expensed
Financial Guaranty Insurance Contracts
 
 
As of
March 31, 2017
 
(in millions)
Net expected loss to be paid - financial guaranty insurance (1)
$
1,141

Contra-paid, net
47

Salvage and subrogation recoverable, net of reinsurance
385

Loss and LAE reserve - financial guaranty insurance contracts, net of reinsurance
(1,118
)
Other recoverable (payable)
2

Net expected loss to be expensed (present value) (2)
$
457

____________________
(1)
See "Net Expected Loss to be Paid (Recovered) by Accounting Model" table in Note 5, Expected Loss to be Paid.

(2)
Excludes $60 million as of March 31, 2017, related to consolidated FG VIEs.

    
    

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Table of Contents

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 accelerations, commutations, changes in expected lives and updates to loss estimates. This table excludes amounts related to FG VIEs, which are eliminated in consolidation.
 
Net Expected Loss to be Expensed
Financial Guaranty Insurance Contracts 

 
As of
March 31, 2017
 
(in millions)
2017 (April 1 – June 30)
$
10

2017 (July 1 – September 30)
9

2017 (October 1 – December 31)
9

Subtotal 2017
28

2018
39

2019
36

2020
33

2021
33

2022-2026
144

2027-2031
83

2032-2036
44

After 2036
17

Net expected loss to be expensed
457

Future accretion
400

Total expected future loss and LAE
$
857

 



39
Table of Contents

The following table presents the loss and LAE recorded in the consolidated statements of operations by sector for insurance contracts. Amounts presented are net of reinsurance.

Loss and LAE
Reported on the
Consolidated Statements of Operations
  
 
First Quarter
 
2017
 
2016
 
(in millions)
Public finance:
 
 
 
U.S. public finance
$
112

 
$
97

Non-U.S. public finance
(3
)
 
0

Public finance
109

 
97

Structured finance:
 
 
 
U.S. RMBS
(9
)
 
11

Triple-X life insurance transactions
(45
)
 
3

Other structured finance
6

 
(14
)
Structured finance
(48
)
 
0

Loss and LAE on insurance contracts before FG VIE consolidation
61

 
97

Gain (loss) related to FG VIE consolidation
(2
)
 
(7
)
Loss and LAE
$
59

 
$
90


 
The following table provides information on financial guaranty insurance contracts categorized as BIG.
 
Financial Guaranty Insurance
BIG Transaction Loss Summary
As of March 31, 2017
 
 
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)
159

 
(33
)
 
71

 
(8
)
 
149

 
(51
)
 
379

 
—

 
379

Remaining weighted-average contract period (in years)
9.4

 
7.0

 
12.7

 
9.2

 
8.1

 
5.4

 
10.1

 
—

 
10.1

Outstanding exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Principal
$
4,732

 
$
(305
)
 
$
3,990

 
$
(292
)
 
$
4,634

 
$
(283
)
 
$
12,476

 
$
—

 
$
12,476

Interest
2,457

 
(132
)
 
2,625

 
(132
)
 
1,859

 
(69
)
 
6,608

 
—

 
6,608

Total(2)
$
7,189

 
$
(437
)
 
$
6,615

 
$
(424
)
 
$
6,493

 
$
(352
)
 
$
19,084

 
$
—

 
$
19,084

Expected cash outflows (inflows)
$
169

 
$
(18
)
 
$
1,525

 
$
(75
)
 
$
1,446

 
$
(60
)
 
$
2,987

 
$
(320
)
 
$
2,667

Potential recoveries(3)
(459
)
 
23

 
(172
)
 
3

 
(758
)
 
40

 
(1,323
)
 
197

 
(1,126
)
Subtotal
(290
)
 
5

 
1,353

 
(72
)
 
688

 
(20
)
 
1,664

 
(123
)
 
1,541

Discount
64

 
(4
)
 
(363
)
 
15

 
(136
)
 
(1
)
 
(425
)
 
25

 
(400
)
Present value of expected cash flows
$
(226
)
 
$
1

 
$
990

 
$
(57
)
 
$
552

 
$
(21
)
 
$
1,239

 
$
(98
)
 
$
1,141

Deferred premium revenue
$
120

 
$
(5
)
 
$
310

 
$
(4
)
 
$
459

 
$
(26
)
 
$
854

 
$
(83
)
 
$
771

Reserves (salvage)
$
(277
)
 
$
6

 
$
802

 
$
(52
)
 
$
318

 
$
(8
)
 
$
789

 
$
(58
)
 
$
731


 

40
Table of Contents

Financial Guaranty Insurance
BIG Transaction Loss Summary
As of December 31, 2016
 
 
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)
165

 
(35
)
 
79

 
(11
)
 
148

 
(49
)
 
392

 
—

 
392

Remaining weighted-average contract period (in years)
8.6

 
7.0

 
13.2

 
10.5

 
8.1

 
6.0

 
10.1

 
—

 
10.1

Outstanding exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Principal
$
4,187

 
$
(326
)
 
$
4,273

 
$
(416
)
 
$
4,703

 
$
(320
)
 
$
12,101

 
$
—

 
$
12,101

Interest
1,932

 
(140
)
 
2,926

 
(219
)
 
1,867

 
(87
)
 
6,279

 
—

 
6,279

Total(2)
$
6,119

 
$
(466
)
 
$
7,199

 
$
(635
)
 
$
6,570

 
$
(407
)
 
$
18,380

 
$
—

 
$
18,380

Expected cash outflows (inflows)
$
172

 
$
(19
)
 
$
1,404

 
$
(86
)
 
$
1,435

 
$
(65
)
 
$
2,841

 
$
(326
)
 
$
2,515

Potential recoveries(3)
(440
)
 
23

 
(146
)
 
4

 
(743
)
 
45

 
(1,257
)
 
198

 
(1,059
)
Subtotal
(268
)
 
4

 
1,258

 
(82
)
 
692

 
(20
)
 
1,584

 
(128
)
 
1,456

Discount
61

 
(4
)
 
(355
)
 
19

 
(114
)
 
(4
)
 
(397
)
 
24

 
(373
)
Present value of expected cash flows
$
(207
)
 
$
0

 
$
903

 
$
(63
)
 
$
578

 
$
(24
)
 
$
1,187

 
$
(104
)
 
$
1,083

Deferred premium revenue
$
131

 
$
(5
)
 
$
246

 
$
(6
)
 
$
476

 
$
(30
)
 
$
812

 
$
(86
)
 
$
726

Reserves (salvage)
$
(255
)
 
$
5

 
$
738

 
$
(58
)
 
$
343

 
$
(10
)
 
$
763

 
$
(64
)
 
$
699

____________________
(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 excess spread and R&W receivables and payables.


Ratings Impact on Financial Guaranty Business
 
A downgrade of one of AGL’s insurance subsidiaries may result in increased claims under financial guaranties issued by the Company if counterparties exercise contractual rights triggered by the downgrade against insured obligors, and the insured obligors are unable to pay. There have been no material changes to the Company's potential claims under interest rate swaps, variable rate demand obligations or guaranteed investment contracts (GICs) since the filing with the SEC of AGL’s Annual Report on Form 10-K for the year ended December 31, 2016.

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.

41
Table of Contents

 
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 First Quarter 2017, 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 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 categorization within the fair value hierarchy is determined based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Company estimates of market assumptions. The fair value hierarchy prioritizes model inputs into three broad levels as follows, with Level 1 being the highest and Level 3 the lowest. An asset's or liability’s categorization 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 models, which include available relevant market information, benchmark curves, benchmarking of like securities, and sector groupings. 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 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 or those that are distressed trades, and therefore may not be indicative of the market. 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 their value is 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. Short term securities that were obtained as part of loss mitigation efforts and whose prices were determined based on models,

42
Table of Contents

where at least one significant model assumption or input is unobservable, are considered to be Level 3 in the fair value hierarchy.
 
Annually, the Company reviews each pricing service’s procedures, controls and models used in the valuations of the Company’s investment portfolio, as well as the competency of the pricing service’s key personnel. In addition, on a quarterly basis, the Company holds a meeting of the internal valuation committee (comprised of individuals within the Company with market, valuation, accounting, and/or finance experience) that reviews and approves prices and assumptions used by the pricing services.

For Level 1 and 2 securities, the Company, on a quarterly basis, reviews internally developed analytic packages that highlight, at a CUSIP level, price changes from the previous quarter to the current quarter. Where unexpected price movements are noted for a specific CUSIP, the Company formally challenges the price provided, and reviews all key inputs utilized in the third party’s pricing model, and compares such information to management’s own market information.

For Level 3 securities, the Company, on a quarterly basis:

•
reviews methodologies, any model updates and inputs and compares such information to management’s own market information and, where applicable, the internal models,

•
reviews internally developed analytic packages that highlight, at a CUSIP level, price changes from the previous quarter to the current quarter, and evaluates, documents, and resolves any significant pricing differences with the assistance of the third party pricing source, and

•
compares prices received from different third party pricing sources, and evaluates, documents the rationale for, and resolves any significant pricing differences.

As of March 31, 2017, the Company used models to price 80 fixed-maturity securities (primarily securities that were purchased or obtained for loss mitigation or other risk management purposes), which were 9.9% or $1,108 million of the Company’s fixed-maturity securities and short-term investments at fair value. Most 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 appreciation/depreciation 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.
 
Other Invested Assets

As of March 31, 2017 and December 31, 2016, other invested assets include investments carried and measured at fair value on a recurring basis of $53 million and $52 million, respectively, and include primarily an investment in the global property catastrophe risk market and an investment in a fund that invests primarily in senior loans and bonds. Fair values for the majority of these investments are based on their respective net asset value (NAV) per share or equivalent.
  
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) and AGM’s Committed Preferred Trust Securities (the AGM CPS) 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 AGC CCS and AGM CPS are carried at fair value with changes in fair value recorded in the consolidated statement of operations. The estimated current cost of the Company’s CCS is based on several factors, including AGM and AGC CDS spreads, the U.S. dollar forward swap curve, London Interbank Offered Rate (LIBOR) curve projections, the Company's publicly traded debt and the term the securities are estimated to remain outstanding.
 

43
Table of Contents

 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 NAV of the funds if a published daily value is not available (Level 2). The NAV are based on observable information.
 
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 following is a description of the fair value methodology applied to the Company's insured CDS that are accounted for as credit derivatives, which constitute the vast majority of the net credit derivative liability in the consolidated balance sheets. The Company did 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 such contracts; however, the Company has mutually agreed with various counterparties to terminate certain CDS transactions. Such transactions are generally terminated for an amount that approximates the present value of future premiums or for a negotiated amount, rather than 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. The non-standard terms generally 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. Management considers the non-standard terms of its credit derivative contracts in determining the fair value of these contracts.
 
Due to the lack of quoted prices and other observable inputs for its instruments or for similar instruments, the Company determines the fair value of its credit derivative contracts primarily through internally developed, proprietary models that use both observable and unobservable market data inputs to derive an estimate of the fair value of the Company's contracts in its principal markets (see "Assumptions and Inputs"). There is no established market where financial guaranty insured credit derivatives are actively traded, therefore, 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 transactions 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 how the Company’s own credit spread affects the pricing of its transactions.

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 and the estimated present value of premiums that a financial guarantor of comparable credit-worthiness would hypothetically charge or pay at the reporting date 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 premium cash flows are the most readily observable inputs since they are based on the CDS contractual terms. Credit spreads capture the effect of recovery rates and performance of underlying assets of these contracts, among other factors. Consistent with previous years, market conditions at March 31, 2017 were such that market prices of the Company’s CDS contracts were not available.
 
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, actual experience may differ from the estimates reflected in the Company’s consolidated financial statements and the differences may be material.


44
Table of Contents

Assumptions and Inputs

The various inputs and assumptions that are key to the establishment of the Company’s fair value for CDS contracts are as follows:
 
•Gross spread.

•The allocation of gross spread among:

◦
the profit the originator, usually an investment bank, realizes for structuring 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 its counterparty credit risk exposure to the Company (hedge cost).

•The weighted average life which is based on debt service schedules.

The rates used to discount future expected premium cash flows ranged from 1.15% to 2.62% at March 31, 2017 and 1.00% to 2.55% at December 31, 2016.
 
The Company obtains gross spreads on its outstanding contracts 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).

•
Transactions priced or closed during a specific quarter within a specific asset class and specific rating. No transactions closed during the periods presented.

•
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.
 

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Table of Contents

Information by Credit Spread Type (1)
 
 
As of
March 31, 2017
 
As of
December 31, 2016
Based on actual collateral specific spreads
7
%
 
7
%
Based on market indices
73
%
 
77
%
Provided by the CDS counterparty
20
%
 
16
%
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 transaction. 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 a similar 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 transaction's 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 transactions. 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 transactions 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 transaction generally decreases. As the cost to acquire CDS protection referencing AGC or AGM decreases, the amount of premium the Company retains on a transaction 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 39% and 26% based on number of transactions, of the Company's CDS contracts are fair valued using this minimum premium as of March 31, 2017 and December 31, 2016, respectively. The percentage of transactions that price using the minimum premiums fluctuates due to changes in AGM's and AGC's credit spreads. In general when AGM's and AGC's credit spreads narrow, the cost to hedge AGM's and AGC's name declines and more transactions price above previously established floor levels. Meanwhile, when AGM's and AGC's credit spreads widen, the cost to hedge AGM's and AGC's name increases causing more transactions to price at 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 transaction 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

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Table of Contents

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 contractual terms of the Company's contracts typically do not require the posting of collateral by the guarantor. 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 transactions 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 and taking the present value of such amounts discounted at the corresponding LIBOR over the weighted average remaining life of the contract.
 
Example
 
The following is an example of how changes in gross spreads, the Company’s own credit spread and the cost to buy protection on the Company affect the amount of premium the Company can demand for its credit protection. The assumptions used in these examples are hypothetical amounts. Scenario 1 represents the market conditions in effect on the transaction date and Scenario 2 represents market conditions at a subsequent reporting date.
 
 
Scenario 1
 
Scenario 2
 
bps
 
% of Total
 
bps
 
% of Total
Original gross spread/cash bond price (in bps)
185

 
 

 
500

 
 

Bank profit (in bps)
115

 
62
%
 
50

 
10
%
Hedge cost (in bps)
30

 
16
%
 
440

 
88
%
The premium the Company receives per annum (in bps)
40

 
22
%
 
10

 
2
%
 
In Scenario 1, the gross spread is 185 basis points. The bank or transaction 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 receives premium of 40 basis points, or 22% of the gross spread.
 
In Scenario 2, the gross spread is 500 basis points. The bank or transaction 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.
 
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.


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Table of Contents

•
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 any 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.

•
The markets for the inputs to the model are 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 amount of protection purchased on AGC or AGM's name.

Fair Value Option on FG VIEs’ Assets and Liabilities

The Company elected the fair value option for all the FG VIEs’ assets and liabilities. See Note 9, Consolidated Variable Interest Entities.
 
The FG VIEs issued securities collateralized by first lien and second lien RMBS as well as loans and receivables. The lowest level input that is significant to the fair value measurement of these assets and liabilities was a Level 3 input (i.e., unobservable), therefore management classified them as Level 3 in the fair value hierarchy. Prices are generally determined with the assistance of an independent third-party, based on a discounted cash flow approach.

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); yields 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, 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 algorithms designed to aggregate market color, received by the third-party, on comparable bonds.

The fair value of the Company’s FG VIE assets is generally 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); yields 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 generally sensitive to the various model inputs described above. 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

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Table of Contents

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
 
For financial guaranty insurance contracts that are acquired in a business combination, the Company measures each contract at fair value on the date of acquisition, and then follows insurance accounting guidance on a recurring basis thereafter.  On a quarterly basis, the Company also discloses the fair value of its outstanding financial guaranty insurance contracts.  In both cases, fair value is 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. It is based on a variety of factors that may include pricing assumptions management has observed for portfolio transfers, commutations, and acquisitions that have occurred in the financial guaranty market, as well as prices observed in the credit derivative market with an adjustment for illiquidity so that the terms would be similar to a financial guaranty insurance contract, and includes 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.

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 was determined by calculating the present value of the expected cash flows. The fair value measurement was classified as Level 3 in the fair value hierarchy.

Other Invested Assets
 
The other invested assets not carried at fair value consist primarily of investments in a guaranteed investment contract. The fair value of the investments in the guaranteed investment contract approximated their carrying value due to their short term nature. The fair value measurement of the guaranteed investment contract was classified as Level 2 in the fair value hierarchy.
 
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.


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Table of Contents

Financial Instruments Carried at Fair Value
 
Amounts recorded at fair value in the Company’s financial statements are presented in the tables below.
 
Fair Value Hierarchy of Financial Instruments Carried at Fair Value
As of March 31, 2017
 
 
 
 
Fair Value Hierarchy
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(in millions)
Assets:
 

 
 

 
 

 
 

Investment portfolio, available-for-sale:
 

 
 

 
 

 
 

Fixed-maturity securities
 

 
 

 
 

 
 

Obligations of state and political subdivisions
$
5,622

 
$
—

 
$
5,580

 
$
42

U.S. government and agencies
414

 
—

 
414

 
—

Corporate securities
1,874

 
—

 
1,812

 
62

Mortgage-backed securities:
 

 
 
 
 
 
 
RMBS
992

 
—

 
590

 
402

Commercial mortgage-backed securities (CMBS)
568

 
—

 
568

 
—

Asset-backed securities
690

 
—

 
88

 
602

Foreign government securities
319

 
—

 
319

 
—

Total fixed-maturity securities
10,479


—

 
9,371

 
1,108

Short-term investments
689

 
313

 
376

 
—

Other invested assets (1)
8

 
—

 
0

 
8

Credit derivative assets
9

 
—

 
—

 
9

FG VIEs’ assets, at fair value
781

 
—

 
—

 
781

Other assets
114

 
26

 
28

 
60

Total assets carried at fair value
$
12,080

 
$
339

 
$
9,775

 
$
1,966

Liabilities:
 

 
 
 
 
 
 
Credit derivative liabilities
$
359

 
$
—

 
$
—

 
$
359

FG VIEs’ liabilities with recourse, at fair value
721

 
—

 
—

 
721

FG VIEs’ liabilities without recourse, at fair value
134

 
—

 
—

 
134

Total liabilities carried at fair value
$
1,214

 
$
—

 
$
—

 
$
1,214

 

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Table of Contents

Fair Value Hierarchy of Financial Instruments Carried at Fair Value
As of December 31, 2016
 
 
 
 
Fair Value Hierarchy
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
 
(in millions)
Assets:
 

 
 

 
 

 
 

Investment portfolio, available-for-sale:
 

 
 

 
 

 
 

Fixed-maturity securities
 

 
 

 
 

 
 

Obligations of state and political subdivisions
$
5,432

 
$
—

 
$
5,393

 
$
39

U.S. government and agencies
440

 
—

 
440

 
—

Corporate securities
1,613

 
—

 
1,553

 
60

Mortgage-backed securities:
 

 
 

 
 

 
 

RMBS
987

 
—

 
622

 
365

CMBS
583

 
—

 
583

 
—

Asset-backed securities
945

 
—

 
140

 
805

Foreign government securities
233

 
—

 
233

 
—

Total fixed-maturity securities
10,233

 
—

 
8,964

 
1,269

Short-term investments
590

 
319

 
271

 
—

Other invested assets (1)
8

 
—

 
0

 
8

Credit derivative assets
13

 
—

 
—

 
13

FG VIEs’ assets, at fair value
876

 
—

 
—

 
876

Other assets
114

 
24

 
28

 
62

Total assets carried at fair value
$
11,834

 
$
343

 
$
9,263

 
$
2,228

Liabilities:
 

 
 

 
 

 
 

Credit derivative liabilities
$
402

 
$
—

 
$
—

 
$
402

FG VIEs’ liabilities with recourse, at fair value
807

 
—

 
—

 
807

FG VIEs’ liabilities without recourse, at fair value
151

 
—

 
—

 
151

Total liabilities carried at fair value
$
1,360

 
$
—

 
$
—

 
$
1,360

____________________
(1)
Excluded from the table above are investment funds of $49 million and $48 million as of March 31, 2017 and December 31, 2016, respectively, measured using NAV per share. Includes Level 3 mortgage loans that are recorded at fair value on a non-recurring basis.


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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 First Quarter 2017 and 2016. 

Fair Value Level 3 Rollforward
Recurring Basis
First Quarter 2017

 
Fixed-Maturity Securities
 
 
 
 
 
 
 
 
 
 
 
 
Obligations
of State and
Political
Subdivisions
 
Corporate Securities
 
RMBS
 
Asset-
Backed
Securities
 
FG VIEs’
Assets at
Fair
Value
 
Other
Assets (8)
 
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, 2016
$
39

 
$
60

 
$
365

 
$
805

 

$
876

 

$
65

 

$
(389
)
 
$
(807
)
 
$
(151
)
 
MBIA UK Acquisition
—

 
—

 
—

 
7

 
—

 
—

 
—

 
—

 
—

 
Total pretax realized and unrealized gains/(losses) recorded in: (1)
 
 
 
 
 
 
 
 

 
 

 
 

 
 

 
 

 
 

Net income (loss)
1

(2
)
2

(2
)
(2
)
(2
)
74

(2
)
17

(3
)
(2
)
(4
)
54

(6
)
(9
)
(3
)
(2
)
(3
)
Other comprehensive income (loss)
4

 
0

 
27

 
7

 

—

 

0

 

—

 

—

 

—

 

Purchases
—

 
—

 
27

 
57

 

—

 

—

 

—

 

—

 

—

 

Settlements
(2
)
 
—

 
(15
)
 
(348
)
 
(46
)
 
—

 

(15
)
 

44

 

4

 

FG VIE consolidations
—

 
—

 
—

 
—

 

21

 

—

 

—

 

—

 
(21
)
 

FG VIE deconsolidations
—

 
—

 
—

 
—

 
(87
)
 
—

 
—

 
51

 
36

 
Fair value as of
March 31, 2017
$
42

 
$
62

 
$
402

 
$
602

 

$
781

 

$
63

 

$
(350
)
 
$
(721
)
 
$
(134
)
 
Change in unrealized gains/(losses) related to financial instruments held as of March 31, 2017
$
4

 
$
0

 
$
27

 
$
73

 
$
21

 
$
(2
)
 
$
25

 
$
(7
)
 
$
(2
)
 



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Table of Contents

Fair Value Level 3 Rollforward
Recurring Basis
First Quarter 2016
 
 
Fixed-Maturity Securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Obligations
of State and
Political
Subdivisions
 
Corporate Securities
 
RMBS
 
Asset-
Backed
Securities
 
Short-Term Investments
 
FG VIEs’
Assets at
Fair
Value
 
Other
Assets (8)
 
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, 2015
$
8

 
$
71

 
$
348

 
$
657

 
$
60

 
$
1,261

 

$
65

 

$
(365
)
 
$
(1,225
)
 
$
(124
)
 
Total pretax realized and unrealized gains/(losses) recorded in: (1)
 
 
 
 
 
 
 
 
 
 
 
 

 
 

 
 

 
 

 
 

Net income (loss)
0

(2
)
2

(2
)
(2
)
(2
)
1

(2
)
0

(2
)
(4
)
(3
)
(16
)
(4
)
(60
)
(6
)
21

(3
)
2

(3
)
Other comprehensive income (loss)
0

 
1

 
(5
)
 
(5
)
 
0

 
—

 

0

 

—

 

—

 

—

 

Purchases
—

 
—

 
34

 
—

 
—

(7
)
—

 

—

 

—

 

—

 

—

 

Settlements
(1
)
 
—

 
(15
)
 
(14
)
 
(60
)
 
(66
)
 
—

 

(9
)
 

39

 

3

 

FG VIE deconsolidations
—

 
—

 
0

 
—

 
—

 
0

 
—

 
—

 
0

 
—

 
Fair value as of
March 31, 2016
$
7

 
$
74

 
$
360

 
$
639

 
$
—

 
$
1,191

 
$
49

 
$
(434
)
 
$
(1,165
)
 
$
(119
)
 
Change in unrealized gains/(losses) related to financial instruments held as of March 31, 2016
$
0

 
$
1

 
$
(6
)
 
$
(5
)
 
$
—

 
$
4

 
$
(16
)
 
$
(79
)
 
$
21

 
$
1

 
 ____________________
(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, net realized investment gains (losses), net investment income and other income.

(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 and other income.

(7)
Primarily non-cash transaction.

(8)
Includes CCS and other invested assets.



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Table of Contents

Level 3 Fair Value Disclosures
 
Quantitative Information About Level 3 Fair Value Inputs
At March 31, 2017

Financial Instrument Description (1)
 
Fair Value at
March 31, 2017 (in millions)
 
Significant Unobservable Inputs
 
Range
 
Weighted Average as a Percentage of Current Par Outstanding
Assets (2):
 
 

 
 
 
 
 
 
Fixed-maturity securities:
 
 

 
 
 
 
 
 
 
 
Obligations of state and political subdivisions
 
$
42

 
Yield
 
4.3
%
-
36.0%
 
11.2%
 
 
 
 
 
 
 
 
 
 
 
Corporate securities
 
62

 
Yield
 
21.0%
 
 
 
 
 
 
 
 
 
 
 
 
 
RMBS
 
402

 
CPR
 
1.2
%
-
17.0%
 
5.5%
 
 
CDR
 
2.0
%
-
9.1%
 
6.7%
 
 
Loss severity
 
35.0
%
-
100.0%
 
78.9%
 
 
Yield
 
3.3
%
-
9.2%
 
5.9%
Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
Triple-X life insurance transactions
 
505

 
Yield
 
5.7
%
 
6.0%
 
5.8%
 
 
 
 
 
 
 
 
 
 
 
Collateralized loan obligations (CLO) /TruPS
 
32

 
Yield
 
2.6
%
-
4.8%
 
3.2%
 
 
 
 
 
 
 
 
 
 
 
Others
 
65

 
Yield
 
3.1
%
-
11.0%
 
10.6%
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ assets, at fair value
 
781

 
CPR
 
3.5
%
-
12.8%
 
8.6%
 
 
CDR
 
2.1
%
-
21.7%
 
5.8%
 
 
Loss severity
 
57.0
%
-
100.0%
 
79.2%
 
 
Yield
 
2.9
%
-
17.9%
 
6.5%
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
60

 
Implied Yield
 
4.6%
-
5.3%
 
4.9%
 
 
Term (years)
 
10 years
 
 
Liabilities:
 
 

 
 
 
 
 
 
 
 
Credit derivative liabilities, net
 
(350
)
 
Year 1 loss estimates
 
0.0
%
-
54.0%
 
1.8%
 
 
Hedge cost (in bps)
 
7.8

-
135.8
 
30.6
 
 
Bank profit (in bps)
 
3.8

-
825.0
 
63.5
 
 
Internal floor (in bps)
 
7.0

-
100.0
 
16.1
 
 
Internal credit rating
 
AAA

-
CCC
 
AA
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ liabilities, at fair value
 
(855
)
 
CPR
 
3.5
%
-
12.8%
 
8.6%
 
 
CDR
 
2.1
%
-
21.7%
 
5.8%
 
 
Loss severity
 
57.0
%
-
100.0%
 
79.2%
 
 
Yield
 
2.4
%
-
17.9%
 
4.9%
___________________
(1)
Discounted cash flow is used as valuation technique for all financial instruments.

(2)
Excludes several investments recorded in other invested assets with fair value of $8 million.

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Quantitative Information About Level 3 Fair Value Inputs
At December 31, 2016

Financial Instrument Description (1)
 
Fair Value at
December 31, 2016
(in millions)
 
Significant Unobservable Inputs
 
Range
 
Weighted Average as a Percentage of Current Par Outstanding
Assets (2):
 
 

 
 
 
 
 
 
 
 
Fixed-maturity securities:
 
 

 
 
 
 
 
 
 
 
Obligations of state and political subdivisions
 
$
39

 
Yield
 
4.3
%
-
22.8%
 
11.1%
 
 
 
 
 
 
 
 
 
 
 
Corporate securities
 
$
60

 
Yield
 
20.1%
 
 
 
 
 
 
 
 
 
 
 
 
 
RMBS
 
365

 
CPR
 
1.6
%
-
17.0%
 
4.6%
 
 
CDR
 
1.5
%
-
10.1%
 
6.7%
 
 
Loss severity
 
30.0
%
-
100.0%
 
77.8%
 
 
Yield
 
3.3
%
-
9.7%
 
6.0%
Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
Triple-X life insurance transactions
 
425

 
Yield
 
5.7
%
-
6.0%
 
5.8%
 
 
 
 
 
 
 
 
 
 
 
Collateralized debt obligations (CDO)
 
332

 
Yield
 
10.0%
 
 
 
 
 
 
 
 
 
 
 
 
 
CLO/TruPS
 
19

 
Yield
 
1.5
%
-
4.8%
 
3.1%
 
 
 
 
 
 
 
 
 
 
 
Others
 
29

 
Yield
 
7.2%
 
 
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ assets, at fair value
 
876

 
CPR
 
3.5
%
-
12.0%
 
7.8%
 
 
CDR
 
2.5
%
-
21.6%
 
5.7%
 
 
Loss severity
 
35.0
%
-
100.0%
 
78.6%
 
 
Yield
 
2.9
%
-
20.0%
 
6.5%
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
62

 
Implied Yield
 
4.5
%
-
5.1%
 
4.8%
 
 
Term (years)
 
10 years
 
 
Liabilities:
 
 

 
 
 
 
 
 
 
 
Credit derivative liabilities, net
 
(389
)
 
Year 1 loss estimates
 
0.0
%
-
38.0%
 
1.3%
 
 
Hedge cost (in bps)
 
7.2

-
118.1
 
24.5
 
 
Bank profit (in bps)
 
3.8

-
825.0
 
61.8
 
 
Internal floor (in bps)
 
7.0

-
100.0
 
13.9
 
 
Internal credit rating
 
AAA

-
CCC
 
AA+
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ liabilities, at fair value
 
(958
)
 
CPR
 
3.5
%
-
12.0%
 
7.8%
 
 
CDR
 
2.5
%
-
21.6%
 
5.7%
 
 
Loss severity
 
35.0
%
-
100.0%
 
78.6%
 
 
Yield
 
2.4
%
-
20.0%
 
5.0%
____________________
(1)
Discounted cash flow is used as valuation technique for all financial instruments.

(2)
Excludes several investments recorded in other invested assets with fair value of $8 million.



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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
March 31, 2017
 
As of
December 31, 2016
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
 
(in millions)
Assets:
 

 
 

 
 

 
 

Fixed-maturity securities
$
10,479

 
$
10,479

 
$
10,233

 
$
10,233

Short-term investments
689

 
689

 
590

 
590

Other invested assets
149

 
151

 
146

 
147

Credit derivative assets
9

 
9

 
13

 
13

FG VIEs’ assets, at fair value
781

 
781

 
876

 
876

Other assets
213

 
213

 
205

 
205

Liabilities:
 

 
 

 
 

 
 

Financial guaranty insurance contracts (1)
3,537

 
8,363

 
3,483

 
8,738

Long-term debt
1,307

 
1,606

 
1,306

 
1,546

Credit derivative liabilities
359

 
359

 
402

 
402

FG VIEs’ liabilities with recourse, at fair value
721

 
721

 
807

 
807

FG VIEs’ liabilities without recourse, at fair value
134

 
134

 
151

 
151

Other liabilities
151

 
151

 
12

 
12

____________________
(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.
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). The credit derivatives portfolio also includes interest rate swaps.
 
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, there are more circumstances under which the Company may be obligated to make payments. Similar to a financial guaranty insurance contract, the Company would be obligated to pay if the obligor failed to make a scheduled payment of principal or interest in full. However, the Company may also be required to pay if the obligor becomes bankrupt or if the reference obligation were restructured if, after negotiation, those credit events are specified in the documentation for the credit derivative transactions. Furthermore, the Company may be required to make a payment due to an event that is unrelated to the performance of the obligation referenced in the credit derivative. 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. In that case, the Company may be required to make a termination payment to its swap counterparty upon such termination. Absent such an event of default or termination event, 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.
 

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Credit Derivative Net Par Outstanding by Sector
 
The estimated remaining weighted average life of credit derivatives was 6.2 years at March 31, 2017 and 5.3 years at December 31, 2016. The components of the Company’s credit derivative net par outstanding are presented below.
 
Credit Derivatives
 
 
 
As of March 31, 2017
 
As of December 31, 2016
Asset Type
 
Net Par
Outstanding
 
Weighted
Average
Credit
Rating
 
Net Par
Outstanding
 
Weighted
Average
Credit
Rating
 
 
(dollars in millions)
Pooled corporate obligations:
 
 

 
 
 
 

 
 
CLO/collateralized bond obligations
 
$
1,461

 
AAA
 
$
2,022

 
AAA
Synthetic investment grade pooled corporate
 
4,400

 
AAA
 
7,224

 
AAA
TruPS CDOs
 
999

 
A-
 
1,179

 
BBB+
Total pooled corporate obligations
 
6,860

 
AAA
 
10,425

 
AAA
U.S. RMBS
 
1,080

 
AA
 
1,142

 
AA-
Pooled infrastructure
 
1,363

 
AAA
 
1,513

 
AAA
Infrastructure finance
 
832

 
BBB+
 
1,021

 
BBB+
Other(1)
 
2,721

 
A-
 
2,896

 
A
Total
 
$
12,856

 
AA
 
$
16,997

 
AA+
____________________
(1)
This comprises numerous transactions across various asset classes, such as commercial receivables, international RMBS, regulated utilities and consumer receivables.


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 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 transactions.
 
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, real estate investment trusts 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.




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Distribution of Credit Derivative Net Par Outstanding by Internal Rating
 
 
 
As of March 31, 2017
 
As of December 31, 2016
Ratings
 
Net Par
Outstanding
 
% of Total
 
Net Par
Outstanding
 
% of Total
 
 
(dollars in millions)
AAA
 
$
7,493

 
58.3
%
 
$
10,967

 
64.6
%
AA
 
1,900

 
14.8

 
2,167

 
12.7

A
 
1,597

 
12.4

 
1,499

 
8.8

BBB
 
1,114

 
8.7

 
1,391

 
8.2

BIG
 
752

 
5.8

 
973

 
5.7

Credit derivative net par outstanding
 
$
12,856

 
100.0
%
 
$
16,997

 
100.0
%


Fair Value of Credit Derivatives
 
Net Change in Fair Value of Credit Derivative Gain (Loss)
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Realized gains on credit derivatives
$
5

 
$
10

Net credit derivative losses (paid and payable) recovered and recoverable and other settlements
10

 
(2
)
Realized gains (losses) and other settlements
15

 
8

Net unrealized gains (losses):
 
 
 
Pooled corporate obligations
20

 
(48
)
U.S. RMBS
9

 
(15
)
Pooled infrastructure
6

 
0

Infrastructure finance
1

 
0

Other
3

 
(5
)
Net unrealized gains (losses)
39

 
(68
)
Net change in fair value of credit derivatives
$
54

 
$
(60
)

     
Terminations and Settlements
of Direct Credit Derivative Contracts

 
First Quarter
 
2017
 
2016
 
(in millions)
Net par of terminated credit derivative contracts
$
184

 
$
—

Realized gains on credit derivatives
0

 
0

Net credit derivative losses (paid and payable) recovered and recoverable and other settlements
(12
)
 
—

Net unrealized gains (losses) on credit derivatives
15

 
11



    

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Table of Contents

During First Quarter 2017, unrealized fair value gains were generated primarily as a result of CDS terminations and tighter implied spreads. During the quarter the Company agreed to terminate several CDS transactions, which was the primary driver of the unrealized fair value gains in the pooled corporate CLO, and U.S. RMBS sectors. The tighter implied spreads were primarily a result of price improvements on the underlying collateral of the Company’s CDS and the increased cost to buy protection in AGC’s and AGM’s name as the market cost of AGC’s and AGM’s credit protection increased during the period. These transactions were pricing at or above their floor levels, therefore when the cost of purchasing CDS protection on AGC and AGM increased, the implied spreads that the Company would expect to receive on these transactions decreased.

During First Quarter 2016, unrealized fair value losses were generated primarily in the trust preferred, and U.S. RMBS prime first lien and subprime sectors, due to wider implied net spreads. The wider implied net spreads were primarily a result of the decreased cost to buy protection on AGC and AGM, particularly for the one year and five year CDS spreads. These transactions were pricing at or above their floor levels (or the minimum rate at which the Company would consider assuming these risks based on historical experience); therefore when the cost of purchasing CDS protection on AGC and AGM decreased, the implied spreads that the Company would expect to receive on these transactions increased. Unrealized fair value losses in the Other Sector were generated primarily by a price decline on a hedge the Company has against another financial guarantor. These losses were partially offset by an unrealized fair value gain on a terminated toll road securitization.

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.
 
CDS Spread on AGC and AGM
Quoted price of CDS contract (in basis points)
 
 
As of
March 31, 2017
 
As of
December 31, 2016
 
As of
March 31, 2016
 
As of
December 31, 2015
Five-year CDS spread:
 
 
 
 
 
 
 
AGC
173

 
158

 
307

 
376

AGM
181

 
158

 
309

 
366

One-year CDS spread
 
 
 
 
 
 
 
AGC
31

 
35

 
105

 
139

AGM
31

 
29

 
102

 
131



Fair Value of Credit Derivatives Assets (Liabilities)
and Effect of AGC and AGM
Credit Spreads

 
As of
March 31, 2017
 
As of
December 31, 2016
 
(in millions)
Fair value of credit derivatives before effect of AGC and AGM credit spreads
$
(713
)
 
$
(811
)
Plus: Effect of AGC and AGM credit spreads
363

 
422

Net fair value of credit derivatives
$
(350
)
 
$
(389
)
 
The fair value of CDS contracts at March 31, 2017, 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 TruPS and pooled corporate securities as well as 2005-2007 vintages of Alt-A, Option ARM and subprime RMBS transactions. The mark to market benefit between March 31, 2017 and December 31, 2016, resulted primarily from several CDS terminations and a narrowing of credit spreads related to the Company's TruPS and U.S. RMBS obligations.
 

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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, 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 2005-2007 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
 
 
 
As of
March 31, 2017
 
As of
December 31, 2016
 
 
(in millions)
Fair value of credit derivative asset (liability), net
 
$
(350
)
 
$
(389
)
Expected loss to be (paid) recovered
 
(4
)
 
(10
)


Collateral Posting for Certain Credit Derivative Contracts
 
The transaction documentation for approximately $506 million in gross par of CDS insured by AGC as of March 31, 2017 requires AGC to post eligible collateral to secure its obligations 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. The collateral requirement for approximately $333 million in gross par of insured CDS is subject to a cap of $300 million, while the collateral requirement for the remaining approximately $173 million in gross par of insured CDS is not capped.

As of March 31, 2017, the Company was posting approximately $36 million of collateral to secure its obligations under insured CDS with collateral posting requirements. Approximately $27 million of that amount related to the capped collateral requirement and the remaining $9 million related to the uncapped requirement.

    As of December 31, 2016, the Company was posting approximately $116 million of collateral to secure its obligations under insured CDS with collateral posting requirements. Approximately $100 million of that amount related to $516 million in gross par for which there was then a posting requirement subject to a cap, and the remaining $16 million related to $174 million in gross par as to which the obligation to collateralize was not capped. In February 2017, the Company terminated all of its remaining CDS contracts with one of its counterparties as to which it had a posting requirement (subject to a cap); the CDS contracts related to approximately $183 million in gross par and $73 million of collateral posted as of December 31, 2016, and all the collateral was returned to the Company.

    

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Table of Contents

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 March 31, 2017

Credit Spreads(1)
 
Estimated Net
Fair Value
(Pre-Tax)
 
Estimated Change
in Gain/(Loss)
(Pre-Tax)
 
 
(in millions)
100% widening in spreads
 
$
(712
)
 
$
(362
)
50% widening in spreads
 
(531
)
 
(181
)
25% widening in spreads
 
(441
)
 
(91
)
10% widening in spreads
 
(387
)
 
(37
)
Base Scenario
 
(350
)
 
—

10% narrowing in spreads
 
(316
)
 
34

25% narrowing in spreads
 
(266
)
 
84

50% narrowing in spreads
 
(182
)
 
168

 ____________________
(1)
Includes the effects of spreads on both the underlying asset classes and the Company’s own credit spread.


9.
Consolidated Variable Interest Entities

Consolidated FG VIEs

The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs. Assured Guaranty does not act as the servicer or collateral manager for any VIE obligations insured by its companies. 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 interest income 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.

Assured Guaranty is not primarily liable for the debt obligations issued by the VIEs it insures and would only be required to make payments on those insured debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due and only for the amount of the shortfall. 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 net claims paid by Assured Guaranty 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

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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 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 for certain VIEs 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 protective rights that could make the Company the control party have not been triggered, then the VIE is not consolidated. If the Company is deemed no longer to have those protective rights, the transaction is deconsolidated.
 
Number of FG VIEs Consolidated

 
First Quarter
 
2017
 
2016
 
 
Beginning of the period, December 31
32

 
34

Consolidated (1)
1

 
—

Deconsolidated (1)
(1
)
 
(1
)
End of the period, March 31
32

 
33

____________________
(1)
Net gain/loss on consolidation and deconsolidation was de minimis in First Quarter 2017 and 2016.

    
The total unpaid principal balance for the FG VIEs’ assets that were over 90 days or more past due was approximately $119 million at March 31, 2017 and $137 million at December 31, 2016. The aggregate unpaid principal of the FG VIEs’ assets was approximately $396 million greater than the aggregate fair value at March 31, 2017. The aggregate unpaid principal of the FG VIEs’ assets was approximately $432 million greater than the aggregate fair value at December 31, 2016.

The change in the instrument-specific credit risk of the FG VIEs’ assets held as of March 31, 2017 that was recorded in the consolidated statements of operations for First Quarter 2017 were gains of $14 million. The change in the instrument-specific credit risk of the FG VIEs’ assets held as of March 31, 2016 that was recorded in the consolidated statements of operations for First Quarter 2016 were gains of $34 million. To calculate the instrument specific credit risk, the changes in the fair value of the FG VIE assets are allocated between changes that are due to the instrument specific credit risk and changes due to other factors, including interest rates. The instrument specific credit risk amount is determined by using expected contractual cash flows versus current expected cash flows discounted at original contractual rate. The net present value is calculated by discounting the expected cash flows of the underlying security, at the relevant effective interest rate.
 
The unpaid principal for FG VIE liabilities with recourse, which represent obligations insured by AGC or AGM, was $775 million and $871 million as of March 31, 2017 and December 31, 2016, respectively. FG VIE liabilities with recourse will mature at various dates ranging from 2025 to 2038. The aggregate unpaid principal balance of the FG VIE liabilities with and without recourse was approximately $84 million greater than the aggregate fair value of the FG VIEs’ liabilities as of March 31, 2017. The aggregate unpaid principal balance was approximately $109 million greater than the aggregate fair value of the FG VIEs' liabilities as of December 31, 2016.
 

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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 for FG VIE liabilities with recourse.

Consolidated FG VIEs
By Type of Collateral

 
As of March 31, 2017
 
As of December 31, 2016
 
Assets
 
Liabilities
 
Assets
 
Liabilities
 
(in millions)
With recourse:
 

 
 

 
 

 
 

U.S. RMBS first lien
$
406

 
$
436

 
$
473

 
$
509

U.S. RMBS second lien
168

 
211

 
178

 
223

Manufactured housing
73

 
74

 
74

 
75

Total with recourse
647

 
721

 
725

 
807

Without recourse
134

 
134

 
151

 
151

Total
$
781

 
$
855

 
$
876

 
$
958



The consolidation of FG VIEs affects net income and shareholders' equity due to (i) changes in fair value gains (losses) on FG VIE assets and liabilities, (ii) the elimination of premiums and losses related to the AGC and AGM FG VIE liabilities with recourse and (iii) 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 (Loss),
Cash Flows From Operating Activities and Shareholders' Equity
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Net earned premiums
$
(4
)
 
$
(5
)
Net investment income
(1
)
 
(5
)
Net realized investment gains (losses)
0

 
1

Fair value gains (losses) on FG VIEs
10

 
18

Loss and LAE
2

 
6

Effect on income before tax
7

 
15

Less: tax provision (benefit)
3

 
5

Effect on net income (loss)
$
4

 
$
10

 
 
 
 
Effect on cash flows from operating activities
$
5


$
6

 
 
As of
March 31, 2017
 
As of
December 31, 2016
 
(in millions)
Effect on shareholders' equity (decrease) increase
$
(4
)
 
$
(9
)

Fair value gains (losses) on FG VIEs represent the net change in fair value on the consolidated FG VIEs’ assets and liabilities. During First Quarter 2017, the Company recorded a pre-tax net fair value gain on consolidated FG VIEs of $10 million, which was driven by price appreciation on the FG VIE assets during the quarter resulting from improvements in the underlying collateral.
 

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Table of Contents

During First Quarter 2016, the Company recorded a pre-tax net fair value gain on consolidated FG VIEs of $18 million due mainly to improvements in the underlying collateral.

Other Consolidated VIEs

In certain instances where the Company consolidates a VIE that was established as part of a loss mitigation negotiated settlement agreement that results in the termination of the original insured financial guaranty insurance or credit derivative contract the Company classifies the assets and liabilities of those VIEs in the line items that most accurately reflect the nature of the items, as opposed to within the FG VIE assets and FG VIE liabilities.

Non-Consolidated VIEs
 
As of March 31, 2017 and December 31, 2016, the Company had financial guaranty contracts outstanding for approximately 590 and 600 VIEs, respectively, that it did not consolidate based on the Company’s analyses which indicate that it is not the primary beneficiary of any other VIEs. 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 4, Outstanding Exposure.

10.
Investments and Cash
 
Net Investment Income and Realized Gains (Losses)

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. Accrued investment income, which is recorded in Other Assets, was $99 million and $91 million as of March 31, 2017 and December 31, 2016, respectively.
 
Net Investment Income
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Income from fixed-maturity securities managed by third parties
$
75

 
$
79

Income from internally managed securities:
 
 
 
Fixed maturities (1)
46

 
17

Other
3

 
5

Gross investment income
124

 
101

Investment expenses
(2
)
 
(2
)
Net investment income
$
122

 
$
99

(1) Includes accretion on Zohar II Notes.

Net Realized Investment Gains (Losses)
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Gross realized gains on available-for-sale securities (1)
$
43

 
$
6

Gross realized losses on available-for-sale securities
(2
)
 
(2
)
Net realized gains (losses) on other invested assets
0

 
(1
)
Other-than-temporary impairment
(9
)
 
(16
)
Net realized investment gains (losses)
$
32

 
$
(13
)
____________________
(1)
First Quarter 2017 primarily consists of a gain on Zohar II Notes used as consideration for the MBIA UK Acquisition. See Note 2, Acquisitions.


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The following table presents the roll-forward of the credit losses of fixed-maturity securities for which the Company has recognized an other-than-temporary-impairment 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

 
First Quarter
 
2017
 
2016
 
(in millions)
Balance, beginning of period
$
134

 
$
108

Additions for credit losses on securities for which an other-than-temporary-impairment was not previously recognized
0

 
1

Reductions for securities sold and other settlement during the period
0

 
(2
)
Additions for credit losses on securities for which an other-than-temporary-impairment was previously recognized
8

 
0

Balance, end of period
$
142

 
$
107



Investment Portfolio

Fixed-Maturity Securities and Short-Term Investments
by Security Type 
As of March 31, 2017

Investment Category
 
Percent
of
Total(1)
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
AOCI(2)
Gain
(Loss) on
Securities
with
Other-Than-Temporary Impairment
 
Weighted
Average
Credit
Rating
 (3)
 
 
(dollars in millions)
Fixed-maturity securities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 
Obligations of state and political subdivisions
 
50
%
 
$
5,432

 
$
219

 
$
(29
)
 
$
5,622

 
$
13

 
AA
U.S. government and agencies
 
4

 
399

 
16

 
(1
)
 
414

 
0

 
AA+
Corporate securities
 
17

 
1,851

 
50

 
(27
)
 
1,874

 
(7
)
 
A
Mortgage-backed securities(4):
 
0

 
 
 
 
 
 

 
 
 
 

 
 
RMBS
 
9

 
978

 
40

 
(26
)
 
992

 
5

 
BBB+
CMBS
 
5

 
561

 
12

 
(5
)
 
568

 
—

 
AAA
Asset-backed securities
 
6

 
573

 
117

 
0

 
690

 
93

 
B-
Foreign government securities
 
3

 
341

 
7

 
(29
)
 
319

 
—

 
AA
Total fixed-maturity securities
 
94

 
10,135

 
461

 
(117
)
 
10,479

 
104

 
A+
Short-term investments
 
6

 
687

 
2

 
0

 
689

 
—

 
AAA
Total investment portfolio
 
100
%
 
$
10,822

 
$
463

 
$
(117
)
 
$
11,168

 
$
104

 
A+



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Table of Contents

Fixed-Maturity Securities and Short-Term Investments
by Security Type 
As of December 31, 2016 

Investment Category
 
Percent
of
Total(1)
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
AOCI
Gain
(Loss) on
Securities
with
Other-Than-Temporary Impairment
 
Weighted
Average
Credit
Rating
 (3)
 
 
(dollars in millions)
Fixed-maturity securities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 
Obligations of state and political subdivisions
 
50
%
 
$
5,269

 
$
202

 
$
(39
)
 
$
5,432

 
$
13

 
AA
U.S. government and agencies
 
4

 
424

 
17

 
(1
)
 
440

 
0

 
AA+
Corporate securities
 
15

 
1,612

 
32

 
(31
)
 
1,613

 
(8
)
 
A-
Mortgage-backed securities(4):
 
 

 
 

 
 

 
 

 
 

 
 

 
 
RMBS
 
9

 
998

 
27

 
(38
)
 
987

 
(21
)
 
A-
CMBS
 
5

 
575

 
13

 
(5
)
 
583

 
—

 
AAA
Asset-backed securities
 
8

 
835

 
110

 
0

 
945

 
33

 
B
Foreign government securities
 
3

 
261

 
4

 
(32
)
 
233

 
—

 
AA
Total fixed-maturity securities
 
94

 
9,974

 
405

 
(146
)
 
10,233

 
17

 
A+
Short-term investments
 
6

 
590

 
0

 
0

 
590

 
—

 
AAA
Total investment portfolio
 
100
%
 
$
10,564

 
$
405

 
$
(146
)
 
$
10,823

 
$
17

 
A+
____________________
(1)
Based on amortized cost.
 
(2)
Accumulated OCI. See also Note 17, Shareholders' Equity for additional information as applicable.
 
(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 40% of mortgage backed securities as of March 31, 2017 and 42% as of December 31, 2016 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.
 

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The following tables summarize, for all fixed-maturity 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 March 31, 2017
 
 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
(dollars in millions)
Obligations of state and political subdivisions
$
994

 
$
(28
)
 
$
6

 
$
(1
)
 
$
1,000

 
$
(29
)
U.S. government and agencies
172

 
(1
)
 
—

 
—

 
172

 
(1
)
Corporate securities
356

 
(8
)
 
120

 
(19
)
 
476

 
(27
)
Mortgage-backed securities:
 
 
 
 
 
 
 

 


 


RMBS
377

 
(13
)
 
93

 
(13
)
 
470

 
(26
)
CMBS
160

 
(5
)
 
1

 
0

 
161

 
(5
)
Asset-backed securities
52

 
0

 
0

 
0

 
52

 
0

Foreign government securities
45

 
(4
)
 
115

 
(25
)
 
160

 
(29
)
Total
$
2,156

 
$
(59
)
 
$
335

 
$
(58
)
 
$
2,491

 
$
(117
)
Number of securities (1)
 

 
542

 
 

 
62

 
 

 
598

Number of securities with other-than-temporary impairment
 

 
12

 
 

 
9

 
 

 
21

 

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Table of Contents

Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time
As of December 31, 2016

 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
(dollars in millions)
Obligations of state and political subdivisions
$
1,110

 
$
(38
)
 
$
6

 
$
(1
)
 
$
1,116

 
$
(39
)
U.S. government and agencies
87

 
(1
)
 
—

 
—

 
87

 
(1
)
Corporate securities
492

 
(11
)
 
118

 
(20
)
 
610

 
(31
)
Mortgage-backed securities:
 

 
 

 
 

 
 

 


 


RMBS
391

 
(23
)
 
94

 
(15
)
 
485

 
(38
)
CMBS
165

 
(5
)
 
—

 
—

 
165

 
(5
)
Asset-backed securities
36

 
0

 
0

 
0

 
36

 
0

Foreign government securities
44

 
(5
)
 
114

 
(27
)
 
158

 
(32
)
Total
$
2,325

 
$
(83
)
 
$
332

 
$
(63
)
 
$
2,657

 
$
(146
)
Number of securities (1)
 

 
622

 
 

 
60

 
 

 
676

Number of securities with other-than-temporary impairment
 

 
8

 
 

 
9

 
 

 
17

___________________
(1)
The number of securities does not add across because lots consisting of the same securities have been purchased at different times and appear in both categories above (i.e., less than 12 months and 12 months or more). If a security appears in both categories, it is counted only once in the total column.

Of the securities in an unrealized loss position for 12 months or more as of March 31, 2017, 41 securities had unrealized losses greater than 10% of book value. The total unrealized loss for these securities as of March 31, 2017 was $52 million. As of December 31, 2016, of the securities in an unrealized loss position for 12 months or more, 41 securities had unrealized losses greater than 10% of book value with an unrealized loss of $59 million. The Company has determined that the unrealized losses recorded as of March 31, 2017 were yield related and not the result of other-than-temporary-impairment.
 
The amortized cost and estimated fair value of available-for-sale fixed maturity securities by contractual maturity as of March 31, 2017 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 March 31, 2017
 
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Due within one year
$
284

 
$
283

Due after one year through five years
1,798

 
1,828

Due after five years through 10 years
2,171

 
2,227

Due after 10 years
4,343

 
4,581

Mortgage-backed securities:
 

 
 

RMBS
978

 
992

CMBS
561

 
568

Total
$
10,135

 
$
10,479

 

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Investments and restricted cash that are either held in trust for the benefit of third party ceding insurers in accordance with statutory requirements, invested in a guaranteed investment contract for future claims payments, placed on deposit to fulfill state licensing requirements, or otherwise restricted aggregate to the amount of $282 million and $285 million, based on fair value, as of March 31, 2017 and December 31, 2016, respectively. The investment portfolio also contains securities that are held in trust by certain AGL subsidiaries for the benefit of other AGL subsidiaries in accordance with statutory and regulatory requirements in the amount of $1,508 million and $1,420 million, based on fair value. as of March 31, 2017 and December 31, 2016, respectively.

The fair value of the Company’s pledged securities to secure its obligations under its CDS exposure totaled $36 million and $116 million as of March 31, 2017 and December 31, 2016, respectively.
 
No material investments of the Company were non-income producing for First Quarter 2017 and First Quarter 2016, respectively.

Externally Managed Portfolio

The majority of the investment portfolio is managed by five outside managers. The Company has established detailed guidelines regarding credit quality, exposure to a particular sector and exposure to a particular obligor within a sector. The Company's investment guidelines generally do not permit its outside managers to purchase securities rated lower than A- by S&P or A3 by Moody’s, excluding a 2.5% allocation to corporate securities not rated lower than BBB by S&P or Baa2 by Moody’s.
 
Internally Managed Portfolio

The investment portfolio tables shown above include both assets managed externally and internally. In the table below, more detailed information is provided for the component of the total investment portfolio that is internally managed (excluding short-term investments). The internally managed portfolio, as defined below, represents approximately 13% and 15% of the investment portfolio, on a fair value basis as of March 31, 2017 and December 31, 2016, respectively. The internally managed portfolio consists primarily of the Company's investments in securities for (i) loss mitigation purposes, (ii) other risk management purposes and (iii) where the Company believes a particular security presents an attractive investment opportunity.
    
One of the Company's strategies for mitigating losses has been to purchase securities it has insured that have expected losses, at discounted prices (loss mitigation securities). In addition, the Company holds other invested assets that were obtained or purchased as part of negotiated settlements with insured counterparties or under the terms of our financial guaranties (other risk management assets). During 2016, the Company established an alternative investments group to focus on deploying a portion of the Company's excess capital to pursue acquisitions and develop new business opportunities that complement the Company's financial guaranty business, are in line with its risk profile and benefit from its core competencies. The alternative investments group has been investigating a number of such opportunities, including, among others, both controlling and non-controlling investments in investment managers.

Internally Managed Portfolio
Carrying Value

 
As of
March 31, 2017
 
As of
December 31, 2016
 
(in millions)
Assets purchased for loss mitigation and other risk management purposes:
 
 
 
Fixed-maturity securities, at fair value
$
1,304

 
$
1,492

Other invested assets
106

 
107

Other
66

 
55

Total
$
1,476

 
$
1,654



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Table of Contents

Cash and Restricted Cash

The following table provides a reconciliation of the cash reported on the consolidated balance sheets and the cash and restricted cash reported in the statements of cash flows.

Cash and Restricted Cash

 
As of March 31, 2017
 
As of December 31, 2016
 
As of March 31, 2016
 
As of December 31, 2015
 
(in millions)
Cash
$
147

 
$
118

 
$
112

 
$
166

Restricted cash (1)
1

 
9

 
0

 
0

Total cash and restricted cash
$
148

 
$
127

 
$
112

 
$
166

____________________
(1)
Amounts relate to cash held in trust accounts and are reported in other assets in consolidated balance sheets. See Note 13, Reinsurance and Other Monoline Exposures, for more information.

    

11.
Insurance Company Regulatory Requirements
 
Dividend Restrictions and Capital Requirements

Under New York insurance law, AGM and MAC may only pay dividends out of "earned surplus," which is the portion of the 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, transferred to stated capital or capital surplus, or applied to other purposes permitted by law, but does not include unrealized appreciation of assets. AGM and MAC may each pay dividends without the prior approval of the New York Superintendent of Financial Services (New York Superintendent) that, together with all dividends declared or distributed by it during the preceding 12 months, do not exceed the lesser of 10% of its policyholders' surplus (as of its last annual or quarterly statement filed with the New York Superintendent) or 100% of its adjusted net investment income during that period.

The maximum amount available during 2017 for AGM to distribute as dividends without regulatory approval is estimated to be approximately $192 million. Of such $192 million, $79 million was distributed by AGM to AGMH in First Quarter 2017 and none of such $192 million is available for distribution in the second quarter of 2017. The maximum amount available during 2017 for MAC to distribute as dividends to MAC Holdings, which is owned by AGM and AGC, without regulatory approval is estimated to be approximately $49 million, of which approximately $37 million is available for distribution in the second quarter of 2017. MAC currently intends to allocate the distribution of such $37 million over the remaining three quarters in 2017.

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 the lesser of 10% of its policyholders' surplus (as of the prior December 31) or 100% of its adjusted net investment income during that period. The maximum amount available during 2017 for AGC to distribute as ordinary dividends is approximately $107 million. Of such $107 million, $28 million was distributed by AGC to AGUS in First Quarter 2017 and approximately $24 million is available for distribution in the second quarter of 2017.

For AG Re, any distribution (including repurchase of shares) of any share capital, contributed surplus or other statutory capital that would reduce its total statutory capital by 15% or more of its total statutory capital as set out in its previous year's financial statements requires the prior approval of the Bermuda Monetary Authority (Authority). Separately, dividends are paid out of an insurer's statutory surplus and cannot exceed that surplus. Further, annual dividends cannot exceed 25% of total statutory capital and surplus as set out in its previous year's financial statements, which is $314 million without AG Re certifying to the Authority that it will continue to meet required margins. As of December 31, 2016, the Authority now requires insurers to prepare statutory financial statements in accordance with the particular accounting principles adopted by the insurer (which, in the case of AG Re, are U.S. GAAP), subject to certain adjustments. As a result of this new requirement, certain assets previously non-admitted by AG Re are now admitted, resulting in an increase to AG Re’s statutory capital and surplus limitation. Based on the foregoing limitations, in 2017 AG Re has the capacity to (i) make capital distributions in an

70
Table of Contents

aggregate amount up to $128 million without the prior approval of the Authority and (ii) declare and pay dividends in an aggregate amount up to approximately $314 million as of March 31, 2017. Such dividend capacity is further limited by the actual amount of AG Re’s unencumbered assets, which amount changes from time to time due in part to collateral posting requirements. As of March 31, 2017, AG Re had unencumbered assets of approximately $543 million.

U.K. company law prohibits each of AGE, AGLN and AGUK from declaring a dividend to its shareholders unless it has “profits available for distribution.” The determination of whether a company has profits available for distribution is based on its accumulated realized profits less its accumulated realized losses. While the U.K. insurance regulatory laws impose no statutory restrictions on a general insurer's ability to declare a dividend, the Prudential Regulation Authority's capital requirements may in practice act as a restriction on dividends. In addition, AGLN currently must confirm that the Prudential Regulation Authority does not object to the payment of any dividend to its parent company before AGLN makes any dividend payment.

Dividends
By Insurance Company Subsidiaries

 
First Quarter
 
2017
 
2016
 
(in millions)
Dividends paid by AGC to AGUS
$
28

 
$
—

Dividends paid by AGM to AGMH
79

 
95

Dividends paid by AG Re to AGL
40

 
25

Dividends paid by MAC to MAC Holdings (1)
12

 
—

____________________
(1)
MAC Holdings distributed the entire amount to AGM and AGC, in proportion to their ownership percentages.

12.
Income Taxes

Overview
 
AGL, and its "Bermuda Subsidiaries," which consist of AG Re, AGRO, 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. AGL'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 AGE, a U.K. domiciled company, have elected under Section 953(d) of the U.S. Internal Revenue Code (the Code) to be taxed as a U.S. domestic corporation.

In November 2013, AGL became tax resident in the U.K. although it remains a Bermuda-based company and its administrative and head office functions continue to be carried on in Bermuda. AGL is subject to U.K. corporation tax in respect of its worldwide profits (both income and capital gains), subject to any applicable exemptions. The main rate of corporation tax is 19% beginning April 1, 2017.

AGUS files a consolidated federal income tax return with all of its U.S. subsidiaries and AGE. In January 2017, AGE submitted a request to the U.S. Internal Revenue Service (IRS) to revoke its election under Section 953(d) of the Code to be taxed as a U.S. domestic corporation. If approved, the revocation is not expected to have a material impact on the Company’s financial condition. On January 10, 2017, AGC purchased MBIA UK, a U.K. based insurance company. After the purchase, MBIA UK changed its name to AGLN and continues to file its tax returns in the U.K. as a separate entity. For additional information on the MBIA UK Acquisition, please refer to Note 2, Acquisitions. Assured Guaranty Overseas US Holdings Inc. and its subsidiaries AGRO and AG Intermediary Inc. file their own consolidated federal income tax return.


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Table of Contents

Provision for Income Taxes

The Company's provision for income taxes for interim financial periods is not based on an estimated annual effective rate due, for example, 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 2017. 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 19.25% unless subject to U.S. tax by election or as a U.S. controlled foreign corporation, and no taxes for the Company’s Bermuda subsidiaries unless subject to U.S. tax by election. For periods subsequent to April 1, 2017, the U.K. corporation tax rate has been reduced to 19%. For the periods between April 1, 2015 and March 31, 2017, the U.K. corporation tax rate was 20%. The Company’s overall 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.

Effective Tax Rate Reconciliation
 
 
First Quarter
 
2017

2016
 
(in millions)
Expected tax provision (benefit) at statutory rates in taxable jurisdictions
$
85

 
$
18

Tax-exempt interest
(12
)
 
(13
)
Gain on bargain purchase
(20
)
 
—

State taxes
5

 
1

Other
(3
)
 
0

Total provision (benefit) for income taxes
$
55

 
$
6

Effective tax rate
14.7
%
 
10.0
%


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. or U.K. domiciled but are subject to U.S. or U.K. tax by election, establishment of tax residency or as controlled foreign corporations, are included at the U.S. or U.K. 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

 
First Quarter
 
2017
 
2016
 
(in millions)
United States
$
246

 
$
55

Bermuda
133

 
17

U.K.
(7
)
 
(7
)
Total
$
372

 
$
65


 

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Table of Contents

Revenue by Tax Jurisdiction

 
First Quarter
 
2017
 
2016
 
(in millions)
United States
$
474

 
$
205

Bermuda
57

 
42

U.K.
(4
)
 
(2
)
Total
$
527

 
$
245

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

Valuation Allowance
 
As part of the Radian Asset Acquisition, the Company acquired $19 million of foreign tax credits (FTC) which will expire in 2020. After reviewing positive and negative evidence, the Company came to the conclusion that it is more likely than not that the FTC will not be utilized, and therefore recorded a valuation allowance with respect to this tax attribute.

The Company came to the conclusion that it is more likely than not that the remaining 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 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.

Audits

As of March 31, 2017, AGUS had open tax years with the IRS for 2009 forward and was under audit for the 2009-2012 tax years. In December 2016, the IRS issued a Revenue Agent Report (RAR) which did not identify any material adjustments that were not already accounted for in the prior periods. In April 2017, the Company received a final letter from the the IRS to close the audit with no additional findings or changes, and as a result the Company expects to release previously recorded uncertain tax position reserve and accrued interest of approximately $34 million in the second quarter of 2017. Assured Guaranty Oversees US Holdings Inc. has open tax years of 2013 forward. The Company's U.K. subsidiaries are not currently under examination and have open tax years of 2014 forward. CIFGNA, which was acquired by AGC during 2016, is not currently under examination and has open tax years of 2013 forward.

Uncertain Tax Positions

The Company's policy is to recognize interest related to uncertain tax positions in income tax expense and has accrued $0.6 million for First Quarter 2017 and $2 million for 2016. As of March 31, 2017 and December 31, 2016, the Company has accrued $8 million and $7 million of interest, respectively.

The total amount of unrecognized tax positions as of March 31, 2017 and December 31, 2016 would affect the effective tax rate, if recognized, was $58 million and $57 million, respectively.
    
13.
Reinsurance and Other Monoline Exposures
 
The Company assumes exposure on insured obligations (Assumed Business) and may cede portions of its exposure on obligations it has insured (Ceded Business) in exchange for premiums, net of ceding commissions. The Company 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 assumes business from third party insurers and reinsurers, including other monoline financial guaranty companies. Under these relationships, the Company assumes a portion of the ceding company’s insured risk in exchange for a

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portion of the ceding Company's premium for the insured risk (typically, net of a ceding commission). 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 assumed 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.
 
The downgrade of the financial strength ratings of AG Re or of AGC gives certain ceding companies the right to recapture business they had ceded to AG Re and AGC, which would lead to a reduction in the Company's unearned premium reserve and related earnings on such reserve. 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 third party ceding company may have the right to recapture business it had ceded to AG Re and/or AGC, and in connection therewith, to receive payment from AG Re or AGC of an amount equal to the statutory unearned premium (net of ceding commissions) and statutory loss reserves (if any) associated with that business, plus, in certain cases, an additional required payment. As of March 31, 2017, if each third party insurer ceding business to AG Re and/or AGC had a right to recapture such business, and chose to exercise such right, the aggregate amounts that AG Re and AGC could be required to pay to all such companies would be approximately $42 million and $16 million, respectively.

The Company has Ceded Business to non-affiliated companies to limit its exposure to risk. Under these relationships, the Company ceded a portion of its insured risk to the reinsurer in exchange for the reinsurer receiving a share of the Company's premiums for the insured risk (typically, net of a ceding commission). 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.

Effective as of March 1, 2017, the Company entered into a commutation agreement to reassume the entire portfolio previously ceded to one of its unaffiliated reinsurers. The size of such portfolio was approximately $1.0 billion of par, consisting predominantly (over 97%) of U.S. public finance and international public and project finance exposures. For such reassumption, the Company received the statutory unearned premium and loss and loss adjustment expense reserves outstanding as of the commutation date, plus a commutation premium and, as a result, the Company recorded a gain of $73 million in other income. There were no commutations in First Quarter 2016.


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The following table presents the components of premiums and losses reported in the consolidated statements of operations and the contribution of the Company's Assumed and Ceded Businesses.

Effect of Reinsurance on Statement of Operations

 
First Quarter
 
2017

2016
 
(in millions)
Premiums Written:
 
 
 
Direct
$
109

 
$
21

Assumed (1)
2

 
(2
)
Ceded (2)
11

 
(17
)
Net
$
122

 
$
2

Premiums Earned:
 
 
 
Direct
$
167

 
$
190

Assumed
6

 
8

Ceded
(9
)
 
(15
)
Net
$
164

 
$
183

Loss and LAE:
 
 
 
Direct
$
67

 
$
109

Assumed
3

 
(14
)
Ceded
(11
)
 
(5
)
Net
$
59

 
$
90

 ____________________
(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.

In addition to the items presented in the table above, the Company records in the consolidated statements of operations, the effect of assumed and ceded credit derivative exposures. These amounts were losses of $0.6 million in First Quarter 2017 and $0.3 million in First Quarter 2016.

Other Monoline Exposures
 
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 third party insurers and reinsurers. 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 change based on the rating of the monoline. As of March 31, 2017, based on fair value, the Company had fixed-maturity securities in its investment portfolio consisting of $106 million insured by National, $81 million insured by Ambac, $135 million insured by FGIC UK Limited and $8 million insured by other guarantors.


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Monoline and Reinsurer Exposure by Company

 
 
Par Outstanding
 
 
As of March 31, 2017
Reinsurer
 
Ceded Par
Outstanding (1)
 
Second-to-
Pay Insured
Par
Outstanding (2)
 
Assumed Par
Outstanding
 
 
(in millions)
Reinsurers rated investment grade:
 
 
 
 
 
 
Tokio Marine & Nichido Fire Insurance Co., Ltd. (3) (4)
 
$
3,269

 
$
—

 
$
—

National
 
—

 
4,057

 
3,962

Subtotal
 
3,269

 
4,057

 
3,962

Reinsurers rated BIG or not rated:
 
 
 
 
 
 
American Overseas Reinsurance Company Limited (3)
 
3,307

 
—

 
30

Syncora (3)
 
1,950

 
1,097

 
654

ACA Financial Guaranty Corp.
 
621

 
12

 
—

Ambac
 
115

 
2,583

 
6,061

MBIA
 
—

 
949

 
151

Financial Guaranty Insurance Company and FGIC UK Limited
 
—

 
1,221

 
404

Ambac Assurance Corp. Segregated Account
 
—

 
57

 
584

Subtotal
 
5,993

 
5,919

 
7,884

Other (3)
 
71

 
538

 
146

Total
 
$
9,333

 
$
10,514

 
$
11,992

____________________
(1)
Of the total ceded par to reinsurers rated BIG or not rated, $359 million is rated BIG.  

(2)
The par on second-to-pay exposure where the primary insurer and underlying transaction rating are both BIG, and/or not rated, is $742 million.

(3)
The total collateral posted by all non-affiliated reinsurers required to post, or that had agreed to post, collateral as of March 31, 2017 was approximately $285 million.

(4)    The Company benefits from trust arrangements that satisfy the triple-A credit requirement of S&P and/or Moody’s.




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Amounts Due (To) From Reinsurers
As of March 31, 2017 

 
Assumed
Premium, net
of Commissions
 
Ceded
Premium, net
of Commissions
 
Assumed
Expected
Loss to be Paid
 
Ceded
Expected
Loss to be Paid
 
(in millions)
Reinsurers rated investment grade
$
5

 
$
(9
)
 
$
4

 
$
44

Reinsurers rated BIG or not rated:
 
 
 
 
 
 
 
American Overseas Reinsurance Company Limited
—

 
(4
)
 
—

 
38

Syncora
13

 
(17
)
 
—

 
(6
)
Ambac
33

 
—

 
(2
)
 
—

MBIA
0

 
—

 
(7
)
 
—

Financial Guaranty Insurance Company and FGIC UK Limited
4

 
—

 
(17
)
 
—

Ambac Assurance Corp. Segregated Account
6

 
—

 
(48
)
 
—

Other
—

 
(3
)
 
—

 
—

Subtotal
56

 
(24
)
 
(74
)
 
32

Total
$
61

 
$
(33
)
 
$
(70
)
 
$
76


 
Excess of Loss Reinsurance Facility
 
AGC, AGM and MAC entered into a $360 million aggregate excess of loss reinsurance facility with a number of reinsurers, effective as of January 1, 2016. This facility replaces a similar $450 million aggregate excess of loss reinsurance facility that AGC, AGM and MAC had entered into effective January 1, 2014 and which terminated on December 31, 2015. The new facility covers losses occurring either from January 1, 2016 through December 31, 2023, or January 1, 2017 through December 31, 2024, at the option of AGC, AGM and MAC. It terminates on January 1, 2018, unless AGC, AGM and MAC choose to extend it. The new facility covers certain U.S. public finance credits insured or reinsured by AGC, AGM and MAC as of September 30, 2015, excluding credits that were rated non-investment grade as of December 31, 2015 by Moody’s or S&P or internally by AGC, AGM or MAC and is subject to certain per credit limits. Among the credits excluded are those associated with the Commonwealth of Puerto Rico and its related authorities and public corporations. The new facility attaches when AGC’s, AGM’s and MAC’s net losses (net of AGC’s and AGM's reinsurance (including from affiliates) and net of recoveries) exceed $1.25 billion in the aggregate. The new facility covers a portion of the next $400 million of losses, with the reinsurers assuming pro rata in the aggregate $360 million of the $400 million of losses and AGC, AGM and MAC jointly retaining the remaining $40 million. The reinsurers are required to be rated at least AA- or to post collateral sufficient to provide AGM, AGC and MAC with the same reinsurance credit as reinsurers rated AA-. AGM, AGC and MAC are obligated to pay the reinsurers their share of recoveries relating to losses during the coverage period in the covered portfolio. AGC, AGM and MAC paid approximately $9 million of premiums in 2016 for the term January 1, 2016 through December 31, 2016 and approximately $9 million of premiums for January 1, 2017 through December 31, 2017.
    
14.    Commitments and Contingencies

Legal Proceedings

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.

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 or prevent losses in the future, including those described in the "Recovery Litigation," section of Note 5, Expected Loss to be Paid. For example, as described there, in January 2016 the Company commenced an action for declaratory judgment and injunctive relief in the U.S. District Court for the District of Puerto Rico to invalidate executive orders issued by the Governor of Puerto Rico directing the retention or transfer of certain taxes and revenues pledged to secure the payment of certain bonds insured by the Company, and in July

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2016, the Company filed a motion and form of complaint in the U.S. District Court for the District of Puerto Rico seeking relief from the PROMESA stay in order to file a complaint to protect its interest in certain pledged PRHTA toll revenues. The amounts, if any, the Company will recover in these and other 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.

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.

Litigation

On November 28, 2011, Lehman Brothers International (Europe) (in administration) (LBIE) sued AG Financial Products Inc. (AGFP), an affiliate of AGC which in the past had provided credit protection to counterparties under CDS. AGC acts as the credit support provider of AGFP under these CDS. 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. Following defaults by LBIE, AGFP properly terminated the transactions in question in compliance with the agreement between AGFP and LBIE, and calculated the termination payment properly. AGFP calculated that LBIE owes AGFP approximately $29 million in connection with the termination of the credit derivative transactions, whereas LBIE asserted in the complaint that AGFP owes LBIE a termination payment of approximately $1.4 billion. 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 improper termination of the nine credit derivative transactions and denied AGFP's motion to dismiss the counts relating to the remaining transactions. On February 22, 2016, AGFP filed a motion for summary judgment on the remaining causes of action asserted by LBIE and on AGFP's counterclaims. Oral argument on AGFP's motion took place on July 21, 2016. LBIE's administrators disclosed in an April 10, 2015 report to LBIE’s unsecured creditors that LBIE's valuation expert has calculated LBIE's claim for damages in aggregate for the 28 transactions to range between a minimum of approximately $200 million and a maximum of approximately $500 million, depending on what adjustment, if any, is made for AGFP's credit risk and excluding any applicable interest.

On December 22, 2014, Deutsche Bank National Trust Company, as indenture trustee for the AAA Trust 2007-2 Re-REMIC (the Trustee), filed a “trust instructional proceeding” petition in the State of California Superior Court (Probate Division, Orange County), seeking the court’s instruction as to how it should allocate the losses resulting from its December 2014 sale of four RMBS owned by the AAA Trust 2007-2 Re-REMIC. This sale of approximately $70 million principal balance of RMBS was made pursuant to AGC’s liquidation direction in November 2014, and resulted in approximately $27 million of gross proceeds to the Re-REMIC. On December 22, 2014, AGC directed the indenture trustee to allocate to the uninsured Class A-3 Notes the losses realized from the sale. On May 4, 2015, the Superior Court rejected AGC’s allocation direction, and ordered the Trustee to allocate to the Class A-3 noteholders a pro rata share of the $27 million of gross proceeds. AGC is appealing the Superior Court’s decision to the California Court of Appeal.

The Company also receives subpoenas duces tecum and interrogatories from regulators from time to time.

Proceedings Resolved Since December 31, 2016

On September 25, 2013, Wells Fargo Bank, N.A., as trust administrator of the MASTR Adjustable Rate Mortgages Trust 2007-3 (Wells Fargo), filed an interpleader complaint in the U.S. District Court for the Southern District of New York seeking adjudication of a dispute between Wales LLC (Wales) and AGM as to whether AGM is entitled to reimbursement from certain cashflows for principal claims paid in respect of insured certificates. After the court issued an opinion on September 30, 2016, denying a motion for judgment on the pleadings filed by Wales, Wales sold its interests in the MASTR Adjustable Rate Mortgage Trust 2007-3 certificates, and on March 20, 2017, the court dismissed the case.
 

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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 March 31, 2017
 
As of December 31, 2016
 
Principal

Carrying
Value

Principal

Carrying
Value
 
(in millions)
AGUS:
 


 


 


 

7% Senior Notes(1)
$
200

 
$
197


$
200

 
$
197

5% Senior Notes(1)
500


496

 
500

 
496

Series A Enhanced Junior Subordinated Debentures(2)
150

 
150


150

 
150

Total AGUS
850

 
843


850

 
843

AGMH(3):
 

 
 


 

 
 

67/8% QUIBS(1)
100

 
69


100

 
69

6.25% Notes(1)
230

 
141


230

 
141

5.6% Notes(1)
100

 
56


100

 
56

Junior Subordinated Debentures(2)
300

 
189


300

 
187

Total AGMH
730

 
455


730

 
453

AGM(3):
 

 
 


 

 
 

AGM Notes Payable
9

 
9


9

 
10

Total AGM
9

 
9

 
9

 
10

Total
$
1,589

 
$
1,307


$
1,589

 
$
1,306

 ____________________
(1)
AGL fully and unconditionally guarantees these obligations

(2)
Guaranteed by AGL on a junior subordinated basis.

(3)                               Carrying amounts are different than principal amounts due primarily to fair value adjustments at the AGMH acquisition date, which are accreted or amortized into interest expense over the remaining terms of these obligations.


Intercompany Credit Facility and Intercompany Debt

On October 25, 2013, AGL, as borrower, and AGUS, as lender, entered into a revolving credit facility pursuant to which AGL may, from time to time, borrow for general corporate purposes. Under the credit facility, AGUS committed to lend a principal amount not exceeding $225 million in the aggregate. Such commitment terminates on October 25, 2018 (the loan termination date). The unpaid principal amount of each loan will bear interest at a fixed rate equal to 100% of the then applicable Federal short-term or mid-term interest rate, as the case may be, as determined under Section 1274(d) of the Code, and interest on all loans will be computed for the actual number of days elapsed on the basis of a year consisting of 360 days. Accrued interest on all loans will be paid on the last day of each June and December, beginning on December 31, 2013, and at maturity.  AGL must repay the then unpaid principal amounts of the loans by the third anniversary of the loan termination date. No amounts are currently outstanding under the credit facility.

In addition, in 2012 AGUS borrowed $90 million from its affiliate AGRO to fund the acquisition of MAC. During 2016, AGUS repaid $20 million in outstanding principal as well as accrued and unpaid interest, and the parties agreed to extend the maturity date of the loan from May 2017 to November 2019. As of March 31, 2017, $70 million remained outstanding.


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Table of Contents

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 a vehicle for providing capital support to AGC by allowing AGC to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option. If the put options were exercised, AGC would receive $200 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. Distributions on the AGC CCS are determined pursuant to an auction process. Beginning 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.
 
In June 2003, $200 million of “AGM CPS”, money market preferred trust securities, were issued by trusts created for the primary purpose of issuing the AGM CPS, 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. 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 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 March 31, 2017 the put option had not been exercised.

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 EPS 

 
First Quarter
 
2017
 
2016
 
(in millions)
Basic EPS:
 
 
 
Net income (loss) attributable to AGL
$
317

 
$
59

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

 
1

Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic
$
317

 
$
58

Basic shares
125.3

 
136.2

Basic EPS
$
2.53

 
$
0.43

 
 
 
 
Diluted EPS:
 
 
 
Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic
$
317

 
$
58

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
$
317

 
$
58

 
 
 
 
Basic shares
125.3

 
136.2

Dilutive securities:
 
 
 
Options and restricted stock awards
1.8

 
0.8

Diluted shares
127.1

 
137.0

Diluted EPS
$
2.49

 
$
0.43

Potentially dilutive securities excluded from computation of EPS because of antidilutive effect
0.1

 
0.8




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17.
Shareholders' Equity

Other Comprehensive Income
 
The following tables present the changes in each component of AOCI and the effect of reclassifications out of AOCI on the respective line items in net income.

Changes in Accumulated Other Comprehensive Income by Component
First Quarter 2017

 
Net Unrealized
Gains (Losses) on
Investments with no Other-Than-Temporary Impairment
 
Net Unrealized
Gains (Losses) on
Investments with Other-Than-Temporary Impairment
 
Cumulative
Translation
Adjustment
 
Cash Flow 
Hedge
 
Total 
Accumulated
Other
Comprehensive
Income
 
(in millions)
Balance, December 31, 2016
$
171

 
$
10

 
$
(39
)
 
$
7

 
$
149

Other comprehensive income (loss) before reclassifications
44

 
50

 
2

 
—

 
96

Amounts reclassified from AOCI to:
 
 
 
 
 
 
 
 
 
Net realized investment gains (losses)
(41
)
 
9

 
—

 
—

 
(32
)
Net investment income
(28
)
 
—

 
—

 
—

 
(28
)
Interest expense
—

 
—

 
—

 
0

 
0

Total before tax
(69
)
 
9

 
—

 
0

 
(60
)
Tax (provision) benefit
24

 
(3
)
 
—

 
0

 
21

Total amount reclassified from AOCI, net of tax
(45
)
 
6

 
—

 
0

 
(39
)
Net current period other comprehensive income (loss)
(1
)
 
56

 
2

 
0

 
57

Balance, March 31, 2017
$
170

 
$
66

 
$
(37
)
 
$
7

 
$
206




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Changes in Accumulated Other Comprehensive Income by Component
First Quarter 2016

 
Net Unrealized
Gains (Losses) on
Investments with no Other-Than-Temporary Impairment
 
Net Unrealized
Gains (Losses) on
Investments with Other-Than-Temporary Impairment
 
Cumulative
Translation
Adjustment
 
Cash Flow 
Hedge
 
Total 
Accumulated
Other
Comprehensive
Income
 
(in millions)
Balance, December 31, 2015
$
260

 
$
(15
)
 
$
(16
)
 
$
8

 
$
237

Other comprehensive income (loss) before reclassifications
95

 
(17
)
 
(2
)
 
—

 
76

Amounts reclassified from AOCI to:
 
 
 
 
 
 
 
 


Net realized investment gains (losses)
(4
)
 
17

 
—

 
—

 
13

Net investment income
(3
)
 
—

 
—

 
—

 
(3
)
Interest expense
—

 
—

 
—

 
0

 
0

Total before tax
(7
)
 
17

 
—

 
0

 
10

Tax (provision) benefit
2

 
(6
)
 
—

 
0

 
(4
)
Total amount reclassified from AOCI, net of tax
(5
)
 
11

 
—

 
0

 
6

Net current period other comprehensive income (loss)
90

 
(6
)
 
(2
)
 
0

 
82

Balance, March 31, 2016
$
350

 
$
(21
)
 
$
(18
)
 
$
8

 
$
319



Share Repurchase

The following table presents share repurchases since January 2016.

Share Repurchases

Period
 
Number of Shares Repurchased
 
Total Payments(in millions)
 
Average Price Paid Per Share
2016 (January 1 - March 31)
 
3,038,928

 
$
75

 
$
24.69

2016 (April 1 - June 30)
 
2,331,474

 
60

 
25.73

2016 (July 1 - September 30)
 
2,050,229

 
55

 
26.83

2016 (October 1 - December 31, 2016)
 
3,300,617

 
116

 
35.09

Total 2016
 
10,721,248

 
306

 
28.53

2017 (January 1 - March 31)
 
5,430,041

 
216

 
39.83

2017 (April 1 - through May 4, 2017)
 
1,377,928

 
53

 
38.13

Total 2017
 
6,807,969

 
269

 
39.49

Cumulative repurchases since the beginning of 2013
 
75,451,176

 
1,984

 
26.29



On February 22, 2017, the Board of Directors (the Board) authorized an additional $300 million of share repurchases. The total remaining authorization was $280 million as of May 4, 2017. The Company expects to repurchase shares from time to time in the open market or in privately negotiated transactions. The timing, form and amount of the share repurchases under the program are at the discretion of management and will depend on a variety of factors, including funds available at the parent company, market conditions, the Company's capital position, legal requirements and other factors. The repurchase program may be modified, extended or terminated by the Board at any time. It does not have an expiration date.



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Deferred Compensation    
    
The Company used a portion of its share repurchase program to repurchase 297,131 common shares from its Chief Executive Officer and 23,062 common shares from its General Counsel on January 6, 2017. The shares were purchased at the closing price of a common share of the Company on the New York Stock Exchange on January 6, 2017. Separately, these officers also received 297,131 and 23,062 common shares, respectively, on January 6, 2017 in settlement of 297,131 share units and 23,062 share units held by them in the employer stock fund of the Assured Guaranty Ltd. Supplemental Employee Retirement Plan (the AGL SERP). The distribution of shares occurred in January 2017 pursuant to the terms of an amendment adopted in 2011 to the AGL SERP. Such amendment was adopted to comply with requirements of Section 409A of the Code and Section 457A of the Code, which required all grandfathered amounts (within the meaning of Section 457A of the Code), including the units in the employer stock fund in the AGL SERP, to be included in the income of the applicable participant no later than 2017.




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18.
Subsidiary Information
 
The following tables present the condensed consolidating financial information for AGUS and AGMH, 100%-owned subsidiaries of AGL, which have issued publicly traded debt securities (see Note 15, Long Term Debt and Credit Facilities). The information for AGL, AGUS and AGMH presents its subsidiaries on the equity method of accounting.
 
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF MARCH 31, 2017
(in millions)
 
 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
ASSETS
 

 
 

 
 

 
 

 
 

 
 

Total investment portfolio and cash
$
12

 
$
312

 
$
20

 
$
11,503

 
$
(359
)
 
$
11,488

Investment in subsidiaries
6,504

 
5,852

 
3,805

 
299

 
(16,460
)
 
—

Premiums receivable, net of commissions payable
—

 
—

 
—

 
1,008

 
(132
)
 
876

Ceded unearned premium reserve
—

 
—

 
—

 
1,074

 
(894
)
 
180

Deferred acquisition costs
—

 
—

 
—

 
155

 
(49
)
 
106

Reinsurance recoverable on unpaid losses
—

 
—

 
—

 
383

 
(309
)
 
74

Credit derivative assets
—

 
—

 
—

 
53

 
(44
)
 
9

Deferred tax asset, net
—

 
—

 
—

 
540

 
(102
)
 
438

Intercompany receivable
—

 
—

 
—

 
70

 
(70
)
 
—

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

 
—

 
—

 
781

 
—

 
781

Dividend receivable from affiliate
125

 
—

 
—

 
—

 
(125
)
 
—

Other
0

 
97

 
38

 
835

 
(247
)
 
723

TOTAL ASSETS
$
6,641

 
$
6,261

 
$
3,863

 
$
16,701

 
$
(18,791
)
 
$
14,675

LIABILITIES AND SHAREHOLDERS’ EQUITY
 

 
 

 
 

 
 

 
 

 
 

Unearned premium reserves
$
—

 
$
—

 
$
—

 
$
4,800

 
$
(973
)
 
$
3,827

Loss and LAE reserve
—

 
—

 
—

 
1,491

 
(298
)
 
1,193

Long-term debt
—

 
843

 
455

 
9

 
—

 
1,307

Intercompany payable
—

 
70

 
—

 
300

 
(370
)
 
—

Credit derivative liabilities
—

 
—

 
—

 
403

 
(44
)
 
359

Deferred tax liabilities, net
—

 
1

 
87

 
—

 
(88
)
 
—

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

 
—

 
—

 
855

 
—

 
855

Dividend payable to affiliate
—

 
125

 
—

 
—

 
(125
)
 
—

Other
4

 
20

 
26

 
857

 
(410
)
 
497

TOTAL LIABILITIES
4

 
1,059

 
568

 
8,715

 
(2,308
)
 
8,038

TOTAL SHAREHOLDERS’ EQUITY ATTRIBUTABLE TO ASSURED GUARANTY LTD.
6,637

 
5,202

 
3,295

 
7,687

 
(16,184
)
 
6,637

Noncontrolling interest
—

 
—

 
—

 
299

 
(299
)
 
—

TOTAL SHAREHOLDERS' EQUITY
6,637

 
5,202

 
3,295

 
7,986

 
(16,483
)
 
6,637

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
6,641

 
$
6,261

 
$
3,863

 
$
16,701

 
$
(18,791
)
 
$
14,675


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Table of Contents

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2016
(in millions)
 
 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
ASSETS
 

 
 

 
 

 
 

 
 

 
 

Total investment portfolio and cash
$
36

 
$
384

 
$
22

 
$
11,029

 
$
(368
)
 
$
11,103

Investment in subsidiaries
6,164

 
5,696

 
3,734

 
296

 
(15,890
)
 
—

Premiums receivable, net of commissions payable
—

 
—

 
—

 
699

 
(123
)
 
576

Ceded unearned premium reserve
—

 
—

 
—

 
1,099

 
(893
)
 
206

Deferred acquisition costs
—

 
—

 
—

 
156

 
(50
)
 
106

Reinsurance recoverable on unpaid losses
—

 
—

 
—

 
484

 
(404
)
 
80

Credit derivative assets
—

 
—

 
—

 
69

 
(56
)
 
13

Deferred tax asset, net
—

 
16

 
—

 
597

 
(116
)
 
497

Intercompany receivable
—

 
—

 
—

 
70

 
(70
)
 
—

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

 
—

 
—

 
876

 
—

 
876

Dividend receivable from affiliate
300


—


—


—

 
(300
)
 
—

Other
11

 
78

 
26

 
801

 
(222
)
 
694

TOTAL ASSETS
$
6,511

 
$
6,174

 
$
3,782

 
$
16,176

 
$
(18,492
)
 
$
14,151

LIABILITIES AND SHAREHOLDERS’ EQUITY
 

 
 

 
 

 
 

 
 

 
 

Unearned premium reserves
$
—

 
$
—

 
$
—

 
$
4,488

 
$
(977
)
 
$
3,511

Loss and LAE reserve
—

 
—

 
—

 
1,596

 
(469
)
 
1,127

Long-term debt
—

 
843

 
453

 
10

 
—

 
1,306

Intercompany payable
—

 
70

 
—

 
300

 
(370
)
 
—

Credit derivative liabilities
—

 
—

 
—

 
458

 
(56
)
 
402

Deferred tax liabilities, net
—

 
—

 
88

 
—

 
(88
)
 
—

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

 
—

 
—

 
958

 
—

 
958

Dividend payable to affiliate
—

 
300

 
—

 
—

 
(300
)
 
—

Other
7

 
3

 
14

 
665

 
(346
)
 
343

TOTAL LIABILITIES
7

 
1,216

 
555

 
8,475

 
(2,606
)
 
7,647

TOTAL SHAREHOLDERS’ EQUITY ATTRIBUTABLE TO ASSURED GUARANTY LTD.
6,504

 
4,958

 
3,227

 
7,405

 
(15,590
)
 
6,504

Noncontrolling interest
—

 
—

 
—

 
296

 
(296
)
 
—

TOTAL SHAREHOLDERS’ EQUITY
6,504

 
4,958

 
3,227

 
7,701

 
(15,886
)
 
6,504

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
6,511

 
$
6,174

 
$
3,782

 
$
16,176

 
$
(18,492
)
 
$
14,151

 

 


 



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Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2017
(in millions)

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

 
 

 
 

 
 

 
 

 
 

Net earned premiums
$
—

 
$
—

 
$
—

 
$
167

 
$
(3
)
 
$
164

Net investment income
0

 
0

 
0

 
123

 
(1
)
 
122

Net realized investment gains (losses)
—

 
0

 
0

 
32

 
0

 
32

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

 
—

 
—

 
15

 
0

 
15

Net unrealized gains (losses)
—

 
—

 
—

 
39

 
—

 
39

Net change in fair value of credit derivatives
—

 
—

 
—

 
54

 
0

 
54

Bargain purchase gain and settlement of pre-existing relationships
—

 
—

 
—

 
58

 
—

 
58

Other
3

 
—

 
—

 
142

 
(48
)
 
97

TOTAL REVENUES
3

 
0

 
0

 
576

 
(52
)
 
527

EXPENSES
 

 
 

 
 

 
 

 
 

 
 

Loss and LAE
—

 
—

 
—

 
11

 
48

 
59

Amortization of deferred acquisition costs
—

 
—

 
—

 
5

 
(1
)
 
4

Interest expense
—

 
12

 
13

 
2

 
(3
)
 
24

Other operating expenses
10

 
6

 
1

 
106

 
(55
)
 
68

TOTAL EXPENSES
10

 
18

 
14

 
124

 
(11
)
 
155

INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN NET EARNINGS OF SUBSIDIARIES
(7
)
 
(18
)
 
(14
)
 
452

 
(41
)
 
372

Total (provision) benefit for income taxes
—

 
6

 
5

 
(76
)
 
10

 
(55
)
Equity in net earnings of subsidiaries
324

 
199

 
115

 
8

 
(646
)
 
—

NET INCOME (LOSS)
$
317

 
$
187

 
$
106

 
$
384

 
$
(677
)
 
$
317

Less: noncontrolling interest
—

 
—

 
—

 
8

 
(8
)
 
—

NET INCOME (LOSS) ATTRIBUTABLE TO ASSURED GUARANTY LTD.
$
317

 
$
187

 
$
106

 
$
376

 
$
(669
)
 
$
317

 
 
 
 
 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME (LOSS)
$
374

 
$
244

 
$
141

 
$
437

 
$
(822
)
 
$
374


 

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Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2016
(in millions)

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

 
 

 
 

 
 

 
 

 
 

Net earned premiums
$
—

 
$
—

 
$
—

 
$
192

 
$
(9
)
 
$
183

Net investment income
0

 
0

 
0

 
100

 
(1
)
 
99

Net realized investment gains (losses)
0

 
—

 
—

 
(12
)
 
(1
)
 
(13
)
Net change in fair value of credit derivatives:
 
 
 
 
 
 
 
 
 
 
 
Realized gains (losses) and other settlements
—

 
—

 
—

 
8

 
0

 
8

Net unrealized gains (losses)
—

 
—

 
—

 
(68
)
 
—

 
(68
)
Net change in fair value of credit derivatives
—

 
—

 
—

 
(60
)
 
0

 
(60
)
Other
0

 
—

 
—

 
36

 
—

 
36

TOTAL REVENUES
0

 
0

 
0

 
256

 
(11
)
 
245

EXPENSES
 

 
 

 
 

 
 

 
 

 
 

Loss and LAE
—

 
—

 
—

 
93

 
(3
)
 
90

Amortization of deferred acquisition costs
—

 
—

 
—

 
7

 
(3
)
 
4

Interest expense
—

 
13

 
13

 
3

 
(3
)
 
26

Other operating expenses
8

 
0

 
1

 
52

 
(1
)
 
60

TOTAL EXPENSES
8

 
13

 
14

 
155

 
(10
)
 
180

INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN NET EARNINGS OF SUBSIDIARIES
(8
)
 
(13
)
 
(14
)
 
101

 
(1
)
 
65

Total (provision) benefit for income taxes
—

 
5

 
5

 
(16
)
 
0

 
(6
)
Equity in net earnings of subsidiaries
67

 
50

 
77

 
9

 
(203
)
 
—

NET INCOME (LOSS)
$
59

 
$
42

 
$
68

 
$
94

 
$
(204
)
 
$
59

Less: noncontrolling interest
—

 
—

 
—

 
9

 
(9
)
 
—

NET INCOME (LOSS) ATTRIBUTABLE TO ASSURED GUARANTY LTD.
$
59

 
$
42

 
$
68

 
$
85

 
$
(195
)
 
$
59

 
 
 
 
 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME (LOSS)
$
141

 
$
80

 
$
92

 
$
178

 
$
(350
)
 
$
141





88
Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2017
(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
$
220

 
$
105

 
$
72

 
$
105

 
$
(400
)
 
$
102

Cash flows from investing activities
 

 
 

 
 

 
 

 
 

 
 

Fixed-maturity securities:
 

 
 

 
 

 
 

 
 

 
 

Purchases
—

 
—

 
(5
)
 
(512
)
 
—

 
(517
)
Sales
—

 
—

 
2

 
321

 
—

 
323

Maturities
—

 
3

 
0

 
262

 
—

 
265

Sales (purchases) of short-term investments, net
25

 
75

 
5

 
(93
)
 
—

 
12

Net proceeds from financial guaranty variable entities’ assets
—

 
—

 
—

 
46

 
—

 
46

Investment in subsidiary
—

 
(3
)
 
—

 
—

 
3

 
—

Acquisition of MBIA UK, net of cash acquired
—

 
—

 
—

 
95

 
—

 
95

Other
—

 
—

 
—

 
(13
)
 
—

 
(13
)
Net cash flows provided by (used in) investing activities
25

 
75

 
2

 
106

 
3

 
211

Cash flows from financing activities
 

 
 

 
 

 
 

 
 

 
 

Capital contribution
—

 
—

 
—

 
3

 
(3
)
 
—

Dividends paid
(19
)
 
(175
)
 
(73
)
 
(152
)
 
400

 
(19
)
Repurchases of common stock
(216
)
 
—

 
—

 
—

 
—

 
(216
)
Repurchases of common stock to pay withholding taxes
(12
)
 
—

 
—

 
—

 
—

 
(12
)
Net paydowns of financial guaranty variable entities’ liabilities
—

 
—

 
—

 
(48
)
 
—

 
(48
)
Payment of long-term debt
—

 
—

 
—

 
(1
)
 
—

 
(1
)
Proceeds from options exercises
2

 
—

 
—

 
—

 
—

 
2

Net cash flows provided by (used in) financing activities
(245
)
 
(175
)
 
(73
)
 
(198
)
 
397

 
(294
)
Effect of exchange rate changes
—

 
—

 
—

 
2

 
—

 
2

Increase (decrease) in cash and restricted cash
—

 
5

 
1

 
15

 
—

 
21

Cash and restricted cash at beginning of period
0

 
1

 
0

 
126

 
—

 
127

Cash and restricted cash at end of period
$
0

 
$
6

 
$
1

 
$
141

 
$
—

 
$
148


 

89
Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2016
(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
$
166

 
$
17

 
$
88

 
$
(74
)
 
$
(287
)
 
$
(90
)
Cash flows from investing activities
 

 
 

 
 

 
 

 
 

 
 

Fixed-maturity securities:
 

 
 

 
 

 
 

 
 

 
 

Purchases
(4
)
 
(11
)
 
—

 
(281
)
 
—

 
(296
)
Sales
1

 
—

 
—

 
161

 
—

 
162

Maturities
—

 
—

 
—

 
301

 
—

 
301

Sales (purchases) of short-term investments, net
(69
)
 
11

 
—

 
(5
)
 
—

 
(63
)
Net proceeds from financial guaranty variable entities’ assets
—

 
—

 
—

 
66

 
—

 
66

Investment in subsidiary
—

 
—

 
—

 
—

 
—

 
—

Other
—

 
—

 
—

 
2

 
—

 
2

Net cash flows provided by (used in) investing activities
(72
)
 
0

 
—

 
244

 
—

 
172

Cash flows from financing activities
 

 
 

 
 

 
 

 
 

 
 
Return of capital
—

 
—

 
—

 
—

 
—

 
—

Dividends paid
(18
)
 
(80
)
 
(87
)
 
(120
)
 
287

 
(18
)
Repurchases of common stock
(75
)
 
—

 
—

 
—

 
—

 
(75
)
Repurchases of common stock to pay withholding taxes
(2
)
 
—

 
—

 
—

 
—

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

 
—

 
—

 
(42
)
 
—

 
(42
)
Payment of long-term debt
—

 
—

 
—

 
0

 
—

 
0

Proceeds from options exercises
1


—

 
—

 
—

 
—

 
1

Net cash flows provided by (used in) financing activities
(94
)
 
(80
)
 
(87
)
 
(162
)
 
287

 
(136
)
Effect of exchange rate changes
—

 
—

 
—

 
0

 
—

 
0

Increase (decrease) in cash and restricted cash
—

 
(63
)
 
1

 
8

 
—

 
(54
)
Cash and restricted cash at beginning of period
0

 
95

 
8

 
63

 
—

 
166

Cash and restricted cash at end of period
$
0

 
$
32

 
$
9

 
$
71

 
$
—

 
$
112





90
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 its subsidiaries (collectively with AGL, 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 adversely are:

•
reduction in the amount of available insurance opportunities and/or in the demand for Assured Guaranty's insurance;
•
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 AGL or any of its subsidiaries, and/or of any securities AGL or any of its subsidiaries have issued, and/or of transactions that AGL's subsidiaries have insured;
•
developments in the world’s financial and capital markets that adversely affect obligors’ payment rates, Assured Guaranty’s loss experience, or its exposure to refinancing risk in transactions (which could result in substantial liquidity claims on its guarantees);
•
the possibility that budget or pension shortfalls or other factors will result in credit losses or impairments on obligations of state, territorial and local governments and their related authorities and public corporations that Assured Guaranty insures or reinsures;
•
the failure of Assured Guaranty to realize loss recoveries that are assumed in its expected loss estimates;
•
increased competition, including from new entrants into the financial guaranty industry;
•
rating agency action on obligors, including sovereign debtors, resulting in a reduction in the value of securities in Assured Guaranty’s investment portfolio and in collateral posted by and to Assured Guaranty;
•
the inability of Assured Guaranty to access external sources of capital on acceptable terms;
•
changes in the world’s credit markets, segments thereof, interest rates or general economic conditions;
•
the impact of market volatility on the mark-to-market of Assured Guaranty’s contracts written in credit default swap form;
•
changes in applicable accounting policies or practices;
•
changes in applicable laws or regulations, including insurance, bankruptcy and tax laws, or other governmental actions;
•
the impact of changes in the world’s economy and credit and currency markets and in applicable laws or regulations relating to the decision of the United Kingdom to exit the European Union;
•
the possibility that acquisitions or alternative investments made by Assured Guaranty do not result in the benefits anticipated or subject Assured Guaranty to unanticipated consequences;
•
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;
•
difficulties with the execution of Assured Guaranty’s business strategy;
•
loss of key personnel;

91
Table of Contents

•
the effects of mergers, acquisitions and divestitures;
•
natural or man-made catastrophes;
•
other risk factors identified in AGL’s filings with the U.S. Securities and Exchange Commission (the SEC);
•
other risks and uncertainties that have not been identified at this time; and
•
management’s response to these factors.
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, as well as the risk factors included in AGL's 2016 Annual Report on Form 10-K. 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).

Available Information
 
The Company maintains an Internet web site at www.assuredguaranty.com. The Company makes available, free of charge, on its web site (under assuredguaranty.com/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 (under assuredguaranty.com/governance) links to the Company's Corporate Governance Guidelines, its Code of Conduct, AGL's Bye-Laws and the charters for its Board committees.

The Company routinely posts important information for investors on its web site (under assuredguaranty.com/company-statements and, more generally, under the Investor Information and Businesses pages). The Company uses this web site as a means of disclosing material information and for complying with its disclosure obligations under SEC Regulation FD (Fair Disclosure). Accordingly, investors should monitor the Company Statements, Investor Information and Businesses portions 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 AGL's 2016 Annual Report on Form 10-K.


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Economic Environment

Many of the positive overall economic trends observed in 2016 in the United States (U.S.) carried over into the three-month period ended March 31, 2017 (First Quarter 2017). According to the U.S. Bureau of Labor Statistics (BLS), for the months of January, February and March 2017, the U.S. economy added an estimated 560 thousand jobs. Additionally, the estimated seasonally adjusted monthly unemployment rate fell to 4.5% in March 2017 from 4.7% in December 2016, a relatively low rate compared to such rate as tracked by the BLS over the past several decades.

U.S. home prices also continued to rise, as measured by the S&P CoreLogic Case-Shiller U.S. National Home Price Index, which was up 5.9% over the 12 months ended January 2017.

Real GDP increased at an annual rate of 0.7% in the First Quarter 2017. This represents the twelfth consecutive quarter of positive growth in real GDP.
 
On March 15, 2017, the Federal Open Market Committee (FOMC) increased the target range for the federal funds rate by 25 basis points to between 0.75% and 1.00%, and reiterated its prior position that three rate increases in 2017 would be likely. In its statement, the FOMC pointed to a strengthened labor market, expanded economic activity, a rise in household spending, and stabilization in business investment as the primary drivers to this increase in the federal funds rate. This positive view of the U.S. market was reflected in rising stock prices during the quarter. The Dow Jones Industrial Average and the S&P 500 Index increased nearly 5% and 6%, respectively, reaching all-time record levels, and the New York Stock Exchange Financials Index was up nearly 4%, reaching a level not seen since 2008.

Average municipal interest rates continued to increase from the historic lows experienced in 2016, during which 30-year AAA MMD rates were at times below 2%. Since July 2016, the 30-year AAA MMD rate increased from a low of 1.95% to 3.05% on March 31, 2017.

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Financial Performance of Assured Guaranty

Financial Results
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Net income (loss)
$
317

 
$
59

Operating income (non-GAAP)(1)
273

 
123

Gain (loss) related to the effect of consolidating FG VIEs (FG VIE consolidation) included in operating income
5

 
10

 
 
 
 
Net income (loss) per diluted share
$
2.49

 
$
0.43

Operating income per share (non-GAAP)(1)
2.14

 
0.89

Gain (loss) related to FG VIE consolidation included in operating income per share
0.03

 
0.07

 
 
 
 
Diluted shares
127.1

 
137.0

 
 
 
 
Gross written premiums (GWP)
$
111

 
$
19

Present value of new business production (PVP)(1)
99

 
38

Gross par written
4,691

 
2,749

 
As of March 31, 2017
 
As of December 31, 2016
 
Amount
 
Per Share
 
Amount
 
Per Share
 
(in millions, except per share amounts)
Shareholders' equity
$
6,637

 
$
53.95

 
$
6,504

 
$
50.82

Non-GAAP operating shareholders' equity(1)
6,460

 
52.51

 
6,386

 
49.89

Non-GAAP adjusted book value(1)
8,798

 
71.51

 
8,506

 
66.46

Gain (loss) related to FG VIE consolidation included in non-GAAP operating shareholders' equity
(3
)
 
(0.03
)
 
(7
)
 
(0.06
)
Gain (loss) related to FG VIE consolidation included in non-GAAP adjusted book value
(20
)
 
(0.16
)
 
(24
)
 
(0.18
)
Common shares outstanding (2)
123.0

 
 
 
128.0

 
 
____________________
(1)
Please refer to “—Non-GAAP Financial Measures” for a definition of the financial measures that were not determined in accordance with accounting principles generally accepted in the United States of America (GAAP) and a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP measure, if available. Please note that the Company changed its definition of Operating Income (non-GAAP), Non-GAAP Operating Shareholders' Equity and Non-GAAP Adjusted Book Value starting in fourth quarter 2016 in response to new non-GAAP guidance issued by the SEC in 2016. Please refer to “—Non-GAAP Financial Measures” for additional details.
 
(2)
Please refer to "Key Business Strategies – Capital Management" below for information on common share repurchases.


First Quarter 2017

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


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Net income for First Quarter 2017 was $317 million compared with $59 million in First Quarter 2016. The increase was due primarily to the acquisition of MBIA UK Insurance Limited (MBIA UK Acquisition), the gain on the commutation of a portfolio of previously ceded business from one of the Company's reinsurers, and fair value gains on credit derivatives in First Quarter 2017 compared with fair value losses in First Quarter 2016.

The Company reported operating income (non-GAAP) of $273 million in First Quarter 2017, compared with $123 million in First Quarter 2016. The increase in operating income was primarily due to MBIA UK Acquisition, the gain on the commutation of a portfolio of previously ceded business from one of the Company's reinsurers, and lower operating loss and loss adjustment expenses (LAE).

Shareholders' equity increased since December 31, 2016 due primarily to positive net income (including the effect of MBIA UK Acquisition) and higher net unrealized gains on available for investment securities recorded in AOCI, partially offset by share repurchases and dividends. Non-GAAP operating shareholders' equity and non-GAAP adjusted book value also increased since December 31, 2016 due to the MBIA UK Acquisition and new business production, offset in part by share repurchases and dividends. Shareholders' equity per share, non-GAAP operating shareholders' equity per share and non-GAAP adjusted book value per share also benefited from the repurchase of 5.4 million common shares in First Quarter 2017.

Key Business Strategies
 
The Company continually evaluates its business strategies. Currently, the Company is pursuing the following business strategies, each described in more detail below:

•
New business production
•
Capital management
•
Alternative strategies to create value, including through acquisitions, investments and commutations
•
Loss mitigation

New Business Production

The Company believes high-profile defaults by municipal obligors, such as the Commonwealth of Puerto Rico, Detroit, Michigan and Stockton, California have led to increased awareness of the value of bond insurance and stimulated demand for the product. The Company believes there will be continued demand for its insurance in this market because, for those exposures that the Company guarantees, it undertakes the tasks of credit selection, analysis, negotiation of terms, surveillance and, if necessary, loss mitigation. The Company believes that its insurance:

•
encourages retail investors, who typically have fewer resources than the Company for analyzing municipal bonds, to purchase such bonds;
•
enables institutional investors to operate more efficiently; and
•
allows smaller, less well-known issuers to gain market access on a more cost-effective basis.

On the other hand, the persistently low interest rate environment has dampened demand for bond insurance and, after a number of years in which the Company was essentially the only financial guarantor, there are now two other financial guarantors active in one of its markets.


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U.S. Municipal Market Data and Penetration Rates (1)
Based on Sale Date
 
 
First Quarter 2017
 
First Quarter 2016
 
Year Ended December 31, 2016
 
(dollars in billions, except number of issues and percent)
Par:
 
 
 
 
 
New municipal bonds issued
$
86.6

 
$
96.5

 
$
423.7

Total insured
$
5.2

 
$
5.7

 
$
25.3

Insured by Assured Guaranty
$
2.9

 
$
3.0

 
$
14.2

Number of issues:
 
 
 
 
 
New municipal bonds issued
2,271

 
2,787

 
12,271

Total insured
377

 
430

 
1,889

Insured by Assured Guaranty
181

 
198

 
904

Market penetration based on:
 
 
 
 
 
Par
6.0
%
 
5.9
%
 
6.0
%
Number of issues
16.6
%
 
15.4
%
 
15.4
%
Single A par sold
28.4
%
 
28.0
%
 
22.6
%
Single A transactions sold
61.6
%
 
58.7
%
 
55.8
%
$25 million and under par sold
19.5
%
 
17.7
%
 
17.8
%
$25 million and under transactions sold
19.5
%
 
17.7
%
 
17.5
%
____________________
(1)    Source: Thomson Reuters.

    

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New Business Production

 
First Quarter
 
2017
 
2016
 
(in millions)
Gross Written Premiums
 
 
 
Public Finance—U.S.
$
51

 
$
15

Public Finance—non-U.S.
58

 
8

Structured Finance—U.S.
1

 
(3
)
Structured Finance—non-U.S.
1

 
(1
)
Total gross written premiums
$
111

 
$
19

 
 
 
 
PVP (1):
 
 
 
Public Finance—U.S.
$
52

 
$
31

Public Finance—non-U.S.
40

 
7

Structured Finance—U.S. (2)
5

 
0

Structured Finance—non-U.S.
2

 
—

Total PVP
$
99

 
$
38

Gross Par Written:
 
 
 
Public Finance—U.S.
$
3,430

 
$
2,749

Public Finance—non-U.S.
990

 
—

Structured Finance—U.S. (2)
243

 
—

Structured Finance—non-U.S.
28

 
—

Total gross par written
$
4,691

 
$
2,749

____________________
(1)
PVP and Gross Par Written in the table above are based on "close date," when the transaction settles. See “– Non-GAAP Financial Measures – PVP or Present Value of New Business Production.”
    
(2)    Includes a capital relief triple-X excess of loss life reinsurance transaction written in 2017.
    
GWP include amounts collected in the current year on upfront new business written, the present value of contractual or expected premiums on new business written (discounted at risk free rates), and the effects of changes in the estimated lives of transactions in the inforce book of business. The increase in GWP to $111 million in First Quarter 2017 from $19 million in First Quarter 2016, was due primarily to new business production as described below. The difference between GWP and PVP relates primarily to the difference in discount rates used in the calculation of PVP compared with GWP and the inclusion in GWP of the effects of changes in the remaining lives of transactions in the existing insured portfolio.

U.S. public finance PVP increased in First Quarter 2017 compared with the comparable prior year period due to higher par written in both the primary and secondary market, including one large U.S. infrastructure transaction. During First Quarter 2017, Assured Guaranty once again guaranteed the majority of insured par issued and maintained an A- average rating on new business written.

U.S. structured finance PVP in First Quarter 2017 represents additional premiums related to an increase in exposure on an existing capital relief triple-X excess-of-loss life reinsurance transaction. Structured finance transactions tend to have long lead times and may vary from period to period. In general, the Company expects that structured finance opportunities will increase in the future as the global economy recovers, interest rates rise, more issuers return to the capital markets for financings and institutional investors again utilize financial guaranties. The Company considers its involvement in both structured finance and international infrastructure transactions to be beneficial because such transactions diversify both the Company's business opportunities and its risk profile beyond U.S. public finance.

Outside the U.S., the Company generated $40 million of public finance PVP in First Quarter 2017 compared with $7 million of PVP in First Quarter 2016. In First Quarter 2017, the Company guaranteed two university housing transactions and one hospital refinancing transaction, as well as several secondary market transactions. The Company’s financial guaranty product is competitive compared to other financing options in certain segments of the infrastructure market.  Future business activity will be influenced by the typically long lead times for these types of transactions.

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Capital Management

In recent years, the Company has developed strategies to manage capital within the Assured Guaranty group more efficiently.

In 2016, Assured Guaranty Municipal Corp. (AGM) sought and received approval from the New York State Department of Financial Services to repurchase $300 million of its common stock from its parent, Assured Guaranty Municipal Holdings Inc. (AGMH). The repurchase was effectuated on December 19, 2016. Subsequently, AGMH distributed the proceeds as dividends to its immediate parent, Assured Guaranty US Holdings Inc. (AGUS), and in 2017, AGUS began using these proceeds to pay dividends to AGL. AGL intends to use these funds predominantly to repurchase its publicly traded common shares. See Part I, Item 1, Financial Statements, Note 11, Insurance Company Regulatory Requirements, for additional information about dividends the Company's insurance companies may and have paid.

From 2013 through May 4, 2017, the Company has repurchased 75.4 million common shares for approximately $1,984 million, excluding commissions. On February 22, 2017, the Board of Directors authorized an additional $300 million in share repurchases. As of May 4, 2017, $280 million remains under the Company's share repurchase authorizations. The Company expects the repurchases to be made from time to time in the open market or in privately negotiated transactions. The timing, form and amount of the share repurchases under the program are at the discretion of management and will depend on a variety of factors, including free funds available at the parent company, market conditions, the Company's capital position, legal requirements and other factors. The repurchase program may be modified, extended or terminated by the Board at any time. It does not have an expiration date. See Part I, Item 1, Financial Statements, Note 17, Shareholders' Equity, for additional information about the Company's repurchases of its common shares.

Summary of Share Repurchases

 
Amount
 
Number of Shares
 
Average price per share
 
(in millions, except per share data)
2013
$
264

 
12.5

 
$
21.12

2014
590

 
24.4

 
24.17

2015
555

 
21.0

 
26.43

2016
306

 
10.7

 
28.53

2017 (January 1 - March 31)
216

 
5.4

 
39.83

2017 (April 1 through May 4, 2017)
53

 
1.4

 
38.13

Cumulative repurchases since the beginning of 2013
$
1,984

 
75.4

 
$
26.29



Accretive Effect of Cumulative Repurchases (1)

 
First Quarter 2017
 
As of March 31, 2017
 
(per share)
Net income
$
0.84

 
 
Operating income (non-GAAP)
0.71

 
 
Shareholders' equity
 
 
$
10.37

Non-GAAP operating shareholders' equity
 
 
9.83

Non-GAAP adjusted book value
 
 
16.97

_________________
(1)
Cumulative repurchases since the beginning of 2013.

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 disproportionately large rating agency

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capital charge. The Company terminated investment grade financial guaranty and credit default swap (CDS) contracts with net par of $167 million and $1.9 billion in First Quarter 2017 and First Quarter 2016, respectively.

Alternative Strategies

The Company considers alternative strategies in order to create long-term shareholder value. For example, the Company considers opportunities to acquire financial guaranty portfolios, whether by acquiring financial guarantors who are no longer actively writing new business or their insured portfolios, or by commuting business that it had previously ceded. These transactions enable the Company to improve its future earnings and deploy some of its excess capital. In 2016, the Company established an alternative investments group to focus on deploying a portion of the Company's excess capital to pursue acquisitions and develop new business opportunities that complement the Company's financial guaranty business, are in line with its risk profile and benefit from its core competencies.

MBIA UK Insurance Limited. On January 10, 2017 (the MBIA UK Acquisition Date), AGC completed its acquisition of MBIA UK. Please refer to Part I, Item I, Financial Statements, Note 2, Acquisitions, for additional information. In First Quarter 2017, the acquisition contributed net income of approximately $0.73 per share including the bargain purchase gain, gain on settlement of pre-existing relationships, realized gain on Zohar II Notes, and activity since the MBIA UK Acquisition Date. The effect on operating income was approximately $0.48 per share. Shareholders' equity and non-GAAP operating shareholders' equity benefited by $0.65 per share and non-GAAP adjusted book value benefited by $2.52 per share as of the MBIA UK Acquisition Date.

    MBIA UK has changed its name to Assured Guaranty (London) Ltd. (AGLN). Assured Guaranty currently maintains AGLN as a stand-alone entity, but is actively working to combine AGLN with its other affiliated European insurance companies. Any such combination will be subject to regulatory and court approvals; as a result, Assured Guaranty cannot predict when, or if, such a combination will be completed.

CIFG Holding Inc. On July 1, 2016, AGC acquired all of the issued and outstanding capital stock of CIFG Holding Inc., for $450.6 million in cash that contributed $2.23 per share to shareholder's equity, $2.23 per share to non-GAAP operating shareholder's equity and $3.85 per share to non-GAAP adjusted book value at the date of acquisition. Please refer to Part II, Item 8, "Financial Statements and Supplementary Data", Note 2, Acquisitions, of the Company's 2016 Annual Report on Form 10-K, for additional information.

Alternative Investments. The alternative investments group has been investigating a number of new business opportunities that complement the Company's financial guaranty business, are in line with its risk profile and benefit from its core competencies, including, among others, both controlling and non-controlling investments in investment managers. In February 2017 the Company agreed to purchase up to $100 million of limited partnership interests in a fund that invests in the equity of private equity managers. The Company continues to investigate additional opportunities.

Commutations. The Company commuted a previously ceded book of business with $1.0 billion in par from one of its reinsurers in First Quarter 2017 that resulted in gains of $73 million (recorded in other income) and additional net unearned premium reserve of $18 million. The reassumed book of business included $150 million in par in Puerto Rico. The Company may in the future enter into new commutation agreements reassuming portions of its remaining ceded business.

Loss Mitigation
    
In an effort to avoid or reduce potential losses in its insurance portfolios, the Company employs a number of strategies.
    
In the public finance area, the Company believes that its experience and the resources it is prepared to deploy, as well as its ability to provide bond insurance or other contributions as part of a solution, have resulted in more favorable outcomes in distressed public finance situations than would have been the case without its participation, as illustrated, for example, by the Company's role in the Detroit, Michigan; Stockton, California; and Jefferson County, Alabama financial crises. Currently, the Company is an active participant in discussions with the Commonwealth of Puerto Rico and its advisors with respect to a number of Puerto Rico credits. For example, on December 24, 2015, AGC and AGM entered into a Restructuring Support Agreement (RSA) with Puerto Rico Electric Power Authority (PREPA), an ad hoc group of uninsured bondholders and a group of fuel-line lenders that would, subject to certain conditions, result in, among other things, modernization of the utility and a restructuring of current debt. Legislation meeting the requirements of the RSA was enacted on February 16, 2016, and a transition charge to be paid by PREPA rate payers for debt service on the securitization bonds as contemplated by the RSA was approved by the Puerto Rico Energy Commission on June 20, 2016. The closing of the restructuring transaction and the

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issuance of the surety bonds are subject to certain conditions, including execution of acceptable documentation and legal opinions. There can be no assurance that the conditions in the RSA will be met or that, if the conditions are met, the RSA's other provisions, including those related to the restructuring of the insured PREPA revenue bonds, will be implemented as currently agreed. In addition, there also can be no assurance that the negotiations with respect to other Puerto Rico credits will result in agreements on consensual recovery plans. There have been a number of developments with respect to Puerto Rico since the RSA was first signed December 2015, but the RSA, as supplemented, remains effective. The Company will also, where appropriate, pursue litigation to enforce its rights, as it has done in Puerto Rico. For more information about developments in Puerto Rico, see Part I, Item 1, Financial Statements, Note 4, Outstanding Exposure.

The Company is currently working with the servicers of some of the residential mortgage-backed securities (RMBS) it insures to encourage the servicers to provide alternatives to distressed borrowers that will encourage them to continue making payments on their loans and so improve the performance of the related RMBS. Many of the home equity lines of credit (HELOC) loans underlying the HELOC RMBS have entered or are entering their amortization periods, which results in material increases to the size of the monthly payments the borrowers are required to make.

    The Company also continues to purchase attractively priced obligations, including below-investment-grade (BIG) obligations, that it has insured and for which it has expected losses to be paid, in order to mitigate the economic effect of insured losses (loss mitigation securities). The fair value of assets purchased for loss mitigation purposes as of March 31, 2017 (excluding the value of the Company's insurance) was $1,004 million, with a par of $1,717 million (including bonds related to FG VIEs of $47 million in fair value and $233 million in par).

In some instances, the terms of the Company's policy gives it the option to pay principal on an accelerated basis on an obligation on which it has paid a claim, thereby reducing the amount of guaranteed interest due in the future. The Company has at times exercised this option, which uses cash but reduces projected future losses.

In an effort to recover losses the Company experienced in its insured U.S. RMBS portfolio, the Company also continues to pursue providers of representations and warranties (R&W) by enforcing R&W provisions in contracts, negotiating agreements with R&W providers relating to those provisions and, where appropriate, pursuing litigation against R&W providers. See Part I, Item 1, Financial Statements, Note 5, Expected Loss to be Paid, for additional information.

Other Events

The Company continues to monitor developments related to the referendum held in the United Kingdom (U.K.) on June 23, 2016, in which a majority voted to exit the European Union, known as "Brexit", and the U.K.’s service of formal notice on March 29, 2017 to the European Council of its wish to withdraw under Article 50 of the Treaty on European Union. The Company may take action in anticipation of or in reaction to Brexit-related developments. The Company cannot predict the direction Brexit-related developments will take nor the impact of those developments on the economies of the markets the Company serves.

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, fair value estimates, other-than-temporary impairment, 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 is of critical importance to understanding its consolidated financial statements. See Part II, Item 8. “Financial Statements and Supplementary Data” of the Company's 2016 Annual Report on Form 10-K for a discussion of the significant accounting policies, the loss estimation process, and the fair value methodologies.

The Company carries a significant amount of its assets and a portion of its liabilities at fair value, the majority of which are measured at fair value on a recurring basis.  Level 3 assets, consisting primarily of FG VIE assets, credit derivative assets and investments, represented approximately 16% and 19% of the total assets that are measured at fair value on a

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recurring basis as of March 31, 2017 and December 31, 2016, respectively. All of the Company's liabilities that are measured at fair value are Level 3. See Part I, Item 1, Financial Statements, Note 7, Fair Value Measurement, for additional information about assets and liabilities classified as Level 3.

Consolidated Results of Operations

Consolidated Results of Operations
 
 
Three Months Ended March 31,
 
2017

2016
 
(in millions)
Revenues:
 
 
 
Net earned premiums
$
164

 
$
183

Net investment income
122

 
99

Net realized investment gains (losses)
32

 
(13
)
Net change in fair value of credit derivatives:
 
 
 
Realized gains (losses) and other settlements
15

 
8

Net unrealized gains (losses)
39

 
(68
)
     Net change in fair value of credit derivatives
54

 
(60
)
Fair value gains (losses) on CCS
(2
)
 
(16
)
Fair value gains (losses) on FG VIEs
10

 
18

Bargain purchase gain and settlement of pre-existing relationships
58

 
—

Other income (loss)
89

 
34

Total revenues
527

 
245

Expenses:
 
 
 
Loss and LAE
59

 
90

Amortization of deferred acquisition costs
4

 
4

Interest expense
24

 
26

Other operating expenses
68

 
60

Total expenses
155

 
180

Income (loss) before provision for income taxes
372

 
65

Provision (benefit) for income taxes
55

 
6

Net income (loss)
$
317

 
$
59



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Net Earned Premiums
 
Net earned premiums are recognized over the contractual lives, or in the case of homogeneous pools of insured obligations, the remaining expected lives, of financial guaranty insurance contracts. The Company estimates remaining expected lives of its insured obligations and makes prospective adjustments for such changes in expected lives. Scheduled net earned premiums are expected to decrease each year unless replaced by a higher amount of new business, reassumptions of previously ceded business or books of business acquired in a business combination. See Part I, Item 1, Financial Statements, Note 6, Contracts Accounted for as Insurance, Financial Guaranty Insurance Premiums, for additional information and the expected timing of future premium earnings.
 
Net Earned Premiums
 
 
First Quarter
 
2017

2016
 
(in millions)
Financial guaranty insurance:
 
 
 
Public finance
 
 
 
Scheduled net earned premiums and accretion
$
83

 
$
69

Accelerations:
 
 
 
Refundings
56

 
79

Terminations
0

 
0

Total accelerations
56

 
79

Total Public finance
139

 
148

Structured finance(1)
 
 
 
Scheduled net earned premiums and accretion
23

 
25

Terminations
2

 
10

Total structured finance
25

 
35

Other
0

 
0

Total net earned premiums
$
164

 
$
183

____________________
(1)
Excludes $4 million and $5 million for First Quarter 2017 and 2016, respectively, related to consolidated FG VIEs.

Net earned premiums decreased in First Quarter 2017 compared with First Quarter 2016 due primarily to lower accelerations, offset in part by higher net earned premiums related to recent acquisitions. At March 31, 2017, $3.7 billion of net deferred premium revenue remained to be earned over the life of the insurance contracts. The MBIA UK Acquisition increased deferred premium revenue by $383 million at the date of the acquisition.

The change in net earned premiums due to accelerations is attributable to changes in the expected lives of insured obligations driven by (a) refundings of insured obligations or (b) terminations of insured obligations either through negotiated agreements or the exercise of our contractual rights to make claim payments on an accelerated basis.
    
Refundings occur in the public finance market and have been at historically high levels in recent years due primarily to the low interest rate environment, which has allowed many municipalities and other public finance issuers to refinance their debt obligations at lower rates. The premiums associated with the insured obligations of municipalities and other public finance issuers are generally received upfront when the obligations are issued and insured. When such issuers pay down insured obligations prior to their originally scheduled maturities, the Company is no longer on risk for payment defaults, and therefore accelerates the recognition of the nonrefundable unearned premiums remaining from the original upfront payment.
    
Terminations are generally negotiated agreements with issuers resulting in the extinguishment of the Company’s insurance obligation with respect to the insured obligations. Terminations are more common in the structured finance asset class, but may also occur in the public finance asset class. While each termination may have different terms, they all result in the expiration of the Company’s insurance risk, such that the Company accelerates the recognition of the associated unearned premiums.

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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.

Net Investment Income (1)

 
First Quarter
 
2017
 
2016
 
(in millions)
Income from fixed-maturity securities managed by third parties
$
75

 
$
79

Income from internally managed securities:
 
 
 
Fixed maturities
46

 
17

Other
3

 
5

Gross investment income
124

 
101

Investment expenses
(2
)
 
(2
)
Net investment income
$
122

 
$
99

____________________
(1)
Net investment income excludes $1 million and $5 million for First Quarter 2017 and 2016, respectively, related to securities in the investment portfolio owned by AGC and AGM that were issued by consolidated FG VIEs.

Net investment income for First Quarter 2017 increased compared to First Quarter 2016 due primarily to the accretion on the Zohar II 2005-1 (the Zohar II Notes) (which was used as consideration for the purchase of MBIA UK) prior to the MBIA UK Acquisition Date.

The overall pre-tax book yield was 3.52% as of March 31, 2017 and 3.65% as of March 31, 2016, respectively. Excluding the internally managed portfolio, pre-tax book yield was 3.16% as of March 31, 2017 compared with 3.45% as of March 31, 2016. The decline in yield was primarily a result of lower yielding assets in the acquired MBIA UK investment portfolio.

Net Realized Investment Gains (Losses)

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

Net Realized Investment Gains (Losses)
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Gross realized gains on available-for-sale securities
$
43

 
$
6

Gross realized losses on available-for-sale securities
(2
)
 
(2
)
Net realized gains (losses) on other invested assets
0

 
(1
)
Other-than-temporary impairment
(9
)
 
(16
)
Net realized investment gains (losses)
$
32

 
$
(13
)

    
Realized gains in First Quarter 2017 comprise primarily the gain on sale of the Zohar II Notes exchanged in the MBIA UK Acquisition. Other-than-temporary-impairments in First Quarter 2017 and 2016 were primarily attributable to securities purchased for loss mitigation purposes.


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Bargain Purchase Gain and Settlement of Pre-existing Relationships 

In connection with the MBIA UK Acquisition in First Quarter 2017, the Company recognized a $56 million bargain purchase gain and a $2 million gain on settlement of pre-existing relationships. See Part I, Item 1, Financial Statements, Note 2, Acquisitions, for additional information.

Other Income (Loss)
 
Other income (loss) comprises recurring items such as foreign exchange remeasurement gains and losses, ancillary fees on financial guaranty policies such as commitment and consent, and if applicable, other revenue items on financial guaranty insurance and reinsurance contracts such as commutation gains on re-assumptions of previously ceded business, loss mitigation recoveries and certain non-recurring items.
            
Other Income (Loss)

 
First Quarter
 
2017
 
2016
 
(in millions)
Foreign exchange gain (loss) on remeasurement of premium receivable and loss reserves
$
10

 
$
(2
)
Commutation gains
73

 
—

Other
6

 
36

Total other income (loss)
$
89

 
$
34


In First Quarter 2017, other income primarily comprise a commutation gain on the reassumption of previously ceded business. In First Quarter 2016, other income primarily represents a benefit due to loss mitigation recoveries.

Economic Loss Development
 
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 Part I, Item 1, Financial Statements, Note 5, Expected Loss to be Paid, for a discussion of the assumptions and methodologies used in calculating the expected loss to be paid for all contracts. For a discussion of the loss estimation process, approach to projecting losses and the measurement and recognition accounting policies under GAAP for each type of contract, see the following in Part II, Item 8, "Financial Statements and Supplementary Data" of the Company's 2016 Annual Report on Form 10-K:

•
Note 5 for expected loss to be paid,
•
Note 6 for contracts accounted for as insurance,
•
Note 7 for fair value methodologies for credit derivatives and FG VIE assets and liabilities,
•
Note 8 for contracts accounted for as credit derivatives, and
•
Note 9 for consolidated FG VIEs.
    
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 notes to the consolidated financial statements. More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly.
    
Net expected loss to be paid consists primarily of the present value of future: expected claim and LAE payments, expected recoveries from excess spread and other collateral in the transaction structures, cessions to reinsurers, and expected recoveries for breaches of R&W and the effects of 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. Assumptions used in the determination of the net expected loss to be paid such as delinquency, severity,

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and discount rates and expected time frames to recovery in the mortgage market were consistent by sector regardless of the accounting model used. The primary drivers of economic loss development are discussed below. Changes in risk free rates used to discount losses affect economic loss development, and loss and LAE; however, the effect of changes in discount rates are not indicative of actual credit impairment or improvement in the period.

The primary differences between net economic loss development and loss and LAE are that the amount reported in the consolidated statements of operations:

•
considers deferred premium revenue in the calculation of loss reserves and loss and LAE for financial guaranty insurance contracts,

•
eliminates loss and LAE related to FG VIEs and

•
does not include estimated losses on credit derivatives.

Loss and LAE reported in operating income (non-GAAP) (i.e. operating loss and LAE) includes losses on financial guaranty insurance contracts, other than those eliminated due to consolidation of FG VIEs, and credit derivatives.

For financial guaranty insurance contracts, the loss and LAE reported in the consolidated statements of operations is generally recorded only when expected losses exceed deferred premium revenue. Therefore, the timing of loss recognition in income does not necessarily coincide with the timing of the actual credit impairment or improvement reported in net economic loss development. Transactions acquired in a business combination generally have the largest deferred premium revenue balances because of the purchase accounting fair value adjustments made at acquisition. Therefore the largest differences between net economic loss development and loss and LAE on financial guaranty insurance contracts generally relate to these policies. See "Loss and LAE (Financial Guaranty Insurance Contracts)" below.

Net Expected Loss to be Paid 

 
As of
March 31, 2017
 
As of
December 31, 2016
 
(in millions)
Public finance
$
1,011

 
$
904

Structured finance
 
 
 
U.S. RMBS
197

 
206

Other structured finance
36

 
88

Structured finance
233

 
294

Total
$
1,244

 
$
1,198



Economic Loss Development (Benefit) (1)

 
First Quarter
 
2017
 
2016
 
(in millions)
Public finance
$
119

 
$
99

Structured finance
 
 
 
U.S. RMBS
(22
)
 
(31
)
Other structured finance
(50
)
 
(9
)
Structured finance
(72
)
 
(40
)
Total
$
47

 
$
59

____________________
(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.


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First Quarter 2017 Net Economic Loss Development

The total economic loss development of $47 million in First Quarter 2017 was primarily related to the public finance sector, offset in part by improvements in the structured finance sector. The risk-free rates used to discount expected losses ranged from 0.0% to 3.14% with a weighted average of 2.65% as of March 31, 2017 and 0.0% to 3.23% with a weighted average of 2.73% as of December 31, 2016. The effect of changes in the risk-free rates used to discount expected losses was a loss of $11 million in First Quarter 2017.

U.S. Public Finance Economic Loss Development: The net par outstanding for U.S. public finance obligations rated BIG by the Company was $7.2 billion as of March 31, 2017 compared with $7.4 billion as of December 31, 2016. The Company projects that its total net expected loss across its troubled U.S. public finance credits as of March 31, 2017 will be $970 million, compared with $871 million as of December 31, 2016. Economic loss development in First Quarter 2017 was $124 million, which was primarily attributable to Puerto Rico exposures. See "Insured Portfolio-Exposure to Puerto Rico" below for details about significant developments that have taken place in Puerto Rico.

U.S. RMBS Economic Loss Development: The net benefit attributable to U.S. RMBS was $22 million and was due mainly to lower delinquency rates in certain HELOC transactions, a benefit from terminating certain transactions and the favorable outcome of the dismissal of an interpleader complaint against the Company. See Part I, Item 1, Financial Statements, Note 5, Expected Loss to be Paid, Recovery Litigation section for additional information.

Other Structured Finance Economic Loss Development: The net benefit attributable to structured finance (excluding U.S. RMBS) was $50 million, due primarily to a benefit from a litigation settlement related to two triple-X transactions. See Part I, Item 1, Financial Statements, Note 5, Expected Loss to be Paid, Recovery Litigation section, for additional information.

First Quarter 2016 Net Economic Loss Development

Total economic loss development of $59 million in First Quarter 2016 was generated mainly by the U.S. public finance sector, partially offset by a net benefit in the structured finance sector. The risk-free rates used to discount expected losses ranged from 0.0% to 2.88% with a weighted average of 1.95% as of March 31, 2016 and 0.0% to 3.25% with a weighted average of 2.36% as of December 31, 2015. The effect of the change in the risk-free rates used to discount expected losses was a loss of $63 million in First Quarter 2016.

U.S. Public Finance Economic Loss Development: The net par outstanding for U.S. public finance obligations rated BIG by the Company was $8.0 billion as of March 31, 2016 compared with $7.8 billion as of December 31, 2015. The Company projected that its total net expected loss across its troubled U.S. public finance credits as of March 31, 2016 would be $864 million, compared with $771 million as of December 31, 2015. Economic loss development in First Quarter 2016 was $98 million, which was primarily attributable to Puerto Rico exposures.

U.S. RMBS Economic Loss Development: The net benefit attributable to U.S. RMBS was $31 million due mainly to the acceleration of claim payments as a means of mitigating future losses on certain Alt-A transactions.

Other Structured Finance Economic Loss Development: The net benefit attributable to structured finance (excluding U.S. RMBS) was $9 million, due primarily to the commutation of certain assumed student loan exposures.
    
Loss and LAE (Financial Guaranty Insurance Contracts)
 
The amount of loss and LAE recognized in the consolidated statements of operations for financial guaranty contracts accounted for as insurance is dependent on the amount of economic loss development discussed above and the deferred premium revenue amortization in a given period, on a contract-by-contract basis. For these transactions, each transaction’s expected loss to be expensed, net of estimated 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 consolidated statements of operations for the amount of such excess.

While expected loss to be paid is an important liquidity measure that provides the present value of amounts that the Company expects to pay or recover in future periods on all contracts, expected loss to be expensed is important because it presents the Company’s projection of loss and LAE that will be recognized in future periods as deferred premium revenue amortizes into income in the consolidated statements of operations for 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 table presents the loss and LAE recorded in the consolidated statements of operations. Amounts presented are net of reinsurance.

Loss and LAE Reported
on the Consolidated Statements of Operations

 
First Quarter
 
2017
 
2016
 
(in millions)
Public finance
$
109

 
$
97

Structured finance:
 
 
 
U.S. RMBS
(9
)
 
11

Other structured finance
(39
)
 
(11
)
Structured finance
(48
)
 
0

Total insurance contracts before FG VIE consolidation
61

 
97

Elimination of losses attributable to FG VIEs
(2
)
 
(7
)
Total loss and LAE (1)
$
59

 
$
90

____________________
(1)
Excludes credit derivative benefit of $18 million and $6 million for First Quarter 2017 and First Quarter 2016.

Loss and LAE in First Quarter 2017 was mainly driven by higher loss reserves on certain Puerto Rico exposures, partially offset by a benefit in certain structured finance transactions from a litigation settlement.

Loss and LAE in First Quarter 2016 was mainly driven by higher loss reserves on certain Puerto Rico exposures partially offset by a benefit from the commutations of certain assumed student loan exposures.

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 loss development and may also include a portion of prior-period economic loss development. The difference between economic loss development on financial guaranty insurance contracts and loss and LAE recognized in the consolidated statements of operations relates to the effect of taking deferred premium revenue into account for loss and LAE, which is not considered in economic loss development.

For additional information on schedule of the expected timing of net expected losses to be expensed please refer to Part I, Item 1, Financial Statements, Note 6, Contracts Accounted for as Insurance, Financial Guaranty Insurance Losses.

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 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. Changes in expected losses in respect of contracts accounted for as credit derivatives are included in the discussion above “Economic Loss Development.”
  
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 credit spreads of the underlying obligations results in unrealized losses and the tightening

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of credit spreads of the underlying obligations results in unrealized gains. 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.

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. 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 several years and as of March 31, 2017, 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. See Part I, Item 1, Financial Statements, Note 7, Fair Value Measurement, for additional information.

Net Change in Fair Value of Credit Derivative Gain (Loss)

 
First Quarter
 
2017
 
2016
 
(in millions)
Realized gains on credit derivatives
$
5

 
$
10

Net credit derivative losses (paid and payable) recovered and recoverable and other settlements
10

 
(2
)
Realized gains (losses) and other settlements(1)
15

 
8

Net unrealized gains (losses):
 
 
 
Pooled corporate obligations
20

 
(48
)
U.S. RMBS
9

 
(15
)
Pooled infrastructure
6

 
0

Infrastructure finance
1

 
0

Other
3

 
(5
)
Net unrealized gains (losses)
39

 
(68
)
Net change in fair value of credit derivatives
$
54

 
$
(60
)
____________________
(1)
Includes realized gains and losses due to terminations and settlements of CDS contracts.


Terminations and Settlements
of Direct Credit Derivative Contracts

 
First Quarter
 
2017
 
2016
 
(in millions)
Net par of terminated credit derivative contracts
$
184

 
$
—

Realized gains on credit derivatives
0

 
0

Net credit derivative losses (paid and payable) recovered and recoverable and other settlements
(12
)
 
—

Net unrealized gains (losses) on credit derivatives
15

 
11


    
During First Quarter 2017, unrealized fair value gains were generated primarily as a result of CDS terminations and tighter implied spreads. During the quarter the Company agreed to terminate several CDS transactions, which was the primary driver of the unrealized fair value gains in the pooled corporate CLO, and U.S. RMBS sectors. The tighter implied spreads were primarily a result of price improvements on the underlying collateral of the Company’s CDS and the increased cost to buy protection in AGC’s and AGM’s name as the market cost of AGC’s and AGM’s credit protection increased during the period.

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These transactions were pricing at or above their floor levels, therefore when the cost of purchasing CDS protection on AGC and AGM increased, the implied spreads that the Company would expect to receive on these transactions decreased.     
    
During First Quarter 2016, unrealized fair value losses were generated primarily in the trust preferred, and U.S. RMBS prime first lien and subprime sectors, due to wider implied net spreads. The wider implied net spreads were primarily a result of the decreased cost to buy protection on AGC and AGM, particularly for the one year and five year CDS spreads. These transactions were pricing at or above their floor levels (or the minimum rate at which the Company would consider assuming these risks based on historical experience); therefore when the cost of purchasing CDS protection on AGC and AGM decreased, the implied spreads that the Company would expect to receive on these transactions increased. Unrealized fair value losses in the Other Sector were generated primarily by a price decline on a hedge the Company has against another financial guarantor. These losses were partially offset by an unrealized fair value gain on a terminated toll road securitization.

CDS Spread on AGC and AGM
Quoted price of CDS contract (in basis points)
 
 
As of
March 31, 2017
 
As of
December 31, 2016
 
As of
March 31, 2016
 
As of
December 31, 2015
Five-year CDS spread:
 
 
 
 
 
 
 
AGC
173

 
158

 
307

 
376

AGM
181

 
158

 
309

 
366

One-year CDS spread
 
 
 
 
 
 
 
AGC
31

 
35

 
105

 
139

AGM
31

 
29

 
102

 
131


 
Effect of Changes in the Company’s Credit Spread on
Net Unrealized Gains (Losses) on Credit Derivatives
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Change in unrealized gains (losses) of credit derivatives:
 
 
 
Before considering implication of the Company’s credit spreads
$
32

 
$
(27
)
Resulting from change in the Company’s credit spreads
7

 
(41
)
After considering implication of the Company’s credit spreads
$
39

 
$
(68
)

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, 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), TruPS CDOs, and collateralized loan obligation (CLO) markets as well as continuing market concerns over the 2005-2007 vintages of RMBS.

Financial Guaranty Variable Interest Entities
 
As of March 31, 2017 and December 31, 2016, the Company consolidated 32 VIEs. The table below presents the effects on reported GAAP income resulting from consolidating these FG VIEs and eliminating their related insurance and investment amounts. The consolidation of FG VIEs has an effect on net income and shareholders' equity due to:

•
changes in fair value gains (losses) on FG VIE assets and liabilities,

•
the eliminations of premiums and losses related to the AGC and AGM FG VIE liabilities with recourse, and


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•
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. See Part I, Item 1, Financial Statements, Note 9, Consolidated Variable Interest Entities, for additional information.
 
Effect of Consolidating FG VIEs on Net Income (Loss)

 
First Quarter
 
2017
 
2016
 
(in millions)
Fair value gains (losses) on FG VIEs
$
10

 
$
18

Elimination of insurance and investment balances
(3
)
 
(3
)
Effect on income before tax
7

 
15

Less: tax provision (benefit)
3

 
5

Effect on net income (loss)
$
4

 
$
10


Fair value gains (losses) on FG VIEs represent the net change in fair value on the consolidated FG VIEs’ assets and liabilities. During First Quarter 2017, the Company recorded a pre-tax net fair value gain on consolidated FG VIEs of $10 million, which was driven by price appreciation on the FG VIE assets during the quarter resulting from improvements in the underlying collateral.
 
During First Quarter 2016, the Company recorded a pre-tax net fair value gain on consolidated FG VIEs of $18 million due mainly to improvements in the underlying collateral.

Other Operating Expenses
    
Other operating expenses in First Quarter 2017 increased by $8 million compared to First Quarter 2016 due primarily to expenses related to the MBIA UK Acquisition and increased compensation expenses, offset in part by lower rent and depreciation expense.

Provision for Income Tax
 
Provision for Income Taxes and Effective Tax Rates
 
 
First Quarter
 
2017
 
2016
 
(dollars in millions)
Total provision (benefit) for income taxes
$
55

 
$
6

Effective tax rate
14.7
%
 
10.0
%

 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%, U.K. subsidiaries taxed at the U.K. blended marginal corporate tax rate of 19.25% unless subject to U.S. tax by election or as a U.S. controlled foreign corporation, and no taxes for the Company’s Bermuda subsidiaries unless subject to U.S tax by election or as a U.S. controlled foreign corporation. The Company’s overall corporate effective tax rate fluctuates based on the distribution of taxable income across these jurisdictions. In each of the periods presented, the portion of taxable income from each jurisdiction varied. The non-taxable book to tax differences were mostly consistent compared with the prior period with the exception of the benefit on bargain purchase gain from the MBIA UK Acquisition.

In April 2017, the Company received a final letter from the Internal Revenue Service to close the audit for the period of 2009 - 2012, with no additional findings or changes, and as a result the Company expects to release previously recorded uncertain tax position reserve and accrued interest of approximately $34 million in the second quarter of 2017.


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Non-GAAP Financial Measures
 
To reflect the key financial measures that management analyzes in evaluating the Company’s operations and progress towards long-term goals, the Company discloses both financial measures determined in accordance with GAAP and financial measures not determined in accordance with GAAP (non-GAAP financial measures).

Financial measures identified as non-GAAP should not be considered substitutes for GAAP financial measures. The primary limitation of non-GAAP financial measures is the potential lack of comparability to financial measures of other companies, whose definitions of non-GAAP financial measures may differ from those of Assured Guaranty. Beginning in fourth quarter 2016, the Company’s publicly disclosed non-GAAP financial measures are different from the financial measures used by management in its decision making process and in its calculation of certain components of management compensation (core financial measures). The Company had previously excluded the effect of consolidating FG VIEs (FG VIE consolidation) in its calculation of its non-GAAP financial measures of operating income (non-GAAP), non-GAAP operating shareholders’ equity and non-GAAP adjusted book value. Starting in fourth quarter 2016, based on the SEC's May 17, 2016 release of updated Compliance and Disclosure Interpretations of the rules and regulations on the use of non-GAAP financial measures, the Company will no longer adjust for FG VIE consolidation. However, wherever possible, the Company has separately disclosed the effect of FG VIE consolidation that is included in its non-GAAP financial measures. The prior-year's quarterly non-GAAP financial measures have been updated to reflect the revised calculation.

Management and the Board of Directors use core financial measures, which are based on non-GAAP financial measures adjusted to remove FG VIE consolidation, as well as GAAP financial measures and other factors, to evaluate the Company’s results of operations, financial condition and progress towards long-term goals. The Company removes FG VIE consolidation in its core financial measures because, although GAAP requires the Company to consolidate certain VIEs that have issued debt obligations insured by the Company, the Company does not own such VIEs and its exposure is limited to its obligation under its financial guaranty insurance contract. By disclosing non-GAAP financial measures, along with FG VIE consolidation, the Company gives investors, analysts and financial news reporters access to information that management and the Board of Directors review internally. Assured Guaranty believes its presentation of non-GAAP financial measures and FG VIE consolidation provides information that is necessary for analysts to calculate their estimates of Assured Guaranty’s financial results in their research reports on Assured Guaranty and for investors, analysts and the financial news media to evaluate Assured Guaranty’s financial results.

Many investors, analysts and financial news reporters use non-GAAP operating shareholders’ equity, adjusted for FG VIE consolidation, 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 this measure to evaluate the Company’s capital adequacy.

Many investors, analysts and financial news reporters also use non-GAAP adjusted book value, adjusted for FG VIE consolidation, to evaluate AGL’s share price and as the basis of their decision to recommend, buy or sell the AGL common shares. Operating income adjusted for the effect of FG VIE consolidation enables investors and analysts to evaluate the Company’s financial results as compared with the consensus analyst estimates distributed publicly by financial databases.

The core financial measures that are used to help determine compensation are: (1) operating income, adjusted for FG VIE consolidation, (2) non-GAAP operating shareholders' equity, adjusted for FG VIE consolidation, (3) growth in non-GAAP adjusted book value per share, adjusted for FG VIE consolidation, and (4) PVP.
 
The following paragraphs define each non-GAAP financial measure disclosed by the Company and describe why it is useful. A reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure is presented below.
 

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Operating Income (non-GAAP)

Management believes that operating income is a useful measure because it clarifies the understanding of the underwriting results and financial condition of the Company and presents the results of operations of the Company excluding the fair value adjustments on credit derivatives and CCS that are not expected to result in economic gain or loss, as well as other adjustments described below. Management adjusts operating income further by removing FG VIE consolidation to arrive at its core operating income measure. Operating income is defined as net income (loss) attributable to AGL, as reported under GAAP, adjusted for the following:
 
1)
Elimination of 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.

2)
Elimination of non-credit-impairment unrealized fair value gains (losses) on credit derivatives, which is the amount of unrealized fair value gains (losses) 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, the Company's credit spreads, and other market factors and are not expected to result in an economic gain or loss.
 
3)
Elimination of fair value gains (losses) on the Company’s CCS. Such amounts are affected by changes in market interest rates, the Company's credit spreads, price indications on the Company's publicly traded debt, and other market factors and are not expected to result in an economic gain or loss.
 
4)
Elimination of foreign exchange gains (losses) on remeasurement of net premium receivables and loss and LAE reserves. Long-dated receivables and loss and LAE reserves represent the present value of future contractual or expected cash flows. 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 tax effects related to the above adjustments, which are determined by applying the statutory tax rate in each of the jurisdictions that generate these adjustments.

 Reconciliation of Net Income (Loss)
to Operating Income (non-GAAP)

 
First Quarter
 
2017
 
2016
 
(in millions)
Net income (loss)
$
317

 
$
59

Less pre-tax adjustments:
 
 
 
Realized gains (losses) on investments
32

 
(14
)
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
25

 
(60
)
Fair value gains (losses) on CCS
(2
)
 
(16
)
Foreign exchange gains (losses) on remeasurement of premiums receivable and loss and LAE reserves
10

 
(2
)
Total pre-tax adjustments
65

 
(92
)
Less tax effect on pre-tax adjustments
(21
)
 
28

Operating income (non-GAAP)
$
273

 
$
123

 
 
 
 
Gain (loss) related to FG VIE consolidation (net of tax provision of $2 and $5) included in operating income
$
5

 
$
10




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Non-GAAP Operating Shareholders’ Equity and Non-GAAP Adjusted Book Value
 
     Management believes that non-GAAP operating shareholders’ equity is a useful measure because it presents the equity of the Company excluding the fair value adjustments on investments, credit derivatives and CCS, that are not expected to result in economic gain or loss, along with other adjustments described below. Management adjusts non-GAAP operating shareholders’ equity further by removing FG VIE consolidation to arrive at its core operating shareholders' equity and core adjusted book value.

Non-GAAP operating shareholders’ equity is the basis of the calculation of non-GAAP adjusted book value (see below). Non-GAAP operating shareholders’ equity is defined as shareholders’ equity attributable to AGL, as reported under GAAP, adjusted for the following:
 
1)
Elimination of non-credit-impairment unrealized fair value gains (losses) on credit derivatives, which is the amount of unrealized fair value gains (losses) 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.
 
2)
Elimination of fair value gains (losses) on the Company’s CCS. Such amounts are affected by changes in market interest rates, the Company's credit spreads, price indications on the Company's publicly traded debt, and other market factors and are not expected to result in an economic gain or loss.
 
3)
Elimination of 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.

4) Elimination of the tax asset or liability related to the above adjustments, which are determined by applying the statutory tax rate in each of the jurisdictions that generate these adjustments.

Management uses non-GAAP adjusted book value, adjusted for FG VIE consolidation, to measure the intrinsic value of the Company, excluding franchise value. Growth in non-GAAP adjusted book value per share adjusted for FG VIE consolidation (core adjusted book value) is one of the key financial measures used in determining the amount of certain long-term compensation elements to management and employees and used by rating agencies and investors. Management believes that this is a useful measure because it enables an evaluation of the net present value of the Company’s in-force premiums and revenues net of expected losses. Non-GAAP adjusted book value is non-GAAP operating shareholders’ equity, as defined above, further adjusted for the following:
 
1)
Elimination of 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 net present value of estimated net future revenue on non financial guaranty contracts. See below.
 
3)
Addition of the deferred premium revenue 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.

4) Elimination of the tax asset or liability related to the above adjustments, which are determined by applying the statutory tax rate in each of the jurisdictions that generate these adjustments.


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The unearned premiums and revenues included in non-GAAP adjusted book value will be earned in future periods, but actual earnings may differ materially from the estimated amounts used in determining current non-GAAP adjusted book value due to changes in foreign exchange rates, prepayment speeds, terminations, credit defaults and other factors.

Reconciliation of Shareholders’ Equity
to Non-GAAP Adjusted Book Value
 
 
As of
March 31, 2017
 
As of
December 31, 2016
 
After-Tax
 
Per Share
 
After-Tax
 
Per Share
 
(dollars in millions, except per share amounts)
Shareholders’ equity
$
6,637

 
$
53.95

 
$
6,504

 
$
50.82

Less pre-tax adjustments:
 
 
 
 
 
 
 
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(164
)
 
(1.33
)
 
(189
)
 
(1.48
)
Fair value gains (losses) on CCS
60

 
0.49

 
62

 
0.48

Unrealized gain (loss) on investment portfolio excluding foreign exchange effect
380

 
3.08

 
316

 
2.47

Less taxes
(99
)
 
(0.80
)
 
(71
)
 
(0.54
)
Non-GAAP operating shareholders’ equity
6,460

 
52.51

 
6,386

 
49.89

Pre-tax adjustments:
 
 
 
 
 

 
 

Less: Deferred acquisition costs
106

 
0.86

 
106

 
0.83

Plus: Net present value of estimated net future revenue
153

 
1.24

 
136

 
1.07

Plus: Net unearned premium reserve on financial guaranty contracts in excess of expected loss to be expensed
3,236

 
26.30

 
2,922

 
22.83

Plus taxes
(945
)
 
(7.68
)
 
(832
)
 
(6.50
)
Non-GAAP adjusted book value
$
8,798

 
$
71.51

 
$
8,506

 
$
66.46

 
 
 
 
 
 
 
 
Gain (loss) related to FG VIE consolidation included in non-GAAP operating shareholders' equity (net of tax benefit of $2 and $4)
$
(3
)
 
$
(0.03
)
 
(7
)
 
(0.06
)
 
 
 
 
 
 
 
 
Gain (loss) related to FG VIE consolidation included in non-GAAP adjusted book value (net of tax benefit of $12 and $12)
$
(20
)
 
$
(0.16
)
 
(24
)
 
(0.18
)
 

Net Present Value of Estimated Net Future Revenue
 
Management believes that this amount is a useful measure because it enables an evaluation of the value of future estimated revenue. There is no corresponding GAAP financial measure. This amount represents the present value of estimated future revenue from the Company’s non-financial guaranty contracts, net of reinsurance, ceding commissions and premium taxes, for contracts without expected economic losses, and is discounted at 6%. Estimated net future 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

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 management believes GAAP gross written premiums and the net credit derivative premiums received and receivable portion of net realized gains and other settlements on credit derivatives (Credit Derivative Realized Gains (Losses)) do not adequately measure. PVP in respect of contracts written in a specified period is defined as gross upfront

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and installment premiums received and the present value of gross estimated future installment premiums, discounted, in each case, at 6%. For purposes of the PVP calculation, management discounts estimated future installment premiums on insurance contracts at 6%. Under GAAP, financial guaranty installment premiums 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 Realized Gains (Losses) 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. 

Reconciliation of GWP to PVP

 
First Quarter 2017
 
First Quarter 2016
 
Public Finance
 
Structured Finance
 
 
 
Public Finance
 
Structured Finance
 
 
 
U.S.
 
Non - U.S.
 
U.S.
 
Non - U.S.
 
Total
 
U.S.
 
Non - U.S.
 
U.S.
 
Non - U.S.
 
Total
 
(in millions)
GWP
$
51

 
$
58

 
$
1

 
$
1

 
$
111

 
$
15

 
$
8

 
$
(3
)
 
$
(1
)
 
$
19

Less: Installment GWP and other GAAP adjustments(1)
(1
)
 
56

 
1

 
1

 
57

 
(16
)
 
8

 
(3
)
 
(1
)
 
(12
)
Plus: Financial guaranty installment premium PVP
—

 
38

 
—

 
—

 
38

 
—

 
7

 
—

 
—

 
7

Plus: PVP of non-financial guaranty insurance
—

 
—

 
5

 
2

 
7

 
—

 
—

 
0

 
—

 
0

PVP
$
52

 
$
40

 
$
5

 
$
2

 
$
99

 
$
31

 
$
7

 
$
0

 
$
—

 
$
38

___________________
(1)
Includes present value of new business on installment policies discounted at the prescribed GAAP discount rates, GWP adjustments on existing installment policies due to changes in assumptions, any cancellations of assumed reinsurance contracts, and other GAAP adjustments.


Insured Portfolio
 
Financial Guaranty

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). The Company excludes amounts attributable to loss mitigation securities (unless otherwise indicated) from par and principal and interest (debt service) outstanding because it manages such securities as investments, not insurance exposures. As of March 31, 2017 and December 31, 2016, the Company excluded $2.1 billion and $2.1 billion, respectively, of net par as a result of loss mitigation strategies, including loss mitigation securities held in the investment portfolio, which are primarily BIG.


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Net Par Outstanding and Average Internal Rating by Sector

 
 
As of March 31, 2017
 
As of December 31, 2016
Sector
 
Net Par
Outstanding
 
Avg.
Rating
 
Net Par
Outstanding
 
Avg.
Rating
 
 
(dollars in millions)
Public finance:
 
 
 
 
 
 

 
 
U.S.:
 
 
 
 
 
 

 
 
General obligation
 
$
103,696

 
A
 
$
107,717

 
A
Tax backed
 
48,772

 
A-
 
49,931

 
A-
Municipal utilities
 
36,327

 
A-
 
37,603

 
A
Transportation
 
19,443

 
A-
 
19,403

 
A-
Healthcare
 
10,955

 
A
 
11,238

 
A
Higher education
 
9,966

 
A
 
10,085

 
A
Infrastructure finance
 
4,127

 
BBB+
 
3,769

 
BBB+
Housing
 
1,344

 
A-
 
1,559

 
A-
Investor-owned utilities
 
693

 
BBB+
 
697

 
BBB+
Other public finance—U.S.
 
2,727

 
A
 
2,796

 
A
Total public finance—U.S.
 
238,050

 
A-
 
244,798

 
A
Non-U.S.:
 
 
 
 
 
 

 
 
Infrastructure finance
 
17,350

 
BBB
 
10,731

 
BBB
Regulated utilities
 
14,679

 
BBB+
 
9,263

 
BBB+
Pooled infrastructure
 
1,363

 
AAA
 
1,513

 
AAA
Other public finance
 
5,951

 
A
 
4,874

 
A
Total public finance—non-U.S.
 
39,343

 
BBB+
 
26,381

 
BBB+
Total public finance
 
277,393

 
A-
 
271,179

 
A-
Structured finance:
 
 
 
 
 
 

 
 
U.S.:
 
 
 
 
 
 

 
 
Pooled corporate obligations
 
6,860

 
AAA
 
10,050

 
AAA
RMBS
 
5,357

 
BBB-
 
5,637

 
BBB-
Insurance securitizations
 
2,307

 
A+
 
2,308

 
A+
Consumer receivables
 
1,640

 
BBB+
 
1,652

 
BBB+
Financial products
 
1,462

 
AA-
 
1,540

 
AA-
Commercial receivables
 
195

 
BBB
 
230

 
BBB-
Other structured finance—U.S.
 
625

 
AA-
 
640

 
AA-
Total structured finance—U.S.
 
18,446

 
A+
 
22,057

 
A+
Non-U.S.:
 
 
 
 
 
 

 
 
Pooled corporate obligations
 
900

 
AA
 
1,535

 
AA
RMBS
 
600

 
A-
 
604

 
A-
Commercial receivables
 
325

 
A-
 
356

 
BBB+
Other structured finance
 
579

 
AA
 
587

 
AA
Total structured finance—non-U.S.
 
2,404

 
A+
 
3,082

 
AA-
Total structured finance
 
20,850

 
A+
 
25,139

 
AA-
Total net par outstanding
 
$
298,243

 
A-
 
$
296,318

 
A
 



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The following tables set forth the Company’s net financial guaranty portfolio by internal rating.
 
Financial Guaranty Portfolio by Internal Rating
As of March 31, 2017

 
 
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
 
$
1,816

 
0.8
%
 
$
2,156

 
5.5
%
 
$
6,765

 
36.7
%
 
$
1,032

 
42.9
%
 
$
11,769

 
3.9
%
AA
 
42,529

 
17.9

 
204

 
0.5

 
5,408

 
29.3

 
99

 
4.1

 
48,240

 
16.2

A
 
132,212

 
55.5

 
12,711

 
32.3

 
1,698

 
9.2

 
264

 
11.0

 
146,885

 
49.3

BBB
 
54,294

 
22.8

 
22,199

 
56.4

 
868

 
4.7

 
760

 
31.6

 
78,121

 
26.2

BIG
 
7,199

 
3.0

 
2,073

 
5.3

 
3,707

 
20.1

 
249

 
10.4

 
13,228

 
4.4

Total net par outstanding (1)
 
$
238,050

 
100.0
%
 
$
39,343

 
100.0
%
 
$
18,446

 
100.0
%
 
$
2,404

 
100.0
%
 
$
298,243

 
100.0
%
_____________________
(1)
The March 31, 2017 amounts include $12.2 billion of net par from the MBIA UK Acquisition.


Financial Guaranty Portfolio by Internal Rating
As of December 31, 2016 

 
 
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
 
$
2,066

 
0.8
%
 
$
2,221

 
8.4
%
 
$
9,757

 
44.2
%
 
$
1,447

 
47.0
%
 
$
15,491

 
5.2
%
AA
 
46,420

 
19.0

 
170

 
0.6

 
5,773

 
26.2

 
127

 
4.1

 
52,490

 
17.7

A
 
133,829

 
54.7

 
6,270

 
23.8

 
1,589

 
7.2

 
456

 
14.8

 
142,144

 
48.0

BBB
 
55,103

 
22.5

 
16,378

 
62.1

 
879

 
4.0

 
759

 
24.6

 
73,119

 
24.7

BIG
 
7,380

 
3.0

 
1,342

 
5.1

 
4,059

 
18.4

 
293

 
9.5

 
13,074

 
4.4

Total net par outstanding
 
$
244,798

 
100.0
%
 
$
26,381

 
100.0
%
 
$
22,057

 
100.0
%
 
$
3,082

 
100.0
%
 
$
296,318

 
100.0
%


Non-Financial Guaranty Insurance

The Company provides capital relief triple-X excess of loss life reinsurance on approximately $444 million of exposure as of March 31, 2017 and $390 million as of December 31, 2016, which is expected to increase to approximately $1.3 billion prior to September 30, 2036. This non-financial guaranty exposure has a similar risk profile to the Company's other investment grade exposure written in financial guaranty form. The Company also has provided legacy mortgage guaranty reinsurance related to loans originated in Ireland on debt service of approximately $36 million as of March 31, 2017, and $36 million as of December 31, 2016. In addition, the Company started providing reinsurance on aircraft residual value insurance policies in the First Quarter of 2017 and had net exposure of $14 million as of March 31, 2017. These transactions are all rated investment grade internally. The Company had outstanding commitments to provide reinsurance on aircraft residual value insurance policies of approximately $28 million as of March 31, 2017. The expiration dates for these commitments range between April 1, 2017 and September 30, 2017. 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.




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Monoline and Reinsurer Exposures
 
The Company has exposure to other monolines and reinsurers through reinsurance arrangements (both as a ceding company and as an assuming company) and in "second-to-pay" transactions. A number of the monolines and reinsurers to which the Company has exposure have experienced financial distress and, as a result, have been downgraded by the rating agencies. In addition, state insurance regulators have intervened with respect to some of these distressed insurers, in some instances limiting the amount of claims payments they are permitted to pay currently in cash.

Ceded par outstanding represents the portion of insured risk ceded to external 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. 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 below are required to 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. In addition, certain authorized reinsurers in the table below post collateral on terms negotiated with the Company. Collateral may be in the form of letters of credit or trust accounts. The total collateral posted by all non-affiliated reinsurers as of March 31, 2017 was approximately $285 million.

Assumed par outstanding represents the amount of par assumed by the Company from third party insurers and reinsurers, including 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.
 
In "second-to-pay" transactions, the Company provides insurance on an obligation that is already insured by another financial guarantor. In that case, if the underlying obligor and the financial guarantor both fail to pay an amount scheduled to be paid, the Company would be obligated to pay. The Company underwrites these transactions based on the underlying obligation, without regard to the financial guarantor. See Part I, Item 1, Financial Statements, Note 13, Reinsurance and Other Monoline Exposures, for additional information.



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Monoline and Reinsurer exposure
by Company

 
 
Par Outstanding
 
 
As of March 31, 2017
Reinsurer
 
Ceded Par
Outstanding (1)
 
Second-to-
Pay Insured
Par
Outstanding (2)
 
Assumed Par
Outstanding
 
 
(in millions)
Reinsurers rated investment grade:
 
 
 
 
 
 
Tokio Marine & Nichido Fire Insurance Co., Ltd. (3) (4)
 
$
3,269

 
$
—

 
$
—

National Public Finance Guarantee Corporation
 
—

 
4,057

 
3,962

Subtotal
 
3,269

 
4,057

 
3,962

Reinsurers rated BIG or not rated:
 
 
 
 
 
 
American Overseas Reinsurance Company Limited (3)
 
3,307

 
—

 
30

Syncora Guarantee Inc. (3)
 
1,950

 
1,097

 
654

ACA Financial Guaranty Corp.
 
621

 
12

 
—

Ambac Assurance Corporation
 
115

 
2,583

 
6,061

MBIA
 
—

 
949

 
151

Financial Guaranty Insurance Company and FGIC UK Limited
 
—

 
1,221

 
404

Ambac Assurance Corp. Segregated Account
 
—

 
57

 
584

Subtotal
 
5,993

 
5,919

 
7,884

Other (3)
 
71

 
538

 
146

Total
 
$
9,333

 
$
10,514

 
$
11,992

____________________
(1)
Of the total ceded par to reinsurers rated BIG or not rated, $359 million is rated BIG.
  
(2)
The par on second-to-pay exposure where the primary insurer and underlying transaction rating are both BIG, and/or not rated, is $742 million.

(3)
The total collateral posted by all non-affiliated reinsurers required to post, or that had agreed to post, collateral as of March 31, 2017 was approximately $285 million.
 
(4)
The Company benefits from trust arrangements that satisfy the triple-A credit requirement of S&P and/or Moody’s.


Exposure to Puerto Rico
         
The Company has insured exposure to general obligation bonds of the Commonwealth of Puerto Rico (Puerto Rico or the Commonwealth) and various obligations of its related authorities and public corporations aggregating $4.9 billion net par as of March 31, 2017, all of which are rated BIG. Puerto Rico has experienced significant general fund budget deficits in recent years and a challenging economic environment. Beginning on January 1, 2016, a number of Puerto Rico credits have defaulted on bond payments, and the Company has now paid claims on several Puerto Rico credits as shown in the table "Puerto Rico Net Par Outstanding" below. Additional information about recent developments in Puerto Rico and the individual credits insured by the Company may be found in Part I, Item 1, Financial Statements, Note 4, Outstanding Exposure.

The Company groups its Puerto Rico exposure into three categories:

•
Constitutionally Guaranteed. The Company includes in this category public debt benefiting from Article VI of the Constitution of the Commonwealth, which expressly provides that interest and principal payments on the public debt are to be paid before other disbursements are made.

•
Public Corporations – Certain Revenues Potentially Subject to Clawback. The Company includes in this category the debt of public corporations for which applicable law permits the Commonwealth to claw back,

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subject to certain conditions and for the payment of public debt, at least a portion of the revenues supporting the bonds the Company insures. As a constitutional condition to clawback, available Commonwealth revenues for any fiscal year must be insufficient to pay Commonwealth debt service before the payment of any appropriations for that year. The Company believes that this condition has not been satisfied to date, and accordingly that the Commonwealth has not to date been entitled to claw back revenues supporting debt insured by the Company. As described in Part I, Item 1, Financial Statements, Note 4, Outstanding Exposure, the Company sued various Puerto Rico governmental officials in the United States District Court, District of Puerto Rico asserting that Puerto Rico's claw back of pledged taxes is unconstitutional, and demanding declaratory and injunctive relief.

•
Other Public Corporations. The Company includes in this category the debt of public corporations that are supported by revenues it does not believe are subject to clawback.


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Exposure to Puerto Rico (1)
As of March 31, 2017

 
 
Net Par Outstanding
 
 
 
 
AGM
 
AGC
 
Assured Guaranty Re Ltd.
(AG Re)
 
Eliminations (2)
 
Total
Net Par Outstanding (3)
 
Gross
Par Outstanding
 
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
 
 
 
 
 
 
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds (4)
 
$
699

 
$
378

 
$
421

 
$
(3
)
 
$
1,495

 
$
1,577

Puerto Rico Public Buildings Authority (PBA) (4)
 
11

 
169

 
0

 
(11
)
 
169

 
174

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
 
 
 
 
 
 
 
 
 
Puerto Rico Highways and Transportation Authority (PRHTA) (Transportation revenue) (4)
 
273

 
519

 
209

 
(83
)
 
918

 
949

PRHTA (Highway revenue)
 
272

 
93

 
44

 
—

 
409

 
556

Puerto Rico Convention Center District Authority (PRCCDA)
 
—

 
152

 
—

 
—

 
152

 
152

Puerto Rico Infrastructure Financing Authority (PRIFA) (4)
 
—

 
17

 
1

 
—

 
18

 
18

Other Public Corporations
 
 
 
 
 
 
 
 
 
 
 
 
PREPA
 
470

 
73

 
234

 
—

 
777

 
876

Puerto Rico Aqueduct and Sewer Authority (PRASA)
 
—

 
285

 
88

 
—

 
373

 
373

Municipal Finance Agency (MFA)
 
195

 
61

 
98

 
—

 
354

 
488

Puerto Rico Sales Tax Financing Corporation (COFINA)
 
262

 
—

 
9

 
—

 
271

 
271

University of Puerto Rico (U of PR)
 
—

 
1

 
—

 
—

 
1

 
1

Total exposure to Puerto Rico
 
$
2,182

 
$
1,748

 
$
1,104

 
$
(97
)
 
$
4,937

 
$
5,435

 ___________________
(1)
The March 31, 2017 amounts include $150 million related to the commutation of previously ceded business. See Part I, Item 1, Financial Statements, Note 13, Reinsurance and Other Monoline Exposures, for more information.
(2)
Net par outstanding eliminations relate to second-to-pay policies under which an Assured Guaranty insurance subsidiary guarantees an obligation already insured by another Assured Guaranty insurance subsidiary.
(3)
Includes exposure to capital appreciation bonds with a current aggregate net par outstanding of $31 million and a fully accreted net par at maturity of $63 million. Of these amounts, current net par of $19 million and fully accreted net par at maturity of $50 million relate to the COFINA, current net par of $7 million and fully accreted net par at maturity of $7 million relate to the PRHTA, and current net par of $5 million and fully accreted net par at maturity of $5 million relate to the Commonwealth General Obligation Bonds.
(4)
As of the date of this filing, the Company has paid claims on these credits.


    
    

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The following table shows the scheduled amortization of the general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations insured by the Company. The Company guarantees payments of interest and principal when those amounts are scheduled to be paid and cannot be required to pay on an accelerated basis. In the event that obligors default on their obligations, the Company would only pay the shortfall between the principal and interest due in any given period and the amount paid by the obligors.     

Amortization Schedule
of Net Par Outstanding of Puerto Rico
As of March 31, 2017

 
Scheduled Net Par Amortization
 
2017 (2Q)
2017 (3Q)
2017 (4Q)
2018
2019
2020
2021
2022 - 2026
2027 - 2031
2032 - 2036
2037 - 2041
2042 - 2047
Total
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
 
 
 
 
 
 
 
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds
$
0

$
93

$
0

$
75

$
82

$
136

$
16

$
227

$
272

$
489

$
105

$
—

$
1,495

PBA
—

28

—

—

3

5

13

24

42

54

—

—

169

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 








 








 
PRHTA (Transportation revenue)
0

36

0

38

32

25

18

119

156

295

194

5

918

PRHTA (Highway revenue)
—

10

—

10

21

22

26

30

73

217

—

—

409

PRCCDA
—

—

—

—

—

—

—

—

19

133

—

—

152

PRIFA
—

—

—

2

—

—

—

2

—

—

14

—

18

Other Public Corporations
 
 
 








 








 
PREPA
0

5

—

4

25

44

24

350

299

26

0

—

777

PRASA
—

—

—

—

—

—

—

53

57

—

2

261

373

MFA
—

52

—

50

48

39

34

100

31

—

—

—

354

COFINA
0

0

0

(1
)
(1
)
(1
)
(2
)
(5
)
(7
)
34

102

152

271

U of PR
—

0

—

0

0

0

0

0

0

1

—

—

1

Total
$
0

$
224

$
0

$
178

$
210

$
270

$
129

$
900

$
942

$
1,249

$
417

$
418

$
4,937



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Amortization Schedule
of Net Debt Service Outstanding of Puerto Rico
As of March 31, 2017

 
Scheduled Net Debt Service Amortization
 
2017 (2Q)
2017 (3Q)
2017 (4Q)
2018
2019
2020
2021
2022 - 2026
2027 - 2031
2032 - 2036
2037 - 2041
2042 - 2047
Total
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
 
 
 
 
 
 
 
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds
$
0

$
132

$
0

$
147

$
151

$
201

$
74

$
493

$
469

$
595

$
111

$
—

$
2,373

PBA
—

32

—

7

10

12

20

55

58

62

—

—

256

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 








 








 
PRHTA (Transportation revenue)
0

60

0

84

76

67

59

305

308

404

229

5

1,597

PRHTA (Highway revenue)
—

21

—

32

42

42

45

111

145

252

—

—

690

PRCCDA
—

3

—

7

7

7

7

35

50

152

—

—

268

PRIFA
—

0

—

3

1

1

1

6

4

3

16

—

35

Other Public Corporations
 
 
 








 








 
PREPA
2

21

2

40

61

79

56

477

344

29

0

—

1,111

PRASA
—

10

—

20

19

19

19

147

129

68

70

327

828

MFA
—

61

—

66

60

49

42

122

34

—

—

—

434

COFINA
0

6

0

13

13

13

13

68

68

103

162

160

619

U of PR
0

0

—

0

0

0

0

0

0

1

—

—

1

Total
$
2

$
346

$
2

$
419

$
440

$
490

$
336

$
1,819

$
1,609

$
1,669

$
588

$
492

$
8,212



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, FG VIE and credit derivative RMBS exposures. As of March 31, 2017, U.S. RMBS exposures represent 2% of the total net par outstanding, and BIG U.S. RMBS represent 23% of total BIG net par outstanding. See Part I, Item 1, Financial Statements, Note 5, Expected Loss to be Paid, for a discussion of expected losses to be paid on U.S. RMBS exposures.
     
Distribution of U.S. RMBS by Rating and Type of Exposure as of March 31, 2017
 
Ratings:
 
Prime
First
Lien
 
Alt-A
First Lien
 
Option
ARMs
 
Subprime
First
Lien
 
Second
Lien
 
Total Net
Par
Outstanding
 
 
(in millions)
AAA
 
$
2

 
$
164

 
$
29

 
$
1,381

 
$
0

 
$
1,576

AA
 
22

 
237

 
50

 
280

 
0

 
589

A
 
14

 
5

 
0

 
60

 
0

 
79

BBB
 
22

 
3

 
—

 
79

 
0

 
103

BIG
 
135

 
548

 
74

 
1,108

 
1,144

 
3,009

Total exposures
 
$
194

 
$
957

 
$
153

 
$
2,908

 
$
1,144

 
$
5,357



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Table of Contents

Distribution of U.S. RMBS by Year Insured and Type of Exposure as of March 31, 2017

Year
insured:
 
Prime
First Lien
 
Alt-A
First Lien
 
Option
ARMs
 
Subprime
First Lien
 
Second
Lien
 
Total Net Par
Outstanding
 
 
(in millions)
2004 and prior
 
$
29

 
$
41

 
$
15

 
$
886

 
$
67

 
$
1,038

2005
 
97

 
360

 
29

 
161

 
249

 
896

2006
 
69

 
73

 
26

 
651

 
333

 
1,152

2007
 
—

 
483

 
84

 
1,145

 
495

 
2,207

2008
 
—

 
—

 
—

 
64

 
—

 
64

Total exposures
 
$
194

 
$
957

 
$
153

 
$
2,908

 
$
1,144

 
$
5,357

    

Exposure to Selected European Countries

The European countries where the Company has exposure and believes heightened uncertainties exist are: Hungary, Italy, Portugal, Spain and Turkey (collectively, the Selected European Countries). The Company’s direct 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 Direct Economic Exposure
to Selected European Countries(1)
As of March 31, 2017
 
Hungary
 
Italy
 
Portugal
 
Spain
 
Turkey
 
Total
 
(in millions)
Sub-sovereign exposure(2)
$
207

 
$
1,121

 
$
77

 
$
433

 
$
—

 
$
1,838

Non-sovereign exposure(3)
114

 
442

 
—

 
—

 
202

 
758

Total
$
321

 
$
1,563

 
$
77

 
$
433

 
$
202

 
$
2,596

Total BIG
$
250

 
$
—

 
$
77

 
$
433

 
$
—

 
$
760



Net Direct Economic Exposure
to Selected European Countries(1)
As of March 31, 2017

 
Hungary
 
Italy
 
Portugal
 
Spain
 
Turkey
 
Total
 
(in millions)
Sub-sovereign exposure(2)
$
204

 
$
912

 
$
75

 
$
345

 
$
—

 
$
1,536

Non-sovereign exposure(3)
114

 
400

 
—

 
—

 
202

 
716

Total
$
318

 
$
1,312

 
$
75

 
$
345

 
$
202

 
$
2,252

Total BIG
$
248

 
$
—

 
$
75

 
$
345

 
$
—

 
$
668

____________________
(1)
While exposures are shown in U.S. dollars, the obligations are in various currencies, primarily euros.

(2)
Sub-sovereign exposure in Selected European Countries includes transactions backed by receivables from, or supported by, sub-sovereigns, which are governmental or government-backed entities other than the ultimate governing body of the country.

(3)
Non-sovereign exposure in Selected European Countries includes debt of regulated utilities, RMBS and diversified payment rights (DPR) securitizations.


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Table of Contents

The tables above include the par amount of financial guaranty contracts accounted for as derivatives of $114 million with a fair value of $2 million, net of reinsurance. 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.

The $202 million net insured par exposure in Turkey is to DPR securitizations sponsored by a major Turkish bank. These DPR securitizations were established outside of Turkey and involve payment orders in U.S. dollars, pounds sterling and Euros from persons outside of Turkey to beneficiaries in Turkey who are customers of the sponsoring bank. The sponsoring bank's correspondent banks have agreed to remit all such payments to a trustee-controlled account outside Turkey, where debt service payments for the DPR securitization are given priority over payments to the sponsoring bank.

The Company has excluded from the exposure tables above its indirect economic exposure to the Selected European Countries through policies it provides on pooled corporate and commercial receivables transactions. The Company calculates indirect exposure to a country by multiplying the par amount of a transaction insured by the Company times the percent of the relevant collateral pool reported as having a nexus to the country. On that basis, the Company has calculated exposure of $78 million to Selected European Countries (plus Greece) in transactions with $1.6 billion of net par outstanding. The indirect exposure to credits with a nexus to Greece is $2 million across several highly rated pooled corporate obligations with net par outstanding of $73 million.

Liquidity and Capital Resources
 
Liquidity Requirements and Sources
 
AGL and its Holding Company Subsidiaries
 
The liquidity of AGL, AGUS and AGMH is largely dependent on dividends from their operating subsidiaries and their access to external financing. The liquidity requirements of these entities include the payment of operating expenses, interest on debt issued by AGUS and AGMH, and dividends on AGL's common shares. AGL and its holding company subsidiaries may also require liquidity to make periodic capital investments in their operating subsidiaries or, in the case of AGL, to repurchase its common shares pursuant to its share repurchase authorization. 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. See “—Dividends From Subsidiaries” below for a discussion of the dividend restrictions of its insurance company subsidiaries.


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Table of Contents

AGL and Holding Company Subsidiaries
Significant Cash Flow Items
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Intercompany sources (uses):
 
 
 
Dividends paid by AGC to AGUS
$
28

 
$
—

Dividends paid by AGM to AGMH
79

 
95

Dividends paid by AG Re to AGL
40

 
25

Dividends paid by MAC to MAC Holdings(1)
12

 
—

External sources (uses):
 
 
 
Dividends paid to AGL shareholders
(19
)
 
(18
)
Repurchases of common shares(2)
(216
)
 
(75
)
Interest paid by AGMH and AGUS
(8
)
 
(7
)
____________________
(1)
MAC Holdings distributed the entire amount to AGM and AGC, in proportion to their ownership percentages.

(2)
See Part I, Item 1, Financial Statements, Note 17, Shareholders' Equity, for additional information about share repurchases and authorizations.

    
Dividends From Subsidiaries

The Company anticipates that for the next twelve months, amounts paid by AGL’s direct and indirect insurance company subsidiaries as dividends or other distributions will be a major source of its liquidity. The insurance company subsidiaries’ ability to pay dividends depends 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. Dividend restrictions applicable to AGC, AGM, MAC and to AG Re, are described in Part I, Item 1, Financial Statements, Note 11, Insurance Company Regulatory Requirements.
    
Dividend restrictions by insurance company subsidiary are as follows:

•
The maximum amount available during 2017 for AGM to distribute as dividends without regulatory approval is estimated to be approximately $192 million. Of such $192 million, $79 million was distributed by AGM to AGMH in First Quarter 2017 and none of such $192 million is available for distribution in the second quarter of 2017.

•
The maximum amount available during 2017 for AGC to distribute as ordinary dividends is approximately $107 million. Of such $107 million, $28 million was distributed by AGC to AGUS in First Quarter 2017 and approximately $24 million is available for distribution in the second quarter of 2017.

•
The maximum amount available during 2017 for MAC to distribute as dividends to MAC Holdings, which is owned by AGM and AGC, without regulatory approval is estimated to be approximately $49 million, of which approximately $37 million is available for distribution in the second quarter of 2017. MAC currently intends to allocate the distribution of such $37 million over the remaining three quarters in 2017.

•
Based on the applicable law and regulations, in 2017 AG Re has the capacity to (i) make capital distributions in an aggregate amount up to $128 million without the prior approval of the Bermuda Monetary Authority and (ii) declare and pay dividends in an aggregate amount up to approximately $314 million. Such dividend capacity is further limited by the actual amount of AG Re’s unencumbered assets, which amount changes from time to time due in part to collateral posting requirements. As of March 31, 2017, AG Re had unencumbered assets of approximately $543 million.

Generally, dividends paid by a U.S. company to a Bermuda holding company are subject to a 30% withholding tax. After AGL became tax resident in the U.K., it became subject to the tax rules applicable to companies resident in the U.K.,

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Table of Contents

including the benefits afforded by the U.K.’s tax treaties. The income tax treaty between the U.K. and the U.S. reduces or eliminates the U.S. withholding tax on certain U.S. sourced investment income (to 5% or 0%), including dividends from U.S. subsidiaries to U.K. resident persons entitled to the benefits of the treaty.

External Financing

From time to time, AGL and its subsidiaries have sought 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.

Intercompany Loans and Guarantees

From time to time, AGL and its subsidiaries have entered into intercompany loan facilities. For example, on October 25, 2013, AGL, as borrower, and AGUS, as lender, entered into a revolving credit facility pursuant to which AGL may, from time to time, borrow for general corporate purposes. Under the credit facility, AGUS committed to lend a principal amount not exceeding $225 million in the aggregate. Such commitment terminates on October 25, 2018 (the loan termination date). The unpaid principal amount of each loan will bear interest at a fixed rate equal to 100% of the then applicable Federal short-term or mid-term interest rate, as the case may be, as determined under Internal Revenue Code Section 1274(d), and interest on all loans will be computed for the actual number of days elapsed on the basis of a year consisting of 360 days. Accrued interest on all loans will be paid on the last day of each June and December, beginning on December 31, 2013, and at maturity. AGL must repay the then unpaid principal amounts of the loans, if any, by the third anniversary of the loan termination date. AGL has not drawn upon the credit facility.

In addition, in 2012 AGUS borrowed $90 million from its affiliate AGRO to fund the acquisition of MAC. During 2016, AGUS repaid $20 million in outstanding principal as well as accrued and unpaid interest, and the parties agreed to extend the maturity date of the loan from May 2017 to November 2019. As of March 31, 2017, $70 million remained outstanding.

Furthermore, AGL fully and unconditionally guarantees the payment of the principal of, and interest on, the $1,130 million aggregate principal amount of senior notes issued by AGUS and AGMH, and the $450 million aggregate principal amount of junior subordinated debentures issued by AGUS and AGMH, in each case, as describe under "Commitments and Contingencies -- Long-Term Debt Obligations" below.

Cash and Investments

As of March 31, 2017, AGL had $12 million in cash and short-term investments. AGUS and AGMH had a total of $185 million in cash and short-term investments. In addition, the Company's U.S. holding companies have $147 million in fixed-maturity securities with weighted average duration of 0.2 years.

Insurance Company Subsidiaries

Liquidity of the insurance company subsidiaries is primarily used to pay for:
•
operating expenses,
•
claims on the insured portfolio,
•
posting of collateral in connection with credit derivatives and reinsurance transactions,
•
reinsurance premiums,
•
dividends to AGL, AGUS and/or AGMH, as applicable,
•
principal of and, where applicable, interest on surplus notes, 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.

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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.
 
 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.

Claims (Paid) Recovered

 
First Quarter
 
2017
 
2016
 
(in millions)
Public finance
$
(25
)
 
$
(5
)
Structured finance:
 
 
 
U.S. RMBS
13

 
(85
)
Other structured finance
(10
)
 
(23
)
Structured finance
3

 
(108
)
Claims (paid) recovered, net of reinsurance(1)
$
(22
)
 
$
(113
)
____________________
(1)
Includes $3 million paid and $8 million paid for consolidated FG VIEs for First Quarter 2017 and 2016, respectively.
    
In addition, the Company has net par exposure to the general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations aggregating $4.9 billion, all of which are BIG. Puerto Rico has experienced significant general fund budget deficits in recent years. Beginning in 2016, the Commonwealth has defaulted on obligations to make payments on its debt. In addition to high debt levels, Puerto Rico faces a challenging economic environment. Information regarding the Company's exposure to the Commonwealth of Puerto Rico and its related authorities and public corporations is set forth in Part I, Item 1, Financial Statements, Note 4, Outstanding Exposure.

As of March 31, 2017, the Company had exposure of approximately $559 million to a long-term infrastructure project that was financed by bonds that mature prior to the expiration of the project concession. The Company expects the cash flows from the project to be sufficient to repay all of the debt over the life of the project concession, and also expects the debt to be refinanced in the market at or prior to its maturity. If the issuer is unable to refinance the debt due to market conditions, the Company may have to pay claims when the debt matures from 2018 to 2022, and then recover 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 claim payments. However, the recovery of such amounts is uncertain and may take from 10 to 35 years, depending on the performance of the underlying collateral.

In connection with the acquisition of AGMH, AGM agreed to retain the risks relating to the debt and strip policy portions of the leveraged lease business. 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. Following such events, 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

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Table of Contents

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 $942 million as of March 31, 2017. 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. At March 31, 2017, approximately $1.6 billion of cumulative strip par exposure had been terminated since 2008 on a consensual basis. The consensual terminations have not resulted in any claims on AGM. 

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 "pay-as-you-go" 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. As of March 31, 2017, the Company was posting approximately $36 million to secure its obligations under CDS. Of that amount, approximately $27 million related to $333 million in CDS gross par insured where the amount of required collateral is capped and the remaining $9 million related to $173 million in CDS gross par insured where the amount of required collateral is based on movements in the mark-to-market valuation of the underlying exposure. In February 2017, the Company terminated all of its remaining CDS contracts with one of its counterparties as to which it had a posting requirement (subject to a cap); the CDS contracts related to approximately $183 million gross par and $73 million of collateral posted, as of December 31, 2016, and all the collateral was returned to the Company.

Consolidated Cash Flows
 
Consolidated Cash Flow Summary
 
 
First Quarter
 
2017
 
2016
 
(in millions)
Net cash flows provided by (used in) operating activities before effects of FG VIE consolidation
$
97

 
$
(96
)
Effect of FG VIE consolidation
5

 
6

Net cash flows provided by (used in) operating activities - reported
102

 
(90
)
Net cash flows provided by (used in) investing activities before effects of FG VIE consolidation
168

 
136

Effect of FG VIE consolidation
43

 
36

Net cash flows provided by (used in) investing activities - reported
211

 
172

Net cash flows provided by (used in) financing activities before effects of FG VIE consolidation
(246
)
 
(94
)
Effect of FG VIE consolidation
(48
)
 
(42
)
Net cash flows provided by (used in) financing activities - reported (1)
(294
)
 
(136
)
Effect of exchange rate changes
2

 
0

Cash and restricted cash at beginning of period
127

 
166

Total cash and restricted cash at the end of the period
$
148

 
$
112

____________________
(1)
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 net cash flows from VIE consolidation, cash outflows from operating activities increased in First Quarter 2017 compared with First Quarter 2016 due primarily to commutation premiums received in 2017, compared with accelerated claim payments in 2016 as a means of mitigating future losses.

Investing activities were primarily net sales (purchases) of fixed-maturity and short-term investment securities. Investing cash flows in First Quarter 2017 and 2016 include inflows of $46 million and $66 million from paydowns on FG VIE assets, respectively. In First Quarter 2017, cash acquired in the MBIA UK Acquisition was $95 million. Consideration paid for MBIA UK was in the form of Zohar II Notes.

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Table of Contents


Financing activities consisted primarily of paydowns of FG VIE liabilities and share repurchases. Financing cash flows in First Quarter 2017 and 2016 include outflows of $48 million and $42 million for FG VIEs, respectively. The remaining cash flows from financing activities relate mainly to share repurchases, which were $216 million and $75 million in First Quarter 2017 and 2016, respectively.

From April 1, 2017 through May 4, 2017, the Company repurchased an additional $53 million common shares. As of May 4, 2017, the Company had remaining authorization to purchase common shares of $280 million. For more information about the Company's share repurchases and authorizations, see Part I, Item 1, Financial Statements, Note 17, Shareholders' Equity.

Commitments and Contingencies
 
Leases
 
AGL and its subsidiaries lease office space and certain other items. Future cash payments associated with contractual obligations pursuant to operating leases for office space have not materially changed since December 31, 2016.

Long-Term Debt Obligations
 
The outstanding principal and interest paid on long-term debt were as follows:

Principal Outstanding
and Interest Paid on Long-Term Debt
 
 
Principal Amount
 
Interest Paid
 
As of March 31,
 
As of December 31,
 
First Quarter
 
2017
 
2016
 
2017

2016
 
(in millions)
AGUS
$
850

 
$
850

 
$
1

 
$
—

AGMH
730

 
730

 
7

 
7

AGM
9

 
9

 
0

 
0

Total
$
1,589

 
$
1,589

 
$
8

 
$
7


Issued by AGUS:

7% Senior Notes.  On May 18, 2004, AGUS issued $200 million of 7% Senior Notes due 2034 for net proceeds of $197 million. Although the coupon on the Senior Notes is 7%, the effective rate is approximately 6.4%, taking into account the effect of a cash flow hedge.
 
5% Senior Notes. On June 20, 2014, AGUS issued $500 million of 5% Senior Notes due 2024 for net proceeds of $495 million. The net proceeds from the sale of the notes were used for general corporate purposes, including the purchase of common shares of AGL.

Series A Enhanced Junior Subordinated Debentures.  On December 20, 2006, AGUS issued $150 million of Debentures due 2066. The Debentures paid a fixed 6.4% 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 one or more times to defer payment of interest for one 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.

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.

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5.6% Notes.  On July 31, 2003, AGMH issued $100 million face amount of 5.6% 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 6.4%. 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.
  
Committed Capital Securities

Each of AGC and AGM have issued $200 million of CCS pursuant to transactions in which AGC CCS or AGM’s Committed Preferred Trust Securities (the AGM CPS), 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 securities 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 CCS 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) specified events occur.

     AGC Committed Capital Securities. AGC entered into separate put agreements with four custodial trusts with respect to its CCS in April 2005. The AGC 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 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 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. 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 with respect to its CCS 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 CCS 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.


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Investment Portfolio
 
The Company’s principal objectives in managing its investment portfolio are to support 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.
 
The Company’s fixed-maturity securities and short-term investments had a duration of 5.4 years as of March 31, 2017 and 5.3 years as of December 31, 2016. Generally, the Company’s fixed-maturity securities are designated as available-for-sale. For more information about the Investment Portfolio and a detailed description of the Company’s valuation of investments see Part I, Item 1, Financial Statements, Note 10, Investments and Cash.

Fixed-Maturity Securities and Short-Term Investments
by Security Type 

 
As of March 31, 2017
 
As of December 31, 2016
 
Amortized
Cost
 
Estimated
Fair Value
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Fixed-maturity securities:
 

 
 

 
 

 
 

Obligations of state and political subdivisions
$
5,432

 
$
5,622

 
$
5,269

 
$
5,432

U.S. government and agencies
399

 
414

 
424

 
440

Corporate securities
1,851

 
1,874

 
1,612

 
1,613

Mortgage-backed securities(1):
 
 
 
 
 
 
 

RMBS
978

 
992

 
998

 
987

Commercial mortgage-backed securities (CMBS)
561

 
568

 
575

 
583

Asset-backed securities
573

 
690

 
835

 
945

Foreign government securities
341

 
319

 
261

 
233

Total fixed-maturity securities
10,135

 
10,479

 
9,974

 
10,233

Short-term investments
687

 
689

 
590

 
590

Total fixed-maturity and short-term investments
$
10,822

 
$
11,168

 
$
10,564

 
$
10,823

 ____________________
(1)
Government-agency obligations were approximately 40% of mortgage backed securities as of March 31, 2017 and 42% as of December 31, 2016, based on fair value.

 

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The following tables summarize, for all fixed-maturity securities in an unrealized loss position as of March 31, 2017 and December 31, 2016, 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 March 31, 2017

 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
(dollars in millions)
Obligations of state and political subdivisions
$
994

 
$
(28
)
 
$
6

 
$
(1
)
 
$
1,000

 
$
(29
)
U.S. government and agencies
172

 
(1
)
 
—

 
—

 
172

 
(1
)
Corporate securities
356

 
(8
)
 
120

 
(19
)
 
476

 
(27
)
Mortgage-backed securities:
 
 
 
 
 
 
 

 
 
 
 
RMBS
377

 
(13
)
 
93

 
(13
)
 
470

 
(26
)
CMBS
160

 
(5
)
 
1

 
0

 
161

 
(5
)
Asset-backed securities
52

 
0

 
0

 
0

 
52

 
0

Foreign government securities
45

 
(4
)
 
115

 
(25
)
 
160

 
(29
)
Total
$
2,156

 
$
(59
)
 
$
335

 
$
(58
)
 
$
2,491

 
$
(117
)
Number of securities (1)
 

 
542

 
 

 
62

 
 

 
598

Number of securities with other-than-temporary impairment
 

 
12

 
 

 
9

 
 

 
21

 

Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time 
As of December 31, 2016

 
Less than 12 months
 
12 months or more
 
Total
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
(dollars in millions)
Obligations of state and political subdivisions
$
1,110

 
$
(38
)
 
$
6

 
$
(1
)
 
$
1,116

 
$
(39
)
U.S. government and agencies
87

 
(1
)
 
—

 
—

 
87

 
(1
)
Corporate securities
492

 
(11
)
 
118

 
(20
)
 
610

 
(31
)
Mortgage-backed securities:
 

 
 

 
 

 
 

 


 


RMBS
391

 
(23
)
 
94

 
(15
)
 
485

 
(38
)
CMBS
165

 
(5
)
 
—

 
—

 
165

 
(5
)
Asset-backed securities
36

 
0

 
0

 
0

 
36

 
—

Foreign government securities
44

 
(5
)
 
114

 
(27
)
 
158

 
(32
)
Total
$
2,325

 
$
(83
)
 
$
332

 
$
(63
)
 
$
2,657

 
$
(146
)
Number of securities(1)
 

 
622

 
 

 
60

 
 

 
676

Number of securities with other-than-temporary impairment
 

 
8

 
 

 
9

 
 

 
17

___________________
(1)
The number of securities does not add across because lots consisting of the same securities have been purchased at different times and appear in both categories above (i.e., less than 12 months and 12 months or more). If a security appears in both categories, it is counted only once in the total column.
 

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Of the securities in an unrealized loss position for 12 months or more as of March 31, 2017, 41 securities had unrealized losses greater than 10% of book value. The total unrealized loss for these securities as of March 31, 2017 was $52 million. As of December 31, 2016, of the securities in an unrealized loss position for 12 months or more, 41 securities had unrealized losses greater than 10% of book value with an unrealized loss of $59 million. The Company has determined that the unrealized losses recorded as of March 31, 2017 and December 31, 2016 were yield related and not the result of other-than-temporary-impairment.
 
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 generally increases and as interest rates rise, the fair value of fixed-maturity securities generally decreases. The Company’s portfolio of fixed-maturity securities consists primarily of high-quality, liquid instruments.
 
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 March 31, 2017
 
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Due within one year
$
284

 
$
283

Due after one year through five years
1,798

 
1,828

Due after five years through 10 years
2,171

 
2,227

Due after 10 years
4,343

 
4,581

Mortgage-backed securities:
 

 
 

RMBS
978

 
992

CMBS
561

 
568

Total
$
10,135

 
$
10,479

 

The following table summarizes the ratings distributions of the Company’s investment portfolio as of March 31, 2017 and December 31, 2016. Ratings reflect the lower of the Moody’s and S&P Global Ratings, a division of Standard & Poor's Financial Services LLC (S&P) classifications, except for bonds purchased for loss mitigation or other risk management strategies, which use Assured Guaranty’s internal ratings classifications.
 
Distribution of
Fixed-Maturity Securities by Rating
 
Rating
 
As of
March 31, 2017
 
As of
December 31, 2016
AAA
 
13.2
%
 
11.6
%
AA
 
54.6

 
54.8

A
 
18.4

 
17.9

BBB
 
1.8

 
1.9

BIG(1)
 
11.6

 
13.5

Not rated
 
0.4

 
0.3

Total
 
100.0
%
 
100.0
%
____________________
(1)
Comprised primarily of loss mitigation and other risk management assets. See Part I, Item I, Financial Statements, Note 10, Investments and Cash, for additional information.
 

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Investments and restricted cash that are either held in trust for the benefit of third party ceding insurers in accordance with statutory requirements, invested in a guaranteed investment contract for future claims payments, placed on deposit to fulfill state licensing requirements, or otherwise restricted aggregate to the amount of $282 million and $285 million, based on fair value, as of March 31, 2017 and December 31, 2016, respectively. The investment portfolio also contains securities that are held in trust by certain AGL subsidiaries for the benefit of other AGL subsidiaries in accordance with statutory and regulatory requirements in the amount of $1,508 million and $1,420 million, based on fair value, as of March 31, 2017 and December 31, 2016, respectively.
 
The fair value of the Company’s pledged securities to secure its obligations under its CDS exposure totaled $36 million and $116 million as of March 31, 2017 and December 31, 2016, respectively. In February 2017, the Company terminated all of its remaining CDS contracts with one of its counterparties as to which it had collateral posting obligations and all of the collateral that the Company had been posting to that counterparty was returned to the Company. See Part I, Item I, Financial Statements, Note 8, Contracts Accounted for as Credit Derivatives, for additional information.
 
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 guaranteed investment contracts (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, described under "--Insurance Company Subsidiaries" above.
 
The GIC Business
 
Until November 2008, AGMH, through its financial products business, offered GICs to municipalities and other market participants. The GICs were issued through certain non-insurance subsidiaries of AGMH. In return for an initial payment, each GIC entitles its holder to receive the return of the holder’s invested principal plus interest at a specified rate, and to withdraw principal from the GIC as permitted by its terms. AGM insures the payment obligations on all these GICs.
 
The proceeds of GICs were loaned to AGMH’s former subsidiary FSA Asset Management LLC (FSAM). FSAM in turn invested these funds in fixed-income obligations (the FSAM assets).
 
As of March 31, 2017, approximately 26.4% of the FSAM assets (measured by aggregate principal balance) were in cash or were obligations backed by the full faith and credit of the U.S. Although AGMH no longer holds any ownership interest in FSAM or the GIC issuers, AGM’s insurance policies on the GICs remain in place, and must remain in place until each GIC is terminated.
 
In June 2009, in connection with the Company's acquisition of AGMH from Dexia Holdings Inc., Dexia SA, the ultimate parent of Dexia Holdings Inc., and certain of its affiliates, entered into a number of agreements intended to mitigate the credit, interest rate and liquidity risks associated with the GIC business and the related AGM insurance policies. Some of those agreements have since terminated or expired, or been modified.
 
To support the primary payment obligations under the GICs, each of Dexia SA and Dexia Crédit Local S.A. are party to a put contract. Pursuant to the put contract, FSAM may put an amount of its FSAM assets to Dexia SA and Dexia Crédit Local S.A. in exchange for funds that FSAM would in turn make available to meet demands for payment under the GICs. To secure their obligations under this put contract, Dexia SA and Dexia Crédit Local S.A. are required to post eligible highly liquid collateral having an aggregate value (subject to agreed reductions and advance rates) equal to at least the excess of (i) the aggregate principal amount of all outstanding GICs over (ii) the aggregate mark-to-market value of FSAM’s assets.

As of March 31, 2017, the aggregate accreted GIC balance was approximately $1.5 billion, compared with approximately $10.2 billion as of December 31, 2009. As of March 31, 2017, the aggregate fair market value of the assets supporting the GIC business (disregarding the agreed upon reductions) plus cash and positive derivative value exceeded by nearly $0.8 billion the aggregate principal amount of all outstanding GICs and certain other business and hedging costs of the GIC business. Even after applying the agreed upon reductions to the fair market value of the assets, the aggregate value of the assets supporting the GIC business plus cash and positive derivative value exceeded the aggregate principal amount of all outstanding GICs and certain other business and hedging costs of the GIC business. Accordingly, no posting of collateral was required under the primary put contract.


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To provide additional support, Dexia Crédit Local S.A. provides a liquidity commitment to FSAM to lend against FSAM assets under a revolving credit agreement. As of March 31, 2017 the commitment totaled $1.4 billion, of which approximately $0.8 billion was drawn. The agreement requires the commitment remain in place, generally until the GICs have been paid in full.

Despite the put contract and revolving credit agreement, 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 SA and its affiliates may not fulfill their contractual obligations. In that case, 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.
 
A downgrade of the financial strength rating of AGM could trigger a payment obligation of AGM in respect to AGMH's former GIC business. 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 Investors Service, Inc. (Moody's). FSAM is expected to have sufficient eligible and liquid assets to satisfy any expected withdrawal and collateral posting obligations resulting from future rating actions affecting AGM.

The Medium Term Notes Business
 
In connection with the acquisition of AGMH, Dexia Crédit Local S.A. agreed to fund, on behalf of AGM, 100% of all policy claims made under financial guaranty insurance policies issued by AGM in relation to the medium term notes issuance program of FSA Global Funding Limited. As of March 31, 2017, FSA Global Funding Limited had approximately $308.6 million of medium term notes outstanding.
 
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. For other quantitative and qualitative disclosures about market risk, see Item 7A, "Quantitative and Qualitative Disclosures About Market Risk", of our Company's Annual Report on Form 10-K for the year ended December 31, 2016. There were no material changes in market risk since December 31, 2016.

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 Exchange Act) that are effective in recording, processing, summarizing and reporting, within the time periods specified in the Securities and Exchange 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.
 
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 March 31, 2017. Based on their evaluation as of March 31, 2017 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.

On January 10, 2017, the Company acquired MBIA UK. See Part I, Item I, Financial Statements, Note 2, Acquisitions, for additional information. The Company has extended its Section 404 compliance program under the Sarbanes-Oxley Act of 2002 and the applicable rules and regulations under such Act to include the integration of MBIA UK financial data into the Company’s existing systems, processes and related controls, as well as the new processes and controls to accommodate the business combination accounting and financial consolidation of MBIA UK during the Company’s quarter ended March 31, 2017.


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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, 2016, and in Part I, Item 1, Financial Statements, Note 14, Commitments and Contingencies – Legal Proceedings contained in this Form 10-Q, which note includes discussion of developments that occurred during the three months ended March 31, 2017.

On September 25, 2013, Wells Fargo Bank, N.A., as trust administrator of the MASTR Adjustable Rate Mortgages Trust 2007-3 (Wells Fargo), filed an interpleader complaint in the U.S. District Court for the Southern District of New York seeking adjudication of a dispute between Wales LLC (Wales) and AGM as to whether AGM is entitled to reimbursement from certain cashflows for principal claims paid in respect of insured certificates. After the court issued an opinion on September 30, 2016, denying a motion for judgment on the pleadings filed by Wales, Wales sold its interests in the MASTR Adjustable Rate Mortgage Trust 2007-3 certificates, and on March 20, 2017, the court dismissed the case.

ITEM 1A.
RISK FACTORS

Please refer to the risk factors set forth in Part I, "Item 1A. Risk Factors" of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. There have been no material changes to the risk factors disclosed in such Annual Report and Quarterly Report during the three months ended March 31, 2017.

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 First Quarter 2017.
 
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)
January 1 - January 31
 
2,215,125

 
$
39.13

 
2,215,125

 
$
162,499,480

February 1 - February 28
 
1,917,969

 
$
40.57

 
1,651,244

 
$
395,393,966

March 1 - March 31
 
1,583,893

 
$
40.00

 
1,563,672

 
$
332,872,711

Total
 
5,716,987

 
$
39.85

 
5,430,041

 
 

____________________
(1)
After giving effect to repurchases since the beginning of 2013 through May 4, 2017, the Company has repurchased a total of 75.4 million common shares for approximately $1,984 million, excluding commissions, at an average price of $26.29 per share. On February 22, 2017, the Board authorized an additional $300 million, including a specifically authorized repurchase from the Company's Chief Executive Officer and its General Counsel. See Part I, Item 1, Financial Statements, Note 17, Shareholders' Equity, for additional information about the Company's repurchases of its common shares, including the details of the authorization of repurchases from its Chief Executive Officer and General Counsel. As of May 4, 2017, $280 million of total capacity remained from the authorizations, on a settlement basis.

(2)
Excludes commissions.


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


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Table of Contents

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 May 5, 2017
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

 
Form of Executive Restricted Stock Unit Agreement under Assured Guaranty Ltd. 2004 Long-Term Incentive Plan for awards commencing in 2017 *
10.2

 
Form of Executive Performance Based Restricted Stock Unit Agreement under Assured Guaranty Ltd. 2004 Long-Term Incentive Plan *
10.3

 
Director Compensation Summary *
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 March 31, 2017 formatted in XBRL: (i) Consolidated Balance Sheets at March 31, 2017 and December 31, 2016; (ii) Consolidated Statements of Operations for the Three Months ended March 31, 2017 and 2016; (iii) Consolidated Statements of Comprehensive Income for the Three Months ended March 31, 2017 and 2016 (iv) Consolidated Statement of Shareholders’ Equity for the Three Months ended March 31, 2017; (v) Consolidated Statements of Cash Flows for the Three Months ended March 31, 2017 and 2016; and (vi) Notes to Consolidated Financial Statements.
 
*
Management contract or compensatory plan



139