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ASSURED GUARANTY LTD - Quarter Report: 2019 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, 2019
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 every Interactive Data File required to be submitted 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 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
 
 
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
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Trading Symbol(s)
Name of exchange on which registered
Common Shares, $0.01 per share
AGO
New York Stock Exchange

The number of registrant’s Common Shares ($0.01 par value) outstanding as of May 7, 2019 was 101,563,349 (includes 67,319 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.

Condensed Consolidated Balance Sheets (unaudited)
 
(dollars in millions except per share and share amounts) 

 
As of
March 31, 2019
 
As of
December 31, 2018
Assets
 

 
 

Investment portfolio:
 

 
 

Fixed-maturity securities, available-for-sale, at fair value (amortized cost of $9,590 and $9,884)
$
9,989

 
$
10,089

Short-term investments, at fair value
727

 
729

Other invested assets
61

 
55

Total investment portfolio
10,777

 
10,873

Cash
123

 
104

Premiums receivable, net of commissions payable
897

 
904

Deferred acquisition costs
104

 
105

Salvage and subrogation recoverable
522

 
490

Financial guaranty variable interest entities’ assets, at fair value
560

 
569

Other assets
568

 
558

Total assets
$
13,551

 
$
13,603

Liabilities and shareholders’ equity
 

 
 

Unearned premium reserve
$
3,437

 
$
3,512

Loss and loss adjustment expense reserve
1,032

 
1,177

Long-term debt
1,232

 
1,233

Credit derivative liabilities
229

 
209

Financial guaranty variable interest entities’ liabilities with recourse, at fair value
505

 
517

Financial guaranty variable interest entities’ liabilities without recourse, at fair value
104

 
102

Other liabilities
343

 
298

Total liabilities
6,882

 
7,048

Commitments and contingencies (see Note 12)

 

Common stock ($0.01 par value, 500,000,000 shares authorized; 102,270,409 and 103,672,592 shares issued and outstanding)
1

 
1

Additional paid-in capital
—

 
86

Retained earnings
6,406

 
6,374

Accumulated other comprehensive income, net of tax of $63 and $38
261

 
93

Deferred equity compensation
1

 
1

Total shareholders’ equity
6,669

 
6,555

Total liabilities and shareholders’ equity
$
13,551

 
$
13,603


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

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Assured Guaranty Ltd.

Condensed Consolidated Statements of Operations (unaudited)
 
(dollars in millions except per share amounts)

 
Three Months Ended March 31,
 
2019
 
2018
Revenues
 
 
 
Net earned premiums
$
118

 
$
145

Net investment income
98

 
100

Net realized investment gains (losses)
(12
)
 
(5
)
Net change in fair value of credit derivatives
(22
)
 
34

Fair value gains (losses) on financial guaranty variable interest entities
5

 
4

Other income (loss)
8

 
15

Total revenues
195

 
293

Expenses
 
 
 
Loss and loss adjustment expenses
46

 
(18
)
Amortization of deferred acquisition costs
6

 
5

Interest expense
23

 
24

Other operating expenses
64

 
65

Total expenses
139

 
76

Income (loss) before income taxes and equity in net earnings of investees
56

 
217

Equity in net earnings of investees
2

 
—

Income (loss) before income taxes
58

 
217

Provision (benefit) for income taxes
4

 
20

Net income (loss)
$
54

 
$
197

 
 
 
 
Earnings per share:
 
 
 
Basic
$
0.52

 
$
1.71

Diluted
$
0.52

 
$
1.68

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

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Assured Guaranty Ltd.

Condensed Consolidated Statements of Comprehensive Income (unaudited)
 
(in millions)
 
 
Three Months Ended March 31,
 
2019
 
2018
Net income (loss)
$
54

 
$
197

Change in net unrealized gains (losses) on:
 
 
 
Investments with no other-than-temporary impairment, net of tax provision (benefit) of $25 and $(29)
163

 
(128
)
Investments with other-than-temporary impairment, net of tax provision (benefit) of $0 and $(1)
5

 
(2
)
Change in net unrealized gains (losses) on investments
168

 
(130
)
Change in net unrealized gains (losses) on financial guaranty variable interest entities' liabilities with recourse resulting from a change in the instrument-specific credit risk, net of tax
—

 
(2
)
Other, net of tax provision (benefit) of $0 and $1
—

 
6

Other comprehensive income (loss)
168

 
(126
)
Comprehensive income (loss)
$
222

 
$
71

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

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Assured Guaranty Ltd.

Condensed Consolidated Statements of Shareholders’ Equity (unaudited)

(dollars in millions, except share data)

For the Three Months Ended March 31, 2019
 
 
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, 2018
103,672,592

 
 
$
1

 
$
86

 
$
6,374

 
$
93

 
$
1

 
$
6,555

Net income
—

 
 
—

 
—

 
54

 
—

 
—

 
54

Dividends ($0.18 per share)
—

 
 
—

 
—

 
(19
)
 
—

 
—

 
(19
)
Common stock repurchases
(1,908,605
)
 
 
—

 
(76
)
 
(3
)
 
—

 
—

 
(79
)
Share-based compensation and other
506,422

 
 
—

 
(10
)
 
—

 
—

 
—

 
(10
)
Other comprehensive income
—

 
 
—

 
—

 
—

 
168

 
—

 
168

Balance at
March 31, 2019
102,270,409

 
 
$
1

 
$
—

 
$
6,406

 
$
261

 
$
1

 
$
6,669


 

For the Three Months Ended March 31, 2018
 
 
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, 2017
116,020,852

 
 
$
1

 
$
573

 
$
5,892

 
$
372

 
$
1

 
$
6,839

Net income
—

 
 
—

 
—

 
197

 
—

 
—

 
197

Dividends ($0.16 per share)
—

 
 
—

 
—

 
(19
)
 
—

 
—

 
(19
)
Common stock repurchases
(2,787,936
)
 
 
—

 
(98
)
 
—

 
—

 
—

 
(98
)
Share-based compensation and other
476,406

 
 
—

 
(9
)
 
—

 
—

 
—

 
(9
)
Other comprehensive loss
—

 
 
—

 
—

 
—

 
(126
)
 
—

 
(126
)
Effect of adoption of ASU 2016-01 (see Note 15)
—

 
 
—

 
—

 
32

 
(32
)
 
—

 
—

Balance at
March 31, 2018
113,709,322

 
 
$
1

 
$
466

 
$
6,102

 
$
214

 
$
1

 
$
6,784




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

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Assured Guaranty Ltd.

Condensed Consolidated Statements of Cash Flows (unaudited)
 
(in millions)
 
 
Three Months Ended March 31,
 
2019
 
2018
Net cash flows provided by (used in) operating activities
$
(332
)
 
$
27

Investing activities
 

 
 

Fixed-maturity securities:
 

 
 

Purchases
(196
)
 
(411
)
Sales
471

 
409

Maturities
177

 
225

Short-term investments with original maturities of over three months:
 
 
 
Purchases
(107
)
 
(47
)
Sales
2

 
—

Maturities
67

 
45

Net sales (purchases) of short-term investments with original maturities of less than three months
25

 
(114
)
Net proceeds from paydowns on financial guaranty variable interest entities’ assets
26

 
33

Other
27

 
(14
)
Net cash flows provided by (used in) investing activities
492

 
126

Financing activities
 

 
 

Dividends paid
(20
)

(18
)
Repurchases of common stock
(80
)

(100
)
Repurchases of common stock to pay withholding taxes
(15
)
 
(12
)
Net paydowns of financial guaranty variable interest entities’ liabilities
(25
)
 
(33
)
Paydown of long-term debt
(3
)
 
(19
)
Proceeds from option exercises
1

 
1

Net cash flows provided by (used in) financing activities
(142
)
 
(181
)
Effect of foreign exchange rate changes
1

 
1

Increase (decrease) in cash and restricted cash
19

 
(27
)
Cash and restricted cash at beginning of period (see Note 9)
104

 
144

Cash and restricted cash at end of period (see Note 9)
$
123

 
$
117

Supplemental cash flow information
 

 
 

Cash paid (received) during the period for:
 

 
 

Income taxes
$
—

 
$
10

Interest on long-term debt
$
9

 
$
21


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

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Table of Contents

Assured Guaranty Ltd.

Notes to Condensed Consolidated Financial Statements (unaudited)
 
March 31, 2019

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 non-financial guaranty insurance and reinsurance on transactions with similar risk profiles to its structured finance exposures written in financial guaranty form.

Basis of Presentation
 
The unaudited interim condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). In management's opinion, all material adjustments 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) are reflected in the periods presented and are of a normal, recurring nature. 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 condensed consolidated financial statements are as of March 31, 2019 and cover the three-month period ended March 31, 2019 (First Quarter 2019) and the three-month period ended March 31, 2018 (First Quarter 2018). 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 condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. The presentation of cash flow amounts related to short-term investments was changed during the fourth quarter of 2018 to reflect cash flows on a gross, rather than a net, basis. The presentation of equity in net earnings of investees was changed in 2019 to reflect amounts previously reported in net investment income and other income to a separate line item on the condensed consolidated statements of operations. Certain prior year balances have been reclassified to conform to the current year's presentation.

The unaudited interim condensed consolidated financial statements include the accounts of AGL, its direct and indirect subsidiaries and its consolidated VIEs. Intercompany accounts and transactions between and among all consolidated entities have been eliminated.
 
These unaudited interim condensed 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, 2018, filed with the U.S. Securities and Exchange Commission (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) plc (AGE), organized in the U.K.;
•
Assured Guaranty Re Ltd. (AG Re), domiciled in Bermuda; and
•
Assured Guaranty Re Overseas Ltd. (AGRO), domiciled in Bermuda.

The Company’s organizational structure includes various holding companies, two of which - Assured Guaranty US Holdings Inc. (AGUS) and Assured Guaranty Municipal Holdings Inc. (AGMH) - have public debt outstanding. See Note 13, Long-Term Debt and Credit Facilities and Note 16, Subsidiary Information.

Adopted Accounting Standards

Leases
    
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842). The Company adopted Topic 842 on January 1, 2019 using the optional transition method that allows the Company to initially apply the new requirements at the effective date, with no revision to prior periods. See Note 12, Commitments and Contingencies, for additional information.

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.  This ASU was adopted on January 1, 2019, with no effect on the Company's condensed consolidated financial statements.

Future Application of Accounting Standards

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 ASU provides a new current expected credit loss model to account for credit losses on certain financial assets and off-balance sheet exposures (e.g., reinsurance recoverables, premium receivables, held-to- maturity debt securities, and loan commitments). That model requires an entity to estimate lifetime credit losses related to certain financial assets, based on relevant historical information, adjusted for current conditions and reasonable and supportable forecasts that could affect the collectability of the reported amount. The ASU also makes targeted amendments to the current impairment model for available-for-sale debt securities, which includes requiring the recognition of an allowance rather than a direct write-down of the investment. The allowance may be reversed in the event that the credit of an issuer improves. In addition, the ASU eliminates the existing guidance for purchased credit impaired assets and introduces a new model for purchased financial assets with credit deterioration, such as the Company's loss mitigation securities. That new model would require the recognition of an initial allowance for credit losses, which is added to the purchase price.

                The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. For reinsurance recoverables, premiums receivable and debt instruments such as loans and held to maturity securities, 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. Early adoption of the amendments is permitted. The Company does not plan to early adopt this ASU. The Company is evaluating the effect that this ASU will have on its financial statements.

Targeted Improvements to the Accounting for Long-Duration Contracts

In August 2018, the FASB issued ASU 2018-12, Financial Services - Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts.  The amendments in this ASU:


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•
improve the timeliness of recognizing changes in the liability for future policy benefits and modify the rate used to discount future cash flows,
•
simplify and improve the accounting for certain market-based options or guarantees associated with deposit (or account balance) contracts,
•
simplify the amortization of deferred acquisition costs, and
•
improve the effectiveness of the required disclosures.

This ASU does not impact the Company’s financial guaranty insurance contracts, but may impact its accounting for certain non-financial guaranty contracts. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption of the amendments is permitted. At this time, the Company does not plan to early adopt this ASU. The Company does not expect this ASU to have a material effect on its condensed consolidated financial statements.

2.    Ratings
 
The financial strength ratings (or similar ratings) for AGL’s insurance subsidiaries, along with the date of the most recent rating action (or confirmation) by the rating agency, are shown in the table below. Ratings are subject to continuous rating agency review and revision or withdrawal at any time. In addition, 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.

 
S&P Global Ratings, a division of Standard & Poor’s Financial Services LLC
 
Kroll Bond Rating
Agency
 
Moody’s Investors Service, Inc.
 
A.M. Best Company,
Inc.
AGM
AA (stable) (6/26/18)
 
AA+ (stable) (12/21/18)
 
A2 (stable) (5/7/18)
 
—
AGC
AA (stable) (6/26/18)
 
AA (stable) (11/30/18)
 
(1)
 
—
MAC
AA (stable) (6/26/18)
 
AA+ (stable) (7/12/18)
 
—
 
—
AG Re
AA (stable) (6/26/18)
 
—
 
—
 
—
AGRO
AA (stable) (6/26/18)
 
—
 
—
 
A+ (stable) (7/13/18)
AGE
AA (stable) (6/26/18)
 
AA+ (stable) (12/21/18)
 
A2 (stable) (5/7/18)
 
—
____________________
(1)
AGC requested that Moody’s Investors Service, Inc. (Moody’s) withdraw its financial strength ratings of AGC in January 2017, but Moody's denied that request. Moody’s continues to rate AGC A3 (stable).

There can be no assurance that any of the rating agencies will not take negative action on the financial strength ratings (or similar ratings) of AGL's insurance subsidiaries in the future or cease to rate one or more of AGL's insurance subsidiaries, either voluntarily or at the request of that subsidiary.
    
For a discussion of the effects of rating actions on the Company, see Note 5, Contracts Accounted for as Insurance, and Note 11, Reinsurance.

3.
Outstanding Exposure
 
The Company primarily sells credit protection contracts in financial guaranty insurance form. Until 2009, the Company also sold credit protection by issuing policies that guaranteed payment obligations under credit derivatives, primarily credit default swaps (CDS). The Company's 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 its financial guaranty insurance contracts. 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 has, however, acquired or reinsured portfolios both before and after 2009 that include financial guaranty contracts in credit derivative form.

The Company also writes non-financial guaranty insurance that is consistent with its risk profile and benefits from its underwriting experience.


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The Company seeks to limit its exposure to losses by underwriting obligations that it views as investment grade at inception, although on occasion it may underwrite new issuances that it views as below-investment-grade (BIG), typically as part of its loss mitigation strategy for existing troubled exposures. The Company also seeks to acquire portfolios of insurance from financial guarantors that are no longer writing new business by acquiring such companies, providing reinsurance on a portfolio of insurance or reassuming a portfolio of reinsurance it had previously ceded; in such instances, it evaluates the risk characteristics of the target portfolio, which may include some BIG exposures, as a whole in the context of the proposed transaction. The Company diversifies its insured portfolio across asset classes and, in the structured finance portfolio, typically requires subordination or collateral to protect it from loss. Reinsurance may be used in order to reduce net exposure to certain insured transactions.

     Public finance obligations insured by the Company primarily consist 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 8, 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. The Company also provides non-financial guaranty insurance and reinsurance on transactions without special purpose entities but with similar risk profiles to its structured finance exposures written in financial guaranty form.

Second-to-pay insured par outstanding represents transactions the Company has insured that are already insured by another financial guaranty insurer and where the Company's obligation to pay under its insurance of such transactions arises only if both the obligor on the underlying insured obligation and the primary financial guaranty insurer default. The Company underwrites such transactions based on the underlying insured obligation without regard to the primary financial guaranty insurer. The second-to-pay insured par outstanding as of March 31, 2019 and December 31, 2018 was $6.5 billion and $6.7 billion, respectively. The par on second-to-pay exposure where the ratings of the primary financial guaranty insurer and underlying insured transaction are both BIG and/or not rated was $108 million and $111 million as of March 31, 2019 and December 31, 2018, respectively.

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 insured portfolio and refreshes its internal credit ratings on individual exposures in quarterly, semi-annual or annual cycles based on the Company’s view of the exposure’s credit quality, loss potential, volatility and sector. Ratings on exposures in sectors identified as under the most stress or with the most potential volatility are reviewed every quarter, although the Company may also review a rating in response to developments impacting the credit when a ratings review is not scheduled. For assumed exposures, the Company may use the ceding company’s credit ratings of transactions where it is impractical for it to assign its own rating.
 
Exposures identified as BIG are subjected to further review to determine the probability of a loss. See Note 4, Expected Loss to be Paid, for additional information. Surveillance personnel then assign each BIG transaction to the appropriate BIG surveillance category based upon whether a future loss is expected and whether a claim has been paid. The Company uses a tax-equivalent yield, which reflects long-term trends in interest rates, to calculate the present value of projected payments and recoveries and determine whether a future loss is expected in order to assign the appropriate BIG surveillance category to a transaction. For financial statement measurement purposes, the Company uses risk-free rates, which are determined each quarter, to calculate the expected loss.

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More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly. For purposes of determining the appropriate surveillance category, 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 on that transaction in the future 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.

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.

Financial Guaranty Exposure

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 from par and debt service outstanding, which amounts are included in the investment portfolio, because it manages such securities as investments and not insurance exposure. As of both March 31, 2019 and December 31, 2018, the Company excluded $1.9 billion of net par attributable to loss mitigation securities and other loss mitigation strategies (which are mostly BIG).

Financial Guaranty
Debt Service Outstanding
 
 
Gross Debt Service
Outstanding
 
Net Debt Service
Outstanding
 
March 31,
2019
 
December 31,
2018
 
March 31,
2019
 
December 31,
2018
 
(in millions)
Public finance
$
354,406

 
$
361,511

 
$
351,396

 
$
358,438

Structured finance
13,290

 
13,569

 
13,245

 
13,148

Total financial guaranty
$
367,696

 
$
375,080

 
$
364,641

 
$
371,586





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Financial Guaranty Portfolio by Internal Rating
As of March 31, 2019

 
 
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
 
$
412

 
0.3
%
 
$
2,442

 
5.5
%
 
$
1,510

 
14.6
%
 
$
246

 
25.5
%
 
$
4,610

 
1.9
%
AA
 
21,666

 
11.9

 
1,710

 
3.8

 
4,230

 
40.9

 
24

 
2.5

 
27,630

 
11.6

A
 
101,576

 
56.0

 
13,305

 
29.8

 
950

 
9.2

 
204

 
21.1

 
116,035

 
48.9

BBB
 
51,697

 
28.5

 
26,157

 
58.6

 
1,166

 
11.3

 
404

 
41.9

 
79,424

 
33.5

BIG
 
6,057

 
3.3

 
1,001

 
2.3

 
2,481

 
24.0

 
87

 
9.0

 
9,626

 
4.1

Total net par outstanding
 
$
181,408

 
100.0
%

$
44,615


100.0
%

$
10,337


100.0
%

$
965


100.0
%

$
237,325


100.0
%



Financial Guaranty Portfolio by Internal Rating
As of December 31, 2018 

 
 
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
 
$
413

 
0.2
%
 
$
2,399

 
5.4
%
 
$
1,533

 
15.4
%
 
$
273

 
22.9
%
 
$
4,618

 
1.9
%
AA
 
21,646

 
11.6

 
1,711

 
3.9

 
3,599

 
36.2

 
65

 
5.4

 
27,021

 
11.2

A
 
105,180

 
56.4

 
13,013

 
29.5

 
1,016

 
10.2

 
206

 
17.3

 
119,415

 
49.4

BBB
 
52,935

 
28.4

 
25,939

 
58.8

 
1,164

 
11.7

 
550

 
46.1

 
80,588

 
33.3

BIG
 
6,388

 
3.4

 
1,041

 
2.4

 
2,632

 
26.5

 
99

 
8.3

 
10,160

 
4.2

Total net par outstanding
 
$
186,562

 
100.0
%
 
$
44,103

 
100.0
%
 
$
9,944

 
100.0
%
 
$
1,193

 
100.0
%
 
$
241,802

 
100.0
%


    
In addition to amounts shown in the table above, the Company had outstanding commitments to provide guaranties of $147 million of gross par as of March 31, 2019, $136 million of which remained outstanding as of 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
Components of BIG Net Par Outstanding
As of March 31, 2019

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
1,711

 
$
398

 
$
3,948

 
$
6,057

 
$
181,408

Non-U.S. public finance
1,001

 
—

 
—

 
1,001

 
44,615

Public finance
2,712

 
398

 
3,948

 
7,058

 
226,023

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. residential mortgage-backed securities (RMBS)
441

 
104

 
1,694

 
2,239

 
4,064

Life insurance transactions
—

 
—

 
85

 
85

 
1,751

Other structured finance
115

 
76

 
53

 
244

 
5,487

Structured finance
556

 
180

 
1,832

 
2,568

 
11,302

Total
$
3,268

 
$
578

 
$
5,780

 
$
9,626

 
$
237,325




Financial Guaranty Portfolio
Components of BIG Net Par Outstanding
As of December 31, 2018

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
1,767

 
$
399

 
$
4,222

 
$
6,388

 
$
186,562

Non-U.S. public finance
796

 
245

 
—

 
1,041

 
44,103

Public finance
2,563

 
644

 
4,222

 
7,429

 
230,665

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. RMBS
368

 
214

 
1,805

 
2,387

 
4,270

Life insurance transactions
—

 
—

 
85

 
85

 
1,184

Other structured finance
127

 
79

 
53

 
259

 
5,683

Structured finance
495

 
293

 
1,943

 
2,731

 
11,137

Total
$
3,058

 
$
937

 
$
6,165

 
$
10,160

 
$
241,802





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Financial Guaranty Portfolio
BIG Net Par Outstanding
and Number of Risks
As of March 31, 2019

 
 
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
 
$
3,191

 
$
77

 
$
3,268

 
128

 
6

 
134

Category 2
 
573

 
5

 
578

 
31

 
1

 
32

Category 3
 
5,709

 
71

 
5,780

 
142

 
8

 
150

Total BIG
 
$
9,473

 
$
153

 
$
9,626

 
301

 
15

 
316



 Financial Guaranty Portfolio
BIG Net Par Outstanding
and Number of Risks
As of December 31, 2018

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

 
 

 
 

 
 

 
 

 
 

Category 1
 
$
2,981

 
$
77

 
$
3,058

 
128

 
6

 
134

Category 2
 
932

 
5

 
937

 
39

 
1

 
40

Category 3
 
6,090

 
75

 
6,165

 
145

 
8

 
153

Total BIG
 
$
10,003

 
$
157

 
$
10,160

 
312

 
15

 
327

_____________________
(1)    Includes 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 had 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 $4.5 billion net par as of March 31, 2019, all of which was rated BIG. Beginning on January 1, 2016, a number of Puerto Rico exposures have defaulted on bond payments, and the Company has now paid claims on all of its Puerto Rico exposures except for Puerto Rico Aqueduct and Sewer Authority (PRASA), Municipal Finance Agency (MFA) and University of Puerto Rico (U of PR).

On November 30, 2015 and December 8, 2015, the former governor of Puerto Rico (Former Governor) issued executive orders (Clawback Orders) directing the Puerto Rico Department of Treasury and the Puerto Rico Tourism Company to "claw back" 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). The Puerto Rico exposures insured by the Company subject to clawback are shown in the table “Puerto Rico Net Par Outstanding.”


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On June 30, 2016, the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) was signed into law by the President of the United States. PROMESA established a seven-member financial oversight board (Oversight Board) with authority to require that balanced budgets and fiscal plans be adopted and implemented by Puerto Rico.

The Company believes that a number of the actions taken by the Commonwealth, the Oversight Board and others with respect to obligations the Company insures are illegal or unconstitutional or both, and has taken legal action, and may take additional legal action in the future, to enforce its rights with respect to these matters. See “Puerto Rico Recovery Litigation” below.

The Company also participates in mediation and negotiations relating to its Puerto Rico exposure.

The final form and timing of responses to Puerto Rico’s financial distress and the devastation of Hurricane Maria eventually taken by the federal government 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:

•
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.

•
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, 2019, the Company had $1,340 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. Despite the requirements of Article VI of its Constitution, the Commonwealth defaulted on the debt service payment due on July 1, 2016, and the Company has been making claim payments on these bonds since that date. The Oversight Board has filed a petition under Title III of PROMESA with respect to the Commonwealth.

On October 23, 2018, the Oversight Board certified a revised fiscal plan for the Commonwealth. The revised certified Commonwealth fiscal plan indicates an expected primary budget surplus, if fiscal plan reforms are enacted, of $17.0 billion that would be available for debt service over the six-year forecast period ending 2023. The Company believes the available surplus set forth in the Oversight Board's revised certified fiscal plan (which assumes certain fiscal reforms are implemented by the Commonwealth) should be sufficient to cover contractual debt service of Commonwealth general obligation issuances and of authorities and public corporations directly implicated by the Commonwealth’s general fund during the forecast period. However, the revised certified Commonwealth fiscal plan indicates a net primary budget deficit for the period from 2023 through 2058, and there can be no assurance that the fiscal reforms will be enacted or, if they are, that the forecasted primary budget surplus will occur or, if it does, that such funds will be used to cover contractual debt service.

Puerto Rico Public Buildings Authority (PBA). As of March 31, 2019, the Company had $142 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. Despite the requirements of Article VI of its Constitution, the PBA defaulted on most of the debt service payment due on July 1, 2016, and the Company has been making claim payments on these bonds since then.

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Public Corporations - Certain Revenues Potentially Subject to Clawback

PRHTA. As of March 31, 2019, the Company had $844 million insured net par outstanding of PRHTA (transportation revenue) bonds and $475 million insured net par outstanding of PRHTA (highways revenue) bonds. The transportation revenue bonds are secured by a subordinate gross lien on 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 lien on gasoline and gas oil and diesel oil taxes, motor vehicle license fees and certain tolls. The non-toll revenues consisting of excise taxes and fees collected by the Commonwealth on behalf of PRHTA and its bondholders that are statutorily allocated to PRHTA and its bondholders are potentially subject to clawback. Despite the presence of funds in relevant debt service reserve accounts that the Company believes should have been employed to fund debt service, PRHTA defaulted on the full July 1, 2017 insured debt service payment, and the Company has been making claim payments on these bonds since that date. The Oversight Board has filed a petition under Title III of PROMESA with respect to PRHTA.

On June 29, 2018, the Oversight Board certified a revised fiscal plan for PRHTA. The revised certified PRHTA fiscal plan projects very limited capacity to pay debt service over the six-year forecast period.

PRCCDA. As of March 31, 2019, 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 potentially subject to clawback. There were sufficient funds in the PRCCDA bond accounts to make only partial payments on the July 1, 2017 PRCCDA bond payments guaranteed by the Company, and the Company has been making claim payments on these bonds since that date.

PRIFA. As of March 31, 2019, the Company had $16 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 potentially subject to the clawback. The Company has been making claim payments on the PRIFA bonds since January 2016.

Other Public Corporations

Puerto Rico Electric Power Authority (PREPA). As of March 31, 2019, the Company had $848 million insured net par outstanding of PREPA obligations, which are secured by a lien on the revenues of the electric system. The Company has been making claim payments on these bonds since July 1, 2017. On July 2, 2017, the Oversight Board commenced proceedings for PREPA under Title III of PROMESA. On August 1, 2018, the Oversight Board certified a revised fiscal plan for PREPA.

On May 3, 2019, AGM and AGC entered into a restructuring support agreement (PREPA RSA) with PREPA and other stakeholders, including a group of uninsured PREPA bondholders, the Commonwealth of Puerto Rico, and the Oversight Board, that is intended to, among other things, provide a framework for the consensual resolution of the treatment of the Company’s insured PREPA revenue bonds in PREPA's recovery plan. Upon consummation of the restructuring transaction, PREPA’s revenue bonds will be exchanged into new securitization bonds issued by a special purpose corporation and secured by a segregated transition charge assessed on electricity bills.

The closing of the restructuring transaction is subject to a number of conditions, including approval by the Title III Court of the PREPA RSA and settlement described therein, a minimum of 67% support of voting bondholders for a plan of adjustment that includes this proposed treatment of PREPA revenue bonds and confirmation of such plan by the Title III court, and execution of acceptable documentation and legal opinions. Under the PREPA RSA, the Company has the option to guarantee its allocated share of the securitization exchange bonds, which may then be offered and sold in the capital markets. The Company believes that the additive value created by attaching its guarantee to the securitization exchange bonds would materially improve its overall recovery under the transaction, as well as generate new insurance premiums; and therefore that its economic results could differ from those reflected in the PREPA RSA.

PRASA. As of March 31, 2019, the Company had $373 million of insured net par outstanding of PRASA bonds, which are secured by a lien on 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. The PRASA bond accounts contained sufficient funds to make the PRASA bond payments due through the date of this filing that were guaranteed by the Company, and those payments were made in full. On August 1, 2018, the Oversight Board certified a revised fiscal plan for PRASA.


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Table of Contents

MFA. As of March 31, 2019, the Company had $303 million net par outstanding of bonds issued by MFA secured by a lien on local property tax revenues. The MFA bond accounts contained sufficient funds to make the MFA bond payments due through the date of this filing that were guaranteed by the Company, and those payments were made in full.

Puerto Rico Sales Tax Financing Corporation (COFINA). As of March 31, 2019, the Company did not have any insured net par outstanding of subordinate COFINA bonds. On February 12, 2019, pursuant to a plan of adjustment approved by the PROMESA Title III Court on February 4, 2019 (COFINA Plan of Adjustment), the Company paid off in full its $273 million net par outstanding of insured COFINA bonds, plus accrued and unpaid interest. Pursuant to the COFINA Plan of Adjustment, the Company received $152 million in initial par of closed lien senior bonds of COFINA validated by the PROMESA Title III Court (COFINA Exchange Senior Bonds), along with cash. The total par recovery (cash and COFINA Exchange Senior Bonds) represents 60% of the Company’s official Title III claim, which relates to amounts owed as of the date COFINA entered Title III proceedings. The Company may retain, sell, or insure and then sell, all or any portion of its $152 million of COFINA Exchange Senior Bonds. The COFINA Exchange Senior Bonds consist of both current interest bonds ($115 million) and capital appreciation bonds ($37 million). The fair value of the COFINA Exchange Senior Bonds, excluding accrued interest, was $139 million and was recorded as salvage received. This was recorded as a non-cash purchase of fixed-maturity securities, which is not shown as an investing cash flow on the condensed consolidated statements of cash flows.

U of PR. As of March 31, 2019, 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. As of the date of this filing, all debt service payments on U of PR bonds insured by the Company have been made.

Puerto Rico Recovery Litigation
 
The Company believes that a number of the actions taken by the Commonwealth, the Oversight Board and others with respect to obligations it insures are illegal or unconstitutional or both, and has taken legal action, and may take additional legal action in the future, to enforce its rights with respect to these matters.

On January 7, 2016, AGM, AGC and Ambac Assurance Corporation commenced an action for declaratory judgment and injunctive relief in the United States District Court for the District of Puerto Rico (Federal District Court for Puerto Rico) to invalidate the executive orders issued by the Former 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 claw back certain taxes and revenues pledged to secure the payment of bonds issued by the PRHTA, the PRCCDA and 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. While the PROMESA automatic stay expired on May 1, 2017, on May 17, 2017, the court stayed the action under Title III of PROMESA.
    
On May 16, 2017, The Bank of New York Mellon, as trustee for the bonds issued by COFINA, filed an adversary complaint for interpleader and declaratory relief with the Federal District Court for Puerto Rico to resolve competing and conflicting demands made by various groups of COFINA bondholders, insurers of certain COFINA bonds and COFINA, regarding funds held by the trustee for certain COFINA bond debt service payments scheduled to occur on and after June 1, 2017. On May 19, 2017, an order to show cause was entered permitting AGM to intervene in this matter. On February 4, 2019, the Federal District Court for Puerto Rico approved the COFINA Plan of Adjustment described above, and the plan became effective on February 12, 2019. As a result, the interpleader action was dismissed on February 20, 2019.

On June 3, 2017, AGC and AGM filed an adversary complaint in the Federal District Court for Puerto Rico seeking (i) a judgment declaring that the application of pledged special revenues to the payment of the PRHTA bonds is not subject to the PROMESA Title III automatic stay and that the Commonwealth has violated the special revenue protections provided to the PRHTA bonds under the United States Bankruptcy Code (Bankruptcy Code); (ii) an injunction enjoining the Commonwealth from taking or causing to be taken any action that would further violate the special revenue protections provided to the PRHTA bonds under the Bankruptcy Code; and (iii) an injunction ordering the Commonwealth to remit the pledged special revenues securing the PRHTA bonds in accordance with the terms of the special revenue provisions set forth in the Bankruptcy Code. On January 30, 2018, the court rendered an opinion dismissing the complaint and holding, among other things, that (x) even though the special revenue provisions of the Bankruptcy Code protect a lien on pledged special revenues, those provisions do not mandate the turnover of pledged special revenues to the payment of bonds and (y) actions to enforce liens on pledged special revenues remain stayed. A hearing on AGM and AGC’s appeal of the trial court’s decision to the United States Court of Appeals for the First Circuit (First Circuit) was held on November 5, 2018. On March 26, 2019, the First Circuit issued its opinion affirming the trial court’s decision and held that Sections 928(a) and 922(d) of the Bankruptcy Code permit, but do not require,

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continued payments during the pendency of the Title III proceedings. The First Circuit agreed with the trial court that (i) Section 928(a) of the Bankruptcy Code does not mandate the turnover of special revenues or require continuity of payments to the PRHTA Bonds during the pendency of the Title III proceedings, and (ii) Section 922(d) of the Bankruptcy Code is not an exception to the automatic stay that would compel PRHTA, or third parties holding special revenues, to apply special revenues to outstanding obligations. On April 9, 2019, AGM, AGC and other petitioners filed a petition with the First Circuit seeking a rehearing by the full court.

On June 26, 2017, AGM and AGC filed a complaint in the Federal District Court for Puerto Rico seeking (i) a declaratory judgment that the PREPA restructuring support agreement executed in December 2015 (2015 PREPA RSA) is a “Preexisting Voluntary Agreement” under Section 104 of PROMESA and the Oversight Board’s failure to certify the 2015 PREPA RSA is an unlawful application of Section 601 of PROMESA; (ii) an injunction enjoining the Oversight Board from unlawfully applying Section 601 of PROMESA and ordering it to certify the 2015 PREPA RSA; and (iii) a writ of mandamus requiring the Oversight Board to comply with its duties under PROMESA and certify the 2015 PREPA RSA. On July 21, 2017, in light of its PREPA Title III petition on July 2, 2017, the Oversight Board filed a notice of stay under PROMESA.

On July 18, 2017, AGM and AGC filed in the Federal District Court for Puerto Rico a motion for relief from the automatic stay in the PREPA Title III bankruptcy proceeding and a form of complaint seeking the appointment of a receiver for PREPA. The court denied the motion on September 14, 2017, but on August 8, 2018, the First Circuit vacated and remanded the court's decision. On October 3, 2018, AGM and AGC, together with other bond insurers, filed a motion with the court to lift the automatic stay to commence an action against PREPA for the appointment of a receiver, and a hearing was scheduled for May 2019. Under the PREPA RSA, AGM and AGC have agreed to withdraw from the lift stay motion upon the Title III Court’s approval of the settlement of claims embodied in the PREPA RSA.

On May 23, 2018, AGM and AGC filed an adversary complaint in the Federal District Court for Puerto Rico seeking a judgment declaring that (i) the Oversight Board lacked authority to develop or approve the new fiscal plan for Puerto Rico which it certified on April 19, 2018 (Revised Fiscal Plan); (ii) the Revised Fiscal Plan and the Fiscal Plan Compliance Law (Compliance Law) enacted by the Commonwealth to implement the original Commonwealth Fiscal Plan violate various sections of PROMESA; (iii) the Revised Fiscal Plan, the Compliance Law and various moratorium laws and executive orders enacted by the Commonwealth to prevent the payment of debt service (a) are unconstitutional and void because they violate the Contracts, Takings and Due Process Clauses of the U.S. Constitution and (b) are preempted by various sections of PROMESA; and (iv) no Title III plan of adjustment based on the Revised Fiscal Plan can be confirmed under PROMESA. On August 13, 2018, the court-appointed magistrate judge granted the Commonwealth's and the Oversight Board's motion to stay this adversary proceeding pending a decision by the First Circuit in an appeal by Ambac Assurance Corporation of an unrelated adversary proceeding decision, which may resolve certain similar issues.

On July 23, 2018, AGC and AGM filed an adversary complaint in the Federal District Court for Puerto Rico seeking a judgment (i) declaring the members of the Oversight Board are officers of the U.S. whose appointments were unlawful under the Appointments Clause of the U.S. Constitution; (ii) declaring void from the beginning the unlawful actions taken by the Oversight Board to date, including (x) development of the Commonwealth's Fiscal Plan, (y) development of PRHTA's Fiscal Plan, and (z) filing of the Title III cases on behalf of the Commonwealth and PRHTA; and (iii) enjoining the Oversight Board from taking any further action until the Oversight Board members have been lawfully appointed in conformity with the Appointments Clause of the U.S. Constitution. The Title III court dismissed a similar lawsuit filed by another party in the Commonwealth’s Title III case in July 2018. On August 3, 2018, a stipulated judgment was entered against AGM and AGC at their request based upon the court's July decision in the other Appointments Clause lawsuit and, on the same date, AGM and AGC appealed the stipulated judgment to the First Circuit. On August 15, 2018, the court consolidated, for purposes of briefing and oral argument, AGM and AGC's appeal with the other Appointments Clause lawsuit. The First Circuit consolidated AGM and AGC's appeal with a third Appointments Clause lawsuit on September 7, 2018 and held a hearing on December 3, 2018. On February 15, 2019, the First Circuit issued its ruling on the appeal and held that members of the Oversight Board were not appointed in compliance with the Appointments Clause of the U.S. Constitution but declined to dismiss the Title III petitions citing the (i) de facto officer doctrine and (ii) negative consequences to the many innocent third parties who relied on the Oversight Board’s actions to date, as well as the further delay which would result from a dismissal of the Title III petitions. The case was remanded back to the Federal District Court for Puerto Rico for the appellants’ requested declaratory relief that the appointment of the board members of the Oversight Board is unconstitutional. The First Circuit delayed the effectiveness of its ruling for 90 days so as to allow the President and the Senate to validate the currently defective appointments or reconstitute the Oversight Board in accordance with the Appointments Clause. On April 23, 2019, the Oversight Board filed a petition for review of the decision by the U.S. Supreme Court and on the following day filed a motion in the First Circuit to further stay the effectiveness of the First Circuit’s February 15, 2019 ruling pending final disposition by the U.S. Supreme Court. On May 6, 2019, the First Circuit denied the request to stay the effectiveness of its ruling pending final disposition by the U.S. Supreme Court and instead extended the stay of the effectiveness of its ruling to July 15, 2019.

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On December 21, 2018, the Oversight Board and the Official Committee of Unsecured Creditors of all Title III Debtors (other than COFINA) filed an adversary complaint in the Federal District Court for Puerto Rico seeking a judgment declaring that (i) the leases to public occupants (Leases) entered into by the PBA are not “true leases” for purposes of Section 365(d)(3) of the Bankruptcy Code and therefore the Commonwealth has no obligation to make payments to the PBA under the Leases or Section 365(d)(3) of the Bankruptcy Code, (ii) the PBA is not entitled to a priority administrative expense claim under the Leases pursuant to Sections 503(b)(1) and 507(a)(2) of the Bankruptcy Code, and (iii) any such claims filed or asserted against the Commonwealth are disallowed. On January 28, 2019, the PBA filed an answer to the complaint. On March 12, 2019, the Federal District Court for Puerto Rico granted, with certain limitations, AGM’s and AGC’s motion to intervene. On March 21, 2019, AGM and AGC, together with certain other intervenors, filed a motion for judgment on the pleadings.

On January 14, 2019 the Oversight Board and the Official Committee of Unsecured Creditors filed an omnibus objection in the Title III Court to claims filed by holders of approximately $6 billion of Commonwealth general obligation bonds issued in 2012 and 2014, asserting among other things that such bonds were issued in violation of the Puerto Rico constitutional debt service limit, such bonds are null and void, and the holders have no equitable remedy against the Commonwealth. On April 10, 2019, AGM filed a notice of participation in these proceedings. As of March 31, 2019, $369 million of the Company’s insured net par outstanding of the general obligation bonds of Puerto Rico were issued on or after March 2012.

In addition, AGM and AGC are named in litigation regarding Puerto Rico described under Note 12, Commitments and Contingencies.

Puerto Rico Par and Debt Service Schedules

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, 2019
 
December 31, 2018
 
March 31, 2019
 
December 31, 2018
 
(in millions)
Exposure to Puerto Rico
$
4,698

 
$
4,971

 
$
7,318

 
$
8,035





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Puerto Rico
Net Par Outstanding

 
As of
March 31, 2019
 
As of
December 31, 2018
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds (1)
$
1,340

 
$
1,340

PBA
142

 
142

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
PRHTA (Transportation revenue) (1)
844

 
844

PRHTA (Highways revenue) (1)
475

 
475

PRCCDA
152

 
152

PRIFA
16

 
16

Other Public Corporations
 
 
 
PREPA (1)
848

 
848

PRASA
373

 
373

MFA
303

 
303

COFINA
—

 
273

U of PR
1

 
1

Total net exposure to Puerto Rico
$
4,494

 
$
4,767

____________________
(1)
As of the date of this filing, the Oversight Board has certified a filing under Title III of PROMESA for these exposures.

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.

     























19
Table of Contents

Amortization Schedule of Puerto Rico Net Par Outstanding
and Net Debt Service Outstanding
As of March 31, 2019

 
Scheduled Net Par Amortization
 
Scheduled Net Debt Service Amortization
 
(in millions)
2019 (April 1 - June 30)
$
—

 
$
3

2019 (July 1 - September 30)
224

 
335

2019 (October 1 - December 31)
—

 
3

Subtotal 2019
224

 
341

2020
286

 
503

2021
149

 
351

2022
139

 
332

2023
205

 
392

2024-2028
1,213

 
1,978

2029-2033
884

 
1,392

2034-2038
957

 
1,184

2039-2043
176

 
259

2044-2047
261

 
300

Total
$
4,494

 
$
7,032




Exposure to the U.S. Virgin Islands
 
As of March 31, 2019, the Company had $496 million insured net par outstanding to the U.S. Virgin Islands and its related authorities (USVI), of which it rated $222 million BIG. The $274 million USVI net par the Company rated investment grade primarily consisted of bonds secured by a lien on matching fund revenues related to excise taxes on products produced in the USVI and exported to the U.S., primarily rum. The $222 million BIG USVI net par consisted of (a) Public Finance Authority bonds secured by a gross receipts tax and the general obligation, full faith and credit pledge of the USVI and (b) bonds of the Virgin Islands Water and Power Authority secured by a net revenue pledge of the electric system.
 
Hurricane Irma caused significant damage in St. John and St. Thomas, while Hurricane Maria made landfall on St. Croix as a Category 4 hurricane on the Saffir-Simpson scale, causing loss of life and substantial damage to St. Croix’s businesses and infrastructure, including the power grid. The USVI is benefiting from the federal response to the 2017 hurricanes and has made its debt service payments to date.

Non-Financial Guaranty Exposure

The Company also provides non-financial guaranty insurance and reinsurance on transactions with similar risk profiles to its structured finance exposures written in financial guaranty form. All non-financial guaranty exposures shown in the table below are rated investment grade internally.


20
Table of Contents

Non-Financial Guaranty Exposure

 
 
Gross Exposure
 
Net Exposure
 
 
As of March 31, 2019
 
As of December 31, 2018
 
As of March 31, 2019
 
As of December 31, 2018
 
 
(in millions)
Life insurance transactions (1)
 
$
912

 
$
880

 
$
788

 
$
763

Aircraft residual value insurance policies
 
360

 
340

 
239

 
218

____________________
(1)
The life insurance transactions net exposure is expected to increase to approximately $1.0 billion prior to September 30, 2036.

    
4.
Expected Loss to be Paid
 
This note provides information regarding expected claim payments to be made under all contracts in the insured portfolio, regardless of the accounting model (insurance, derivative or VIE).

Loss Estimation Process

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, sector-driven loss severity assumptions and/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, 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 loss 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 life of most contracts.

The Company does not use traditional actuarial approaches to determine its estimates of expected losses. 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.

In some instances, the terms of the Company's policy gives it the option to pay principal losses that have been recognized in the transaction but which it is not yet required to pay, thereby reducing the amount of guaranteed interest due in the future. The Company has sometimes exercised this option, which uses cash but reduces projected future losses.

    









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Table of Contents

The following tables present a roll forward of net expected loss to be paid for all contracts. The Company used risk-free rates for U.S. dollar denominated obligations that ranged from 0.00% to 2.87% with a weighted average of 2.46% as of March 31, 2019 and 0.00% to 3.06% with a weighted average of 2.74% as of December 31, 2018. Expected losses to be paid for transactions denominated in currencies other than the U.S. dollar represented approximately 3.2% and 2.7% of the total as of March 31, 2019 and December 31, 2018, respectively.

Net Expected Loss to be Paid
Roll Forward

 
First Quarter
 
2019
 
2018
 
(in millions)
Net expected loss to be paid, beginning of period
$
1,183

 
$
1,303

Economic loss development (benefit) due to:
 
 
 
Accretion of discount
8

 
8

Changes in discount rates
(4
)
 
(6
)
Changes in timing and assumptions
(6
)
 
(26
)
Total economic loss development (benefit)
(2
)
 
(24
)
Net (paid) recovered losses
(218
)
 
19

Net expected loss to be paid, end of period
$
963

 
$
1,298







































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Table of Contents

Net Expected Loss to be Paid
Roll Forward by Sector
First Quarter 2019

 
Net Expected
Loss to be Paid (Recovered) as of
December 31, 2018
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be Paid (Recovered) as of
March 31, 2019
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
832

 
$
62

 
$
(228
)
 
$
666

Non-U.S. public finance
32

 
(1
)
 
—

 
31

Public finance
864

 
61

 
(228
)
 
697

Structured finance:
 
 
 
 
 
 
 
U.S. RMBS
293

 
(65
)
 
9

 
237

Other structured finance
26

 
2

 
1

 
29

Structured finance
319

 
(63
)
 
10

 
266

Total
$
1,183

 
$
(2
)
 
$
(218
)
 
$
963



Net Expected Loss to be Paid
Roll Forward by Sector
First Quarter 2018

 
Net Expected
Loss to be
Paid (Recovered) as of
December 31, 2017
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be
Paid (Recovered) as of
March 31, 2018
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
1,157

 
$
(39
)
 
$
(111
)
 
$
1,007

Non-U.S. public finance
46

 
(3
)
 
—

 
43

Public finance
1,203

 
(42
)
 
(111
)
 
1,050

Structured finance:
 

 
 

 
 

 
 
U.S. RMBS
73

 
16

 
130

 
219

Other structured finance
27

 
2

 
—

 
29

Structured finance
100

 
18

 
130

 
248

Total
$
1,303

 
$
(24
)
 
$
19

 
$
1,298

____________________
(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 amounts in First Quarter 2019 are net of the COFINA Exchange Senior Bonds and cash that were received pursuant to the Plan of Adjustment. See Note 3, Outstanding Exposure, for additional information.

The tables above include (1) loss adjustment expenses (LAE) paid of $7 million and $5 million for First Quarter 2019 and 2018, respectively, and (2) expected LAE to be paid of $28 million as of March 31, 2019 and $31 million as of December 31, 2018.


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Table of Contents

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, 2019
 
As of
December 31, 2018
 
First Quarter 2019
 
First Quarter 2018
 
(in millions)
Insurance
$
904

 
$
1,110

 
$
10

 
$
(33
)
Financial guaranty VIEs (FG VIEs) (See Note 8)
65

 
75

 
(10
)
 
2

Credit derivatives (See Note 7)
(6
)
 
(2
)
 
(2
)
 
7

Total
$
963

 
$
1,183

 
$
(2
)
 
$
(24
)

Selected U.S. Public Finance Transactions
 
The Company insured general obligation bonds of the Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations aggregating $4.5 billion net par as of March 31, 2019, all of which was BIG. For additional information regarding the Company's Puerto Rico exposure, see "Exposure to Puerto Rico" in Note 3, Outstanding Exposure.

The Company had approximately $18 million of net par exposure as of March 31, 2019 to bonds issued by Parkway East Public Improvement District (District), which is located in Madison County, Mississippi (the County). The bonds, which are rated BIG, are payable from special assessments on properties within the District, as well as amounts paid under a contribution agreement with the County in which the County covenants that it will provide funds in the event special assessments are not sufficient to make a debt service payment. The special assessments have not been sufficient to pay debt service in full.

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, 2019, the Company’s net par subject to the plan consisted of $110 million of pension obligation bonds. As part of the plan of adjustment, the City will repay any claims paid on the pension obligation bonds from certain fixed payments and certain variable payments contingent on the City’s revenue growth. 

The Company projects its total net expected loss across its troubled U.S. public finance exposures as of March 31, 2019 including those mentioned above, to be $666 million, compared with a net expected loss of $832 million as of December 31, 2018. The total net expected loss for troubled U.S. public finance exposures is net of a credit for estimated future recoveries of claims already paid. At March 31, 2019 that credit was $652 million compared with $586 million at December 31, 2018. The economic loss development for U.S. public finance transactions for First Quarter 2019 was $62 million, which was primarily attributable to Puerto Rico exposures.

Selected Non - U.S. Public Finance Transactions

The Company insures and reinsures transactions 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 exposures is $420 million and $71 million, respectively. The Company rates all of these exposures BIG due to the financial condition of Spain and Portugal and their dependence on the sovereign.
    
The Company also insures an obligation backed by the availability and toll revenues of a major arterial road into a city in the U.K. with $195 million of net par outstanding as of March 31, 2019. This transaction has been underperforming due to higher costs compared with expectations at underwriting, and is rated BIG. Traffic continues to be strong, and that has contributed to some of the improvement for the overall transaction.

These transactions, together with other non-U.S. public finance insured obligations, had expected loss to be paid of $31 million as of March 31, 2019, compared with $32 million as of December 31, 2018. The economic benefit was approximately $1 million during First Quarter 2019.

24
Table of Contents

U.S. RMBS Loss Projections
 
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 expected representation and warranty (R&W) recoveries/payables to the projected performance of the collateral over time. The resulting projected claim payments or reimbursements are then discounted using risk-free rates.

As of March 31, 2019, the Company had a net R&W payable of $19 million to R&W counterparties, compared with a net R&W receivable of $5 million as of December 31, 2018. The Company’s agreements with providers of R&W generally provide for reimbursement to the Company as claim payments are made and, to the extent the Company later receives reimbursements of such claims from excess spread or other sources, for the Company to provide reimbursement to the R&W providers. When the Company projects receiving more reimbursements in the future than it projects to pay in claims on transactions covered by R&W settlement agreements, the Company will have a net R&W payable.

The Company's RMBS loss projection methodology assumes that the housing and mortgage markets will continue improving. Each period the Company makes a judgment as to whether to change the assumptions it uses to make RMBS loss projections based on its observation during the 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, and, to the extent it observes changes, it makes a judgment as to whether those changes are normal fluctuations or part of a trend. The assumptions that the Company uses to project RMBS losses are shown in the sections below.

Net Economic Loss Development (Benefit)
U.S. RMBS

 
First Quarter
 
2019
 
2018
 
(in millions)
First lien U.S. RMBS
$
(31
)
 
$
24

Second lien U.S. RMBS
(34
)
 
(8
)


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, 2019
 
December 31, 2018
Delinquent/Modified in the Previous 12 Months
 
 
 
Alt-A and Prime
20%
 
20%
Option ARM
20
 
20
Subprime
20
 
20
30 – 59 Days Delinquent
 
 
 
Alt-A and Prime
30
 
30
Option ARM
35
 
35
Subprime
40
 
40
60 – 89 Days Delinquent
 
 
 
Alt-A and Prime
40
 
40
Option ARM
45
 
45
Subprime
45
 
45
90+ Days Delinquent
 
 
 
Alt-A and Prime
50
 
50
Option ARM
55
 
55
Subprime
50
 
50
Bankruptcy
 
 
 
Alt-A and Prime
45
 
45
Option ARM
50
 
50
Subprime
40
 
40
Foreclosure
 
 
 
Alt-A and Prime
60
 
60
Option ARM
65
 
65
Subprime
60
 
60
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 most heavily weighted scenario (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 4.25 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 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 had reached historically high levels, and the Company is assuming in the base case that the still elevated levels

26
Table of Contents

generally will continue for another 18 months. The Company determines its initial loss severity based on actual recent experience. Each quarter the Company reviews available data and (if necessary) adjusts its severities based on its observations. 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 vintage 2004 - 2008 first lien U.S. RMBS.

Key Assumptions in Base Case Expected Loss Estimates
First Lien RMBS
 
 
As of
March 31, 2019
 
As of
December 31, 2018
 
Range
 
Weighted Average
 
Range
 
Weighted Average
Alt-A First Lien
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
1.0
%
-
10.7%
 
4.3%
 
1.2
%
-
11.4%
 
4.6%
Final CDR
0.0
%
-
0.5%
 
0.2%
 
0.1
%
-
0.6%
 
0.2%
Initial loss severity:
 
 
 
 
 
 
 
2005 and prior
60%
 
 
 
60%
 
 
2006
70%
 
 
 
70%
 
 
2007+
70%
 
 
 
70%
 
 
Option ARM
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
2.1
%
-
9.3%
 
5.9%
 
1.8
%
-
8.3%
 
5.6%
Final CDR
0.1
%
-
0.5%
 
0.3%
 
0.1
%
-
0.4%
 
0.3%
Initial loss severity:
 
 
 
 
 
 
 
2005 and prior
60%
 
 
 
60%
 
 
2006
60%
 
 
 
60%
 
 
2007+
70%
 
 
 
70%
 
 
Subprime
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
2.4
%
-
24.1%
 
6.2%
 
1.8
%
-
23.2%
 
6.2%
Final CDR
0.1
%
-
1.2%
 
0.3%
 
0.1
%
-
1.2%
 
0.3%
Initial loss severity:
 
 
 
 
 
 
 
2005 and prior
80%
 
 
 
80%
 
 
2006
75%
 
 
 
75%
 
 
2007+
95%
 
 
 
95%
 
 


 
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, 2018.
 
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, 2019 and December 31, 2018.
    

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Table of Contents

Total expected loss to be paid on all first lien U.S. RMBS was $209 million and $243 million as of March 31, 2019 and December 31, 2018, respectively. The $31 million economic benefit in First Quarter 2019 for first lien U.S. RMBS was primarily attributable to higher excess spread mainly on certain transactions with insured floating rate debt linked to London Interbank Offered Rate (LIBOR) supported by large portions of fixed rate assets (either originally fixed or modified to be fixed). The Company used a similar approach to establish its pessimistic and optimistic scenarios as of March 31, 2019 as it used as of December 31, 2018, 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 $54 million for all first lien U.S. RMBS 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 $38 million for all first lien U.S. RMBS 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 mortgages. 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 CPR of the collateral, the interest rate environment, and assumptions about 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. 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, representing six months of delinquent loan liquidations, followed by 28 months of decrease to the steady state CDR, the same as of December 31, 2018.

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. This causes the borrower's total monthly payment to increase, sometimes substantially, at the end of the initial interest-only period. In prior periods, as the HELOC loans underlying the Company's insured HELOC transactions reached their principal amortization period, the Company incorporated an assumption that a percentage of loans reaching their principal amortization periods would default around the time of the payment increase.

The HELOC loans underlying the Company's insured HELOC transactions are now past their original interest-only reset date, although a significant number of HELOC loans were modified to extend the original interest-only period for another five years. As a result, in 2017, the Company eliminated the CDR increase that was applied when such loans reached their principal amortization period. In addition, based on the average performance history, the Company applied a CDR floor of 2.5% for the future steady state CDR on all its HELOC transactions.

When a second lien loan defaults, there is generally a very low recovery. The Company assumed as of March 31, 2019 that it will generally recover only 2% of future defaulting collateral at the time of charge-off, with additional amounts of post charge-off recoveries assumed to come in over time. This is the same assumption used as of December 31, 2018. A second lien on the borrower’s home may be retained in the Company's second lien transactions after the loan is charged off and the loss applied to the transaction, particularly in cases where the holder of the first lien has not foreclosed. If the second lien is retained and the value of the home increases, the servicer may be able to use the second lien to increase recoveries, either by arranging for the borrower to resume payments or by realizing value upon the sale of the underlying real estate.  In instances where the Company is able to obtain information on the lien status of charged-off loans, it assumes future recoveries of 10% of the balance of the charged off loans where the second lien is still intact. The Company assumes the recoveries are received evenly

28
Table of Contents

over the next five years, although actual recoveries will vary. The Company evaluates its assumptions periodically based on actual recoveries of charged off loans.
 
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 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, 2018. To the extent that prepayments differ from projected levels it could materially change the Company’s projected excess spread and losses.
 
In estimating expected losses, the Company modeled and probability weighted five scenarios, each with a different CDR curve applicable to the period preceding the return to the long-term steady state CDR. The Company believes that the level of the elevated CDR and the length of time it will persist and the ultimate prepayment rate 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. Total expected loss to be paid on all second lien U.S. RMBS was $28 million as of March 31, 2019 and $50 million as of December 31, 2018. The $34 million economic benefit in First Quarter 2019 for second lien U.S. RMBS was primarily attributable to improved performance in certain transactions, higher excess spread and progress on loss mitigation efforts.

The following table shows the range as well as the average, weighted by net par outstanding, for key assumptions used in the calculation of expected loss to be paid for individual transactions for vintage 2004 - 2008 HELOCs.

Key Assumptions in Base Case Expected Loss Estimates
HELOCs

 
As of
March 31, 2019
 
As of
December 31, 2018
 
Range
 
Weighted Average
 
Range
 
Weighted Average
Plateau CDR
5.5
%
-
25.6%
 
9.5%
 
4.6
%
-
26.8%
 
10.1%
Final CDR trended down to
2.5
%
-
3.2%
 
2.5%
 
2.5
%
-
3.2%
 
2.5%
Liquidation rates:
 
 
 
 
 
 
 
 
 
 
 
Delinquent/Modified in the Previous 12 Months
20%
 
 
 
20%
 
 
30 – 59 Days Delinquent
30
 
 
 
35
 
 
60 – 89 Days Delinquent
45
 
 
 
50
 
 
90+ Days Delinquent
65
 
 
 
70
 
 
Bankruptcy
55
 
 
 
55
 
 
Foreclosure
60
 
 
 
65
 
 
Real Estate Owned
100
 
 
 
100
 
 
Loss severity (1)
98%
 
 
 
98%
 
 

___________________
(1)    Loss severities on future defaults.


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. In the Company's most stressful scenario, 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) would increase the expected loss by approximately $8 million for HELOC transactions. On the other hand, in the Company's least stressful scenario, 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 $9 million for HELOC transactions.


29
Table of Contents

Other Structured Finance
 
The Company had $1.8 billion of net par exposure to financial guaranty life insurance transactions as of March 31, 2019, of which $85 million in net par is rated BIG. The life insurance transactions are based on discrete blocks of individual life insurance business. In older vintage life insurance transactions, which include the 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 BIG-rated transactions, material amounts of their assets were invested in U.S. RMBS.

The Company has insured or reinsured $1.1 billion net par of student loan securitizations issued by private issuers that are classified as structured finance. Of this amount, $96 million is rated BIG. In general, the projected 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 Company projected that its total net expected loss across its troubled non- U.S. RMBS structured finance exposures as of March 31, 2019 including those mentioned above was $29 million and is primarily attributable to structured student loans. The economic loss development during First Quarter 2019 was $2 million.

Recovery Litigation

In the ordinary course of their respective businesses, certain of AGL's subsidiaries assert claims in legal proceedings against third parties to recover losses paid in prior periods or prevent losses in the future.
 
Public Finance Transactions

The Company has asserted claims in a number of legal proceedings in connection with its exposure to Puerto Rico. See Note 3, Outstanding Exposure, for a discussion of the Company's exposure to Puerto Rico and related recovery litigation being pursued by the Company.

RMBS Transactions

On November 26, 2012, CIFG Assurance North America Inc. (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.

5.
Contracts Accounted for as Insurance

Premiums

The portfolio of outstanding exposures discussed in Note 3, Outstanding Exposure, includes contracts that are accounted for as insurance contracts, derivatives, and as consolidated FG VIEs. Amounts presented in this note relate only to contracts accounted for as insurance. See Note 7, Contracts Accounted for as Credit Derivatives for amounts that relate to CDS and Note 8, Variable Interest Entities for amounts that are accounted for as consolidated FG VIEs.


30
Table of Contents

Net Earned Premiums
 
 
First Quarter
 
2019
 
2018
 
(in millions)
Financial guaranty:
 
 
 
Scheduled net earned premiums
$
87

 
$
88

Accelerations from refundings and terminations
26

 
52

Accretion of discount on net premiums receivable
4

 
4

Financial guaranty insurance net earned premiums
117

 
144

Non-financial guaranty net earned premiums
1

 
1

  Net earned premiums (1)
$
118

 
$
145

 ___________________
(1)
Excludes $3 million and $3 million for First Quarter 2019 and 2018, respectively, related to consolidated FG VIEs.

Gross Premium Receivable,
Net of Commissions on Assumed Business
Roll Forward 

 
First Quarter
 
2019
 
2018
 
(in millions)
Beginning of year
$
904

 
$
915

Less: Non-financial guaranty insurance premium receivable
1

 
1

Financial guaranty insurance premiums receivable
903

 
914

Gross written premiums on new business, net of commissions
41

 
75

Gross premiums received, net of commissions
(54
)
 
(63
)
Adjustments:
 
 
 
Changes in the expected term
(4
)
 
(3
)
Accretion of discount, net of commissions on assumed business
1

 
(4
)
Foreign exchange translation and remeasurement (1)
9

 
24

Financial guaranty insurance premium receivable (2)
896

 
943

Non-financial guaranty insurance premium receivable
1

 
1

March 31,
$
897


$
944

____________________
(1)
Includes foreign exchange gain (loss) on remeasurement recorded in the condensed consolidated statements of operations of $9 million in First Quarter 2019 and $23 million in First Quarter 2018. The remaining foreign exchange translation in First Quarter 2018 was recorded in other comprehensive income (OCI).

(2)
Excludes $8 million and $9 million as of March 31, 2019 and March 31, 2018, respectively, related to consolidated FG VIEs.


Approximately 72% of installment premiums at both March 31, 2019 and December 31, 2018 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 those of expected collections in the table below due to factors such as foreign exchange rate fluctuations, counterparty collectability issues, accelerations, commutations, changes in expected lives and new business.


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Table of Contents

Expected Collections of
Financial Guaranty Insurance Gross Premiums Receivable,
Net of Commissions on Assumed Business
(Undiscounted)

 
As of
March 31, 2019
 
(in millions)
2019 (April 1 - June 30)
$
39

2019 (July 1 - September 30)
26

2019 (October 1 - December 31)
19

2020
99

2021
79

2022
80

2023
66

2024-2028
285

2029-2033
190

2034-2038
100

After 2038
102

Total (1)
$
1,085

 ____________________
(1)
Excludes expected cash collections on consolidated FG VIEs of $11 million.

The timing and cumulative amount of actual net earned premiums may differ from those of expected net earned premiums in the table below due to factors such as accelerations, commutations, changes in expected lives and new business.

Scheduled Financial Guaranty Insurance Net Earned Premiums

 
As of
March 31, 2019
 
(in millions)
2019 (April 1 - June 30)
$
85

2019 (July 1 - September 30)
83

2019 (October 1 - December 31)
80

Subtotal 2019
248

2020
304

2021
276

2022
251

2023
230

2024-2028
903

2029-2033
609

2034-2038
341

After 2038
286

Net deferred premium revenue (1)
3,448

Future accretion
181

Total future net earned premiums
$
3,629

 ____________________
(1)
Excludes net earned premiums on consolidated FG VIEs of $63 million.


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Table of Contents

Selected Information for Financial Guaranty Insurance
Policies Paid in Installments

 
As of
March 31, 2019
 
As of
December 31, 2018
 
(dollars in millions)
Premiums receivable, net of commission payable
$
896

 
$
903

Gross deferred premium revenue
1,280

 
1,313

Weighted-average risk-free rate used to discount premiums
2.3
%
 
2.3
%
Weighted-average period of premiums receivable (in years)
9.1

 
9.1



Financial Guaranty Insurance Losses

The following table provides information on net reserve (salvage), which includes loss and LAE reserves and salvage and subrogation recoverable, both net of reinsurance. To discount loss reserves, the Company used risk-free rates for U.S. dollar denominated financial guaranty insurance obligations that ranged from 0.00% to 2.87% with a weighted average of 2.46% as of March 31, 2019 and 0.00% to 3.06% with a weighted average of 2.74% as of December 31, 2018.

Net Reserve (Salvage) 

 
As of
March 31, 2019
 
As of
December 31, 2018
 
(in millions)
Public finance:
 
 
 
U.S. public finance
$
459

 
$
612

Non-U.S. public finance
13

 
14

Public finance
472

 
626

Structured finance:
 
 
 
U.S. RMBS (1)
(13
)
 
21

Other structured finance
35

 
30

Structured finance
22

 
51

Subtotal
494

 
677

Other payable (recoverable)
(2
)
 
(3
)
Total
$
492

 
$
674

____________________
(1)
Excludes net reserves of $41 million and $47 million as of March 31, 2019 and December 31, 2018, respectively, related to consolidated FG VIEs.
 



33
Table of Contents

Components of Net Reserves (Salvage)
 
 
As of
March 31, 2019
 
As of
December 31, 2018
 
(in millions)
Loss and LAE reserve
$
1,032

 
$
1,177

Reinsurance recoverable on unpaid losses (1)
(40
)
 
(34
)
Loss and LAE reserve, net
992

 
1,143

Salvage and subrogation recoverable
(522
)
 
(490
)
Salvage and subrogation payable (2)
24

 
24

Other payable (recoverable) (1)
(2
)
 
(3
)
Salvage and subrogation recoverable, net, and other recoverable
(500
)
 
(469
)
Net reserves (salvage)
$
492

 
$
674

____________________
(1)
Recorded as a component of other assets in the condensed consolidated balance sheets.

(2)
Represents ceded reinsurance amounts recorded as a component of other liabilities in the condensed consolidated balance sheets.

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 (and therefore recognized in income but not yet received), 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, 2019
 
(in millions)
Net expected loss to be paid - financial guaranty insurance
$
903

Contra-paid, net
65

Salvage and subrogation recoverable, net, and other recoverable
500

Loss and LAE reserve - financial guaranty insurance contracts, net of reinsurance
(991
)
Net expected loss to be expensed (present value) (1)
$
477

____________________
(1)    Excludes $33 million as of March 31, 2019, related to consolidated FG VIEs.

34
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, 2019
 
(in millions)
2019 (April 1 - June 30)
$
9

2019 (July 1 - September 30)
9

2019 (October 1 - December 31)
8

Subtotal 2019
26

2020
35

2021
35

2022
36

2023
36

2024-2028
150

2029-2033
103

2034-2038
46

After 2038
10

Net expected loss to be expensed
477

Future accretion
15

Total expected future loss and LAE
$
492

 

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

Loss and LAE
Reported on the
Condensed Consolidated Statements of Operations
  
 
Loss (Benefit)
 
First Quarter
 
2019
 
2018
 
(in millions)
Public finance:
 
 
 
U.S. public finance
$
70

 
$
(28
)
Non-U.S. public finance
—

 
(1
)
Public finance
70

 
(29
)
Structured finance:
 
 
 
U.S. RMBS (1)
(27
)
 
16

Other structured finance
3

 
(5
)
Structured finance
(24
)
 
11

Loss and LAE
$
46

 
$
(18
)

____________________
(1)
Excludes a benefit of $1 million and a loss of $6 million for First Quarter 2019 and 2018, respectively, related to consolidated FG VIEs.

35
Table of Contents

The following tables provide information on financial guaranty insurance contracts categorized as BIG.
 
Financial Guaranty Insurance
BIG Transaction Loss Summary
As of March 31, 2019
 
 
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)
128

 
(8
)
 
31

 
(1
)
 
142

 
(7
)
 
301

 
—

 
301

Remaining weighted-average contract period (in years)
7.5

 
6.2

 
16.4

 
2.1

 
9.7

 
8.8

 
9.4

 
—

 
9.4

Outstanding exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Principal
$
3,262

 
$
(71
)
 
$
579

 
$
(6
)
 
$
5,868

 
$
(159
)
 
$
9,473

 
$
—

 
$
9,473

Interest
1,351

 
(28
)
 
484

 
(1
)
 
2,756

 
(70
)
 
4,492

 
—

 
4,492

Total (2)
$
4,613

 
$
(99
)
 
$
1,063

 
$
(7
)
 
$
8,624

 
$
(229
)
 
$
13,965

 
$
—

 
$
13,965

Expected cash outflows (inflows)
$
133

 
$
(5
)
 
$
151

 
$
(1
)
 
$
3,852

 
$
(120
)
 
$
4,010

 
$
(284
)
 
$
3,726

Potential recoveries (3)
(509
)
 
23

 
(61
)
 
—

 
(2,557
)
 
98

 
(3,006
)
 
198

 
(2,808
)
Subtotal
(376
)
 
18

 
90

 
(1
)
 
1,295

 
(22
)
 
1,004

 
(86
)
 
918

Discount
82

 
(5
)
 
(19
)
 
—

 
(85
)
 
(9
)
 
(36
)
 
21

 
(15
)
Present value of expected cash flows
$
(294
)
 
$
13

 
$
71

 
$
(1
)
 
$
1,210

 
$
(31
)
 
$
968

 
$
(65
)
 
$
903

Deferred premium revenue
$
191

 
$
(4
)
 
$
25

 
$
—

 
$
544

 
$
(2
)
 
$
754

 
$
(62
)
 
$
692

Reserves (salvage)
$
(330
)
 
$
15

 
$
51

 
$
(1
)
 
$
827

 
$
(30
)
 
$
532

 
$
(41
)
 
$
491

 

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Table of Contents

Financial Guaranty Insurance
BIG Transaction Loss Summary
As of December 31, 2018
 
 
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)
128

 
(8
)
 
39

 
(1
)
 
145

 
(7
)
 
312

 
—

 
312

Remaining weighted-average contract period (in years)
7.9

 
6.5

 
13.2

 
2.1

 
10.1

 
9.1

 
9.8

 
—

 
9.8

Outstanding exposure:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Principal
$
3,052

 
$
(71
)
 
$
938

 
$
(6
)
 
$
6,249

 
$
(159
)
 
$
10,003

 
$
—

 
$
10,003

Interest
1,319

 
(29
)
 
592

 
(1
)
 
3,140

 
(72
)
 
4,949

 
—

 
4,949

Total (2)
$
4,371

 
$
(100
)
 
$
1,530

 
$
(7
)
 
$
9,389

 
$
(231
)
 
$
14,952

 
$
—

 
$
14,952

Expected cash outflows (inflows)
$
98

 
$
(5
)
 
$
264

 
$
(1
)
 
$
4,029

 
$
(80
)
 
$
4,305

 
$
(290
)
 
$
4,015

Potential recoveries (3)
(465
)
 
23

 
(81
)
 
—

 
(2,542
)
 
55

 
(3,010
)
 
192

 
(2,818
)
Subtotal
(367
)
 
18

 
183

 
(1
)
 
1,487

 
(25
)
 
1,295

 
(98
)
 
1,197

Discount
83

 
(5
)
 
(53
)
 
—

 
(134
)
 
(2
)
 
(111
)
 
23

 
(88
)
Present value of expected cash flows
$
(284
)
 
$
13

 
$
130

 
$
(1
)
 
$
1,353

 
$
(27
)
 
$
1,184

 
$
(75
)
 
$
1,109

Deferred premium revenue
$
125

 
$
(4
)
 
$
151

 
$
—

 
$
518

 
$
(2
)
 
$
788

 
$
(64
)
 
$
724

Reserves (salvage)
$
(311
)
 
$
15

 
$
48

 
$
(1
)
 
$
993

 
$
(24
)
 
$
720

 
$
(47
)
 
$
673

____________________
(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)
Represents expected inflows for future payments by obligors pursuant to restructuring agreements, settlement or litigation judgments, excess spread on any underlying collateral and other estimated recoveries.


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. See Part II, Item 8, Financial Statements and Supplementary Data, Note 6, Contracts Accounted for as Insurance, of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

6.
Fair Value Measurement
 
The Company carries a 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.

37
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 2019, no changes were made to the Company’s valuation models that had, or are expected to have, a material impact on the Company’s condensed 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.
 
During the periods presented, there were no transfers into or from Level 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 take into account: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, industry and economic events, 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.

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. The valuation of fixed-maturity investments is more subjective when markets are less liquid due to the lack of market based inputs.
    
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.
 
As of March 31, 2019, the Company used models to price 131 securities, including securities that were purchased or obtained for loss mitigation or other risk management purposes, with a Level 3 fair value of $1,428 million. 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

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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 security 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 have materially changed the expected timing of cash flows within these securities which is a significant factor in determining the fair value of the securities.
 
Other Assets
 
The fair value of committed capital securities (CCS) represents the difference between the present value of remaining expected put option premium payments under 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 13, Long Term Debt and Credit Facilities). The change in fair value of the AGC CCS and AGM CPS are recorded in other income in the condensed consolidated statement of operations. The estimated current cost of the Company’s CCS is based on several factors, including AGM and AGC CDS spreads, LIBOR curve projections, the Company's publicly traded debt and the term the securities are estimated to remain outstanding. The AGC CCS and AGM CPS are classified as Level 3 in the fair value hierarchy.

The fair value of the Company's various supplemental executive retirement plan (SERP) assets are based on either (i) the observable published daily values of the underlying mutual fund included in the aforementioned plans (Level 1) or (ii) the net asset value (NAV) of the funds if a published daily value is not available (Level 2). The NAV's are based on observable information. Change in fair value of SERP assets is recorded in other operating expenses in the condensed consolidated statement of operations.
 
Contracts Accounted for as Credit Derivatives
 
The Company’s credit derivatives primarily consist of insured CDS contracts, and also include interest rate swaps that qualify as derivatives under GAAP, which requires fair value measurement with changes recorded in the statement of operations. 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. In transactions where the counterparty does not have the right to terminate, 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, 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. 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 as there are multiple unobservable inputs 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 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, 2019 were such that market prices of the Company’s CDS contracts were not available.

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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: the gross spread, the allocation of gross spread among the bank profit, net spread and hedge cost, and the weighted average life which is based on debt service schedules. 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. The bank profit represents the profit the originator, usually an investment bank, realizes for structuring and funding the transaction; the net spread represents the premiums paid to the Company for the Company’s credit protection provided; and the hedge cost represents the cost of CDS protection purchased by the originator to hedge its counterparty credit risk exposure to the Company.

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.

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. The following spread hierarchy is utilized in determining which source of gross spread to use.

•
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 adjusted to reflect the non-standard terms of the Company's CDS contracts.

•
Credit spreads provided by the counterparty of the CDS.

•
Credit spreads extrapolated based upon transactions of similar asset classes, similar ratings, and similar time to maturity.
 
Information by Credit Spread Type (1)
 
 
As of
March 31, 2019
 
As of
December 31, 2018
Based on actual collateral specific spreads
20
%
 
20
%
Based on market indices
31
%
 
33
%
Provided by the CDS counterparty
49
%
 
47
%
Total
100
%
 
100
%
 ____________________
(1)    Based on par.


The rates used to discount future expected premium cash flows ranged from 2.34% to 2.64% at March 31, 2019 and 2.47% to 2.89% at December 31, 2018.

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

40
Table of Contents

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. Due to the low volume and total net par of CDS contracts remaining in AGM's portfolio, changes in AGM's credit spreads do not significantly affect the fair value of these CDS contracts.

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 0.1%, and 17%, based on fair value, of the Company's CDS contracts were fair valued using this minimum premium as of March 31, 2019, and December 31, 2018, respectively. The percentage of transactions that price using the minimum premiums fluctuates due to changes in AGC's credit spreads. In general when AGC's credit spreads narrow, the cost to hedge AGC's name declines and more transactions price above previously established floor levels. Meanwhile, when AGC's credit spreads widen, the cost to hedge 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 implied credit risk of AGC and AGM, indicated by the trading level of AGC’s and AGM’s own credit spread, is a significant factor in the amount of exposure to AGC and AGM that a bank or transaction hedges. When AGC's or AGM's credit spreads widen, the hedging cost of a bank or originator increases. Higher hedging costs reduce the amount of contractual cash flows AGC and AGM can capture as premium for selling its protection, while lower hedging costs increase the amount of contractual cash flows AGC and AGM can capture.

The amount of premium a financial guaranty insurance market participant can demand is inversely related to the cost of credit protection on the insurance company as measured by market credit spreads assuming all other assumptions remain constant. This is because the buyers of credit protection typically hedge a portion of their risk to the financial guarantor, due to the fact that the 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 credit derivative liability on protection sold is the result of contractual cash inflows on in-force transactions that are less than 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 realize a loss representing the difference between the lower 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.
 
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 model maximizes the use of market-driven inputs whenever they are available.

•
The model is a consistent approach to valuing positions.
 
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.

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Table of Contents

•
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.

Fair Value Option on FG VIEs’ Assets and Liabilities

The Company elected the fair value option for all the FG VIEs’ assets and liabilities and classifies them as Level 3 in the fair value hierarchy. The prices are generally determined with the assistance of an independent third party, based on a discounted cash flow approach. The net change in the fair value of consolidated FG VIEs’ assets and liabilities is recorded in "fair value gains (losses) on FG VIEs" in the consolidated statements of operations, except for change in fair value of FG VIEs’ liabilities with recourse caused by changes in instrument-specific credit risk (ISCR) which is separately presented in OCI. Interest income and interest expense are derived from the trustee reports and also included in "fair value gains (losses) on FG VIEs." The FG VIEs issued securities collateralized by first lien and second lien RMBS as well as loans and receivables.

The fair value of the Company’s FG VIEs’ assets is generally sensitive to changes in 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 have materially changed the market value of the FG VIEs’ assets and the implied collateral losses within the transaction. In general, the fair value of the FG VIEs’ assets is most sensitive to changes in the projected collateral losses, where an increase in collateral losses typically could lead to a decrease in the fair value of FG VIEs’ assets, while a decrease in collateral losses typically leads to an increase in the fair value of FG VIEs’ assets.

The third party 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 independent third party, on comparable bonds.

The models to price the FG VIEs’ liabilities used, where appropriate, the same inputs used in determining fair value of FG VIEs’ assets and, for those liabilities insured by the Company, the benefit of the Company's insurance policy guaranteeing the timely payment of principal and interest, taking into account the Company's own credit risk.

Significant changes to any of the inputs described above could have materially changed the timing of expected losses within the insured transaction which is a significant factor in determining the implied benefit of the Company’s insurance policy guaranteeing the timely payment of principal and interest for the tranches of debt issued by the FG VIEs. In general, extending the timing of expected loss payments by the Company into the future typically could lead to a decrease in the value of the Company’s insurance and a decrease in the fair value of the Company’s FG VIEs’ liabilities with recourse, while a shortening of the timing of expected loss payments by the Company typically could lead to an increase in the value of the Company’s insurance and an increase in the fair value of the Company’s FG VIEs’ liabilities with recourse.


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Table of Contents

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, 2019
 
 
 
 
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
$
4,843

 
$
—

 
$
4,739

 
$
104

U.S. government and agencies
166

 
—

 
166

 
—

Corporate securities
2,154

 
—

 
2,106

 
48

Mortgage-backed securities:
 

 
 
 
 
 
 
RMBS
959

 
—

 
641

 
318

Commercial mortgage-backed securities (CMBS)
539

 
—

 
539

 
—

Asset-backed securities
1,076

 
—

 
118

 
958

Non-U.S. government securities
252

 
—

 
252

 
—

Total fixed-maturity securities
9,989


—

 
8,561

 
1,428

Short-term investments
727

 
454

 
273

 
—

Other invested assets (1)
7

 
—

 
—

 
7

FG VIEs’ assets, at fair value
560

 
—

 
—

 
560

Other assets
137

 
30

 
41

 
66

Total assets carried at fair value
$
11,420

 
$
484

 
$
8,875

 
$
2,061

Liabilities:
 

 
 
 
 
 
 
Credit derivative liabilities
$
229

 
$
—

 
$
—

 
$
229

FG VIEs’ liabilities with recourse, at fair value
505

 
—

 
—

 
505

FG VIEs’ liabilities without recourse, at fair value
104

 
—

 
—

 
104

Total liabilities carried at fair value
$
838

 
$
—

 
$
—

 
$
838

 

43
Table of Contents

Fair Value Hierarchy of Financial Instruments Carried at Fair Value
As of December 31, 2018
 
 
 
 
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
$
4,911

 
$
—

 
$
4,812

 
$
99

U.S. government and agencies
175

 
—

 
175

 
—

Corporate securities
2,136

 
—

 
2,080

 
56

Mortgage-backed securities:
 

 
 

 
 

 
 

RMBS
982

 
—

 
673

 
309

CMBS
539

 
—

 
539

 
—

Asset-backed securities
1,068

 
—

 
121

 
947

Non-U.S. government securities
278

 
—

 
278

 
—

Total fixed-maturity securities
10,089

 
—

 
8,678

 
1,411

Short-term investments
729

 
429

 
300

 
—

Other invested assets (1)
7

 
—

 
—

 
7

FG VIEs’ assets, at fair value
569

 
—

 
—

 
569

Other assets
139

 
25

 
38

 
76

Total assets carried at fair value
$
11,533

 
$
454

 
$
9,016

 
$
2,063

Liabilities:
 

 
 

 
 

 
 

Credit derivative liabilities
$
209

 
$
—

 
$
—

 
$
209

FG VIEs’ liabilities with recourse, at fair value
517

 
—

 
—

 
517

FG VIEs’ liabilities without recourse, at fair value
102

 
—

 
—

 
102

Total liabilities carried at fair value
$
828

 
$
—

 
$
—

 
$
828

____________________
(1)
Includes Level 3 mortgage loans that are recorded at fair value on a non-recurring basis.








44
Table of Contents

Changes in Level 3 Fair Value Measurements
 
The tables below present a roll forward of the Company’s Level 3 financial instruments carried at fair value on a recurring basis during First Quarter 2019 and 2018. 

Fair Value Level 3 Rollforward
Recurring Basis
First Quarter 2019

 
Fixed-Maturity Securities
 
 
 
 
 
 
 
FG VIEs’ Liabilities, at Fair Value
 
 
Obligations
of State and
Political
Subdivisions
 
Corporate Securities
 
RMBS
 
Asset-
Backed
Securities
 
FG VIEs’
Assets at
Fair
Value
 
Other
(6)
 
Credit
Derivative
Asset
(Liability),
net (4)
 
With
Recourse
 
Without
Recourse
 
 
(in millions)
Fair value as of
December 31, 2018
$
99

 
$
56

 
$
309

 
$
947

 
$
569

 
$
77

 
$
(207
)
 
$
(517
)
 
$
(102
)
 
Total pretax realized and unrealized gains/(losses) recorded in:
 
 
 
 
 
 
 
 

 
 
 
 

 
 

 
 

 
 

Net income (loss)
1

(1
)
(11
)
(1
)
6

(1
)
14

(1
)
17

(2
)
(9
)
(3
)
(22
)
(5
)
(11
)
(2
)
(4
)
(2
)
Other comprehensive income (loss)
5

 
3

 
5

 
(9
)
 

—

 
—

 

—

 

—

 

—

 

Purchases
—

 
—

 
11

 
10

 

—

 
—

 

—

 

—

 

—

 

Settlements
(1
)
 
—

 
(13
)
 
(4
)
 
(26
)
 
—

 

1

 

23

 

2

 

Fair value as of
March 31, 2019
$
104

 
$
48

 
$
318

 
$
958

 
$
560

 
$
68

 
$
(228
)
 
$
(505
)
 
$
(104
)
 
Change in unrealized gains/(losses) included in earnings related to financial instruments held as of March 31, 2019
 
 
 
 
 
 
 
 
$
20

(2
)
$
(9
)
(3
)
$
(21
)
(5
)
$
(11
)
(2
)
$
(3
)
(2
)
Change in unrealized gains/(losses) included in OCI related to financial instruments held as of March 31, 2019
$
5

 
$
3

 
$
5

 
$
(8
)
 
 
 
$
—

 
 
 
$
—

 
 
 

45
Table of Contents

Fair Value Level 3 Rollforward
Recurring Basis
First Quarter 2018

 
Fixed-Maturity Securities
 
 
 
 
 
 
 
FG VIEs’ Liabilities, at Fair Value
 
 
Obligations
of State and
Political
Subdivisions
 
Corporate Securities
 
RMBS
 
Asset-
Backed
Securities
 
FG VIEs’
Assets at
Fair
Value
 
Other
(6)
 
Credit
Derivative
Asset
(Liability),
net (4)
 

With
Recourse
 

Without
Recourse
 
 
(in millions)
Fair value as of
December 31, 2017
$
76

 
$
67

 
$
334

 
$
787

 
$
700

 
$
64

 
$
(269
)
 
$
(627
)
 
$
(130
)
 
Total pretax realized and unrealized gains/(losses) recorded in:
 
 
 
 
 
 
 
 
 
 
 
 

 
 

 
 

 
 

Net income (loss)
1

(1
)
(5
)
(1
)
7

(1
)
15

(1
)
1

(2
)
(1
)
(3
)
34

(5
)
—

(2
)
1

(2
)
Other comprehensive income (loss)
3

 
—

 
(7
)
 
3

 
—

 
—

 

—

 

(2
)
 

—

 

Purchases
4

 
—

 
—

 
9

 
—

 
—

 

—

 

—

 

—

 

Settlements
(1
)
 
—

 
(20
)
 
(5
)
 
(33
)
 
(1
)
 

(1
)
 

30

 

3

 

FG VIE deconsolidations
—

 
—

 
—

 
—

 
(17
)
 
—

 
—

 
1

 
16

 
Fair value as of
March 31, 2018
$
83

 
$
62

 
$
314

 
$
809

 
$
651

 
$
62

 
$
(236
)
 
$
(598
)
 
$
(110
)
 
Change in unrealized gains/(losses) related to financial instruments held as of March 31, 2018
$
3

 
$
—

 
$
(6
)
 
$
4

 
$
4

(2
)
$
(1
)
(3
)
$
28

(5
)
$
(3
)
(2
)
$
1

(2
)
 ____________________
(1)
Included in net realized investment gains (losses) and net investment income.

(2)
Included in fair value gains (losses) on FG VIEs.

(3)
Recorded in net investment income and other income.

(4)
Represents the net position of credit derivatives. Credit derivative assets (recorded in other assets) and credit derivative liabilities (presented as a separate line item) are shown gross in the condensed consolidated balance sheet based on net exposure by counterparty.

(5)
Reported in net change in fair value of credit derivatives.

(6)
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, 2019

Financial Instrument Description (1)
 
Fair Value at
March 31, 2019
(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
 
$
104

 
Yield
 
4.5
%
-
32.7%
 
10.1%
 
 
 
 
 
 
 
 
 
 
 
Corporate securities
 
48

 
Yield
 
29.1%
 
 
 
 
 
 
 
 
 
 
 
 
 
RMBS
 
318

 
CPR
 
2.7
%
-
15.8%
 
6.1%
 
 
CDR
 
1.5
%
-
6.9%
 
5.1%
 
 
Loss severity
 
40.0
%
-
125.0%
 
85.4%
 
 
Yield
 
4.7
%
-
7.2%
 
5.5%
Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
Life insurance transactions
 
620

 
Yield
 
6.0
%
-
6.6%
 
6.3%
 
 
 
 
 
 
 
 
 
 
 
Collateralized loan obligations (CLOs) /Trust preferred securities (TruPS)
 
286

 
Yield
 
3.2
%
-
4.8%
 
4.0%
 
 
 
 
 
 
 
 
 
 
 
Others
 
52

 
Yield
 
10.7%
 
 
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ assets, at fair value
 
560

 
CPR
 
0.9
%
-
18.3%
 
9.1%
 
 
CDR
 
1.3
%
-
24.0%
 
4.9%
 
 
Loss severity
 
60.0
%
-
100.0%
 
79.7%
 
 
Yield
 
4.4
%
-
9.5%
 
6.3%
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
65

 
Implied Yield
 
6.3
%
-
6.9%
 
6.6%
 
 
Term (years)
 
10 years
 
 
Liabilities:
 
 

 
 
 
 
 
 
 
 
Credit derivative liabilities, net
 
(228
)
 
Year 1 loss estimates
 
0.0
%
-
73.0%
 
2.4%
 
 
Hedge cost (in basis points (bps))
 
3.3

-
55.5
 
16.0
 
 
Bank profit (in bps)
 
8.3

-
443.9
 
66.5
 
 
Internal floor (in bps)
 
8.8

-
30.0
 
10.2
 
 
Internal credit rating
 
AAA

-
CCC
 
AA-
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ liabilities, at fair value
 
(609
)
 
CPR
 
0.9
%
-
18.3%
 
9.1%
 
 
CDR
 
1.3
%
-
24.0%
 
4.9%
 
 
Loss severity
 
60.0
%
-
100.0%
 
79.7%
 
 
Yield
 
4.2
%
-
9.5%
 
4.9%
___________________
(1)
Discounted cash flow is used as the primary valuation technique for all financial instruments listed in this table.

(2)
Excludes several investments recorded in other invested assets with fair value of $7 million.

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Table of Contents

Quantitative Information About Level 3 Fair Value Inputs
At December 31, 2018

Financial Instrument Description (1)
 
Fair Value at
December 31, 2018
(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
 
$
99

 
Yield
 
4.5
%
-
32.7%
 
12.0%
 
 
 
 
 
 
 
 
 
 
 
Corporate securities
 
56

 
Yield
 
29.5%
 
 
 
 
 
 
 
 
 
 
 
 
 
RMBS
 
309

 
CPR
 
3.4
%
-
19.4%
 
6.2%
 
 
CDR
 
1.5
%
-
6.9%
 
5.2%
 
 
Loss severity
 
40.0
%
-
125.0%
 
82.7%
 
 
Yield
 
5.3
%
-
8.1%
 
6.3%
Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
Life insurance transactions
 
620

 
Yield
 
6.5
%
-
7.1%
 
6.8%
 
 
 
 
 
 
 
 
 
 
 
CLOs/TruPS
 
274

 
Yield
 
3.8
%
-
4.7%
 
4.3%
 
 
 
 
 
 
 
 
 
 
 
Others
 
53

 
Yield
 
11.5%
 
 
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ assets, at fair value
 
569

 
CPR
 
0.9
%
-
18.1%
 
9.3%
 
 
CDR
 
1.3
%
-
23.7%
 
5.1%
 
 
Loss severity
 
60.0
%
-
100.0%
 
79.8%
 
 
Yield
 
5.0
%
-
10.2%
 
7.1%
 
 
 
 
 
 
 
 
 
 
 
Other assets
 
74

 
Implied Yield
 
6.6
%
-
7.2%
 
6.9%
 
 
Term (years)
 
10 years
 
 
Liabilities:
 
 

 
 
 
 
 
 
 
 
Credit derivative liabilities, net
 
(207
)
 
Year 1 loss estimates
 
0.0
%
-
66.0%
 
2.2%
 
 
Hedge cost (in basis points (bps))
 
5.5

-
82.5
 
23.3
 
 
Bank profit (in bps)
 
7.2

-
509.9
 
77.3
 
 
Internal floor (in bps)
 
8.8

-
30.0
 
19.0
 
 
Internal credit rating
 
AAA

-
CCC
 
AA-
 
 
 
 
 
 
 
 
 
 
 
FG VIEs’ liabilities, at fair value
 
(619
)
 
CPR
 
0.9
%
-
18.1%
 
9.3%
 
 
CDR
 
1.3
%
-
23.7%
 
5.1%
 
 
Loss severity
 
60.0
%
-
100.0%
 
79.8%
 
 
Yield
 
5.0
%
-
10.2%
 
5.6%

____________________
(1)
Discounted cash flow is used as the primary valuation technique for all financial instruments listed in this table.

(2)
Excludes several investments recorded in other invested assets with fair value of $7 million.



48
Table of Contents

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.  In addition, the Company 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 also includes adjustments to the carrying value of unearned premium reserve for stressed losses, ceding commissions and return on capital. The Company classified this fair value measurement as Level 3.
 
Long-Term Debt
 
Long-term debt issued by AGUS and AGMH 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 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.
 
The carrying amount and estimated fair value of the Company’s financial instruments not carried at fair value are presented in the following table.

Fair Value of Financial Instruments Not Carried at Fair Value
 
 
As of
March 31, 2019
 
As of
December 31, 2018
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
 
(in millions)
Assets:
 

 
 

 
 

 
 

Other invested assets
$
1

 
$
2

 
$
1

 
$
2

Other assets (2)
119

 
119

 
130

 
130

Liabilities:
 

 
 

 
 

 
 

Financial guaranty insurance contracts (1)
2,987

 
5,740

 
3,240

 
5,932

Long-term debt
1,232

 
1,517

 
1,233

 
1,496

Other liabilities (2)
48

 
48

 
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. 

(2)
The Company's other assets and other liabilities consist predominantly of accrued interest, receivables for securities sold and payables for securities purchased, for which the carrying value approximates fair value.

7.
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 derivative portfolio also includes interest rate swaps.
 
Credit derivative transactions are governed by International Swaps and Derivative Association, Inc. documentation and have certain characteristics that differ 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

49
Table of Contents

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.
 
Credit Derivative Net Par Outstanding by Sector
 
The components of the Company’s credit derivative net par outstanding are presented in the table below. The estimated remaining weighted average life of credit derivatives was 11.6 years as of both March 31, 2019 and at December 31, 2018.
 
Credit Derivatives (1)
 
 
 
As of March 31, 2019
 
As of December 31, 2018
Asset Type
 
Net Par
Outstanding
 
Net Fair Value
 
Net Par
Outstanding
 
Net Fair Value
 
 
(in millions)
Pooled infrastructure
 
$
1,403

 
$
(41
)
 
$
1,373

 
$
(34
)
Infrastructure finance
 
1,294

 
(87
)
 
1,300

 
(63
)
Regulated utilities
 
1,115

 
(10
)
 
1,096

 
(11
)
TruPS collateralized debt obligations (CDOs)
 
606

 
(22
)
 
642

 
(28
)
U.S. RMBS
 
588

 
(30
)
 
641

 
(31
)
Other (2)
 
1,114

 
(38
)
 
1,130

 
(40
)
Total
 
$
6,120

 
$
(228
)
 
$
6,182

 
$
(207
)

____________________
(1)    Expected recoveries were $6 million as of March 31, 2019 and $2 million as of December 31, 2018.

(2)
This represents numerous transactions across various asset classes, such as health care revenue, municipal utilities and consumer receivables.

Distribution of Credit Derivative Net Par Outstanding by Internal Rating
 
 
 
As of March 31, 2019
 
As of December 31, 2018
Ratings
 
Net Par
Outstanding
 
% of Total
 
Net Par
Outstanding
 
% of Total
 
 
(dollars in millions)
AAA
 
$
1,795

 
29.3
%
 
$
1,813

 
29.4
%
AA
 
1,665

 
27.2

 
1,690

 
27.3

A
 
1,180

 
19.3

 
1,171

 
18.9

BBB
 
1,327

 
21.7

 
1,351

 
21.9

BIG (1)
 
153

 
2.5

 
157

 
2.5

Credit derivative net par outstanding
 
$
6,120

 
100.0
%
 
$
6,182

 
100.0
%

____________________
(1)
BIG relates to U.S. RMBS.


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Table of Contents

Fair Value of Credit Derivatives
 
Net Change in Fair Value of Credit Derivative Gain (Loss)
 
 
First Quarter
 
2019
 
2018
 
(in millions)
Realized gains on credit derivatives
$
3

 
$
2

Net credit derivative losses (paid and payable) recovered and recoverable and other settlements
(4
)
 
—

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

Net unrealized gains (losses)
(21
)
 
32

Net change in fair value of credit derivatives
$
(22
)
 
$
34



     During First Quarter 2019, unrealized fair value losses were generated primarily as a result of wider implied net spreads driven by the decreased cost to buy protection in AGC’s name, as the market cost of AGC’s credit protection decreased during the period. For those CDS transactions that were pricing at or above their floor levels, when the cost of purchasing CDS protection on AGC, which management refers to as the CDS spread on AGC, decreased, the implied spreads that the Company would expect to receive on these transactions increased.

During First Quarter 2018, unrealized fair value gains were generated primarily as a result of the increase in credit given to the primary insurer on one of the Company's second-to-pay CDS policies related to certain U.S. RMBS exposure, the paydown of CDS par, CDS terminations, and price improvements on the underlying collateral of the Company’s CDS. The unrealized fair value gains were partially offset by unrealized fair value losses related to the decreased cost to buy protection in AGC’s and AGM’s name as the market cost of AGC’s and AGM’s credit protection decreased during the period.

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 bps)
 
 
As of
March 31, 2019
 
As of
December 31, 2018
 
As of
March 31, 2018
 
As of
December 31, 2017
Five-year CDS spread:
 
 
 
 
 
 
 
AGC
74

 
110

 
121

 
163

AGM
72

 
116

 
109

 
145

 
 
 
 
 
 
 
 
One-year CDS spread
 
 
 
 
 
 
 
AGC
20

 
22

 
25

 
70

AGM
13

 
24

 
22

 
28




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Table of Contents

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

 
As of
March 31, 2019
 
As of
December 31, 2018
 
(in millions)
Fair value of credit derivatives before effect of AGC and AGM credit spreads
$
(370
)
 
$
(407
)
Plus: Effect of AGC and AGM credit spreads
142

 
200

Net fair value of credit derivatives
$
(228
)
 
$
(207
)


 
The fair value of CDS contracts at March 31, 2019, 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 the low rating of certain credits. Offsetting the benefit attributable to AGC’s credit spread were wide credit spreads in the fixed income security markets. The wide credit spreads in the fixed income security market are due to the lack of liquidity in the TruPS CDO, pooled infrastructure, and infrastructure finance markets as well as continuing market concerns over the 2005-2007 vintages of RMBS.
 
Collateral Posting for Certain Credit Derivative Contracts
 
The transaction documentation with one counterparty for $221 million in CDS net par insured by AGC requires AGC to post collateral, subject to a $221 million cap, to secure its obligation to make payments under such contracts. Eligible collateral is generally cash or U.S. government or agency securities; eligible collateral other than cash is valued at a discount to the face amount. The table below summarizes AGC’s CDS collateral posting requirements as of March 31, 2019 and December 31, 2018.

AGC Insured CDS Collateral Posting Requirements

 
As of
March 31, 2019
 
As of
December 31, 2018
 
(in millions)
Gross par of CDS with collateral posting requirement
$
221

 
$
250

Maximum posting requirement
221

 
250

Collateral posted
1

 
1


    
8.
Variable Interest Entities

The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs but does not act as the servicer or collateral manager for any VIE obligations guaranteed by its insurance subsidiaries. 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 Company's financial guaranty insurance policy only covers a senior layer of losses experienced by multiple obligations issued by the VIE. 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 VIEs generate interest income that are in excess of the interest payments on the debt issued by the VIE. 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 VIE (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 FG VIEs’ liabilities. Net fair value gains and losses on FG VIEs are expected to reverse to zero at maturity of the FG VIEs’ debt, except for net premiums received and net

52
Table of Contents

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 4, Expected Loss to be Paid.

As part of the terms of its financial guaranty contracts, the Company, under its insurance contract, obtains certain protective rights with respect to the VIE that give the Company additional controls over a VIE. These protective rights are triggered by the occurrence of certain events, such as failure to be in compliance with a covenant due to poor deal performance or a deterioration in a servicer or collateral manager's financial condition. At deal inception, the Company typically is not deemed to control a VIE; however, once a trigger event occurs, the Company's control of the VIE typically increases. The Company continuously evaluates its power to direct the activities that most significantly impact the economic performance of VIEs that have debt obligations insured by the Company and, accordingly, where the Company is obligated to absorb VIE losses or receive benefits that could potentially be significant to the VIE. The Company 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 VIE is deconsolidated.

Consolidated FG VIEs

As of both March 31, 2019 and December 31, 2018, the Company consolidated 31 FG VIEs. During First Quarter 2018, there was one FG VIE that was deconsolidated. There were no other consolidations or deconsolidations for the periods presented.

The change in the ISCR of the FG VIEs’ assets held as of the end of the reporting period that was recorded in the condensed consolidated statements of operations were gains of $6 million for First Quarter 2019 and $2 million for First Quarter 2018. To calculate ISCR, the change in the fair value of the FG VIEs’ assets is allocated between changes that are due to ISCR and changes due to other factors, including interest rates. The ISCR amount is determined by using expected cash flows at the original date of consolidation discounted at the effective yield less current expected cash flows discounted at that same original effective yield.
  
 
As of
March 31, 2019
 
As of
December 31, 2018
 
(in millions)
Excess of unpaid principal over fair value of:
 
 
 
FG VIEs' assets
$
330

 
$
350

FG VIEs' liabilities with recourse
38

 
48

FG VIEs' liabilities without recourse
24

 
28

 
 
 
 
Unpaid principal balance for the FG VIEs’ assets that were over 90 days or more past due
67

 
71

 
 
 
 
Unpaid principal for FG VIEs’ liabilities with recourse (1)
542

 
565

____________________
(1)
FG VIEs’ liabilities with recourse will mature at various dates ranging from 2019 to 2038.


53
Table of Contents

The table below shows the carrying value of the consolidated FG VIEs’ assets and liabilities in the condensed consolidated financial statements, segregated by the types of assets that collateralize the respective debt obligations for FG VIEs’ liabilities with recourse.

Consolidated FG VIEs
By Type of Collateral

 
As of March 31, 2019
 
As of December 31, 2018
 
Assets
 
Liabilities
 
Assets
 
Liabilities
 
(in millions)
With recourse:
 

 
 

 
 

 
 

U.S. RMBS first lien
$
295

 
$
321

 
$
299

 
$
326

U.S. RMBS second lien
111

 
132

 
115

 
137

Manufactured housing
50

 
52

 
53

 
54

Total with recourse
456

 
505

 
467

 
517

Without recourse
104

 
104

 
102

 
102

Total
$
560

 
$
609

 
$
569

 
$
619



The effects of consolidating FG VIEs includes (i) changes in fair value gains (losses) on FG VIEs’ assets and liabilities, (ii) the elimination of premiums and losses related to the AGC and AGM FG VIEs’ liabilities with recourse and (iii) the elimination of investment balances related to the Company’s purchase of AGC and AGM insured FG VIEs’ 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 

 
First Quarter
 
2019
 
2018
 
(in millions)
Net earned premiums
$
(3
)
 
$
(3
)
Net investment income
(1
)
 
(1
)
Fair value gains (losses) on FG VIEs (1)
5

 
4

Loss and LAE
(1
)
 
6

Effect on income before tax
—

 
6

Less: tax provision (benefit)
—

 
1

Effect on net income (loss)
$
—

 
$
5

 
 
 
 
Effect on OCI
$
(1
)
 
$
(2
)
 
 
 
 
Effect on cash flows from operating activities
$
1


$
2

 ____________________
(1)
See condensed consolidated statements of comprehensive income and Note 15, Shareholders' Equity, for information on changes in fair value of the FG VIEs’ liabilities with recourse that are attributable to changes in the Company's own credit risk.

The consolidation of FG VIEs had no effect on shareholders' equity as of March 31, 2019 and increased it $1 million as of December 31, 2018.

The primary driver of the gain during First Quarter 2019 was price appreciation on the FG VIE assets resulting from improvement in the underlying collateral. The primary driver of the gain in First Quarter 2018 in fair value of FG VIEs’ assets and FG VIEs’ liabilities was an increase in the value of the FG VIEs’ assets resulting from improvement in the underlying collateral.


54
Table of Contents

Other Consolidated VIEs

In certain instances where the Company consolidates a VIE that was established as part of a loss mitigation negotiated settlement 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 VIEs’ assets and FG VIEs’ liabilities. The largest of these VIEs had assets of $88 million and liabilities of $13 million as of March 31, 2019, and assets of $87 million and liabilities of $21 million as of December 31, 2018, primarily recorded in the investment portfolio and credit derivative liabilities on the condensed consolidated balance sheets.

Non-Consolidated VIEs
 
As described in Note 3, Outstanding Exposure, the Company monitors all policies in the insured portfolio. Of the approximately 18 thousand policies monitored as of March 31, 2019, approximately 16 thousand policies are not within the scope of Accounting Standards Codification (ASC) 810 because these financial guaranties relate to the debt obligations of governmental organizations or financing entities established by a governmental organization. The majority of the remaining policies involve transactions where the Company is not deemed to currently have control over the FG VIEs’ most significant activities. As of both March 31, 2019 and December 31, 2018, the Company identified 110 policies that contain provisions and experienced events that may trigger consolidation. Based on management’s assessment of these potential triggers or events, the Company consolidated 31 FG VIEs as of both March 31, 2019 and December 31, 2018. The Company’s exposure provided through its financial guaranties with respect to debt obligations of FG VIEs is included within net par outstanding in Note 3, Outstanding Exposure.

9.
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 $92 million and $91 million as of March 31, 2019 and December 31, 2018, respectively.
 
Net Investment Income
 
 
First Quarter
 
2019
 
2018
 
(in millions)
Income from fixed-maturity securities managed by third parties
$
72

 
$
75

Income from internally managed securities
28

 
27

Gross investment income
100

 
102

Investment expenses
(2
)
 
(2
)
Net investment income
$
98

 
$
100




55
Table of Contents

The table below presents the components of net realized investment gains (losses). Realized gains and losses on sales of investments are determined using the specific identification method.

Net Realized Investment Gains (Losses)
 
 
First Quarter
 
2019
 
2018
 
(in millions)
Gross realized gains on available-for-sale securities
$
6

 
$
9

Gross realized losses on available-for-sale securities
(2
)
 
(5
)
Net realized gains (losses) on other invested assets
—

 
(1
)
Other-than-temporary impairment (OTTI):
 
 
 
Total OTTI
(13
)
 
(11
)
Less: portion of OTTI recognized in OCI
3

 
(3
)
Net OTTI recognized in net income (loss) (1)
(16
)
 
(8
)
Net realized investment gains (losses)
$
(12
)
 
$
(5
)

____________________
(1)
Net OTTI recognized in net income was primarily a result of a decline in expected cash flows on loss mitigation and other risk management securities.

The following table presents the roll-forward of the credit losses on fixed-maturity securities for which the Company has recognized an OTTI and for which unrealized loss was recognized in OCI.
 
Roll Forward of Credit Losses
in the Investment Portfolio

 
First Quarter
 
2019
 
2018
 
(in millions)
Balance, beginning of period
$
185

 
$
162

Additions for credit losses on securities for which an OTTI was previously recognized
12

 
7

Balance, end of period
$
197

 
$
169




See Part II, Item 8, Financial Statements and Supplementary Data, Note 10, Investments and Cash, of the Company's 2018 Annual Report on Form 10-K for a discussion of the accounting policy for evaluating investments for OTTI.

Investment Portfolio

As of March 31, 2019, the majority of the investment portfolio is managed by seven outside managers (including Wasmer, Schroeder & Company LLC, in which the Company has a minority interest). 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 Global Ratings, a division of Standard & Poor's Financial Services LLC (S&P) or A3 by Moody’s, excluding an allocation not to exceed 15% of the aggregate externally managed portfolio, to corporate and municipal securities not rated lower than BBB- by S&P or Baa3 by Moody’s.

The investment portfolio tables shown below include assets managed both externally and internally. The internally managed portfolio primarily consists of the Company's investments in securities for (i) loss mitigation purposes, (ii) other risk management purposes and (iii) other alternative investments that the Company believes present an attractive investment opportunity.
    

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One of the Company's strategies for mitigating losses has been to purchase loss mitigation securities at discounted prices. The Company also holds other invested assets that were obtained or purchased as part of negotiated settlements with insured counterparties or under the terms of the financial guaranties (other risk management assets).

Alternative investments include investing in both equity and debt securities as well as 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 of which $83 million remains to be invested as of March 31, 2019.

Investment Portfolio
Carrying Value

 
As of
March 31, 2019
 
As of
December 31, 2018
 
(in millions)
Fixed-maturity securities (1):
 
 
 
Externally managed
$
8,661

 
$
8,909

Internally managed
1,328

 
1,180

Short-term investments
727

 
729

Other invested assets:
 
 
 
Internally managed
 
 
 
Alternative investments
45

 
39

Other
16

 
16

Total
$
10,777

 
$
10,873

____________________
(1)
10.9% and 10.8% of fixed-maturity securities are rated BIG as of March 31, 2019 and December 31, 2018, respectively.

The Company has a de minimis amount of restricted cash as of March 31, 2019 and December 31, 2018.


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Fixed-Maturity Securities and Short-Term Investments
by Security Type 
As of March 31, 2019

Security Type
 
Percent
of
Total (1)
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
AOCI (2)
Gain
(Loss) on
Securities
with
OTTI
 
Weighted
Average
Credit
Rating
 (3)
 
 
(dollars in millions)
Fixed-maturity securities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 
Obligations of state and political subdivisions
 
45
%
 
$
4,597

 
$
249

 
$
(3
)
 
$
4,843

 
$
46

 
AA-
U.S. government and agencies
 
1

 
157

 
9

 
—

 
166

 
—

 
AA+
Corporate securities
 
21

 
2,125

 
46

 
(17
)
 
2,154

 
—

 
A
Mortgage-backed securities (4):
 
0

 
 
 
 
 
 

 
 
 
 

 
 
RMBS
 
9

 
960

 
23

 
(24
)
 
959

 
(11
)
 
A-
CMBS
 
5

 
532

 
10

 
(3
)
 
539

 
—

 
AAA
Asset-backed securities
 
9

 
957

 
122

 
(3
)
 
1,076

 
88

 
BB
Non-U.S. government securities
 
3

 
262

 
5

 
(15
)
 
252

 
—

 
AA
Total fixed-maturity securities
 
93

 
9,590

 
464

 
(65
)
 
9,989

 
123

 
A+
Short-term investments
 
7

 
727

 
—

 
—

 
727

 
—

 
AAA
Total investment portfolio
 
100
%
 
$
10,317

 
$
464

 
$
(65
)
 
$
10,716

 
$
123

 
A+


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Fixed-Maturity Securities and Short-Term Investments
by Security Type 
As of December 31, 2018 

Security Type
 
Percent
of
Total (1)
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
AOCI
Gain
(Loss) on
Securities
with
OTTI
 
Weighted
Average
Credit
Rating
 (3)
 
 
(dollars in millions)
Fixed-maturity securities:
 
 

 
 

 
 

 
 

 
 

 
 

 
 
Obligations of state and political subdivisions
 
45
%
 
$
4,761

 
$
168

 
$
(18
)
 
$
4,911

 
$
40

 
AA-
U.S. government and agencies
 
2

 
167

 
9

 
(1
)
 
175

 
—

 
AA+
Corporate securities
 
20

 
2,175

 
13

 
(52
)
 
2,136

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

 
 

 
 

 
 

 
 

 
 

 
 
RMBS
 
9

 
999

 
17

 
(34
)
 
982

 
(15
)
 
A-
CMBS
 
5

 
542

 
4

 
(7
)
 
539

 
—

 
AAA
Asset-backed securities
 
9

 
942

 
131

 
(5
)
 
1,068

 
97

 
BB
Non-U.S. government securities
 
3

 
298

 
2

 
(22
)
 
278

 
—

 
AA
Total fixed-maturity securities
 
93

 
9,884

 
344

 
(139
)
 
10,089

 
118

 
A+
Short-term investments
 
7

 
729

 
—

 
—

 
729

 
—

 
AAA
Total investment portfolio
 
100
%
 
$
10,613

 
$
344

 
$
(139
)
 
$
10,818

 
$
118

 
A+
____________________
(1)
Based on amortized cost.
 
(2)
Accumulated OCI (AOCI). See Note 15, Shareholders' Equity.

(3)
Ratings 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 primarily consists of high-quality, liquid instruments.
 
(4)
U.S. government-agency obligations were approximately 46% of mortgage backed securities as of March 31, 2019 and 48% as of December 31, 2018 based on fair value.


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.


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Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time
As of March 31, 2019
 
 
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
$
17

 
$
—

 
$
152

 
$
(3
)
 
$
169

 
$
(3
)
U.S. government and agencies
20

 
—

 
24

 
—

 
44

 
—

Corporate securities
101

 
(1
)
 
381

 
(16
)
 
482

 
(17
)
Mortgage-backed securities:
 
 
 
 
 
 
 

 


 


RMBS
37

 
(1
)
 
371

 
(23
)
 
408

 
(24
)
CMBS
1

 
—

 
86

 
(3
)
 
87

 
(3
)
Asset-backed securities
308

 
(3
)
 
18

 
—

 
326

 
(3
)
Non-U.S. government securities
46

 
(1
)
 
86

 
(14
)
 
132

 
(15
)
Total
$
530

 
$
(6
)
 
$
1,118

 
$
(59
)
 
$
1,648

 
$
(65
)
Number of securities (1)
 

 
128

 
 

 
333

 
 

 
456

Number of securities with OTTI (1)
 

 
5

 
 

 
24

 
 

 
28

 

Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time
As of December 31, 2018

 
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
$
195

 
$
(4
)
 
$
658

 
$
(14
)
 
$
853

 
$
(18
)
U.S. government and agencies
11

 
—

 
24

 
(1
)
 
35

 
(1
)
Corporate securities
836

 
(19
)
 
522

 
(33
)
 
1,358

 
(52
)
Mortgage-backed securities:
 

 
 

 
 

 
 

 


 


RMBS
85

 
(2
)
 
447

 
(32
)
 
532

 
(34
)
CMBS
111

 
(1
)
 
164

 
(6
)
 
275

 
(7
)
Asset-backed securities
322

 
(4
)
 
38

 
(1
)
 
360

 
(5
)
Non-U.S. government securities
83

 
(4
)
 
99

 
(18
)
 
182

 
(22
)
Total
$
1,643

 
$
(34
)
 
$
1,952

 
$
(105
)
 
$
3,595

 
$
(139
)
Number of securities (1)
 

 
417

 
 

 
608

 
 

 
997

Number of securities with OTTI (1)
 

 
22

 
 

 
22

 
 

 
42


___________________
(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, 2019 and December 31, 2018, 37 and 38 securities, respectively, had unrealized losses greater than 10% of book value. The total unrealized loss for these securities was $33 million as of March 31, 2019 and $43 million as of December 31, 2018. The Company considered the credit quality, cash flows, interest rate movements, ability to hold a security to recovery and intent to sell a security in determining whether a security had a credit loss. The Company has determined that the unrealized losses recorded as of March 31, 2019 and December 31, 2018 were yield-related and not the result of OTTI.
 
The amortized cost and estimated fair value of available-for-sale fixed maturity securities by contractual maturity as of March 31, 2019 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, 2019
 
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Due within one year
$
217

 
$
213

Due after one year through five years
1,500

 
1,524

Due after five years through 10 years
2,249

 
2,316

Due after 10 years
4,132

 
4,438

Mortgage-backed securities:
 

 
 

RMBS
960

 
959

CMBS
532

 
539

Total
$
9,590

 
$
9,989


 
Based on fair value, investments and restricted cash that are either held in trust for the benefit of third party ceding insurers in accordance with statutory requirements, placed on deposit to fulfill state licensing requirements, or otherwise pledged or restricted totaled $269 million and $266 million, as of March 31, 2019 and December 31, 2018, respectively. The investment portfolio also contains securities that are held in trust by certain AGL subsidiaries or otherwise restricted for the benefit of other AGL subsidiaries in accordance with statutory and regulatory requirements in the amount of $1,873 million and $1,855 million, based on fair value as of March 31, 2019 and December 31, 2018, respectively.

10.
Income Taxes

Overview
 
AGL and its Bermuda subsidiaries AG Re, AGRO, and Cedar Personnel Ltd. (Bermuda Subsidiaries) 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, has 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. As a U.K. tax resident company, AGL is required to file a corporation tax return with Her Majesty's Revenue & Customs. 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 corporation tax rate is at 19% for 2019. Assured Guaranty expects that the dividends AGL receives from its direct subsidiaries will be exempt from U.K. corporation tax due to the exemption in section 931D of the U.K. Corporation Tax Act 2009. In addition, any dividends paid by AGL to its shareholders should not be subject to any withholding tax in the U.K. Assured Guaranty does not expect any profits of non-U.K. resident members of the group to be taxed under the U.K. "controlled foreign companies" regime and has obtained a clearance from Her Majesty's Revenue & Customs confirming this on the basis of current facts.

AGUS files a consolidated federal income tax return with all of its U.S. subsidiaries.


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Assured Guaranty Overseas US Holdings Inc. (AGOUS) and its subsidiaries AGRO and AG Intermediary Inc. file their own consolidated federal income tax return.

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 loss reserves, fair value of its credit derivatives and VIEs, and foreign exchange gains and losses which prevents the Company from projecting a reliable estimated annual effective tax rate and pretax income for the full year 2019. 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 21%, U.K. subsidiaries taxed at the U.K. marginal corporate tax rate of 19%, and no taxes for the Company’s Bermuda Subsidiaries unless subject to U.S. tax by election. 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
 
2019
 
2018
 
(in millions)
Expected tax provision (benefit) at statutory rates in taxable jurisdictions
$
9

 
$
35

Tax-exempt interest
(5
)
 
(6
)
Change in liability for uncertain tax positions
—

 
(7
)
State taxes
1

 
2

Foreign taxes
1

 
(4
)
Taxes on reinsurance
1

 
—

Deferred compensation
(2
)
 
(1
)
Other
(1
)
 
1

Total provision (benefit) for income taxes
$
4

 
$
20

Effective tax rate
7.8
%
 
9.3
%



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. 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 tables present pretax income and revenue by jurisdiction.
 
Pretax Income (Loss) by Tax Jurisdiction

 
First Quarter
 
2019
 
2018
 
(in millions)
U.S.
$
35

 
$
175

Bermuda
16

 
49

U.K. and Other
7

 
(7
)
Total
$
58

 
$
217





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Revenue by Tax Jurisdiction

 
First Quarter
 
2019
 
2018
 
(in millions)
U.S.
$
149

 
$
247

Bermuda
33

 
52

U.K. and Other
13

 
(6
)
Total
$
195

 
$
293


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

Tax Assets (Liabilities)
    
Deferred and Current Tax Assets (Liabilities) (1)

 
As of
March 31, 2019
 
As of
December 31, 2018
 
(in millions)
Deferred tax assets (liabilities)
$
33

 
$
68

Current tax assets (liabilities)
28

 
22

____________________
(1)
Included in other assets or other liabilities on the condensed consolidated balance sheets.

Valuation Allowance
 
The Company has $13 million of foreign tax credit (FTC) carryovers from previous acquisitions and $23 million of FTC due to the 2017 Tax Cuts and Jobs Act for use against regular tax in future years. FTCs will begin to expire in 2020 and will fully expire by 2027. In analyzing the future realizability of FTCs, the Company notes limitations on future foreign source income due to overall foreign losses as negative evidence. After reviewing positive and negative evidence, the Company came to the conclusion that it is more likely than not that the FTC of $36 million 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 the remaining net deferred tax asset. The Company will continue to analyze the need for a valuation allowance on a quarterly basis.

Audits

As of March 31, 2019, AGUS had open tax years with the U.S. IRS for 2015 to present. In December 2016, the IRS issued a Revenue Agent Report for the 2009 - 2012 audit period, which did not identify any material adjustments that were not already accounted for in prior periods. The 2013 and 2014 tax years closed in 2018. AGOUS has open tax years of 2015 forward. The Company's U.K. subsidiaries are not currently under examination and have open tax years of 2016 forward. CIFGNA, which was acquired by AGC during 2016, is not currently under examination and has open tax years of 2015 to the date of acquisition.


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Table of Contents

Uncertain Tax Positions

The Company's policy is to recognize interest related to uncertain tax positions in income tax expense and has accrued $0.2 million for First Quarter 2019 and $1 million for the full year 2018. As of both March 31, 2019 and December 31, 2018, the Company has accrued $2 million of interest.

The total amount of reserves for unrecognized tax positions, including accrued interest, as of both March 31, 2019 and December 31, 2018 that would affect the effective tax rate, if recognized, was $16 million.

11.
Reinsurance
 
The Company assumes exposure (Assumed Business) from third party insurers, primarily other monoline financial guaranty companies that currently are in runoff and no longer actively writing new business (Legacy Monoline Insurers), and may cede portions of exposure it has insured (Ceded Business) in exchange for premiums, net of any ceding commissions. The Company, if required, secures its reinsurance obligations to these Legacy Monoline Insurers, typically by depositing in trust assets with a market value equal to its assumed liabilities calculated on a U.S. statutory basis.

Substantially all of the Company’s Assumed Business and Ceded Business relates to financial guaranty business, except for a modest amount that relates to AGRO's non-financial guaranty business. The Company historically entered into, and with respect to new business originated by AGRO continues to enter into, ceded reinsurance contracts in order to obtain greater business diversification and reduce the net potential loss from large risks.

Financial Guaranty Business
 
The Company’s facultative and treaty assumed agreements with the Legacy Monoline Insurers are generally subject to termination at the option of the ceding company:

•
if the Company fails to meet certain financial and regulatory criteria;

•
if the Company fails to maintain a specified minimum financial strength rating, or

•
upon certain changes of control of the Company.
 
Upon termination due to one of the above events, the Company typically would be required to return to the ceding company unearned premiums (net of ceding commissions) and loss reserves, calculated on a U.S. statutory basis, attributable to the assumed business (plus in certain cases, an additional required amount), after which the Company would be released from liability with respect to such business.

As of March 31, 2019, if each third party company 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 $41 million and $312 million, respectively.

The Company has ceded financial guaranty business to non-affiliated companies to limit its exposure to risk. 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. The Company’s ceded contracts generally allow the Company to recapture ceded financial guaranty business after certain triggering events, such as reinsurer downgrades.

Non-Financial Guaranty Business

The Company, through AGRO, assumes non-financial guaranty business from third party insurers (Assumed Non-Financial Guaranty Business). It also cedes and retrocedes some of its non-financial guaranty business to third party reinsurers. A downgrade of AGRO’s financial strength rating by S&P below A would require AGRO to post, as of March 31, 2019, an estimated $1 million of collateral in respect of certain of its Assumed Non-Financial Guaranty Business. A further downgrade of AGRO’s S&P rating below A- would give the company ceding such business the right to recapture the business for AGRO’s collateral amount, and, if also accompanied by a downgrade of AGRO's financial strength rating by A.M. Best Company, Inc. below A-, would also require AGRO to post, as of March 31, 2019, an estimated $10 million of collateral in respect of a different portion of AGRO’s Assumed Non-Financial Guaranty Business. AGRO’s ceded/retroceded contracts generally have

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equivalent provisions requiring the assuming reinsurer to post collateral and/or allowing AGRO to recapture the ceded/retroceded business upon certain triggering events, such as reinsurer rating downgrades.

Effect of Reinsurance

The following table presents the components of premiums and losses reported in the condensed consolidated statements of operations and the contribution of the Company's Assumed and Ceded Businesses (both financial guaranty and non-financial guaranty).

Effect of Reinsurance on Statement of Operations

 
First Quarter
 
2019
 
2018
 
(in millions)
Premiums Written:
 
 
 
Direct
$
39

 
$
73

Assumed
—

 
—

Ceded (1)
15

 
(11
)
Net
$
54

 
$
62

Premiums Earned:
 
 
 
Direct
$
105

 
$
143

Assumed
15

 
5

Ceded
(2
)
 
(3
)
Net
$
118

 
$
145

Loss and LAE:
 
 
 
Direct
$
54

 
$
(14
)
Assumed
1

 
(3
)
Ceded
(9
)
 
(1
)
Net
$
46

 
$
(18
)
____________________
(1)    Positive ceded premiums written were due to terminations and changes in expected debt service schedules.

Ceded Reinsurance (1)

 
As of
March 31, 2019
 
As of
December 31, 2018
 
(in millions)
Ceded premium, net of commissions
$
(7
)
 
$
(26
)
Ceded expected loss to be paid
19

 
14

Financial guaranty ceded par outstanding (2)
1,979

 
2,389

Non-financial guaranty ceded exposure (see Note 3)
245

 
239

____________________
(1)
The total collateral posted by all non-affiliated reinsurers required to post, or that had agreed to post, collateral as of March 31, 2019 and December 31, 2018 was approximately $75 million and $80 million, respectively. Such collateral is posted (i) in the case of certain reinsurers not authorized or "accredited" in the U.S., in order for the Company to receive credit for the liabilities ceded to such reinsurers, and (ii) in the case of certain reinsurers authorized in the U.S., on terms negotiated with the Company.

(2)
Of the total par ceded to unrated or BIG rated reinsurers, $235 million and $236 million is rated BIG as of March 31, 2019 and December 31, 2018, respectively.


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Table of Contents

Commutations

In recent years the Company has reassumed previously ceded books of business from several of its reinsurers. During First Quarter 2018, there was a commutation of previously ceded business from a reinsurer resulting in increase of net unearned premium reserve of $4 million and net par outstanding of $42 million. There were no commutations in First Quarter 2019.

Excess of Loss Reinsurance Facility

     Effective January 1, 2018, AGC, AGM and MAC entered into a $400 million aggregate excess of loss reinsurance facility of which $180 million was placed with an unaffiliated reinsurer. This facility covers losses occurring either from January 1, 2018 through December 31, 2024, or January 1, 2019 through December 31, 2025, at the option of AGC, AGM and MAC. It terminates on January 1, 2020, unless AGC, AGM and MAC choose to extend it. It covers certain U.S. public finance exposures insured or reinsured by AGC, AGM and MAC as of September 30, 2017, excluding exposures that were rated below investment grade as of December 31, 2017 by Moody’s or S&P or internally by AGC, AGM or MAC and is subject to certain per credit limits. Among the exposures excluded are those associated with the Commonwealth of Puerto Rico and its related authorities and public corporations. The 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 $0.8 billion in the aggregate. The facility covers a portion of the next $400 million of losses, with the reinsurer assuming $180 million of the $400 million of losses and AGC, AGM and MAC jointly retaining the remaining $220 million. The reinsurer is required to be rated at least AA- or to post collateral sufficient to provide AGC, AGM and MAC with the same reinsurance credit as reinsurers rated AA-. AGC, AGM and MAC are each obligated to pay the reinsurer its share of recoveries relating to losses during the coverage period in the covered portfolio. AGC, AGM and MAC paid approximately $3.2 million of premiums in 2018 for the term January 1, 2018 through December 31, 2018 and approximately $3.2 million of premiums in 2019 for the term January 1, 2019 through December 31, 2019.

12.    Commitments and Contingencies

Leases

The Company is party to various non-cancelable lease agreements. The largest lease relates to approximately 103,500 square feet of office space in New York City, which expires in 2032. Subject to certain conditions, the Company has an option to renew this lease for an additional five years at a fair market rent. The Company also has leases for additional office and apartment space in several other locations which expire at various dates through 2029.

Effective January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842), which requires the establishment of a right-of-use (ROU) asset and a lease liability on the balance sheet for operating leases. All of the Company’s leases are classified as operating leases, however, the Company made an accounting policy election not to apply the recognition requirements of Topic 842 to short-term leases with an initial term of 12 months or less. At the inception of a lease the total payments under a lease agreement are discounted utilizing an incremental borrowing rate that represents the Company’s collateralized borrowing rate. The rate was determined based on the remaining lease term as of the date of adoption. The Company does not include its renewal options in calculating the lease liability.
  
Operating lease expense is recognized on a straight-line basis over the lease term. Actual costs incurred related to non-lease components for all the Company’s office leases are recorded as a variable lease expense in the period incurred.

The Company elected the package of practical expedients, which permits organizations not to reassess (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification of expired or existing leases and (iii) initial direct costs for existing leases. The Company also elected the practical expedient to account for all lease components and their associated non-lease components (i.e., common area maintenance, real estate taxes, building insurance and other operating expenses) as a single lease component and has allocated all of the contract consideration across lease components.
 
Upon adoption, the Company recognized lease liabilities of approximately $95 million (recorded in other liabilities) and ROU assets of approximately $69 million (recorded in other assets), and derecognized existing deferred rent and lease incentive liabilities of approximately $26 million, resulting in no cumulative-effect adjustment to retained earnings.

As of March 31, 2019, the ROU assets were $67 million and the lease liabilities were $93 million.


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Components of Lease Expense

 
First Quarter 2019
 
(in millions)
Lease cost (1)
$
2

 
 
Cash paid for amounts included in the measurement of lease liabilities
$
2

Weighted average remaining lease term (years)-operating leases
12.5

Weighted average discount rate-operating leases
3.0
%

 ____________________
(1)    Substantially all of the lease cost relates to operating lease costs.


Future Minimum Rental Payments

 
 
As of
March 31, 2019
Year
 
(in millions)
2019 (remaining nine months)
$
6

2020
9

2021
8

2022
8

2023
9

Thereafter
72

Total lease payments (1)
112

Less: imputed interest
19

Total operating lease liabilities
$
93


 ____________________
(1)
The Company did not enter into any new leases in First Quarter 2019.  At December 31, 2018, future lease payments were $9 million, $9 million, $8 million, $8 million, and $9 million for 2019 through 2023, respectively, and $72 million in aggregate for all years thereafter.


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 AGL's subsidiaries assert claims in legal proceedings against third parties to recover losses paid in prior periods or prevent losses in the future. For example, the Company has commenced a number of legal actions in the Federal District Court for Puerto Rico to enforce its rights with respect to the obligations it insures of Puerto Rico and various of its related authorities and public corporations. See "Exposure to Puerto Rico" section of Note 3, Outstanding Exposure, for a description of such actions. See "Recovery Litigation" section of Note 4, Expected Loss to be Paid, for a description of recovery litigation unrelated to Puerto Rico. 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 also receives subpoenas duces tecum and interrogatories from regulators from time to time.


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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, asserted a claim for breach of the implied covenant of good faith and fair dealing based on AGFP's termination of nine credit derivative transactions between LBIE and AGFP and asserted claims for breach of contract and breach of the implied covenant of good faith and fair dealing based on AGFP's termination of 28 other credit derivative transactions between LBIE and AGFP and AGFP's calculation of the termination payment in connection with those 28 other credit derivative transactions. 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. AGFP filed a motion to dismiss the claims for breach of the implied covenant of good faith in LBIE's complaint, and on March 15, 2013, the court granted AGFP's motion to dismiss in respect of the count relating to the nine credit derivative transactions and narrowed LBIE's claim with respect to the 28 other credit derivative transactions. 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. AGFP filed a motion for summary judgment on the remaining causes of action asserted by LBIE and on AGFP's counterclaims, and on July 2, 2018, the court granted in part and denied in part AGFP’s motion. The court dismissed, in its entirety, LBIE’s remaining claim for breach of the implied covenant of good faith and fair dealing and also dismissed LBIE’s claim for breach of contract solely to the extent that it is based upon AGFP’s conduct in connection with the auction. With respect to LBIE’s claim for breach of contract, the court held that there are triable issues of fact regarding whether AGFP calculated its loss reasonably and in good faith. On October 1, 2018, AGFP filed an appeal with the Appellate Division of the Supreme Court of the State of New York, First Judicial Department, seeking reversal of the portions of the lower court's ruling denying AGFP’s motion for summary judgment with respect to LBIE’s sole remaining claim for breach of contract. On January 17, 2019, the Appellate Division affirmed the Supreme Court's decision, holding that the lower court correctly determined that there are triable issues of fact regarding whether AGFP calculated its loss reasonably and in good faith.

On May 2, 2019, the Oversight Board and the Official Committee of Unsecured Creditors of the Commonwealth filed an adversary complaint in the Federal District Court for Puerto Rico against various Commonwealth general obligation bondholders and bond insurers, including AGC and AGM, that had asserted in their proofs of claim that their bonds are secured. The complaint seeks a judgment declaring that defendants do not hold consensual or statutory liens and are unsecured claimholders to the extent they hold allowed claims. The complaint also asserts that even if Commonwealth law granted statutory liens, such liens are avoidable under Section 545 of the Bankruptcy Code.

 

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13.
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, 2019
 
As of December 31, 2018
 
Principal

Carrying
Value

Principal

Carrying
Value
 
(in millions)
AGUS:
 


 


 


 

7% Senior Notes (1)
$
200

 
$
197


$
200

 
$
197

5% Senior Notes (1)
500


497

 
500

 
497

Series A Enhanced Junior Subordinated Debentures (2)
150

 
150


150

 
150

Total AGUS
850

 
844


850

 
844

AGMH(3):
 

 
 


 

 
 

6 7/8% QUIBS (1)
100

 
70


100

 
70

6.25% Notes (1)
230

 
144


230

 
143

5.6% Notes (1)
100

 
57


100

 
57

Junior Subordinated Debentures (2)
300

 
199


300

 
198

Total AGMH
730

 
470


730

 
468

AGM (3):
 

 
 


 

 
 

Notes Payable
5

 
5


5

 
5

Total AGM
5

 
5

 
5

 
5

AGMH's debt purchased by AGUS
(131
)
 
(87
)
 
(128
)
 
(84
)
Total
$
1,454

 
$
1,232


$
1,457

 
$
1,233


 ____________________
(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 primarily due to fair value adjustments at the date of the AGMH acquisition, which are accreted or amortized into interest expense over the remaining terms of these obligations.

The following table presents the principal amounts of AGMH's outstanding Junior Subordinated Debentures that AGUS purchased and the loss on extinguishment of debt recognized by the Company. The Company may choose to make additional purchases of this or other Company debt in the future.

AGUS's Purchase
of AGMH's Junior Subordinated Debentures

 
First Quarter
 
2019
 
2018
 
(in millions)
Principal amount repurchased
$
3

 
$
20

Loss on extinguishment of debt (1)
(1
)
 
(7
)
 ____________________
(1)
Included in other income in the condensed consolidated statements of operations. The loss represents the difference between the amount paid to purchase AGMH's debt and the carrying value of the debt, which includes the unamortized fair value adjustments that were recorded upon the acquisition of AGMH in 2009.


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Table of Contents

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. In September 2018, AGL and AGUS amended the revolving credit facility to extend the commitment until October 25, 2023 (the loan commitment termination date). The unpaid principal amount of each loan will bear interest at a fixed rate equal to 100% of the then applicable interest rate 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 commitment 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. In 2018, the maturity date was extended to November 2023. During 2018 AGUS repaid $10 million in outstanding principal as well as accrued and unpaid interest. As of March 31, 2019, $50 million remained outstanding.

Committed Capital Securities
 
Each of AGC and AGM have entered into put agreements with four separate custodial trusts allowing AGC and AGM, respectively, to issue an aggregate of $200 million of non-cumulative redeemable perpetual preferred securities to the trusts in exchange for cash. Each custodial trust was created for the primary purpose of issuing $50 million face amount of CCS, investing the proceeds in high-quality assets and entering into put options with AGC or AGM, as applicable. The Company does not consider itself to be the primary beneficiary of the trusts and the trusts are not consolidated in Assured Guaranty's financial statements.

The trusts provide AGC and AGM access to new equity 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 its sale of 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. Both AGC and AGM continue to have the ability to exercise their respective put options and cause the related trusts to purchase their preferred stock.

Prior to 2008 or 2007, the amounts paid on the CCS were established through an auction process. All of those auctions failed in 2008 or 2007, and the rates paid on the CCS increased to their respective maximums. The annualized rate on the AGC CCS is one-month LIBOR plus 250 bps, and the annualized rate on the AGM CPS is one-month LIBOR plus 200 bps.

See Note 6, Fair Value Measurement, –Other Assets–Committed Capital Securities, for a discussion of the fair value measurement of the CCS.


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14.    Earnings Per Share
 
Computation of Earnings Per Share 

 
First Quarter
 
2019

2018
 
(in millions, except per share amounts)
Basic Earnings Per Share (EPS):
 
 
 
Net income (loss) attributable to AGL
$
54

 
$
197

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

 
1

Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic
$
54

 
$
196

Basic shares
103.0

 
115.2

Basic EPS
$
0.52

 
$
1.71

 
 
 
 
Diluted EPS:
 
 
 
Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic
$
54

 
$
196

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

 
—

Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, diluted
$
54

 
$
196

 
 
 
 
Basic shares
103.0

 
115.2

Dilutive securities:
 
 
 
Options and restricted stock awards
1.0

 
1.4

Diluted shares
104.0

 
116.6

Diluted EPS
$
0.52

 
$
1.68

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

 
0.2





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15.
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 2019

 
Net Unrealized
Gains (Losses) on Investments with no OTTI
 
Net Unrealized
Gains (Losses) on Investments with OTTI
 
Net Unrealized Gains (Losses) on FG VIEs’ Liabilities with Recourse due to ISCR
 
Cumulative
Translation
Adjustment
 
Cash Flow 
Hedge
 
Total 
AOCI
 
(in millions)
Balance, December 31, 2018
$
59

 
$
94

 
$
(31
)
 
$
(37
)
 
$
8

 
$
93

Other comprehensive income (loss) before reclassifications
165

 
(7
)
 
(2
)
 
—

 
—

 
156

Less: Amounts reclassified from AOCI to:
 
 
 
 
 
 
 
 
 
 
 
Net realized investment gains (losses)
3

 
(15
)
 
—

 
—

 
—

 
(12
)
Fair value gains (losses) on FG VIEs
—

 
—

 
(2
)
 
—

 
—

 
(2
)
Total before tax
3

 
(15
)
 
(2
)
 
—

 
—

 
(14
)
Tax (provision) benefit
(1
)
 
3

 
—

 
—

 
—

 
2

Total amount reclassified from AOCI, net of tax
2

 
(12
)
 
(2
)
 
—

 
—

 
(12
)
Net current period other comprehensive income (loss)
163

 
5

 
—

 
—

 
—

 
168

Balance, March 31, 2019
$
222

 
$
99

 
$
(31
)
 
$
(37
)
 
$
8

 
$
261


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Table of Contents

Changes in Accumulated Other Comprehensive Income by Component
First Quarter 2018

 
Net Unrealized
Gains (Losses) on
Investments with no OTTI
 
Net Unrealized
Gains (Losses) on
Investments with OTTI
 
Net Unrealized Gains (Losses) on FG VIEs’ Liabilities with Recourse due to ISCR
 
Cumulative
Translation
Adjustment
 
Cash Flow 
Hedge
 
Total 
AOCI
 
(in millions)
Balance, December 31, 2017
$
273

 
$
120

 
$
—

 
$
(29
)
 
$
8

 
$
372

Effect of adoption of ASU 2016-01 (1)
1

 
—

 
(33
)
 
—

 
—

 
(32
)
Other comprehensive income (loss) before reclassifications
(122
)
 
(11
)
 
(4
)
 
6

 
—

 
(131
)
Less: Amounts reclassified from AOCI to:
 
 
 
 
 
 
 
 
 
 
 
Net realized investment gains (losses)
6

 
(11
)
 
—

 
—

 
—

 
(5
)
Fair value gains (losses) on FG VIEs
—

 
—

 
(3
)
 
—

 
—

 
(3
)
Total before tax
6

 
(11
)
 
(3
)
 
—

 
—

 
(8
)
Tax (provision) benefit
—

 
2

 
1

 
—

 
—

 
3

Total amount reclassified from AOCI, net of tax
6

 
(9
)
 
(2
)
 
—

 
—

 
(5
)
Net current period other comprehensive income (loss)
(128
)
 
(2
)
 
(2
)
 
6

 
—

 
(126
)
Balance, March 31, 2018
$
146

 
$
118

 
$
(35
)
 
$
(23
)
 
$
8

 
$
214


____________________
(1)
On January 1, 2018, the Company adopted ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities, resulting in a cumulative-effect reclassification of a $32 million loss, net of tax, from retained earnings to AOCI.

Share Repurchases

On February 27, 2019, the Board of Directors (the Board) authorized the repurchase of another $300 million of common shares. As of May 9, 2019, the Company was authorized to purchase $279 million of its common shares. 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, other potential uses for such funds, 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.
Share Repurchases

Period
 
Number of Shares Repurchased
 
Total Payments
(in millions)
 
Average Price Paid Per Share
2018 (January 1 - March 31)
 
2,787,936

 
$
98

 
$
35.20

2018 (April 1 - June 30)
 
4,163,190

 
152

 
36.48

2018 (July 1 - September 30)
 
3,299,049

 
130

 
39.41

2018 (October 1 - December 31)
 
2,992,932

 
120

 
40.09

Total 2018
 
13,243,107

 
$
500

 
$
37.76

2019 (January 1 - March 31)
 
1,908,605

 
79

 
41.62

2019 (April 1 - May 9, 2019)
 
853,432

 
40

 
46.25

Total 2019
 
2,762,037

 
$
119

 
$
43.05

Cumulative repurchases since the beginning of 2013
 
97,317,994

 
$
2,835

 
$
29.13



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Table of Contents

16.
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 that are fully and unconditionally guaranteed by AGL (see Note 13, Long-Term Debt and Credit Facilities). The information for AGL, AGUS and AGMH presents their subsidiaries on the equity method of accounting.
 
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF MARCH 31, 2019
(in millions)
 
 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer) (1)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
Assets
 

 
 

 
 

 
 

 
 

 
 

Total investment portfolio and cash
$
43

 
$
362

 
$
44

 
$
10,880

 
$
(429
)
 
$
10,900

Investment in subsidiaries
6,570

 
5,923

 
4,080

 
231

 
(16,804
)
 
—

Premiums receivable, net of commissions payable
—

 
—

 
—

 
1,059

 
(162
)
 
897

Deferred acquisition costs
—

 
—

 
—

 
141

 
(37
)
 
104

Intercompany loan receivable
—

 
—

 
—

 
50

 
(50
)
 
—

FG VIEs’ assets, at fair value
—

 
—

 
—

 
560

 
—

 
560

Dividends receivable from affiliate
58

 
—

 
—

 
—

 
(58
)
 
—

Other
20

 
91

 
27

 
2,587

 
(1,635
)
 
1,090

Total assets
$
6,691

 
$
6,376

 
$
4,151

 
$
15,508

 
$
(19,175
)
 
$
13,551

Liabilities and shareholders' equity
 

 
 

 
 

 
 

 
 

 
 

Unearned premium reserves
$
—

 
$
—

 
$
—

 
$
4,358

 
$
(921
)
 
$
3,437

Loss and LAE reserve
—

 
—

 
—

 
1,312

 
(280
)
 
1,032

Long-term debt
—

 
844

 
470

 
5

 
(87
)
 
1,232

Intercompany loan payable
—

 
50

 
—

 
300

 
(350
)
 
—

Credit derivative liabilities
—

 
—

 
—

 
260

 
(31
)
 
229

FG VIEs’ liabilities, at fair value
—

 
—

 
—

 
609

 
—

 
609

Dividends payable to affiliate
—

 
58

 
—

 
—

 
(58
)
 
—

Other
22

 
83

 
73

 
750

 
(585
)
 
343

Total liabilities
22

 
1,035

 
543

 
7,594

 
(2,312
)
 
6,882

Total shareholders' equity attributable to Assured Guaranty Ltd.
6,669

 
5,341

 
3,608

 
7,683

 
(16,632
)
 
6,669

Noncontrolling interest
—

 
—

 
—

 
231

 
(231
)
 
—

Total shareholders' equity
6,669

 
5,341

 
3,608

 
7,914

 
(16,863
)
 
6,669

Total liabilities and shareholders' equity
$
6,691

 
$
6,376

 
$
4,151

 
$
15,508

 
$
(19,175
)
 
$
13,551

 ____________________
(1)
The fair value of the AGMH debt purchased by AGUS, and recorded in the AGUS investment portfolio, was $129 million. See Note 13, Long-Term Debt and Credit Facilities for more information.


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Table of Contents

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2018
(in millions)
 
 
Assured
Guaranty Ltd.
(Parent)
 
AGUS
(Issuer) (1)
 
AGMH
(Issuer)
 
Other
Entities
 
Consolidating
Adjustments
 
Assured
Guaranty Ltd.
(Consolidated)
Assets
 

 
 

 
 

 
 

 
 

 
 

Total investment portfolio and cash
$
45

 
$
334

 
$
23

 
$
11,000

 
$
(425
)
 
$
10,977

Investment in subsidiaries
6,440

 
5,835

 
3,991

 
226

 
(16,492
)
 
—

Premiums receivable, net of commissions payable
—

 
—

 
—

 
1,071

 
(167
)
 
904

Deferred acquisition costs
—

 
—

 
—

 
143

 
(38
)
 
105

Deferred tax asset, net
—

 
—

 
—

 
162

 
(94
)
 
68

Intercompany loan receivable
—

 
—

 
—

 
50

 
(50
)
 
—

FG VIEs’ assets, at fair value
—

 
—

 
—

 
569

 
—

 
569

Dividends receivable from affiliate
60

 
—

 
—

 
—

 
(60
)
 
—

Other
29

 
66

 
24

 
2,437

 
(1,576
)
 
980

Total assets
$
6,574

 
$
6,235

 
$
4,038

 
$
15,658

 
$
(18,902
)
 
$
13,603

Liabilities and shareholders' equity
 

 
 

 
 

 
 

 
 

 
 

Unearned premium reserves
$
—

 
$
—

 
$
—

 
$
4,452

 
$
(940
)
 
$
3,512

Loss and LAE reserve
—

 
—

 
—

 
1,467

 
(290
)
 
1,177

Long-term debt
—

 
844

 
468

 
5

 
(84
)
 
1,233

Intercompany loan payable
—

 
50

 
—

 
300

 
(350
)
 
—

Credit derivative liabilities
—

 
—

 
—

 
236

 
(27
)
 
209

Deferred tax liabilities, net
—

 
49

 
50

 
—

 
(99
)
 
—

FG VIEs’ liabilities, at fair value
—

 
—

 
—

 
619

 
—

 
619

Dividends payable to affiliate
—

 
60

 
—

 
—

 
(60
)
 
—

Other
19

 
3

 
17

 
763

 
(504
)
 
298

Total liabilities
19

 
1,006

 
535

 
7,842

 
(2,354
)
 
7,048

Total shareholders' equity attributable to Assured Guaranty Ltd.
6,555

 
5,229

 
3,503

 
7,590

 
(16,322
)
 
6,555

Noncontrolling interest
—

 
—

 
—

 
226

 
(226
)
 
—

Total shareholders' equity
6,555

 
5,229

 
3,503

 
7,816

 
(16,548
)
 
6,555

Total liabilities and shareholders' equity
$
6,574

 
$
6,235

 
$
4,038

 
$
15,658

 
$
(18,902
)
 
$
13,603


 ____________________
(1)
The fair value of the AGMH debt purchased by AGUS, and recorded in the AGUS investment portfolio, was $125 million. See Note 13, Long-Term Debt and Credit Facilities for more information.
 

 


 



 

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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2019
(in millions)

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

 
 

 
 

 
 

 
 

 
 

Net earned premiums
$
—

 
$
—

 
$
—

 
$
121

 
$
(3
)
 
$
118

Net investment income
—

 
2

 
—

 
101

 
(5
)
 
98

Net realized investment gains (losses)
—

 
—

 
—

 
(12
)
 
—

 
(12
)
Net change in fair value of credit derivatives
—

 
—

 
—

 
(22
)
 
—

 
(22
)
Other
2

 
—

 
—

 
66

 
(55
)
 
13

Total revenues
2

 
2

 
—

 
254

 
(63
)
 
195

Expenses
 

 
 

 
 

 
 

 
 

 
 

Loss and LAE
—

 
—

 
—

 
47

 
(1
)
 
46

Amortization of deferred acquisition costs
—

 
—

 
—

 
7

 
(1
)
 
6

Interest expense
—

 
12

 
13

 
4

 
(6
)
 
23

Other operating expenses
10

 
1

 
—

 
107

 
(54
)
 
64

Total expenses
10

 
13

 
13

 
165

 
(62
)
 
139

Equity in net earnings of investees
—

 
1

 
—

 
1

 
—

 
2

Income (loss) before income taxes and equity in net earnings of subsidiaries
(8
)
 
(10
)
 
(13
)
 
90

 
(1
)
 
58

Total (provision) benefit for income taxes
—

 
2

 
3

 
(9
)
 
—

 
(4
)
Equity in net earnings of subsidiaries
62

 
50

 
68

 
4

 
(184
)
 
—

Net income (loss)
$
54

 
$
42

 
$
58

 
$
85

 
$
(185
)
 
$
54

Less: noncontrolling interest
—

 
—

 
—

 
4

 
(4
)
 
—

Net income (loss) attributable to Assured Guaranty Ltd.
$
54

 
$
42

 
$
58

 
$
81

 
$
(181
)
 
$
54

 
 
 
 
 
 
 
 
 
 
 
 
Comprehensive income (loss)
$
222

 
$
170

 
$
152

 
$
254

 
$
(576
)
 
$
222


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Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2018
(in millions)

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

 
 

 
 

 
 

 
 

 
 

Net earned premiums
$
—

 
$
—

 
$
—

 
$
149

 
$
(4
)
 
$
145

Net investment income
—

 
2

 
—

 
101

 
(3
)
 
100

Net realized investment gains (losses)
—

 
—

 
—

 
(5
)
 
—

 
(5
)
Net change in fair value of credit derivatives
—

 
—

 
—

 
34

 
—

 
34

Other
3

 
—

 
—

 
74

 
(58
)
 
19

Total revenues
3

 
2

 
—

 
353

 
(65
)
 
293

Expenses
 

 
 

 
 

 
 

 
 

 
 

Loss and LAE
—

 
—

 
—

 
(16
)
 
(2
)
 
(18
)
Amortization of deferred acquisition costs
—

 
—

 
—

 
6

 
(1
)
 
5

Interest expense
—

 
12

 
13

 
3

 
(4
)
 
24

Other operating expenses
10

 
3

 
—

 
105

 
(53
)
 
65

Total expenses
10

 
15

 
13

 
98

 
(60
)
 
76

Equity in net earnings of investees
—

 
—

 
—

 
—

 
—

 
—

Income (loss) before income taxes and equity in net earnings of subsidiaries
(7
)
 
(13
)
 
(13
)
 
255

 
(5
)
 
217

Total (provision) benefit for income taxes
—

 
3

 
3

 
(25
)
 
(1
)
 
(20
)
Equity in net earnings of subsidiaries
204

 
161

 
102

 
7

 
(474
)
 
—

Net income (loss)
$
197

 
$
151

 
$
92

 
$
237

 
$
(480
)
 
$
197

Less: noncontrolling interest
—

 
—

 
—

 
7

 
(7
)
 
—

Net income (loss) attributable to Assured Guaranty Ltd.
$
197

 
$
151

 
$
92

 
$
230

 
$
(473
)
 
$
197

 
 
 
 
 
 
 
 
 
 
 
 
Comprehensive income (loss)
$
71

 
$
67

 
$
46

 
$
111

 
$
(224
)
 
$
71









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Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2019
(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
$
112

 
$
87

 
$
68

 
$
(334
)
 
$
(265
)
 
$
(332
)
Cash flows from investing activities
 

 
 

 
 

 
 

 
 

 
 

Fixed-maturity securities:
 

 
 

 
 

 
 

 
 

 
 

Purchases
—

 
(3
)
 
—

 
(196
)
 
3

 
(196
)
Sales
—

 
—

 
—

 
471

 
—

 
471

Maturities
—

 
—

 
1

 
176

 
—

 
177

Short-term investments with maturities of over three months:
 
 
 
 
 
 
 
 
 
 
 
Purchases
—

 
—

 
—

 
(107
)
 
—

 
(107
)
Sales
—

 
—

 
—

 
2

 
—

 
2

Maturities
—

 
8

 
—

 
59

 
—

 
67

Net sales (purchases) of short-term investments with maturities of less than three months
2

 
(33
)
 
(20
)
 
76

 
—

 
25

Net proceeds from FG VIEs’ assets
—

 
—

 
—

 
26

 
—

 
26

Other
—

 
—

 
—

 
27

 
—

 
27

Net cash flows provided by (used in) investing activities
2

 
(28
)
 
(19
)
 
534

 
3

 
492

Cash flows from financing activities
 

 
 

 
 

 
 

 
 

 
 

Dividends paid
(20
)
 
(60
)
 
(47
)
 
(158
)
 
265

 
(20
)
Repurchases of common stock
(80
)
 
—

 
—

 
—

 
—

 
(80
)
Repurchases of common stock to pay withholding taxes
(15
)
 
—

 
—

 
—

 
—

 
(15
)
Net paydowns of FG VIEs’ liabilities
—

 
—

 
—

 
(25
)
 
—

 
(25
)
Paydown of long-term debt
—

 
—

 
—

 
—

 
(3
)
 
(3
)
Proceeds from options exercises
1

 
—

 
—

 
—

 
—

 
1

Net cash flows provided by (used in) financing activities
(114
)
 
(60
)
 
(47
)
 
(183
)
 
262

 
(142
)
Effect of exchange rate changes
—

 
—

 
—

 
1

 
—

 
1

Increase (decrease) in cash and restricted cash
—

 
(1
)
 
2

 
18

 
—

 
19

Cash and restricted cash at beginning of period
—

 
1

 
—

 
103

 
—

 
104

Cash and restricted cash at end of period
$
—

 
$
—

 
$
2

 
$
121

 
$
—

 
$
123


 

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Table of Contents

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2018
(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
$
128

 
$
83

 
$
63

 
$
46

 
$
(293
)
 
$
27

Cash flows from investing activities
 

 
 

 
 

 
 

 
 

 
 

Fixed-maturity securities:
 

 
 

 
 

 
 

 
 

 
 

Purchases
—

 
(18
)
 
(12
)
 
(400
)
 
19

 
(411
)
Sales
—

 
11

 
2

 
396

 
—

 
409

Maturities
—

 
—

 
—

 
225

 
—

 
225

Short-term investments with maturities of over three months:
 
 
 
 
 
 
 
 
 
 
 
Purchases
—

 
—

 
—

 
(47
)
 
—

 
(47
)
Sales
—

 
—

 
—

 
—

 
—

 
—

Maturities
—

 
—

 
—

 
45

 
—

 
45

Net sales (purchases) of short-term investments with maturities of less than three months
1

 
(217
)
 
(4
)
 
106

 
—

 
(114
)
Net proceeds from FG VIEs’ assets
—

 
—

 
—

 
33

 
—

 
33

Proceeds from stock redemption and return of capital from subsidiaries
—

 
200

 
—

 
—

 
(200
)
 
—

Other
—

 
(13
)
 
—

 
(1
)
 
—

 
(14
)
Net cash flows provided by (used in) investing activities
1

 
(37
)
 
(14
)
 
357

 
(181
)
 
126

Cash flows from financing activities
 

 
 

 
 

 
 

 
 

 
 
Dividends paid
(18
)
 
(78
)
 
(50
)
 
(165
)
 
293

 
(18
)
Repurchases of common stock
(100
)
 
—

 
—

 
—

 
—

 
(100
)
Repurchases of common stock to pay withholding taxes
(12
)
 
—

 
—

 
(200
)
 
200

 
(12
)
Net paydowns of FG VIEs’ liabilities
—

 
—

 
—

 
(33
)
 
—

 
(33
)
Paydown of long-term debt
—

 
—

 
—

 
—

 
(19
)
 
(19
)
Proceeds from options exercises
1

 
—

 
—

 
—

 
—

 
1

Net cash flows provided by (used in) financing activities
(129
)

(78
)

(50
)

(398
)

474


(181
)
Effect of exchange rate changes
—

 
—

 
—

 
1

 
—

 
1

Increase (decrease) in cash and restricted cash
—

 
(32
)
 
(1
)
 
6

 
—

 
(27
)
Cash and restricted cash at beginning of period
—

 
33

 
2

 
109

 
—

 
144

Cash and restricted cash at end of period
$
—

 
$
1

 
$
1

 
$
115

 
$
—

 
$
117






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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 or Assured Guaranty’s loss experience;

•
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 assets and liabilities subject to mark-to-market, including certain of its investments, most of its contracts written in credit default swap (CDS) form, and variable interest entities;

•
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 (U.K.) to exit the European Union (EU);

•
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;

•
difficulties with the execution of Assured Guaranty’s business strategy;

•
loss of key personnel;

•
the effects of mergers, acquisitions and divestitures;

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Table of Contents

•
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 2018 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 www.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 www.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 www.assuredguaranty.com/company-statements and, more generally, under the Investor Information tab at www.assuredguaranty.com/investor-information and Businesses tab at www.assuredguaranty.com/businesses). 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 2018 Annual Report on Form 10-K.


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Table of Contents

Economic Environment
    
The positive economic momentum in the United States (U.S.) since the beginning of 2016 continued through March 31, 2019. According to the U.S. Bureau of Labor Statistics (BLS), after revisions, job gains averaged 180,000 per month over the three-month period ended March 31, 2019 (First Quarter 2019). Additionally, the BLS estimated that, at the end of the quarter, the unemployment rate stood at 3.8%, nearly a fifty-year low.
    
The Bureau of Economic Analysis (BEA) latest data showed that real gross domestic product (GDP) increased at an annual rate of 3.2% in First Quarter 2019, and 2.2% in the fourth quarter of 2018. Real GDP increased 2.9% in 2018.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, reported a 4.0% annual gain in February 2019, the latest data available. The 20-City Composite posted a 3.0% year-over-year gain. The data released for February 2019 shows that the rate of home price increases across the U.S. has continued to slow. See Item 1, Financial Statements, Note 4, Expected Loss to be Paid, for a discussion of the residential market assumptions used in determining expected losses for U.S. residential mortgage-backed securities (RMBS).

At the March 2019 Federal Open Market Committee (FOMC) meeting, the FOMC decided to maintain the target range for the federal funds rate at 2.25% and 2.50%. In its press release, the FOMC stated: “On a 12-month basis, overall inflation has declined, largely as a result of lower energy prices…On balance, market-based measures of inflation compensation have remained low in recent months, and survey-based measures of longer-term inflation expectations are little changed.” At the May 2019 FOMC meeting, the FOMC again maintained the target range for the federal funds rate at 2.25% and 2.50%, stating “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.” In terms of average municipal interest rates, the 30-year AAA Municipal Market Data (MMD) rate started the quarter at 3.02%, reaching a high of 3.11% on January 23, 2019, and finished the quarter at 2.6%. Municipal interest rates remain low by historical standards. See Key Business Strategies, New Business Production section below for the impact of the low interest rate environment and relatively tight U.S. municipal credit spreads on the demand for bond insurance.

The U.S. equity markets overall returned to positive performance in First Quarter 2019. For the quarter, the S&P 500 Index, the Dow Jones Industrial Average (DJIA), and the NASDAQ Composite, along with other domestic indices such as the Russell 1000 Growth Index, finished appreciably higher.


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Table of Contents

Financial Performance of Assured Guaranty

Financial Results
 
 
First Quarter
 
2019

2018
 
(in millions)
Net income (loss)
$
54

 
$
197

Non-GAAP operating income (1)
86

 
155

Gain (loss) related to the effect of consolidating financial guaranty variable interest entities (FG VIE consolidation) included in non-GAAP operating income
—

 
5

 
 
 
 
Net income (loss) per diluted share
$
0.52

 
$
1.68

Non-GAAP operating income per share (1)
0.82

 
1.33

Gain (loss) related to FG VIE consolidation included in non-GAAP operating income per share
—

 
0.04

 
 
 
 
Diluted shares
104.0

 
116.6

 
 
 
 
Gross written premiums (GWP)
$
39

 
$
73

Present value of new business production (PVP) (1)
42

 
61

Gross par written
2,707

 
2,202


 
As of March 31, 2019
 
As of December 31, 2018
 
Amount
 
Per Share
 
Amount
 
Per Share
 
(in millions, except per share amounts)
Shareholders' equity
$
6,669

 
$
65.21

 
$
6,555

 
$
63.23

Non-GAAP operating shareholders' equity (1)
6,341

 
62.00

 
6,342

 
61.17

Non-GAAP adjusted book value (1)
8,893

 
86.95

 
8,922

 
86.06

Gain (loss) related to FG VIE consolidation included in non-GAAP operating shareholders' equity
3

 
0.03

 
3

 
0.03

Gain (loss) related to FG VIE consolidation included in non-GAAP adjusted book value
(20
)
 
(0.20
)
 
(15
)
 
(0.15
)
Common shares outstanding (2)
102.3

 
 
 
103.7

 
 
____________________
(1)
See “—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.
See “—Non-GAAP Financial Measures” for additional details.
 
(2)
See "Key Business Strategies – Capital Management" below for information on common share repurchases.

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 such as: 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 fair value of credit derivatives related to the Company's own credit spreads, and changes in risk-free rates used to discount expected losses. Changes in the Company's and/or collateral credit spreads generally have the most significant effect on the fair value of credit derivatives and FG VIEs’ assets and liabilities.

In addition to non-economic factors, other factors such as: changes in expected claims and recoveries, the amount and timing of the refunding and/or termination of insured obligations, realized gains and losses on the investment portfolio (including other-than-temporary impairments (OTTI)), the effects of large settlements, commutations, acquisitions, the effects of the Company's various loss mitigation strategies, and changes in laws and regulations, among others, may also have a significant effect on reported net income or loss in a given reporting period. 


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Table of Contents

First Quarter 2019
        
Net income for First Quarter 2019 was $54 million compared with $197 million for the three-month period ended March 31, 2018 (First Quarter 2018). Net income decreased mainly due to higher loss and loss adjustment expenses (LAE) in First Quarter 2019, fair value losses on credit derivatives in First Quarter 2019 compared with gains in First Quarter 2018, and lower net earned premiums.

Non-GAAP operating income was $86 million in First Quarter 2019, compared with $155 million in First Quarter 2018. Non-GAAP operating income declined mainly due to higher loss and LAE and lower net earned premiums.

Shareholders' equity increased since December 31, 2018 primarily due to unrealized gains on available for sale investment securities and net income, partially offset by share repurchases and dividends. Non-GAAP operating shareholders' equity decreased slightly in First Quarter 2019 as non-GAAP operating income was offset mainly by share purchases and dividends. Non-GAAP adjusted book value decreased slightly in First Quarter 2019 primarily due to share repurchases and dividends, partially offset by new direct business production.

Shareholders' equity per share, non-GAAP operating shareholders' equity per share and non-GAAP adjusted book value per share all increased in First Quarter 2019, and benefited from the repurchase of an additional 1.9 million shares in First Quarter 2019 under the share repurchase program that began in 2013. See "Accretive Effect of Cumulative Repurchases" table below.

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
•
Loss mitigation

New Business Production

The Company believes high-profile defaults by municipal obligors, such as 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 and relatively tight U.S. municipal credit spreads have dampened demand for bond insurance, and provisions in legislation known as the 2017 Tax Cuts and Jobs Act (Tax Act), such as the termination of the tax-exempt status of advance refunding bonds and the reduction in corporate tax rates, have resulted in a reduction of supply and made municipal obligations less attractive to certain institutional investors.


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Table of Contents

U.S. Municipal Market Data and Bond Insurance Penetration Rates (1)
Based on Sale Date
 
 
First Quarter 2019
 
First Quarter 2018
 
Year Ended December 31, 2018
 
(dollars in billions, except number of issues and percent)
Par:
 
 
 
 
 
New municipal bonds issued
$
75.6

 
$
61.8

 
$
320.3

Total insured
$
3.6

 
$
3.6

 
$
18.9

Insured by Assured Guaranty
$
2.0

 
$
2.2

 
$
10.5

Number of issues:
 
 
 
 
 
New municipal bonds issued
1,811

 
1,674

 
8,555

Total insured
290

 
258

 
1,246

Insured by Assured Guaranty
163

 
119

 
596

Bond insurance market penetration based on:
 
 
 
 
 
Par
4.8
%
 
5.9
%
 
5.9
%
Number of issues
16.0
%
 
15.4
%
 
14.6
%
Single A par sold
21.8
%
 
21.3
%
 
17.8
%
Single A transactions sold
53.4
%
 
53.1
%
 
52.8
%
$25 million and under par sold
17.7
%
 
17.9
%
 
17.2
%
$25 million and under transactions sold
19.8
%
 
18.1
%
 
17.1
%
____________________
(1)
Source: The amounts in the table are those reported by Thomson Reuters. In addition, the Company considers $500 million of taxable ProMedica Toledo Hospital bonds insured by Assured Guaranty in 2018 to be public finance business.

    

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Gross Written Premiums and
New Business Production

 
First Quarter
 
2019

2018
 
(in millions)
GWP
 
 
 
Public Finance—U.S.
$
30

 
$
33

Public Finance—non-U.S.
2

 
39

Structured Finance—U.S.
6

 
1

Structured Finance—non-U.S.
1

 
—

Total GWP
$
39

 
$
73

 
 
 
 
PVP (1):
 
 
 
Public Finance—U.S.
$
32

 
$
35

Public Finance—non-U.S.
4

 
26

Structured Finance—U.S.
5

 
—

Structured Finance—non-U.S. (2)
1

 
—

Total PVP
$
42

 
$
61

Gross Par Written (1):
 
 
 
Public Finance—U.S.
$
2,016

 
$
2,004

Public Finance—non-U.S.
176

 
187

Structured Finance—U.S.
494

 
11

Structured Finance—non-U.S. (2)
21

 
—

Total gross par written
$
2,707

 
$
2,202

Average rating on new business written
A
 
A-
____________________
(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)    Included aircraft residual value insurance policies in First Quarter 2019.
    
GWP relates to both financial guaranty insurance and non-financial guaranty insurance contracts. Credit derivatives are accounted for at fair value and therefore not included in GWP. Financial guaranty GWP includes amounts collected upfront on new business written, the present value of future premiums on new business written (discounted at risk-free rates), as well as the effects of changes in the estimated lives of transactions in the inforce book of business. Non-financial guaranty GWP is recorded as premiums are received. Non-GAAP PVP, on the other hand, includes upfront premiums and estimated future installments on new business at the time of issuance, discounted at 6% for all contracts whether in insurance or credit derivative form.

Assured Guaranty once again guaranteed the majority of insured U.S. public finance insured par and number of transactions issued.

This is the fourteenth consecutive quarter that the Company generated non-U.S. PVP. In First Quarter 2019, the Company issued a debt service reserve guarantee on a water and sewerage company in the United Kingdom (U.K.) and provided reinsurance on an aircraft residual value insurance policy. During First Quarter 2018, the Company closed U.K. public-private-partnership and utility transactions in both the primary and secondary markets, most of which were refinancings that resulted in no additional par written.

In the U.S. structured finance market, the Company insured a collateralized loan obligation.

The average rating of new business written, based on par, was A in First Quarter 2019 compared with A- in First Quarter 2018.     


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The Company believes its financial guaranty product is competitive with other financing options in certain segments of the global infrastructure and structured finance markets. For example, certain investors may receive advantageous capital requirement treatment with the addition of the Company’s guaranty. The Company considers its involvement in both international infrastructure and structured finance transactions to be beneficial because such transactions diversify both the Company's business opportunities and its risk profile beyond U.S. public finance. Quarterly business activity in the international infrastructure and structured finance sectors is influenced by typically long lead times and therefore may vary from quarter to quarter.

Capital Management

The Company employs several strategies to manage capital within the Assured Guaranty group efficiently.
    
From 2013 through May 9, 2019, the Company has repurchased 97.3 million common shares for approximately $2,835 million, representing 50% of the total shares outstanding at the beginning of the repurchase program in 2013. On February 27, 2019, the Board of Directors authorized an additional $300 million of share repurchases. As of May 9, 2019, $279 million remained under the aggregate share repurchase authorization. Shares may be repurchased 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, other potential uses for such free funds, market conditions, the Company's capital position, legal requirements and other factors. The repurchase program may be modified, extended or terminated by the Board of Directors at any time and it does not have an expiration date. See Item 1, Financial Statements, Note 15, 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 - 2018
$
2,716

 
94.56

 
$
28.73

2019 (First Quarter)
79

 
1.91

 
41.62

2019 (April 1 - May 9, 2019)
40

 
0.85

 
46.25

Cumulative repurchases since the beginning of 2013
$
2,835

 
97.32

 
$
29.13



Accretive Effect of Cumulative Repurchases (1)

 
First Quarter 2019
 
As of
March 31, 2019
 
(per share)
Net income
$
0.16

 
 
Non-GAAP operating income
0.30

 
 
Shareholders' equity
 
 
$
17.38

Non-GAAP operating shareholders' equity
 
 
15.84

Non-GAAP adjusted book value
 
 
27.83

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

In March 2019, Municipal Assurance Corp. (MAC) received approval from the New York State Department of Financial Services to dividend to Municipal Assurance Holdings Inc. (MAC Holdings) $100 million in 2019, an amount that exceeds the amount available to dividend without such approval in 2019 under applicable law.  Subject to approval by MAC’s Board of Directors, MAC expects to distribute a $100 million dividend to MAC Holdings during the second quarter of 2019.

The Company considers the appropriate mix of debt and equity in its capital structure, and may repurchase some of its debt from time to time. For example, in First Quarter 2019 and First Quarter 2018, Assured Guaranty US Holdings Inc. (AGUS) purchased $3 million and $20 million, respectively, of par of Assured Guaranty Municipal Holdings Inc.'s (AGMH) outstanding Junior Subordinated Debentures, which resulted in a loss on extinguishment of debt of $1 million in First Quarter

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2019 and $7 million in First Quarter 2018. The Company may choose to make additional purchases of this or other Company debt in the future.

Alternative Strategies

The Company considers alternative strategies to create long-term shareholder value, including acquisitions, investments and commutations. 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 previously ceded business. These transactions enable the Company to improve its future earnings and deploy excess capital.

Commutations. Commutations resulted in gains of $1 million and added net unearned premium reserve of $4 million in First Quarter 2018. There were no commutations in First Quarter 2019. In the future, the Company may enter into new commutation agreements to reassume portions of its insured business ceded to other reinsurers, but such opportunities are expected to be limited given the small number of unaffiliated reinsurers currently reinsuring the Company.

Alternative Investments. The alternative investments group has been investigating a number of new business opportunities that complement the Company's financial guaranty business, are consistent with its risk profile and benefit from its core competencies, including, among others, both controlling and non-controlling investments in investment managers.

In February 2018, the Company acquired a minority interest in the holding company of Rubicon Infrastructure Advisors, a full-service investment firm based in Dublin that provides investment banking services in the global infrastructure sector. In September 2017, the Company acquired an interest in Wasmer, Schroeder & Company LLC, an independent investment advisory firm specializing in separately managed accounts (SMAs). 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; as of March 31, 2019, $17 million had been invested.

The Company continues to investigate additional opportunities, but there can be no assurance of whether or when the Company will find suitable opportunities on appropriate terms.

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 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, result in more favorable outcomes in distressed public finance situations than would be the case without its participation. This has been illustrated by the Company's role in the Detroit, Michigan; Stockton, California; and Jefferson County, Alabama financial crises. Currently the Company is actively working to mitigate potential losses in connection with the obligations it insures of the Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations and was an active participant in negotiating the Puerto Rico Electric Power Authority (PREPA) restructuring support agreement and the Puerto Rico Sales Tax Financing Corporation (COFINA) plan of adjustment. The Company will also, where appropriate, pursue litigation to enforce its rights, and it has initiated a number of legal actions to enforce its rights in Puerto Rico. For more information about developments in Puerto Rico and related recovery litigation being pursued by the Company, see Item 1, Financial Statements, Note 3, Outstanding Exposure.

The Company is currently working with the servicers of some of the RMBS it insures to encourage the servicers to provide alternatives to distressed borrowers that will encourage them to continue making payments on their loans to help improve the performance of the related RMBS.

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. The Company may also facilitate the issuance of refunding bonds, by either providing insurance on the refunding bonds or purchasing refunding bonds, or both. Refunding bonds may provide the issuer with payment relief.





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Other Events

The Company is evaluating the impact on its business of the referendum held in the U.K on June 23, 2016, in which a majority voted for the U.K. to exit the European Union (EU), known as “Brexit”. Negotiations are ongoing to determine the future terms of the U.K’s relationship with the EU, including the terms of trade between the U.K. and the EU. The Company believes that the negotiations are likely to last at least until fall 2019. Brexit may impact laws, rules and regulations applicable to the Company’s European subsidiaries and operations and the transactions insured by its European subsidiaries. The Company cannot predict the direction Brexit-related developments will take nor the impact of those developments on its European operations and the economies of the markets the Company serves, but the Company is in the process of implementing contingency plans in the event of a so-called 'hard' Brexit.

Results of Operations
 
Estimates and Assumptions
 
The Company’s condensed consolidated financial statements include amounts that are determined using estimates and assumptions. It is possible that actual amounts realized could differ, possibly materially from the amounts currently recorded in the Company’s condensed consolidated financial statements. Management believes the most significant items requiring inherently subjective and complex estimates are expected losses, fair value estimates, OTTI, deferred income taxes, and premium revenue recognition. The following discussion of the results of operations includes information regarding the estimates and assumptions used for these items and should be read in conjunction with the notes to the Company’s condensed consolidated financial statements.
 
An understanding of the Company’s accounting policies is critical to understanding its condensed consolidated financial statements. See Part II, Item 8, Financial Statements and Supplementary Data, of the Company's 2018 Annual Report on Form 10-K for a discussion of significant accounting policies, the loss estimation process, and fair value methodologies.

The Company carries a portion of its assets and liabilities at fair value, the majority of which are measured at fair value on a recurring basis.  Level 3 assets, primarily consisting of loss mitigation securities and FG VIEs’ assets, represented approximately 18% of the total assets that are measured at fair value on a recurring basis as of both March 31, 2019 and December 31, 2018. All of the Company's liabilities that are measured at fair value are Level 3. See Item 1, Financial Statements, Note 6, Fair Value Measurement, for additional information about assets and liabilities classified as Level 3.
 

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Condensed Consolidated Results of Operations

Condensed Consolidated Results of Operations
 
 
Three Months Ended March 31,
 
2019
 
2018
 
(in millions)
Revenues:
 
 
 
Net earned premiums
$
118

 
$
145

Net investment income
98

 
100

Net realized investment gains (losses)
(12
)
 
(5
)
Net change in fair value of credit derivatives
(22
)
 
34

Fair value gains (losses) on FG VIEs
5

 
4

Other income (loss)
8

 
15

Total revenues
195

 
293

Expenses:
 
 
 
Loss and LAE
46

 
(18
)
Amortization of deferred acquisition costs
6

 
5

Interest expense
23

 
24

Other operating expenses
64

 
65

Total expenses
139

 
76

Income (loss) before provision for income taxes and equity in net earnings of investees
56

 
217

Equity in net earnings of investees
2

 
—

Income (loss) before income taxes
58

 
217

Provision (benefit) for income taxes
4

 
20

Net income (loss)
$
54

 
$
197



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Table of Contents

Net Earned Premiums
 
Premiums are earned 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 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 Item 1, Financial Statements, Note 5, Contracts Accounted for as Insurance, Financial Guaranty Insurance Premiums, for additional information.
 
Net Earned Premiums
 
 
First Quarter
 
2019
 
2018
 
(in millions)
Financial guaranty insurance:
 
 
 
Public finance
 
 
 
Scheduled net earned premiums
$
71

 
$
72

Accelerations:
 
 
 
Refundings
27

 
46

Terminations
—

 
6

Total accelerations
27

 
52

Total public finance
98

 
124

Structured finance (1)
 
 
 
Scheduled net earned premiums
20

 
20

Terminations
(1
)
 
—

Total structured finance
19

 
20

Non-financial guaranty
1

 
1

Total net earned premiums
$
118

 
$
145

____________________
(1)
Excludes $3 million for both First Quarter 2019 and 2018, related to consolidated FG VIEs.
    
Net earned premiums decreased in First Quarter 2019 compared with First Quarter 2018 due primarily to a reduction in accelerations from refundings and terminations as well as a decline in par outstanding. At March 31, 2019, 3.5 billion of net deferred premium revenue remained to be earned over the life of the insurance contracts.

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 the Company's contractual rights to make claim payments on an accelerated basis.
    
Refundings occur in the public finance market and had been at historically high levels in recent years primarily due 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 deferred premium revenue remaining. Provisions in the 2017 Tax Act regarding the termination of the tax-exempt status of advance refunding bonds has resulted in fewer refundings.

Terminations are generally negotiated agreements with beneficiaries resulting in the extinguishment of the Company’s insurance obligation. 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, the acceleration of the recognition of the associated deferred premium revenue and the reduction of any remaining premiums receivable.


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Net Investment Income
 
Net investment income is a function of the yield earned and the size of the investment 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
 
2019
 
2018
 
(in millions)
Income from fixed-maturity securities managed by third parties
$
72

 
$
75

Income from internally managed securities
28

 
27

Gross investment income
100

 
102

Investment expenses
(2
)
 
(2
)
Net investment income
$
98

 
$
100

        
Net investment income for First Quarter 2019 decreased compared to First Quarter 2018 primarily due to lower average asset balances in the investment portfolio. The overall pre-tax book yield was 3.82% as of March 31, 2019 and 3.75% as of March 31, 2018, respectively. Excluding the internally managed portfolio, pre-tax book yield was 3.24% as of March 31, 2019 compared with 3.14% as of March 31, 2018.

Net Realized Investment Gains (Losses)

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

Net Realized Investment Gains (Losses)
 
 
First Quarter
 
2019
 
2018
 
(in millions)
Gross realized gains on available-for-sale securities
$
6

 
$
9

Gross realized losses on available-for-sale securities
(2
)
 
(5
)
Net realized gains (losses) on other invested assets
—

 
(1
)
OTTI
(16
)
 
(8
)
Net realized investment gains (losses)
$
(12
)
 
$
(5
)

OTTI in all periods presented were primarily attributable to securities purchased for loss mitigation purposes.

Net Change in Fair Value of Credit Derivatives
  
Changes in the fair value of credit derivatives occur because of changes in the Company's own credit rating and credit spreads, collateral credit spreads, notional amounts, credit ratings of the referenced entities, expected terms, realized gains (losses) and other settlements, interest rates, 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 of “Economic Loss Development” below. In addition, see Item 1, Financial Statements, Note 6, Fair Value Measurement for information on the valuation of the CDS and Note 7, Contracts Accounted for as Credit Derivatives, for information on the components of the change in fair value of CDS.

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During First Quarter 2019, unrealized fair value losses were generated primarily as a result of wider implied net spreads driven by the decreased cost to buy protection in AGC’s name, as the market cost of AGC’s credit protection decreased during the period. For those CDS transactions that were pricing at or above their floor levels, when the cost of purchasing CDS protection on AGC, which management refers to as the CDS spread on AGC, decreased, the implied spreads that the Company would expect to receive on these transactions increased.

During First Quarter 2018, unrealized fair value gains were generated primarily as a result of the increase in credit given to the primary insurer on one of the Company's second-to-pay CDS policies related to certain U.S. RMBS exposure, the paydown of CDS par, CDS terminations, and price improvements on the underlying collateral of the Company’s CDS. The unrealized fair value gains were partially offset by unrealized fair value losses related to the decreased cost to buy protection in AGC’s and AGM’s name as the market cost of AGC’s and AGM’s credit protection decreased during the period.
 
Effect of Changes in the Company’s Credit Spread on
Net Unrealized Gains (Losses) on Credit Derivatives
 
 
First Quarter
 
2019
 
2018
 
(in millions)
Change in unrealized gains (losses) on credit derivatives:
 
 
53

Before considering implication of the Company’s credit spreads
$
22

 
$
53

Resulting from change in the Company’s credit spreads
(43
)
 
(21
)
After considering implication of the Company’s credit spreads
$
(21
)
 
$
32


Management believes that the trading level of Assured Guaranty Corp.’s (AGC) and Assured Guaranty Municipal Corp.’s (AGM) 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.
    
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, 2019
 
As of December 31, 2018
Credit Spreads (1)
 
Estimated Net
Fair Value
(Pre-Tax)
 
Estimated Change
in Gain/(Loss)
(Pre-Tax)
 
Estimated Net
Fair Value
(Pre-Tax)
 
Estimated Change
in Gain/(Loss)
(Pre-Tax)
 
 
(in millions)
Increase of 25 basis points (bps)
 
$
(328
)
 
$
(100
)
 
$
(348
)
 
$
(141
)
Base Scenario
 
(228
)
 
—

 
(207
)
 
—

Decrease of 25 bps
 
(156
)
 
72

 
(143
)
 
64

All transactions priced at floor
 
(106
)
 
122

 
(101
)
 
106

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

Financial Guaranty Variable Interest Entities
 
As of March 31, 2019 and December 31, 2018, the Company consolidated 31 FG VIEs. The effect of FG VIE consolidation on net income and shareholders' equity includes the following:

•
Changes in fair value gains (losses) on FG VIEs’ assets and liabilities are recorded in the condensed consolidated statements of operations except the change in fair value of FG VIEs’ liabilities with recourse attributable to instrument-specific credit risk which is recorded in other comprehensive income (OCI).


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•
Upon consolidation of a FG VIE, premiums and losses related to AGC's and AGM's insurance of FG VIEs’ liabilities with recourse and any investment balances related to the Company’s purchase of AGC and AGM insured FG VIEs’ debt, are considered intercompany transactions and are therefore eliminated.

The consolidation of FG VIEs had no net effect on the statement of operations in First Quarter 2019 and was $5 million gain in net income in First Quarter 2018. See Item 1, Financial Statements, Note 8, Variable Interest Entities, for additional information.
     
The primary driver of the gain during First Quarter 2019 was price appreciation on the FG VIE assets resulting from improvement in the underlying collateral. The primary driver of the gain in First Quarter 2018 in fair value of FG VIEs’ assets and FG VIEs’ liabilities was an increase in the value of the FG VIEs’ assets resulting from improvement in the underlying collateral.

Other Income (Loss)
 
Other income (loss) consists of recurring items such as those listed in the table below as well as ancillary fees on financial guaranty policies for commitments and consents, and if applicable, other revenue items on financial guaranty insurance and reinsurance contracts such as loss mitigation recoveries and other non-recurring items.

Other Income (Loss)

 
First Quarter
 
2019
 
2018
 
(in millions)
Foreign exchange gain (loss) on remeasurement (1)
$
11

 
$
22

Loss on extinguishment of debt (2)
(1
)
 
(7
)
Fair value gains (losses) on CCS
(9
)
 
(1
)
Other
7

 
1

Total other income (loss)
$
8

 
$
15

 ____________________
(1)
Foreign exchange gains primarily relate to remeasurement of premiums receivable and are mainly due to changes in the exchange rate of the British pound sterling relative to the U.S. dollar.

(2)
The loss on extinguishment of debt is related to AGUS' purchase of a portion of the principal amount of AGMH's outstanding Junior Subordinated Debentures. The loss represents the difference between the amount paid to purchase AGMH's debt and the carrying value of the debt, which includes the unamortized fair value adjustments that were recorded upon the acquisition of AGMH in 2009. AGUS purchased $3 million in principal in First Quarter 2019 and $20 million in First Quarter 2018. See Item 1, Financial Statements, Note 13, Long-Term Debt and Credit Facilities, for additional information.


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. See Item 1, Financial Statements, Note 4, Expected Loss to be Paid, for a discussion of assumptions and methodologies used in calculating the expected loss to be paid for all contracts, the loss estimation process and approach to projecting losses and the measurement and recognition accounting policies under GAAP for each type of contract, see Part II, Item 8, Financial Statements and Supplementary Data, of the Company's 2018 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 VIEs’ assets and liabilities,
•
Note 8 for contracts accounted for as credit derivatives, and
•
Note 9 for FG VIEs.


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Table of Contents

In order to efficiently evaluate and manage the economics of the entire insured portfolio, management compiles and analyzes expected loss information for all policies on a consistent basis. The discussion of losses that follows encompasses losses on all contracts in the insured portfolio regardless of accounting model, unless otherwise specified. Net expected loss to be paid primarily consists of the present value of future: expected claim and LAE payments, expected recoveries from issuers or excess spread, cessions to reinsurers, expected recoveries/payables for breaches of representations and warranties, 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, and discount rates and expected time frames to recovery 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.

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, 2019
 
As of
December 31, 2018
 
First Quarter 2019
 
First Quarter 2018
 
(in millions)
Insurance
$
904

 
$
1,110

 
$
10

 
$
(33
)
FG VIEs
65

 
75

 
(10
)
 
2

Credit derivatives
(6
)
 
(2
)
 
(2
)
 
7

Total
$
963

 
$
1,183

 
$
(2
)
 
$
(24
)


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

 
Net Expected Loss to be Paid (Recovered)
 
Net Economic Loss Development (Benefit)
 
As of
March 31, 2019
 
As of
December 31, 2018
 
First Quarter 2019
 
First Quarter 2018
 
(in millions)
Public finance
$
697

 
$
864

 
$
61

 
$
(42
)
Structured finance
 
 
 
 
 
 
 
U.S. RMBS
237

 
293

 
(65
)
 
16

Other structured finance
29

 
26

 
2

 
2

Structured finance
266

 
319

 
(63
)
 
18

Total
$
963

 
$
1,183

 
$
(2
)
 
$
(24
)



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Risk-Free Rates

 
Risk-Free Rates used in Expected Loss for U.S. Dollar Denominated Obligations
 
Range
 
Weighted Average
As of March 31, 2019
0.00
%
-
2.87%
 
2.46
%
As of December 31, 2018
0.00

-
3.06
 
2.74

As of March 31, 2018
0.00

-
3.11
 
2.82

As of December 31, 2017
0.00

-
2.78
 
2.38


 
Effect of Changes in the Risk-Free Rates on Economic Loss Development (Benefit)
 
(in millions)
First Quarter 2019
$
(4
)
First Quarter 2018
(6
)

First Quarter 2019 Net Economic Loss Development

Public Finance Economic Loss Development: Public finance expected loss to be paid primarily related to U.S. exposure, which had below-investment-grade (BIG) net par outstanding of $6.1 billion as of March 31, 2019 compared with $6.4 billion as of December 31, 2018. The Company projects that its total net expected loss across its troubled U.S. public finance exposures as of March 31, 2019 will be $666 million, compared with $832 million as of December 31, 2018. Economic loss development on U.S. exposures in First Quarter 2019 was $62 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. The economic benefit was approximately $1 million for non-U.S. exposures during First Quarter 2019.

U.S. RMBS Economic Loss Development: The net benefit attributable to U.S. RMBS was $65 million and was mainly related to a general increase in excess spread and improved performance of second lien transactions.

See Item 1, Financial Statements, Note 4, Expected Loss to be Paid for additional information.

First Quarter 2018 Net Economic Loss Development

Public Finance Economic Loss Development: Public finance expected loss to be paid primarily related to U.S. exposure, which had BIG net par outstanding of $6.6 billion as of March 31, 2018 compared with $7.1 billion as of December 31, 2017. The Company projected that its total net expected loss across its troubled U.S. public finance exposures as of March 31, 2018 would be $1,007 million, compared with $1,157 million as of December 31, 2017. Economic benefit on U.S. exposures in First Quarter 2018 was $39 million, which was primarily attributable to the State of Connecticut's agreement to pay the debt service costs of certain bonds of the City of Hartford, including the bonds insured by the Company. The economic benefit of approximately $3 million on non-U.S. exposures during First Quarter 2018 was attributable to strong traffic performance in an insured U.K. arterial road.

U.S. RMBS Economic Loss Development: The economic loss development attributable to U.S. RMBS was $16 million and was mainly related to lower excess spread, partially offset by the improvement in liquidation rates for certain delinquency categories in first and second lien transactions.

Loss and LAE (Financial Guaranty Insurance Contracts)

The primary differences between net economic loss development and the amount reported as loss and LAE in the condensed consolidated statements of operations are that loss and LAE: (1) considers deferred premium revenue in the calculation of loss reserves and loss and LAE for financial guaranty insurance contracts, (2) eliminates loss and LAE related to consolidated FG VIEs and (3) does not include estimated losses on credit derivatives.     


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Loss and LAE reported in non-GAAP operating income (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 each transaction’s expected loss to be expensed is compared with the deferred premium revenue of that transaction. When the expected loss to be expensed exceeds the deferred premium revenue, a loss is recognized in the condensed consolidated statements of operations for the amount of such excess. 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 (particularly BIG transactions) acquired in a business combination or seasoned portfolios assumed from legacy financial guaranty insurers generally have the largest deferred premium revenue balances. Therefore the largest differences between net economic loss development and loss and LAE on financial guaranty insurance contracts generally relate to those policies.

The amount of loss and LAE recognized in the condensed consolidated statements of operations for financial guaranty contracts accounted for as insurance is a function of the amount of economic loss development discussed above and the deferred premium revenue amortization in a given period, on a contract-by-contract basis.

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 for financial guaranty insurance policies.

The following table presents the loss and LAE recorded in the condensed consolidated statements of operations. Amounts presented are net of reinsurance.

Loss and LAE Reported
on the Condensed Consolidated Statements of Operations

 
Loss (Benefit)
 
First Quarter
 
2019
 
2018
 
(in millions)
Public finance
$
70

 
$
(29
)
Structured finance
 
 
 
U.S. RMBS (1)
(27
)
 
16

Other structured finance
3

 
(5
)
Structured finance
(24
)
 
11

Total loss and LAE (2)
$
46

 
$
(18
)
____________________
(1)
Excludes a benefit of $1 million and a loss of $6 million for First Quarter 2019 and 2018, respectively, related to consolidated FG VIEs.

(2)
Excludes credit derivative benefit of $1 million and credit derivative loss of $1 million for First Quarter 2019 and First Quarter 2018.


Loss and LAE in First Quarter 2019 was mainly driven by higher losses on certain Puerto Rico exposures, partially offset by a benefit on U.S. RMBS exposures. Loss and LAE in First Quarter 2018 was a benefit mainly driven by the reduction of loss reserves on the City of Hartford exposure, partially offset by higher losses on RMBS exposures.

For additional information on the expected timing of net expected losses to be expensed see Item 1, Financial Statements, Note 5, Contracts Accounted for as Insurance, Financial Guaranty Insurance Losses.


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Table of Contents

Other Operating Expenses and Amortization of Deferred Acquisition Costs (DAC)

 
First Quarter
 
2019
 
2018
 
(in millions)
Employee compensation and benefits
$
45

 
$
44

Deferred costs
(4
)
 
(4
)
Total employee compensation and benefits net of deferred costs
41

 
40

Professional fees
5

 
5

Premises and equipment
5

 
5

Other
13

 
15

Other operating expenses
64

 
65

Amortization of DAC
6

 
5

Total other operating expenses and amortization of DAC
$
70

 
$
70

 
Provision for Income Tax

The Company’s effective tax rate reflects the proportion of income recognized by each of the Company’s operating subsidiaries, with U.S. subsidiaries generally taxed at the U.S. marginal corporate income tax rate of 21%, U.K. subsidiaries taxed at the U.K. marginal corporate tax rate of 19% unless taxed as a U.S. controlled foreign corporation, and no taxes for the Company’s Bermuda subsidiaries, which consist of Assured Guaranty Re Ltd. (AG Re), Assured Guaranty Re Overseas Ltd. (AGRO), and Cedar Personnel Ltd., unless subject to U.S. tax by election or as a U.S. controlled foreign corporation.

Provision for Income Taxes and Effective Tax Rates
 
 
First Quarter
 
2019
 
2018
 
(dollars in millions)
Total provision (benefit) for income taxes
$
4

 
$
20

Effective tax rate
7.8
%
 
9.3
%


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 the Company.

By disclosing non-GAAP financial measures, the Company gives investors, analysts and financial news reporters access to information that management and the Board of Directors review internally. The Company believes its presentation of non-GAAP financial measures, along with the effect of 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.

GAAP requires the Company to consolidate certain VIEs that have issued debt obligations insured by the Company. However, the Company does not own such VIEs and its exposure is limited to its obligation under its financial guaranty insurance contract. Management and the Board of Directors use non-GAAP financial measures adjusted to remove FG VIE consolidation (which the Company refers to as its core financial measures), 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

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Table of Contents

Company uses these core financial measures in its decision making process and in its calculation of certain components of management compensation. Wherever possible, the Company has separately disclosed the effect of FG VIE consolidation.

Many investors, analysts and financial news reporters use non-GAAP operating shareholders’ equity, adjusted to remove the effect of 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 to remove the effect of 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. Non-GAAP operating income adjusted for the effect of FG VIE consolidation enables investors and analysts to evaluate the Company’s financial results in comparison with the consensus analyst estimates distributed publicly by financial databases.

The core financial measures that the Company uses to help determine compensation are: (1) non-GAAP operating income, adjusted to remove the effect of FG VIE consolidation, (2) non-GAAP operating shareholders' equity, adjusted to remove the effect of FG VIE consolidation, (3) growth in non-GAAP adjusted book value per share, adjusted to remove the effect of 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. To the extent there is a directly comparable GAAP financial measure, a reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure is presented below.
 
Non-GAAP Operating Income

Management believes that non-GAAP 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 non-GAAP operating income further by removing FG VIE consolidation to arrive at its core operating income measure. Non-GAAP 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 that are recognized in net income, 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 that are recognized in net income. 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 that are recognized in net income. 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.

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Table of Contents

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

 
First Quarter
 
2019

2018
 
(in millions)
Net income (loss)
$
54

 
$
197

Less pre-tax adjustments:
 
 
 
Realized gains (losses) on investments
(12
)
 
(5
)
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(28
)
 
30

Fair value gains (losses) on CCS (1)
(9
)
 
(1
)
Foreign exchange gains (losses) on remeasurement of premiums receivable and loss and LAE reserves (1)
9

 
22

Total pre-tax adjustments
(40
)
 
46

Less tax effect on pre-tax adjustments
8

 
(4
)
Non-GAAP operating income
$
86

 
$
155

 
 
 
 
Gain (loss) related to FG VIE consolidation (net of tax provision (benefit) of $- and $1 included in non-GAAP operating income
$
—

 
$
5

____________________
(1)
Included in other income (loss) in the condensed consolidated statements of operations.


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 effects 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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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 non-GAAP adjusted book value is a useful measure because it enables an evaluation 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. 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 effects related to the above adjustments, which are determined by applying the statutory tax rate in each of the jurisdictions that generate these adjustments.

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, 2019
 
As of December 31, 2018
 
After-Tax
 
Per Share
 
After-Tax
 
Per Share
 
(dollars in millions, except per share amounts)
Shareholders’ equity
$
6,669

 
$
65.21

 
$
6,555

 
$
63.23

Less pre-tax adjustments:
 
 
 
 
 
 
 
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(73
)
 
(0.71
)
 
(45
)
 
(0.44
)
Fair value gains (losses) on CCS
65

 
0.63

 
74

 
0.72

Unrealized gain (loss) on investment portfolio excluding foreign exchange effect
419

 
4.09

 
247

 
2.39

Less taxes
(83
)
 
(0.80
)
 
(63
)
 
(0.61
)
Non-GAAP operating shareholders’ equity
6,341

 
62.00

 
6,342

 
61.17

Pre-tax adjustments:
 
 
 
 
 

 
 

Less: Deferred acquisition costs
104

 
1.01

 
105

 
1.01

Plus: Net present value of estimated net future revenue
199

 
1.95

 
204

 
1.96

Plus: Net unearned premium reserve on financial guaranty contracts in excess of expected loss to be expensed
2,972

 
29.05

 
3,005

 
28.98

Plus taxes
(515
)
 
(5.04
)
 
(524
)
 
(5.04
)
Non-GAAP adjusted book value
$
8,893

 
$
86.95

 
$
8,922

 
$
86.06

 
 
 
 
 
 
 
 
Gain (loss) related to FG VIE consolidation included in non-GAAP operating shareholders' equity (net of tax provision of $1 and $1)
$
3

 
$
0.03

 
3

 
0.03

 
 
 
 
 
 
 
 
Gain (loss) related to FG VIE consolidation included in non-GAAP adjusted book value (net of tax benefit of $5 and $4)
$
(20
)
 
$
(0.20
)
 
(15
)
 
(0.15
)


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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 for contracts other than financial guaranty insurance contracts (such as non-financial guaranty insurance contracts and credit derivatives). There is no corresponding GAAP financial measure. This amount represents the present value of estimated future revenue from these 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 and installment premiums received and the present value of gross estimated future installment premiums, discounted, in each case, 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 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 2019
 
First Quarter 2018
 
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
$
30

 
$
2

 
$
6

 
$
1

 
$
39

 
$
33

 
$
39

 
$
1

 
$
—

 
$
73

Less: Installment GWP and other GAAP adjustments (1)
(2
)
 
2

 
5

 
—

 
5

 
(2
)
 
23

 
1

 
—

 
22

Upfront GWP
32

 
—

 
1

 
1

 
34

 
35

 
16

 
—

 
—

 
51

Plus: Installment premium PVP
—

 
4

 
4

 
—

 
8

 
—

 
10

 
—

 
—

 
10

PVP
$
32

 
$
4

 
$
5

 
$
1

 
$
42

 
$
35

 
$
26

 
$
—

 
$
—

 
$
61

___________________
(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.


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Insured Portfolio
 
Financial Guaranty Exposure

The following table presents the insured financial guaranty portfolio by sector 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 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 from par and scheduled principal and interest payments (debt service) outstanding. These amounts are included in the investment portfolio, because the Company manages such securities as investments and not insurance exposure. As of both March 31, 2019 and December 31, 2018, the Company excluded $1.9 billion of net par attributable to loss mitigation strategies. See Item 1, Financial Statements, Note 3, Outstanding Exposure, for additional information.


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Financial Guaranty
Net Par Outstanding and Average Internal Rating by Sector

 
 
As of March 31, 2019
 
As of December 31, 2018
Sector
 
Net Par
Outstanding
 
Avg.
Rating
 
Net Par
Outstanding
 
Avg.
Rating
 
 
(dollars in millions)
Public finance:
 
 
 
 
 
 

 
 
U.S.:
 
 
 
 
 
 

 
 
General obligation
 
$
77,262

 
A-
 
$
78,800

 
A-
Tax backed
 
39,006

 
A-
 
40,616

 
A-
Municipal utilities
 
27,431

 
A-
 
28,462

 
A-
Transportation
 
14,881

 
A-
 
15,197

 
A-
Higher education
 
6,568

 
A-
 
6,643

 
A-
Healthcare
 
6,396

 
A-
 
6,750

 
A-
Infrastructure finance
 
5,439

 
A-
 
5,489

 
A-
Housing revenue
 
1,468

 
BBB+
 
1,435

 
BBB+
Investor-owned utilities
 
815

 
A-
 
1,001

 
A-
Other public finance—U.S.
 
2,142

 
A-
 
2,169

 
A-
Total public finance—U.S.
 
181,408

 
A-
 
186,562

 
A-
Non-U.S.:
 
 
 
 
 
 

 
 
Regulated utilities
 
18,554

 
BBB+
 
18,325

 
BBB+
Infrastructure finance
 
17,554

 
BBB
 
17,216

 
BBB
Pooled infrastructure
 
1,403

 
AAA
 
1,373

 
AAA
Other public finance
 
7,104

 
A
 
7,189

 
A
Total public finance—non-U.S.
 
44,615

 
BBB+
 
44,103

 
BBB+
Total public finance
 
226,023

 
A-
 
230,665

 
A-
Structured finance:
 
 
 
 
 
 

 
 
U.S.:
 
 
 
 
 
 

 
 
RMBS
 
4,064

 
BBB-
 
4,270

 
BBB-
Life insurance transactions
 
2,001

 
AA-
 
1,435

 
A+
Pooled corporate obligations
 
1,397

 
AA-
 
1,215

 
AA-
Consumer receivables
 
1,211

 
A-
 
1,255

 
A-
Financial products
 
1,006

 
AA-
 
1,094

 
AA-
Other structured finance—U.S.
 
658

 
A-
 
675

 
A-
Total structured finance—U.S.
 
10,337

 
A-
 
9,944

 
A-
Non-U.S.:
 
 
 
 
 
 

 
 
RMBS
 
493

 
A-
 
576

 
A-
Pooled corporate obligations
 
57

 
BB+
 
126

 
A
Other structured finance
 
415

 
A+
 
491

 
A
Total structured finance—non-U.S.
 
965

 
A
 
1,193

 
A
Total structured finance
 
11,302

 
A-
 
11,137

 
A-
Total net par outstanding
 
$
237,325

 
A-
 
$
241,802

 
A-
 



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The following table sets forth the Company’s net financial guaranty portfolio by internal rating.
 
Financial Guaranty Portfolio by Internal Rating

 
 
As of March 31, 2019
 
As of December 31, 2018
Rating
Category
 
Net Par Outstanding
 
%
 
Net Par Outstanding
 
%
 
 
(dollars in millions)
AAA
 
$
4,610

 
1.9
%
 
$
4,618

 
1.9
%
AA
 
27,630

 
11.6

 
27,021

 
11.2

A
 
116,035

 
48.9

 
119,415

 
49.4

BBB
 
79,424

 
33.5

 
80,588

 
33.3

BIG
 
9,626

 
4.1

 
10,160

 
4.2

Total net par outstanding
 
$
237,325

 
100.0
%
 
$
241,802

 
100.0
%


Exposure to Puerto Rico
         
The Company had 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 $4.5 billion net par as of March 31, 2019, all of which was rated BIG. Beginning on January 1, 2016, a number of Puerto Rico exposures have defaulted on bond payments, and the Company has now paid claims on all of its Puerto Rico exposures except for Puerto Rico Aqueduct and Sewer Authority (PRASA), Municipal Finance Agency (MFA) and University of Puerto Rico (U of PR). Additional information about recent developments in Puerto Rico and the individual exposures insured by the Company may be found in Item 1, Financial Statements, Note 3, 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, 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.

•
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
As of March 31, 2019

 
 
Net Par Outstanding
 
 
 
 
AGM
 
AGC
 

AG Re
 
Eliminations (1)
 
Total
Net Par Outstanding
 
Gross
Par Outstanding
 
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
 
 
 
 
 
 
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds (2) (3)
 
$
647

 
$
301

 
$
393

 
$
(1
)
 
$
1,340

 
$
1,383

Puerto Rico Public Buildings Authority (PBA)
 
9

 
142

 
—

 
(9
)
 
142

 
148

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
 
 
 
 
 
 
 
 
 
Puerto Rico Highways and Transportation Authority (PRHTA) (Transportation revenue) (3)
 
233

 
495

 
195

 
(79
)
 
844

 
874

PRHTA (Highway revenue) (3)
 
351

 
84

 
40

 
—

 
475

 
536

Puerto Rico Convention Center District Authority (PRCCDA)
 
—

 
152

 
—

 
—

 
152

 
152

Puerto Rico Infrastructure Financing Authority (PRIFA)
 
—

 
15

 
1

 
—

 
16

 
16

Other Public Corporations
 
 
 
 
 
 
 
 
 
 
 
 
Puerto Rico Electric Power Authority (PREPA) (3)
 
544

 
72

 
232

 


 
848

 
866

PRASA
 
—

 
284

 
89

 
—

 
373

 
373

MFA
 
189

 
40

 
74

 
—

 
303

 
349

U of PR
 
—

 
1

 
—

 
—

 
1

 
1

Total exposure to Puerto Rico
 
$
1,973

 
$
1,586

 
$
1,024

 
$
(89
)
 
$
4,494

 
$
4,698

 ___________________
(1)
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.

(2)
Includes exposure to capital appreciation bonds with a current aggregate net par outstanding of $2.4 million and a fully accreted net par at maturity of $2.5 million.

(3)
As of the date of this filing, the seven-member financial oversight board established by the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) has certified a filing under Title III of PROMESA for these exposures.



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The following tables show 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, 2019

 
Scheduled Net Par Amortization
 
2019 (2Q)
2019 (3Q)
2019 (4Q)
2020
2021
2022
2023
2024 - 2028
2029 - 2033
2034 - 2038
2039 - 2043
2044 - 2047
Total
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
 
 
 
 
 
 
 
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds
$
—

$
87

$
—

$
141

$
15

$
37

$
14

$
298

$
341

$
407

$
—

$
—

$
1,340

PBA
—

3

—

5

13

—

7

58

36

20

—

—

142

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 




 
 
 
 
 
 
 
 
PRHTA (Transportation revenue)
—

32

—

25

18

28

33

120

127

296

165

—

844

PRHTA (Highway revenue)
—

21

—

22

35

6

32

77

145

137

—

—

475

PRCCDA
—

—

—

—

—

—

—

19

50

83

—

—

152

PRIFA
—

—

—

—

—

—

2

—

—

3

11

—

16

Other Public Corporations
 
 
 




 
 
 
 
 
 
 
 
PREPA
—

26

—

48

28

28

95

440

174

9

—

—

848

PRASA
—

—

—

—

—

—

—

110

—

2

—

261

373

MFA
—

55

—

45

40

40

22

91

10

—

—

—

303

U of PR
—

—

—

—

—

—

—

—

1

—

—

—

1

Total
$
—

$
224

$
—

$
286

$
149

$
139

$
205

$
1,213

$
884

$
957

$
176

$
261

$
4,494



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Table of Contents

Amortization Schedule
of Net Debt Service Outstanding of Puerto Rico
As of March 31, 2019

 
Scheduled Net Debt Service Amortization
 
2019 (2Q)
2019 (3Q)
2019 (4Q)
2020
2021
2022
2023
2024 - 2028
2029 - 2033
2034 - 2038
2039 - 2043
2044 - 2047
Total
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
 
 
 
 
 
 
 
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds
$
—

$
122

$
—

$
206

$
74

$
94

$
70

$
539

$
512

$
457

$
—

$
—

$
2,074

PBA
—

7

—

12

20

6

13

84

50

23

—

—

215

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 




 
 
 
 
 
 
 
 
PRHTA (Transportation revenue)
—

54

—

67

59

68

72

294

262

375

180

—

1,431

PRHTA (Highway revenue)
—

34

—

46

58

27

52

159

208

152

—

—

736

PRCCDA
—

3

—

7

7

7

7

53

79

91

—

—

254

PRIFA
—

—

—

1

1

1

3

4

3

7

12

—

32

Other Public Corporations
 
 
 




 
 
 
 
 
 
 
 
PREPA
3

43

3

87

63

62

128

541

198

9

—

—

1,137

PRASA
—

10

—

19

19

19

19

198

68

70

67

300

789

MFA
—

62

—

58

50

48

28

106

11

—

—

—

363

U of PR
—

—

—

—

—

—

—

—

1

—

—

—

1

Total
$
3

$
335

$
3

$
503

$
351

$
332

$
392

$
1,978

$
1,392

$
1,184

$
259

$
300

$
7,032



Financial Guaranty Exposure to U.S. RMBS
 
The table below provides information on certain risk characteristics of the Company’s financial guaranty insurance, FG VIE and credit derivative U.S. RMBS exposures. As of March 31, 2019, U.S. RMBS net par outstanding was $4.1 billion, of which $2.2 billion was rated BIG. 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 Item 1, Financial Statements, Note 4, 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 Year Insured and Type of Exposure as of March 31, 2019

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
 
$
26

 
$
22

 
$
2

 
$
678

 
$
62

 
$
790

2005
 
59

 
236

 
28

 
231

 
161

 
715

2006
 
44

 
48

 
13

 
333

 
255

 
693

2007
 
—

 
370

 
38

 
1,031

 
381

 
1,820

2008
 
—

 
—

 
—

 
46

 
—

 
46

Total exposures
 
$
129

 
$
676

 
$
81

 
$
2,319

 
$
859

 
$
4,064

    



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Table of Contents

Non-Financial Guaranty Exposure

The Company also provides non-financial guaranty insurance and reinsurance on transactions with similar risk profiles to its structured finance exposures written in financial guaranty form. All non-financial guaranty exposures shown in the table below are rated investment grade internally.

Non-Financial Guaranty Exposure

 
Gross Exposure
 
Net Exposure
 
As of March 31, 2019
 
As of December 31, 2018
 
As of March 31, 2019
 
As of December 31, 2018
 
(in millions)
Life insurance transactions (1)
$
912

 
$
880

 
$
788

 
$
763

Aircraft residual value insurance policies
360

 
340

 
239

 
218

____________________
(1)
The life insurance transactions net exposure is expected to increase to approximately $1.0 billion prior to September 30, 2036.


Reinsurer Exposures
 
The Company has exposure to reinsurers through reinsurance arrangements (both as a ceding company and as an assuming company). Most of the Company's exposure as a ceding company and as an assuming company relates to financial guaranty contracts written before 2009, although the Company has assumed or reassumed (from financial guarantors no longer writing new business) some of those exposures more recently. The Company continues to cede portions of certain non-financial guaranty exposures to reinsurers to mitigate its risk. See Item 1, Financial Statements, Note 11, Reinsurance.

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, purchase the Company's outstanding debt, 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 “—Distributions From Subsidiaries” below for a discussion of the dividend restrictions of its insurance company subsidiaries.

The following table presents significant holding company cash flow activity (other than investment income, expenses and taxes) related to distributions from subsidiaries and outflows for debt service and dividends, dividends to AGL shareholders and other capital management activities.

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Table of Contents

AGL and U.S. Holding Company Subsidiaries
Significant Cash Flow Items

 
AGL
 
AGUS
 
AGMH
 
Other Subsidiaries
 
(in millions)
First Quarter 2019
 
 
 
 
 
 
 
Intercompany sources
$
100

 
$
89

 
$
74

 
$
—

Intercompany (uses)
—

 
(60
)
 
(47
)
 
(156
)
External sources (uses):
 
 
 
 
 
 
 
Dividends paid to AGL shareholders
(20
)
 
—

 
—

 
—

Repurchases of common shares (1)
(80
)
 
—

 
—

 
—

Interest paid (2)
—

 
(2
)
 
(7
)
 
—

Purchase of AGMH's debt by AGUS
—

 
(3
)
 
—

 
—

 
 
 
 
 
 
 
 
First Quarter 2018
 
 
 
 
 
 
 
Intercompany sources
$
118

 
$
302

 
$
73

 
$
—

Intercompany (uses)
—

 
(78
)
 
(50
)
 
(365
)
External sources (uses):
 
 
 
 
 
 
 
Dividends paid to AGL shareholders
(18
)
 
—

 
—

 
—

Repurchases of common shares (1)
(100
)
 
—

 
—

 
—

Interest paid (2)
—

 
(14
)
 
(7
)
 
—

Purchase of AGMH's debt by AGUS
—

 
(19
)
 
—

 
—

____________________
(1)
See Item 1, Financial Statements, Note 15, Shareholders' Equity, for additional information about share repurchases and authorizations.

(2)
See Long-Term Obligations below for interest paid by subsidiary.

Distributions 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, other potential uses for such funds, 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. See Part II, Item 8, Financial Statements and Supplementary Data, Note 11, Insurance Company Regulatory Requirements, of the Company's Annual Report on Form 10-K for the year ended December 31, 2018 for a complete discussion of the Company's dividend restrictions applicable to AGC, AGM, MAC, AG Re and AGRO.
    
Dividend restrictions by insurance company subsidiary are as follows:

•
The maximum amount available during 2019 for AGM to distribute as dividends without regulatory approval is estimated to be approximately $176 million, of which $4 million is estimated to be available for distribution in the second quarter of 2019.

•
The maximum amount available during 2019 for AGC to distribute as ordinary dividends is approximately $123 million, of which approximately $24 million is available for distribution in the second quarter of 2019.

•
The maximum amount available during 2019 for MAC to distribute as dividends to MAC Holdings, which is owned by AGM and AGC, without regulatory approval, is estimated to be approximately $32 million, of which approximately $15 million is available for distribution in the second quarter of 2019. In March 2019, MAC received approval from the New York State Department of Financial Services to dividend to MAC Holdings $100 million in 2019, an amount that exceeds the amount available to dividend without such approval in 2019 under

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applicable law.  Subject to approval by MAC’s Board of Directors, MAC expects to distribute a $100 million dividend to MAC Holdings during the second quarter of 2019.

•
Based on the applicable law and regulations, in 2019 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 (the Authority) and (ii) declare and pay dividends in an aggregate amount up to approximately $312 million as of March 31, 2019. 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, 2019, AG Re had unencumbered assets of approximately $409 million.

•
Based on the applicable law and regulations, in 2019 AGRO has the capacity to (i) make capital distributions in an aggregate amount up to $21 million without the prior approval of the Authority and (ii) declare and pay dividends in an aggregate amount up to approximately $96 million as of March 31, 2019. Such dividend capacity is further limited by the actual amount of AGRO’s unencumbered assets, which amount changes from time to time due in part to collateral posting requirements. As of March 31, 2019, AGRO had unencumbered assets of approximately $364 million.

Distributions from
Insurance Company Subsidiaries

 
First Quarter
 
2019
 
2018
 
(in millions)
Dividends paid by AGC to AGUS
$
42

 
$
52

Dividends paid by AGM to AGMH
74

 
73

Dividends paid by AG Re to AGL
40

 
40

Dividends paid by MAC to MAC Holdings (1)
5

 
—

Repurchase of common stock by AGC from AGUS
—

 
200

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

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., 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. The commitment under the revolving credit facility terminates on October 25, 2023 (the loan commitment termination date). The unpaid principal amount of each loan will bear semi-annual interest at a fixed rate equal to 100% of the then applicable interest rate 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 commitment termination date. AGL has not drawn upon the credit facility.

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Table of Contents

In addition, in 2012 AGUS borrowed $90 million from its affiliate AGRO to fund the acquisition of MAC. In 2018, the maturity date was extended to November 2023. During 2018, AGUS repaid $10 million in outstanding principal as well as accrued and unpaid interest. As of March 31, 2019, $50 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 described under "Commitments and Contingencies -- Long-Term Debt Obligations" below.

Cash and Investments

As of March 31, 2019, AGL had $43 million in cash and short-term investments. AGUS and AGMH had a total of$238 million in cash and short-term investments. In addition, the Company's U.S. holding companies have $24 million in fixed-maturity securities (excluding AGUS's investment in AGMH's debt) with weighted average duration of 1.4 years.

Insurance Company Subsidiaries

Liquidity of the insurance company subsidiaries is primarily used to pay for:

•
operating expenses,
•
claims on the insured portfolio,
•
dividends or other distributions to AGL, AGUS and/or AGMH, as applicable,
•
posting of collateral in connection with reinsurance and credit derivative transactions,
•
reinsurance premiums,
•
principal of and, where applicable, interest on surplus notes, and
•
capital investments in their own subsidiaries, where appropriate.

Management believes that the insurance 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 of amortized cost.
 
Beyond the next twelve months, the ability of the operating subsidiaries to declare and pay dividends may be influenced by a variety of factors, including market conditions, insurance regulations and rating agency capital requirements and general economic conditions.
 
Insurance policies issued provide, in general, that payments of principal, interest and other amounts insured may not be accelerated by the holder of the obligation. Amounts paid by the Company therefore are typically in accordance with the obligation’s original payment schedule, unless the Company accelerates such payment schedule, at its sole option.
 
 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.

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 $4.5 billion, all of which is rated BIG. Beginning in 2016, the Commonwealth and certain related authorities and public corporations have defaulted on obligations to make payments on its debt. Information regarding the Company's exposure to the Commonwealth of Puerto Rico and its related authorities and public corporations is set forth in Item 1, Financial Statements, Note 3, Outstanding Exposure.


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Table of Contents

Claims (Paid) Recovered

 
First Quarter
 
2019
 
2018
 
 
 
 
Public finance
$
(228
)
 
$
(111
)
Structured finance:
 
 
 
U.S. RMBS
9

 
130

Other structured finance
1

 
—

Structured finance
10

 
130

Claims (paid) recovered, net of reinsurance (1)
$
(218
)
 
$
19

____________________
(1)
Includes $1 million recovered and $1 million paid for consolidated FG VIEs for First Quarter 2019 and 2018, respectively. The amounts in First Quarter 2019 are net of the closed lien senior bonds of COFINA validated by the PROMESA Title III Court, and cash that were received pursuant to the COFINA Plan of Adjustment. See Item 1, Financial Statements, Note 3, Outstanding Exposure, for additional information.

    
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 the tax-exempt entities did not make the required early termination payments, then AGM would be exposed to possible liquidity claims on gross exposure of approximately $749 million as of March 31, 2019. 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. As of March 31, 2019, approximately $1.7 billion of cumulative strip par exposure had been terminated since 2008 on a consensual basis. The consensual terminations have resulted in no claims on AGM. 

The terms of the Company’s CDS contracts generally are modified from standard CDS contract forms approved by International Swaps and Derivative Association, Inc. 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. 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 Company may be required to make a cash termination payment to its swap counterparty upon such termination. Any such payment would probably occur prior to the maturity of the reference obligation and be in an amount larger than the amount due for that period on on a “pay-as-you-go” basis.


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Table of Contents

The transaction documentation with one counterparty for $221 million of the CDS net par insured by AGC requires AGC to post collateral, subject to a cap, to secure its obligation to make payments under such contracts. As of March 31, 2019, AGC had posted $1 million of collateral to satisfy these requirements and the maximum posting requirement was $221 million.

Condensed Consolidated Cash Flows
 
Condensed Consolidated Cash Flow Summary
 
 
First Quarter
 
2019
 
2018
 
(in millions)
Net cash flows provided by (used in) operating activities before effects of FG VIE consolidation
$
(333
)
 
$
25

Effect of FG VIE consolidation
1

 
2

Net cash flows provided by (used in) operating activities
(332
)
 
27

Net cash flows provided by (used in) investing activities before effects of FG VIE consolidation
468

 
95

Effect of FG VIE consolidation
24

 
31

Net cash flows provided by (used in) investing activities
492

 
126

Dividends paid
(20
)
 
(18
)
Repurchases of common stock
(80
)
 
(100
)
Repurchase of debt
(3
)
 
(19
)
Effect of FG VIE consolidation
(25
)
 
(33
)
Other
(14
)
 
(11
)
Net cash flows provided by (used in) financing activities (1)
(142
)
 
(181
)
Effect of exchange rate changes
1

 
1

Cash and restricted cash at beginning of period
104

 
144

Total cash and restricted cash at the end of the period
$
123

 
$
117

____________________
(1)
Claims paid on consolidated FG VIEs are presented in the condensed consolidated cash flow statements as a component of paydowns on FG VIEs' liabilities in financing activities as opposed to operating activities.

Excluding net cash flows from consolidated FG VIEs, cash inflows from operating activities decreased in First Quarter 2019 compared with First Quarter 2018 due primarily to higher net claim payments (including the COFINA settlement) and lower premium collections, which were partially offset by lower interest and tax payments.

Investing activities primarily consisted of net sales (purchases) of fixed-maturity and short-term investments, and paydowns on FG VIEs’ assets. The increase in investing cash inflows was mainly attributable to sales of securities to fund the COFINA claim payment in First Quarter 2019.

Financing activities primarily consisted of share repurchases, dividends, debt extinguishment and paydowns of FG VIEs’ liabilities.

From April 1, 2019 through May 9, 2019, the Company repurchased an additional $40 million of common shares. As of May 9, 2019, the Company was authorized to purchase $279 million of its common shares, including a $300 million authorization that was approved by the Board of Directors on February 27, 2019. For more information about the Company's share repurchases and authorizations, see Item 1, Financial Statements, Note 15, Shareholders' Equity.


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Table of Contents

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, 2018. See Item 1, Financial Statements, Note 12, Commitments and Contingencies.

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
 
2019
 
2018
 
2019
 
2018
 
(in millions)
AGUS
$
850

 
$
850

 
$
2

 
$
14

AGMH
730

 
730

 
7

 
7

AGM
5

 
5

 
—

 
—

AGMH's debt purchased by AGUS (1)
(131
)
 
(128
)
 
—

 
—

Total
$
1,454

 
$
1,457

 
$
9

 
$
21

 ____________________
(1)
Represents principal amount of Junior Subordinated Debentures issued by AGMH that has been purchased by AGUS. See Item 1, Financial Statements, Note 13, Long-Term Debt and Credit Facilities, for additional information.

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. The notes are redeemable, in whole or in part, at their principal amount plus accrued and unpaid interest at the date of redemption or, if greater, the make-whole redemption price.
 
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. The notes are redeemable, in whole or in part, at their principal amount plus accrued and unpaid interest at the date of redemption or, if greater, the make-whole redemption price.

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%. LIBOR may be discontinued. See the Risk Factor captioned "The Company may be adversely impacted by the transition from LIBOR as a reference rate" under Risks Related to the Financial, Credit and Financial Guaranty Markets in Part I, Item 1A, Risk Factors in AGL's Annual Report on Form 10-K for the year ended December 31, 2018. 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. The debentures are redeemable, in whole or in part, at their principal amount plus accrued and unpaid interest to the date of redemption.

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 redeemable without premium or penalty in whole or in part at their principal amount plus accrued and unpaid interest up to but not including the date of redemption.
 

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6.25% Notes.  On November 26, 2002, AGMH issued $230 million face amount of 6.25% Notes due November 1, 2102, which are redeemable without premium or penalty in whole or in part at their principal amount plus accrued and unpaid interest up to but not including the date of redemption.
 
5.6% Notes.  On July 31, 2003, AGMH issued $100 million face amount of 5.6% Notes due July 15, 2103, which are redeemable without premium or penalty in whole or in part at their principal amount plus accrued and unpaid interest up to but not including the date of redemption.
 
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. LIBOR may be discontinued. See the Risk Factor captioned "The Company may be adversely impacted by the transition from LIBOR as a reference rate" under Risks Related to the Financial, Credit and Financial Guaranty Markets in Part I, Item 1A, Risk Factors in AGL's Annual Report on Form 10-K for the year ended December 31, 2018. 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. In First Quarter 2019 and First Quarter 2018, AGUS purchased $3 million and $20 million, respectively, of par of the debentures, which resulted in a loss on extinguishment of debt on a consolidated basis of $1 million in First Quarter 2019 and $7 million in First Quarter 2018. The Company may choose to make additional purchases of this or other Company debt in the future.
  
Committed Capital Securities

Each of AGC and AGM have entered into put agreements with four separate custodial trusts allowing AGC and AGM, respectively, to issue an aggregate of $200 million of non-cumulative redeemable perpetual preferred securities to the trusts in exchange for cash. Each custodial trust was created for the primary purpose of issuing $50 million face amount of CCS, investing the proceeds in high-quality assets and entering into put options with AGC or AGM, as applicable. The Company does not consider itself to be the primary beneficiary of the trusts and the trusts are not consolidated in Assured Guaranty's financial statements.

The trusts provide AGC and AGM access to new equity 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 its sale of 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. Both AGC and AGM continue to have the ability to exercise their respective put options and cause the related trusts to purchase their preferred stock.

Prior to 2008 or 2007, the amounts paid on the CCS were established through an auction process. All of those auctions failed in 2008 or 2007, and the rates paid on the CCS increased to their respective maximums. The annualized rate on the AGC CCS is one-month LIBOR plus 250 basis points, and the annualized rate on the AGM Committed Preferred Trust Securities (CPS) is one-month LIBOR plus 200 basis points. LIBOR may be discontinued. See the Risk Factor captioned "The Company may be adversely impacted by the transition from LIBOR as a reference rate" under Risks Related to the Financial, Credit and Financial Guaranty Markets in Part I, Item 1A, Risk Factors in AGL's Annual Report on Form 10-K for the year ended December 31, 2018.


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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 4.7 years as of March 31, 2019 and 4.9 years as of December 31, 2018. 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 Item 1, Financial Statements, Note 9, Investments and Cash.

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

 
As of March 31, 2019
 
As of December 31, 2018
 
Amortized
Cost
 
Estimated
Fair Value
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Fixed-maturity securities:
 

 
 

 
 

 
 

Obligations of state and political subdivisions
$
4,597

 
$
4,843

 
$
4,761

 
$
4,911

U.S. government and agencies
157

 
166

 
167

 
175

Corporate securities
2,125

 
2,154

 
2,175

 
2,136

Mortgage-backed securities (1):
 
 
 
 
 
 
 

RMBS
960

 
959

 
999

 
982

Commercial mortgage-backed securities (CMBS)
532

 
539

 
542

 
539

Asset-backed securities
957

 
1,076

 
942

 
1,068

Non-U.S. government securities
262

 
252

 
298

 
278

Total fixed-maturity securities
9,590

 
9,989

 
9,884

 
10,089

Short-term investments
727

 
727

 
729

 
729

Total fixed-maturity and short-term investments
$
10,317

 
$
10,716

 
$
10,613

 
$
10,818

 ____________________
(1)
U.S. government-agency obligations were approximately 46% of mortgage backed securities as of March 31, 2019 and 48% as of December 31, 2018, 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, 2019 and December 31, 2018, 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, 2019

 
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
$
17

 
$
—

 
$
152

 
$
(3
)
 
$
169

 
$
(3
)
U.S. government and agencies
20

 
—

 
24

 
—

 
44

 
—

Corporate securities
101

 
(1
)
 
381

 
(16
)
 
482

 
(17
)
Mortgage-backed securities:
 
 
 
 
 
 
 

 
 
 
 
RMBS
37

 
(1
)
 
371

 
(23
)
 
408

 
(24
)
CMBS
1

 
—

 
86

 
(3
)
 
87

 
(3
)
Asset-backed securities
308

 
(3
)
 
18

 
—

 
326

 
(3
)
Non-U.S. government securities
46

 
(1
)
 
86

 
(14
)
 
132

 
(15
)
Total
$
530

 
$
(6
)
 
$
1,118

 
$
(59
)
 
$
1,648

 
$
(65
)
Number of securities (1)
 

 
128

 
 

 
333

 
 

 
456

Number of securities with OTTI (1)
 

 
5

 
 

 
24

 
 

 
28

 

Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time 
As of December 31, 2018

 
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
$
195

 
$
(4
)
 
$
658

 
$
(14
)
 
$
853

 
$
(18
)
U.S. government and agencies
11

 
—

 
24

 
(1
)
 
35

 
(1
)
Corporate securities
836

 
(19
)
 
522

 
(33
)
 
1,358

 
(52
)
Mortgage-backed securities:
 

 
 

 
 

 
 

 


 


RMBS
85

 
(2
)
 
447

 
(32
)
 
532

 
(34
)
CMBS
111

 
(1
)
 
164

 
(6
)
 
275

 
(7
)
Asset-backed securities
322

 
(4
)
 
38

 
(1
)
 
360

 
(5
)
Non-U.S. government securities
83

 
(4
)
 
99

 
(18
)
 
182

 
(22
)
Total
$
1,643

 
$
(34
)
 
$
1,952

 
$
(105
)
 
$
3,595

 
$
(139
)
Number of securities (1)
 

 
417

 
 

 
608

 
 

 
997

Number of securities with OTTI (1)
 

 
22

 
 

 
22

 
 

 
42

___________________
(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, 2019 and December 31, 2018, 37 and 38 securities, respectively, had unrealized losses greater than 10% of book value. The total unrealized loss for these securities was $33 million as of March 31, 2019 and $43 million as of December 31, 2018. The Company considered the credit quality, cash flows, interest rate movements, ability to hold a security to recovery and intent to sell a security in determining whether a security had a credit loss. The Company has determined that the unrealized losses recorded as of March 31, 2019 and December 31, 2018 were yield-related and not the result of OTTI.
 
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 primarily consists 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, 2019
 
 
Amortized
Cost
 
Estimated
Fair Value
 
(in millions)
Due within one year
$
217

 
$
213

Due after one year through five years
1,500

 
1,524

Due after five years through 10 years
2,249

 
2,316

Due after 10 years
4,132

 
4,438

Mortgage-backed securities:
 

 
 

RMBS
960

 
959

CMBS
532

 
539

Total
$
9,590

 
$
9,989

 

The following table summarizes the ratings distributions of the Company’s investment portfolio as of March 31, 2019 and December 31, 2018. Ratings reflect the lower of the Moody’s Investors Service, Inc. and S&P Global Ratings, a division of Standard & Poor's Financial Services LLC 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, 2019
 
As of
December 31, 2018
AAA
 
15.5
%
 
15.7
%
AA
 
45.9

 
48.2

A
 
20.4

 
19.8

BBB
 
5.3

 
5.0

BIG (1)
 
10.9

 
10.8

Not rated (2)
 
2.0

 
0.5

Total
 
100.0
%
 
100.0
%
____________________
(1)
Includes primarily loss mitigation and other risk management assets. See Item I, Financial Statements, Note 9, Investments and Cash, for additional information.
 
(2)
March 31, 2019 balance includes COFINA bonds with a fair value of $145 million.


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Based on fair value, investments and restricted cash that are either held in trust for the benefit of third party ceding insurers in accordance with statutory requirements, placed on deposit to fulfill state licensing requirements, or otherwise pledged or restricted totaled $269 million and $266 million, as of March 31, 2019 and December 31, 2018, respectively. The investment portfolio also contains securities that are held in trust by certain AGL subsidiaries or otherwise restricted for the benefit of other AGL subsidiaries in accordance with statutory and regulatory requirements in the amount of $1,873 million and $1,855 million, based on fair value, as of March 31, 2019 and December 31, 2018, respectively.
 
The Company has collateral posting obligations with respect to one CDS counterparty. See Item I, Financial Statements, Note 7, Contracts Accounted for as Credit Derivatives, for additional information.

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There were no material changes in the market risks that the Company is exposed to since December 31, 2018.

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, 2019. Based on their evaluation as of March 31, 2019 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.



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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, 2018, and in Part I, Item 1, Financial Statements, Note 12, Commitments and Contingencies – Legal Proceedings contained in this Form 10-Q. Material developments to such proceedings during the three months ended March 31, 2019, are described below and in the "Litigation" section of Note 12, Commitments and Contingencies, of the Financial Statements.

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, asserted a claim for breach of the implied covenant of good faith and fair dealing based on AGFP's termination of nine credit derivative transactions between LBIE and AGFP and asserted claims for breach of contract and breach of the implied covenant of good faith and fair dealing based on AGFP's termination of 28 other credit derivative transactions between LBIE and AGFP and AGFP's calculation of the termination payment in connection with those 28 other credit derivative transactions. 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. AGFP filed a motion to dismiss the claims for breach of the implied covenant of good faith in LBIE's complaint, and on March 15, 2013, the court granted AGFP's motion to dismiss in respect of the count relating to the nine credit derivative transactions and narrowed LBIE's claim with respect to the 28 other credit derivative transactions. 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. AGFP filed a motion for summary judgment on the remaining causes of action asserted by LBIE and on AGFP's counterclaims, and on July 2, 2018, the court granted in part and denied in part AGFP’s motion. The court dismissed, in its entirety, LBIE’s remaining claim for breach of the implied covenant of good faith and fair dealing and also dismissed LBIE’s claim for breach of contract solely to the extent that it is based upon AGFP’s conduct in connection with the auction. With respect to LBIE’s claim for breach of contract, the court held that there are triable issues of fact regarding whether AGFP calculated its loss reasonably and in good faith. On October 1, 2018, AGFP filed an appeal with the Appellate Division of the Supreme Court of the State of New York, First Judicial Department, seeking reversal of the portions of the lower court's ruling denying AGFP’s motion for summary judgment with respect to LBIE’s sole remaining claim for breach of contract. On January 17, 2019, the Appellate Division affirmed the Supreme Court's decision, holding that the lower court correctly determined that there are triable issues of fact regarding whether AGFP calculated its loss reasonably and in good faith.

On May 2, 2019, the Oversight Board and the Official Committee of Unsecured Creditors of the Commonwealth filed an adversary complaint in the Federal District Court for Puerto Rico against various Commonwealth general obligation bondholders and bond insurers, including AGC and AGM, that had asserted in their proofs of claim that their bonds are secured. The complaint seeks a judgment declaring that defendants do not hold consensual or statutory liens and are unsecured claimholders to the extent they hold allowed claims. The complaint also asserts that even if Commonwealth law granted statutory liens, such liens are avoidable under Section 545 of the Bankruptcy Code.

ITEM 1A.
RISK FACTORS

See 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, 2018. There have been no material changes to the risk factors disclosed in such Annual Report on Form 10-K during the three months ended March 31, 2019.


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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 2019.
 
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
 
643,315

 
$
39.29

 
636,405

 
$
72,873,202

February 1 - February 28
 
926,662

 
$
41.12

 
564,096

 
$
349,821,124

March 1 - March 31
 
708,104

 
$
44.32

 
708,104

 
$
318,437,567

Total
 
2,278,081

 
$
41.60

 
1,908,605

 
 

____________________
(1)
After giving effect to repurchases since the beginning of 2013 through May 9, 2019, the Company has repurchased a total of 97.3 million common shares for approximately $2,835 million, excluding commissions, at an average price of $29.13 per share. The Board of Directors authorized, on February 27, 2019, an additional $300 million of share repurchases. As of May 9, 2019, after combining the remaining authorization and the new authorization, the Company was authorized to purchase $279 million of its common shares, on a settlement basis.

(2)
Excludes commissions.


ITEM 6.
EXHIBITS.
 
The following exhibits are filed with this report:
 
Exhibit
Number
 
Description of Document
10.1

 
10.2

 
10.3

 
10.4

 
31.1

 
31.2

 
32.1

 
32.2

 
101.1

 
The following financial information from Assured Guaranty Ltd.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2019 formatted in inline XBRL: (i) Condensed Consolidated Balance Sheets at March 31, 2019 and December 31, 2018; (ii) Condensed Consolidated Statements of Operations for the Three Months ended March 31, 2019 and 2018; (iii) Condensed Consolidated Statements of Comprehensive Income for the Three Months ended March 31, 2019 and 2018; (iv) Condensed Consolidated Statements of Shareholders’ Equity for the Three Months ended March 31, 2019 and 2018; (v) Condensed Consolidated Statements of Cash Flows for the Three Months ended March 31, 2019 and 2018; and (vi) Notes to Condensed Consolidated Financial Statements.

*    Management contract or compensatory plan 


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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
ASSURED GUARANTY LTD.
(Registrant)
 
 
Dated May 10, 2019
By:
/s/ ROBERT A. BAILENSON
 
 
 
 
 
Robert A. Bailenson
Chief Financial Officer (Principal Financial Officer and Duly Authorized Officer)



123