AGO 10-Q Quarterly Report May 9, 2014 | Alphaminr
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AGO 10-Q Quarter ended May 9, 2014

Balance Sheet
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Income Statement
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10-Q 1 gaapago-03x31x2014x10q.htm 10-Q GAAP AGO-03-31-2014-10Q
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, 2014
Or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition Period from              to
Commission File No. 001-32141
ASSURED GUARANTY LTD.
(Exact name of registrant as specified in its charter)
Bermuda
98-0429991
(State or other jurisdiction
(I.R.S. employer
of incorporation)
identification no.)
30 Woodbourne Avenue
Hamilton HM 08
Bermuda
(Address of principal executive offices)
(441) 279-5700
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No x
The number of registrant’s Common Shares ($0.01 par value) outstanding as of May 7, 2014 w as 179,629,028 (includes 47,747 unvested restricted shares).



ASSURED GUARANTY LTD.

INDEX TO FORM 10-Q
Page
2. Rating Actions and Quarterly Developments
9. Consolidated Variable Interest Entities
17. Shareholders' Equity


PART I.
FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
Assured Guaranty Ltd.

Consolidated Balance Sheets (unaudited)
(dollars in millions except per share and share amounts)
As of
March 31, 2014
As of
December 31, 2013
Assets


Investment portfolio:


Fixed-maturity securities, available-for-sale, at fair value (amortized cost of $9,729 and $9,488)
$
10,094

$
9,711

Short-term investments, at fair value
720

904

Other invested assets
134

170

Total investment portfolio
10,948

10,785

Cash
219

184

Premiums receivable, net of commissions payable
863

876

Ceded unearned premium reserve
454

452

Deferred acquisition costs
122

124

Reinsurance recoverable on unpaid losses
37

36

Salvage and subrogation recoverable
241

174

Credit derivative assets
78

94

Deferred tax asset, net
637

688

Financial guaranty variable interest entities’ assets, at fair value
1,257

2,565

Other assets
250

309

Total assets
$
15,106

$
16,287

Liabilities and shareholders’ equity


Unearned premium reserve
$
4,504

$
4,595

Loss and loss adjustment expense reserve
636

592

Reinsurance balances payable, net
165

148

Long-term debt
812

816

Credit derivative liabilities
2,001

1,787

Current income tax payable
26

44

Financial guaranty variable interest entities’ liabilities with recourse, at fair value
1,346

1,790

Financial guaranty variable interest entities’ liabilities without recourse, at fair value
101

1,081

Other liabilities
306

319

Total liabilities
9,897

11,172

Commitments and contingencies (See Note 14)


Common stock ($0.01 par value, 500,000,000 shares authorized; 181,158,708 and 182,177,866 shares issued and outstanding)
2

2

Additional paid-in capital
2,434

2,466

Retained earnings
2,504

2,482

Accumulated other comprehensive income, net of tax of $117 and $71
264

160

Deferred equity compensation (320,193 and 320,193 shares)
5

5

Total shareholders’ equity
5,209

5,115

Total liabilities and shareholders’ equity
$
15,106

$
16,287

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


1

Assured Guaranty Ltd.

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

Three Months Ended March 31,
2014
2013
Revenues
Net earned premiums
$
132

$
248

Net investment income
103

94

Net realized investment gains (losses):
Other-than-temporary impairment losses
(3
)
(1
)
Less: portion of other-than-temporary impairment loss
recognized in other comprehensive income
2

4

Net impairment loss
(5
)
(5
)
Other net realized investment gains (losses)
7

33

Net realized investment gains (losses)
2

28

Net change in fair value of credit derivatives:
Realized gains (losses) and other settlements
19

18

Net unrealized gains (losses)
(230
)
(610
)
Net change in fair value of credit derivatives
(211
)
(592
)
Fair value gains (losses) on committed capital securities
(9
)
(10
)
Fair value gains (losses) on financial guaranty variable interest entities
157

70

Other income (loss)
21

(14
)
Total revenues
195

(176
)
Expenses
Loss and loss adjustment expenses
41

(48
)
Amortization of deferred acquisition costs
5

3

Interest expense
20

21

Other operating expenses
60

60

Total expenses
126

36

Income (loss) before income taxes
69

(212
)
Provision (benefit) for income taxes
Current
21

55

Deferred
6

(123
)
Total provision (benefit) for income taxes
27

(68
)
Net income (loss)
$
42

$
(144
)
Earnings per share:
Basic
$
0.23

$
(0.74
)
Diluted
$
0.23

$
(0.74
)
Dividends per share
$
0.11

$
0.10

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

2

Assured Guaranty Ltd.

Consolidated Statements of Comprehensive Income (unaudited)
(in millions)
Three Months Ended March 31,
2014
2013
Net income (loss)
$
42

$
(144
)
Unrealized holding gains (losses) arising during the period on:
Investments with no other-than-temporary impairment, net of tax provision (benefit) of $41 and $(19)
94

(50
)
Investments with other-than-temporary impairment, net of tax provision (benefit) of $3 and $(8)
8

(16
)
Unrealized holding gains (losses) arising during the period, net of tax
102

(66
)
Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $(1) and $(2)
(2
)
(3
)
Change in net unrealized gains on investments
104

(63
)
Other, net of tax provision
0

(5
)
Other comprehensive income (loss)
$
104

$
(68
)
Comprehensive income (loss)
$
146

$
(212
)
The accompanying notes are an integral part of these consolidated financial statements.

3

Assured Guaranty Ltd.

Consolidated Statement of Shareholders’ Equity (unaudited)
For the Three Months Ended March 31, 2014
(dollars in millions, except share data)

Common Shares Outstanding
Common Stock Par Value
Additional
Paid-in
Capital
Retained Earnings
Accumulated
Other
Comprehensive Income
Deferred
Equity Compensation
Total
Shareholders’ Equity
Balance at December 31, 2013
182,177,866

$
2

$
2,466

$
2,482

$
160

$
5

$
5,115

Net income
—

—

—

42

—

—

42

Dividends ($0.11 per share)
—

—

—

(20
)
—

—

(20
)
Common stock repurchases
(1,350,443
)
0

(35
)
—

—

—

(35
)
Share-based compensation and other
331,285

0

3

—

—

—

3

Other comprehensive income
—

—

—

—

104

—

104

Balance at March 31, 2014
181,158,708

$
2

$
2,434

$
2,504

$
264

$
5

$
5,209

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

4

Assured Guaranty Ltd.

Consolidated Statements of Cash Flows (unaudited)
(in millions)
Three Months Ended March 31,
2014
2013
Net cash flows provided by (used in) operating activities
$
101

$
(14
)
Investing activities


Fixed-maturity securities:


Purchases
(517
)
(510
)
Sales
155

183

Maturities
148

283

Net sales (purchases) of short-term investments
184

88

Proceeds from paydowns on financial guaranty variable interest entities’ assets
286

138

Other
19

55

Net cash flows provided by (used in) investing activities
275

237

Financing activities


Dividends paid
(20
)
(19
)
Repurchases of common stock
(35
)
(39
)
Share activity under option and incentive plans
0

(2
)
Paydowns of financial guaranty variable interest entities’ liabilities
(281
)
(167
)
Repayment of long-term debt
(6
)
(6
)
Net cash flows provided by (used in) financing activities
(342
)
(233
)
Effect of exchange rate changes
1

(3
)
Increase (decrease) in cash
35

(13
)
Cash at beginning of period
184

138

Cash at end of period
$
219

$
125

Supplemental cash flow information


Cash paid (received) during the period for:


Income taxes
$
37

$
32

Interest
$
8

$
9

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

5

Assured Guaranty Ltd.

Notes to Consolidated Financial Statements (unaudited)
March 31, 2014

1.
Business and Basis of Presentation
Business
Assured Guaranty Ltd. (“AGL” and, together with its subsidiaries, “Assured Guaranty” or the “Company”) is a Bermuda-based holding company that provides, through its operating subsidiaries, credit protection products to the United States (“U.S.”) and international public finance (including infrastructure) and structured finance markets. The Company applies its credit underwriting judgment, risk management skills and capital markets experience to offer 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. Obligations insured by the Company include bonds issued by U.S. state or municipal governmental authorities; notes issued to finance international infrastructure projects; and asset-backed securities issued by special purpose entities. 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"). The Company also guarantees obligations issued in other countries and regions, including Australia and Western Europe.

In the past, the Company had sold credit protection by issuing policies that guaranteed payment obligations under credit derivatives, primarily credit default swaps ("CDS"). Financial guaranty contracts accounted for as credit derivatives are generally structured such that the circumstances giving rise to the Company’s obligation to make loss payments are similar to those for financial guaranty insurance contracts. The Company’s credit derivative transactions are governed by International Swaps and Derivative Association, Inc. (“ISDA”) documentation. The Company has not entered into any new CDS in order to sell credit protection since the beginning of 2009, when regulatory guidelines were issued that limited the terms under which such protection could be sold. The capital and margin requirements applicable under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) also contributed to the Company not entering into such new CDS since 2009. The Company actively pursues opportunities to terminate existing CDS, which have the effect of reducing future fair value volatility in income and/or reducing rating agency capital charges.

Basis of Presentation
The unaudited interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and, in the opinion of management, reflect all adjustments that are of a normal recurring nature, necessary for a fair statement of the financial condition, results of operations and cash flows of the Company and its consolidated financial guaranty variable interest entities (“FG VIEs”) for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These unaudited interim consolidated financial statements are as of March 31, 2014 and cover the three-month period ended March 31, 2014 (" First Quarter 2014 ") and the three-month period ended March 31, 2013 (" First Quarter 2013 "). Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but is not required for interim reporting purposes, has been condensed or omitted. The year-end balance sheet data was derived from audited financial statements.
The unaudited interim consolidated financial statements include the accounts of AGL, its direct and indirect subsidiaries (collectively, the “Subsidiaries”) and its consolidated FG VIEs. Intercompany accounts and transactions between and among all consolidated entities have been eliminated. Certain prior year balances have been reclassified to conform to the current year’s presentation.
These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements included in AGL’s Annual Report on Form 10-K for the year ended December 31, 2013 , filed with the U.S. Securities and Exchange Commission (the “SEC”).


6

The Company's principal insurance company subsidiaries are:

•
Assured Guaranty Municipal Corp. ("AGM"), domiciled in New York;
•
Municipal Assurance Corp. ("MAC"), domiciled in New York;
•
Assured Guaranty Corp. ("AGC"), domiciled in Maryland;
•
Assured Guaranty (Europe) Ltd. ("AGE"), organized in the United Kingdom; and
•
Assured Guaranty Re Ltd. (“AG Re”), 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 15, Long Term Debt and Credit Facilities.

2.
Rating Actions and Quarterly Developments
Rating Actions
On March 18, 2014, Standard & Poor's Ratings Services ("S&P") upgraded the financial strength ratings of all of AGL's insurance subsidiaries to AA (stable outlook) from AA- (stable outlook). The most recent rating action of Moody's Investors Service, Inc. ("Moody's") was on February 10, 2014, when it affirmed the financial strength ratings of AGM, AGC and AG Re, and affirmed the outlooks on AGM's and AGC's ratings at stable but changed the outlook on AG Re's rating to negative. Kroll Bond Rating Agency's most recent action was to assign a financial strength rating of AA+ (stable outlook) to MAC on July 22, 2013. In the last several years, S&P and Moody's have changed, multiple times, their financial strength ratings of the Company's insurance subsidiaries, or changed the outlook on such ratings. There can be no assurance that the rating agencies will not take negative action on the Company’s financial strength ratings in the future.

When a rating agency assigns a public rating to a financial obligation guaranteed by one of AGL’s insurance company subsidiaries, it generally awards that obligation the same rating it has assigned to the financial strength of the AGL subsidiary that provides the guaranty. Investors in products insured by AGL’s insurance company subsidiaries frequently rely on ratings published by nationally recognized statistical rating organizations (“NRSROs”) because such ratings influence the trading value of securities and form the basis for many institutions’ investment guidelines as well as individuals’ bond purchase decisions. Therefore, the Company manages its business with the goal of achieving high financial strength ratings. However, the methodologies and models used by NRSROs differ, presenting conflicting goals that may make it inefficient or impractical to reach the highest rating level. The methodologies and models are not fully transparent, contain subjective elements and data (such as assumptions about future market demand for the Company’s products) and change frequently. Ratings are subject to continuous review and revision or withdrawal at any time. If the financial strength ratings of one (or more) of the Company’s insurance subsidiaries were reduced below current levels, the Company expects it could have adverse effects on the impacted subsidiary's future business opportunities as well as the premiums the impacted subsidiary could charge for its insurance policies. For a discussion of other effects of rating actions on the Company, see the following:

•
Note 5, Expected Loss to be Paid
•
Note 8, Financial Guaranty Contracts Accounted for as Credit Derivatives
•
Note 13, Reinsurance and Other Monoline Exposures
•
Note 15, Long Term Debt and Credit Facilities (regarding the impact on the Company's insured leveraged lease transactions)
Quarterly Developments

•
Repurchase of Common Shares: The Company repurchased approximately 1.4 million common shares in First Quarter 2014. See Note 17, Shareholders' Equity, for more information.

•
Reinsurance: The Company entered into commutation agreements to reassume previously ceded business. See Note 13, Reinsurance and Other Monoline Exposures.

3.
Outstanding Exposure
The Company’s financial guaranty contracts are written in either insurance or credit derivative form, but collectively are considered financial guaranty contracts. The Company seeks to limit its exposure to losses by underwriting obligations that are investment grade at inception, diversifying its insured portfolio and maintaining rigorous subordination or collateralization requirements on structured finance obligations. The Company also has utilized reinsurance by ceding business to third-party

7

reinsurers. The Company provides financial guaranties with respect to debt obligations of special purpose entities, including variable interest entities ("VIEs"). Some of these VIEs are consolidated as described in Note 9, Consolidated Variable Interest Entities. The outstanding par and Debt Service amounts presented below include outstanding exposures on VIEs whether or not they are consolidated.

The Company has issued financial guaranty insurance policies on public finance obligations and structured finance obligations. Public finance obligations insured by the Company consist primarily of general obligation bonds supported by the taxing powers of U.S. state or municipal governmental authorities, as well as tax-supported bonds, revenue bonds and other obligations supported by covenants from state or municipal governmental authorities or other municipal obligors to impose and collect fees and charges for public services or specific infrastructure projects. The Company also includes within public finance obligations those obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including utilities, toll roads, health care facilities and government office buildings. Structured finance obligations insured by the Company are generally issued by special purpose entities and backed by pools of assets having an ascertainable cash flow or market value or other specialized financial obligations.
Surveillance Categories
The Company segregates its insured portfolio into investment grade and below-investment-grade ("BIG") surveillance categories to facilitate the appropriate allocation of resources to monitoring and loss mitigation efforts and to aid in establishing the appropriate cycle for periodic review for each exposure. BIG exposures include all exposures with internal credit ratings below BBB-. The Company’s internal credit ratings are based on internal assessments of the likelihood of default and loss severity in the event of default. Internal credit ratings are expressed on a ratings scale similar to that used by the rating agencies and are generally reflective of an approach similar to that employed by the rating agencies, except that the Company's internal credit ratings focus on future performance rather than lifetime performance.
The Company monitors its investment grade credits to determine whether any new credits need to be internally downgraded to BIG. The Company refreshes its internal credit ratings on individual credits in quarterly, semi-annual or annual cycles based on the Company’s view of the credit’s quality, loss potential, volatility and sector. Ratings on credits in sectors identified as under the most stress or with the most potential volatility are reviewed every quarter. The Company’s credit ratings on assumed credits are based on the Company’s reviews of low-rated credits or credits in volatile sectors, unless such information is not available, in which case, the ceding company’s credit rating of the transactions are used. The Company models the performance of many of its structured finance transactions as part of its periodic internal credit rating review of them. The Company models most assumed residential mortgage-backed security ("RMBS") credits with par above $ 1 million , as well as certain RMBS credits below that amount.
Credits identified as BIG are subjected to further review to determine the probability of a loss. See Note 5, Expected Loss to be Paid, 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. For surveillance purposes, the Company calculates present value using a constant discount rate of 5% . (A risk-free rate is used for calculating the expected loss for financial statement purposes.)
More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly. The Company expects “future losses” on a transaction when the Company believes there is at least a 50% chance that, on a present value basis, it will pay more claims over the future of that transaction than it will have reimbursed. The three BIG categories are:
•
BIG Category 1: Below-investment-grade transactions showing sufficient deterioration to make future losses possible, but for which none are currently expected.
•
BIG Category 2: Below-investment-grade transactions for which future losses are expected but for which no claims (other than liquidity claims which is a claim that the Company expects to be reimbursed within one year) have yet been paid.
•
BIG Category 3: Below-investment-grade transactions for which future losses are expected and on which claims (other than liquidity claims) have been paid.


8

Components of Outstanding Exposure

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

Debt Service Outstanding

Gross Debt Service
Outstanding
Net Debt Service
Outstanding
March 31,
2014
December 31,
2013
March 31,
2014
December 31,
2013
(in millions)
Public finance
$
639,981

$
650,924

$
601,433

$
610,011

Structured finance
81,195

86,456

75,535

80,524

Total financial guaranty
$
721,176

$
737,380

$
676,968

$
690,535

In addition to the amounts shown in the table above, the Company’s net mortgage guaranty insurance debt service was approximately $ 153 million as of March 31, 2014. The net mortgage guaranty insurance in force constitutes assumed excess of loss business written between 2004 and 2006 and comprises $ 145 million covering loans originated in Ireland and $ 8 million covering loans originated in the U.K.

Financial Guaranty Portfolio by Internal Rating
As of March 31, 2014

Public Finance
U.S.
Public Finance
Non-U.S.
Structured Finance
U.S
Structured Finance
Non-U.S
Total
Rating
Category
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
(dollars in millions)
AAA
$
4,658

1.3
%
$
1,020

2.9
%
$
29,868

53.9
%
$
8,856

68.2
%
$
44,402

9.9
%
AA
104,577

30.2

427

1.2

9,396

17.0

570

4.4

114,970

25.6

A
187,433

54.1

9,595

27.6

2,340

4.2

661

5.1

200,029

44.4

BBB
40,783

11.8

22,173

63.7

3,496

6.3

1,829

14.1

68,281

15.2

BIG
8,977

2.6

1,611

4.6

10,293

18.6

1,062

8.2

21,943

4.9

Total net par outstanding (excluding loss mitigation bonds)
$
346,428

100.0
%
$
34,826

100.0
%
$
55,393

100.0
%
$
12,978

100.0
%
$
449,625

100.0
%
Loss Mitigation Bonds
32

—

1,204

—

1,236

Net Par Outstanding (including loss mitigation bonds)
$
346,460

$
34,826

$
56,597

$
12,978

$
450,861


9

Financial Guaranty Portfolio by Internal Rating
As of December 31, 2013

Public Finance
U.S.
Public Finance
Non-U.S.
Structured Finance
U.S
Structured Finance
Non-U.S
Total
Rating
Category
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
(dollars in millions)
AAA
$
4,998

1.4
%
$
1,016

3.0
%
$
32,317

54.9
%
$
9,684

69.1
%
$
48,015

10.5
%
AA
107,503

30.5

422

1.2

9,431

16.0

577

4.1

117,933

25.7

A
192,841

54.8

9,453

27.9

2,580

4.4

742

5.3

205,616

44.8

BBB
37,745

10.7

21,499

63.2

3,815

6.4

1,946

13.9

65,005

14.1

BIG
9,094

2.6

1,608

4.7

10,764

18.3

1,072

7.6

22,538

4.9

Total net par outstanding (excluding loss mitigation bonds)
$
352,181

100.0
%
$
33,998

100.0
%
$
58,907

100.0
%
$
14,021

100.0
%
$
459,107

100.0
%
Loss Mitigation Bonds
32

—

1,163

—

1,195

Net Par Outstanding (including loss mitigation bonds)
$
352,213

$
33,998

$
60,070

$
14,021

$
460,302

In accordance with the terms of certain credit derivative contracts, the referenced obligations in such contracts have been delivered to the Company and therefore are included in the investment portfolio. Such amounts are still included in the financial guaranty insured portfolio, and totaled $ 165 million and $ 195 million in gross par outstanding as of March 31, 2014 and December 31, 2013 , respectively.

In addition to amounts shown in the tables above, the Company had outstanding commitments to provide guaranties of $ 577 million for structured finance and $ 330 million for public finance obligations at March 31, 2014 . The structured finance commitments include the unfunded component of pooled corporate and other transactions. Public finance commitments typically relate to primary and secondary public finance debt issuances. The expiration dates for the public finance commitments range between April 15, 2014 and February 25, 2017 , with $ 206 million expiring prior to December 31, 2014. 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.


10

Components of BIG Portfolio
Components of BIG Net Par Outstanding
(Insurance and Credit Derivative Form)
As of March 31, 2014

BIG Net Par Outstanding
Net Par
BIG Net Par as
a % of Total Net Par
BIG 1
BIG 2
BIG 3
Total BIG
Outstanding
Outstanding
(in millions)
First lien U.S. RMBS:






Prime first lien
$
77

$
289

$
29

$
395

$
528

0.1
%
Alt-A first lien
703

787

1,223

2,713

3,478

0.6

Option ARM
66

59

440

565

877

0.1

Subprime
227

860

769

1,856

5,921

0.4

Second lien U.S. RMBS:






Closed-end second lien
8

19

116

143

239

0.0

Home equity lines of credit (“HELOCs”)
1,480

19

235

1,734

1,982

0.4

Total U.S. RMBS
2,561

2,033

2,812

7,406

13,025

1.6

Trust preferred securities (“TruPS”)
1,235

343

—

1,578

4,826

0.4

Other structured finance
1,348

304

719

2,371

50,520

0.5

U.S. public finance
8,117

419

441

8,977

346,428

2.0

Non-U.S. public finance
989

622

—

1,611

34,826

0.4

Total
$
14,250

$
3,721

$
3,972

$
21,943

$
449,625

4.9
%

Components of BIG Net Par Outstanding
(Insurance and Credit Derivative Form)
As of December 31, 2013

BIG Net Par Outstanding
Net Par
BIG Net Par as
a % of Total Net Par
BIG 1
BIG 2
BIG 3
Total BIG
Outstanding
Outstanding
(in millions)
First lien U.S. RMBS:






Prime first lien
$
52

$
321

$
30

$
403

$
541

0.1
%
Alt-A first lien
656

1,137

935

2,728

3,590

0.6

Option ARM
71

60

467

598

937

0.1

Subprime
297

908

740

1,945

6,130

0.4

Second lien U.S. RMBS:






Closed-end second lien
8

20

118

146

244

0.0

HELOCs
1,499

20

378

1,897

2,279

0.4

Total U.S. RMBS
2,583

2,466

2,668

7,717

13,721

1.6

TruPS
1,587

135

—

1,722

4,970

0.4

Other structured finance
1,367

309

721

2,397

54,237

0.5

U.S. public finance
8,205

440

449

9,094

352,181

2.0

Non-U.S. public finance
1,009

599

—

1,608

33,998

0.4

Total
$
14,751

$
3,949

$
3,838

$
22,538

$
459,107

4.9
%


11

BIG Net Par Outstanding
and Number of Risks
As of March 31, 2014

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
$
12,242

$
2,008

$
14,250

193

24

217

Category 2
2,253

1,468

3,721

80

21

101

Category 3
2,872

1,100

3,972

109

27

136

Total BIG
$
17,367

$
4,576

$
21,943

382

72

454


BIG Net Par Outstanding
and Number of Risks
As of December 31, 2013

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






Category 1
$
12,391

$
2,360

$
14,751

185

25

210

Category 2
2,323

1,626

3,949

80

21

101

Category 3
3,031

807

3,838

119

27

146

Total BIG
$
17,745

$
4,793

$
22,538

384

73

457

_____________________
(1) Includes net par outstanding for FG VIEs.
(2)
A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making Debt Service payments.
Direct Economic Exposure to the Selected European Countries

Several European countries continue to experience significant economic, fiscal and/or political strains such that the likelihood of default on obligations with a nexus to those countries may be higher than the Company anticipated when such factors did not exist. The European countries where the Company believes heightened uncertainties exist are: Hungary, Ireland, Italy, Portugal and Spain (collectively, the “Selected European Countries”). The Company is closely monitoring its exposures in the Selected European Countries where it believes heightened uncertainties exist. The Company’s economic exposure to the Selected European Countries (based on par for financial guaranty contracts and notional amount for financial guaranty contracts accounted for as derivatives) is shown in the following table, net of ceded reinsurance.

12

Net Direct Economic Exposure to Selected European Countries(1)
As of March 31, 2014

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






Non-infrastructure public finance (3)
$
—

$
—

$
1,026

$
98

$
274

$
1,398

Infrastructure finance
370

—

18

12

156

556

Sub-total
370

—

1,044

110

430

1,954

Non-sovereign exposure:






Regulated utilities
—

—

235

—

—

235

RMBS
217

145

312

—

—

674

Sub-total
217

145

547

—

—

909

Total
$
587

$
145

$
1,591

$
110

$
430

$
2,863

Total BIG
$
587

$
—

$
—

$
110

$
429

$
1,126

____________________
(1)
While the Company’s exposures are shown in U.S. dollars, the obligations the Company insures are in various currencies, including U.S. dollars and Euros. Included in the table above is $ 145 million of reinsurance assumed on a 2004 - 2006 pool of Irish residential mortgages that is part of the Company’s remaining legacy mortgage reinsurance business. One of the residential mortgage-backed securities included in the table above includes residential mortgages in both Italy and Germany, and only the portion of the transaction equal to the portion of the original mortgage pool in Italian mortgages is shown in the table.

(2)
See Note 5, Expected Loss to be Paid.

(3)
The exposure shown in the “Non-infrastructure public finance” category is from transactions backed by receivable payments from sub-sovereigns in Italy, Spain and Portugal. Sub-sovereign debt is debt issued by a governmental entity or government backed entity, or supported by such an entity, that is other than direct sovereign debt of the ultimate governing body of the country.
When the Company directly insures an obligation, it assigns the obligation to a geographic location or locations based on its view of the geographic location of the risk. For direct exposure this can be a relatively straight-forward determination as, for example, a debt issue supported by availability payments for a toll road in a particular country. The Company may also assign portions of a risk to more than one geographic location. The Company may also have direct exposures to the Selected European Countries in business assumed from unaffiliated monoline insurance companies. In the case of assumed business for direct exposures, the Company depends upon geographic information provided by the primary insurer.

The Company has excluded from the exposure tables above its indirect economic exposure to the Selected European Countries through policies it provides on (a) pooled corporate and (b) commercial receivables transactions. The Company considers economic exposure to a selected European Country to be indirect when the exposure relates to only a small portion of an insured transaction that otherwise is not related to a Selected European Country. The Company has reviewed transactions through which it believes it may have indirect exposure to the Selected European Countries that is material to the transaction and calculated total net indirect exposure to Selected European Counties in non-sovereign pooled corporate and non-sovereign commercial receivables to be $710 million and $89 million , respectively, based on the proportion of the insured par equal to the proportion of obligors identified as being domiciled in a Selected European Country.


13

Exposure to Puerto Rico
The Company insures general obligation bonds of the Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations aggregating $5.3 billion net par. The Company rates $5.1 billion net par of that amount BIG. The following table shows estimated amortization of the general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations insured and rated BIG 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. The column labeled “Estimated BIG Net Debt Service Amortization” shows the total amount of principal and interest due in the period indicated and represents the maximum net amount the Company would be required to pay on BIG Puerto Rico exposures in a given period, assuming the obligors paid nothing on all of those obligations in that period.
Amortization Schedule of BIG Net Par Outstanding
and BIG Net Debt Service Outstanding of Puerto Rico
As of March 31, 2014

Estimated BIG Net Par Amortization
Estimated BIG Net Debt Service Amortization
(in millions)
2014 (April 1 - June 30)
$
—

$
64

2014 (July 1 - September 30)
254

315

2014 (October 1 - December 31)
—

61

2015
364

601

2016
289

509

2017
208

415

2018
159

358

2019-2023
884

1,718

2024-2028
937

1,566

2029-2033
697

1,125

After 2033
1,281

1,574

Total
$
5,073

$
8,306


Recent announcements and actions by the Governor and his administration indicate officials of the Commonwealth are focused on measures to help Puerto Rico operate within its financial resources and maintain its access to the capital markets. All Puerto Rico credits insured by the Company are current on their debt service payments. Neither Puerto Rico nor its related authorities and public corporations are eligible debtors under Chapter 9 of the U.S. Bankruptcy Code. However, Puerto Rico faces high debt levels, a declining population and an economy that has been in recession since 2006. Puerto Rico has been operating with a structural budget deficit in recent years, and its two largest pension funds are significantly underfunded.

4.
Financial Guaranty Insurance Premiums

The portfolio of outstanding exposures discussed in Note 3, Outstanding Exposure, includes financial guaranty contracts that meet the definition of insurance contracts as well as those that meet the definition of a derivative under GAAP. Amounts presented in this note relate only to financial guaranty insurance contracts. See Note 8, Financial Guaranty Contracts Accounted for as Credit Derivatives for amounts that relate to CDS.


14

Net Earned Premiums
First Quarter
2014
2013
(in millions)
Scheduled net earned premiums
$
107

$
128

Acceleration of net earned premiums
19

113

Accretion of discount on net premiums receivable
6

7

Net earned premiums(1)
$
132

$
248

___________________
(1)
Excludes $17 million and $18 million for First Quarter 2014 and 2013, respectively, related to consolidated FG VIEs.

Components of Unearned Premium Reserve
As of March 31, 2014
As of December 31, 2013
Gross
Ceded
Net(1)
Gross
Ceded
Net(1)
(in millions)
Deferred premium revenue:
Financial guaranty insurance
$
4,567

$
472

$
4,095

$
4,647

$
470

$
4,177

Other
5

—

5

5

—

5

Deferred premium revenue
$
4,572

$
472

$
4,100

$
4,652

$
470

$
4,182

Contra-paid
(68
)
(18
)
(50
)
(57
)
(18
)
(39
)
Unearned premium reserve
$
4,504

$
454

$
4,050

$
4,595

$
452

$
4,143

____________________
(1)
Excludes $ 137 million and $ 187 million of deferred premium revenue, and $49 million and $55 million of contra-paid related to FG VIEs as of March 31, 2014 and December 31, 2013 , respectively.
Gross Premium Receivable,
Net of Commissions on Assumed Business
Roll Forward
First Quarter
2014
2013
(in millions)
Beginning of period, December 31
$
876

$
1,005

Gross premium written, net of commissions on assumed business
33

17

Gross premiums received, net of commissions on assumed business
(53
)
(53
)
Adjustments:
Changes in the expected term
(3
)
1

Accretion of discount, net of commissions on assumed business
7

9

Foreign exchange translation
2

(23
)
Other adjustments
1

0

End of period, March 31 (1)
$
863

$
956

____________________
(1)
Excludes $ 18 million and $ 28 million as of March 31, 2014 and March 31, 2013, respectively, related to consolidated FG VIEs.
Gains or losses due to foreign exchange rate changes relate to installment premium receivables denominated in currencies other than the U.S. dollar. Approximately 49% and 48% of installment premiums at March 31, 2014 and December 31, 2013 respectively, are denominated in currencies other than the U.S. dollar, primarily the Euro and British Pound Sterling.

15

The timing and cumulative amount of actual collections may differ from expected collections in the tables below due to factors such as foreign exchange rate fluctuations, counterparty collectability issues, accelerations, commutations and changes in expected lives.
Expected Collections of
Gross Premiums Receivable,
Net of Commissions on Assumed Business
(Undiscounted)
As of
March 31, 2014
(in millions)
2014 (April 1 - June 30)
$
46

2014 (July 1 - September 30)
24

2014 (October 1 – December 31)
26

2015
95

2016
86

2017
79

2018
71

2019-2023
282

2024-2028
176

2029-2033
123

After 2033
130

Total(1)
$
1,138

____________________
(1)
Excludes expected cash collections on FG VIEs of $ 23 million .

Scheduled Net Earned Premiums

As of March 31, 2014
(in millions)
2014 (April 1 - June 30)
$
105

2014 (July 1 - September 30)
103

2014 (October 1–December 31)
99

2015
359

2016
335

2017
297

2018
271

2019 - 2023
1,058

2024 - 2028
676

2029 - 2033
412

After 2033
380

Total present value basis(1)
4,095

Discount
239

Total future value
$
4,334

____________________
(1)
Excludes scheduled net earned premiums on consolidated FG VIEs of $ 137 million .


16

Selected Information for Policies Paid in Installments

As of
March 31, 2014
As of
December 31, 2013
(dollars in millions)
Premiums receivable, net of commission payable
$
863

$
876

Gross deferred premium revenue
1,560

1,576

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

9.4


5.
Expected Loss to be Paid
The following table presents a roll forward of the present value of net expected loss to be paid for all contracts, whether accounted for as insurance, credit derivatives or FG VIEs, by sector, after the benefit for net expected recoveries for contractual breaches of representations and warranties ("R&W"). The Company used weighted average risk-free rates for U.S. dollar denominated obligations, which ranged from 0.0% to 3.97% as of March 31, 2014 and 0.0% to 4.44% as of December 31, 2013 .

Net Expected Loss to be Paid
After Net Expected Recoveries for Breaches of R&W
Roll Forward by Sector
First Quarter 2014
Net Expected
Loss to be
Paid as of
December 31, 2013(2)
Economic Loss
Development
(Paid)
Recovered
Losses(1)
Net Expected
Loss to be
Paid as of
March 31, 2014(2)
(in millions)
U.S. RMBS:




First lien:




Prime first lien
$
21

$
(3
)
$
—

$
18

Alt-A first lien
304

8

(4
)
308

Option ARM
(9
)
(15
)
(4
)
(28
)
Subprime
304

(7
)
(2
)
295

Total first lien
620

(17
)
(10
)
593

Second lien:




Closed-end second lien
(11
)
5

2

(4
)
HELOCs
(116
)
2

5

(109
)
Total second lien
(127
)
7

7

(113
)
Total U.S. RMBS
493

(10
)
(3
)
480

TruPS
51

(19
)
—

32

Other structured finance
120

19

(1
)
138

U.S. public finance
264

23

(6
)
281

Non-U.S public finance
57

—

—

57

Other insurance
(3
)
(1
)
—

(4
)
Total
$
982

$
12

$
(10
)
$
984



17

Net Expected Loss to be Paid
After Net Expected Recoveries for Breaches of R&W
Roll Forward by Sector
First Quarter 2013
Net Expected
Loss to be
Paid as of
December 31, 2012
Economic Loss
Development
(Paid)
Recovered
Losses(1)
Net Expected
Loss to be
Paid as of
March 31, 2013
(in millions)
U.S. RMBS:




First lien:




Prime first lien
$
6

$
6

$
(1
)
$
11

Alt-A first lien
315

9

(11
)
313

Option ARM
(131
)
(138
)
(58
)
(327
)
Subprime
242

25

(4
)
263

Total first lien
432

(98
)
(74
)
260

Second lien:
Closed-end second lien
(39
)
1

17

(21
)
HELOCs
(111
)
(3
)
(8
)
(122
)
Total second lien
(150
)
(2
)
9

(143
)
Total U.S. RMBS
282

(100
)
(65
)
117

TruPS
27

(3
)
(1
)
23

Other structured finance
312

(2
)
(3
)
307

U.S. public finance
7

7

(23
)
(9
)
Non-U.S public finance
52

10

—

62

Other insurance
(3
)
(10
)
—

(13
)
Total
$
677

$
(98
)
$
(92
)
$
487

____________________
(1)
Net of ceded paid losses, whether or not such amounts have been settled with reinsurers. Ceded paid losses are typically settled 45 days after the end of the reporting period. Such amounts are recorded in reinsurance recoverable on paid losses included in other assets.

(2)
Includes expected loss adjustment expenses ("LAE") to be paid for mitigating claim liabilities of $29 million as of March 31, 2014 and $34 million as of December 31, 2013. The Company paid $6 million and $13 million in LAE for First Quarter 2014 and 2013, respectively.


18

Net Expected Recoveries from
Breaches of R&W Rollforward
First Quarter 2014
Future Net
R&W Benefit as of
December 31, 2013
R&W Development
and Accretion of
Discount
During First Quarter 2014
R&W Recovered
During First Quarter 2014(1)
Future Net
R&W Benefit as of
March 31, 2014
(in millions)
U.S. RMBS:
First lien:
Prime first lien
$
4

$
(1
)
$
—

$
3

Alt-A first lien
274

3

(8
)
269

Option ARM
173

9

(30
)
152

Subprime
118

28

—

146

Total first lien
569

39

(38
)
570

Second lien:
Closed-end second lien
98

(3
)
—

95

HELOC
45

12

(1
)
56

Total second lien
143

9

(1
)
151

Total
$
712

$
48

$
(39
)
$
721

Net Expected Recoveries from
Breaches of R&W Rollforward
First Quarter 2013

Future Net
R&W Benefit as of
December 31, 2012
R&W Development
and Accretion of
Discount
During First Quarter 2013
R&W Recovered
During First Quarter 2013(1)
Future Net
R&W Benefit as of
March 31, 2013
(in millions)
U.S. RMBS:
First lien:
Prime first lien
$
4

$
—

$
—

$
4

Alt-A first lien
378

(8
)
(8
)
362

Option ARM
591

153

(54
)
690

Subprime
109

4

—

113

Total first lien
1,082

149

(62
)
1,169

Second lien:
Closed-end second lien
138

(9
)
(21
)
108

HELOC
150

17

(6
)
161

Total second lien
288

8

(27
)
269

Total
$
1,370

$
157

$
(89
)
$
1,438

____________________
(1)
Gross amounts recovered were $41 million and $92 million for First Quarter 2014 and 2013, respectively.



19

The following tables present the present value of net expected loss to be paid for all contracts by accounting model, by sector and after the benefit for estimated and contractual recoveries for breaches of R&W.

Net Expected Loss to be Paid
By Accounting Model
As of March 31, 2014
Financial
Guaranty
Insurance
FG VIEs(1)
Credit
Derivatives
Total
(in millions)
U.S. RMBS:




First lien:




Prime first lien
$
3

$
—

$
15

$
18

Alt-A first lien
212

19

77

308

Option ARM
(38
)
—

10

(28
)
Subprime
140

80

75

295

Total first lien
317

99

177

593

Second lien:




Closed-end second lien
(32
)
26

2

(4
)
HELOCs
(92
)
(17
)
—

(109
)
Total second lien
(124
)
9

2

(113
)
Total U.S. RMBS
193

108

179

480

TruPS
2

—

30

32

Other structured finance
176

—

(38
)
138

U.S. public finance
281

—

—

281

Non-U.S. public finance
56

—

1

57

Subtotal
$
708

$
108

$
172

988

Other
(4
)
Total
$
984



20

Net Expected Loss to be Paid
By Accounting Model
As of December 31, 2013

Financial
Guaranty
Insurance
FG VIEs(1)
Credit
Derivatives
Total
(in millions)
U.S. RMBS:
First lien:
Prime first lien
$
3

$
—

$
18

$
21

Alt-A first lien
199

31

74

304

Option ARM
(18
)
(2
)
11

(9
)
Subprime
149

81

74

304

Total first lien
333

110

177

620

Second Lien:




Closed-end second lien
(34
)
25

(2
)
(11
)
HELOCs
(41
)
(75
)
—

(116
)
Total second lien
(75
)
(50
)
(2
)
(127
)
Total U.S. RMBS
258

60

175

493

TruPS
3

—

48

51

Other structured finance
161

—

(41
)
120

U.S. public finance
264

—

—

264

Non-U.S. public finance
55

—

2

57

Subtotal
$
741

$
60

$
184

985

Other
(3
)
Total
$
982

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



21

The following tables present the net economic loss development for all contracts by accounting model, by sector and after the benefit for estimated and contractual recoveries for breaches of R&W.

Net Economic Loss Development
By Accounting Model
First Quarter 2014
Financial
Guaranty
Insurance
FG VIEs(1)
Credit
Derivatives(2)
Total
(in millions)
U.S. RMBS:
First lien:
Prime first lien
$
—

$
—

$
(3
)
$
(3
)
Alt-A first lien
19

(12
)
1

8

Option ARM
(16
)
1

—

(15
)
Subprime
(8
)
(2
)
3

(7
)
Total first lien
(5
)
(13
)
1

(17
)
Second lien:




Closed-end second lien
(1
)
2

4

5

HELOCs
(56
)
58

—

2

Total second lien
(57
)
60

4

7

Total U.S. RMBS
(62
)
47

5

(10
)
TruPS
(1
)
—

(18
)
(19
)
Other structured finance
17

—

2

19

U.S. public finance
23

—

—

23

Non-U.S. public finance
—

—

—

—

Subtotal
$
(23
)
$
47

$
(11
)
13

Other
(1
)
Total
$
12



22

Net Economic Loss Development
By Accounting Model
First Quarter 2013

Financial
Guaranty
Insurance
FG VIEs(1)
Credit
Derivatives(2)
Total
(in millions)
U.S. RMBS:
First lien:
Prime first lien
$
—

$
—

$
6

$
6

Alt-A first lien
5

(1
)
5

9

Option ARM
(93
)
(37
)
(8
)
(138
)
Subprime
12

4

9

25

Total first lien
(76
)
(34
)
12

(98
)
Second lien:




Closed-end second lien
5

(3
)
(1
)
1

HELOCs
(7
)
4

—

(3
)
Total second lien
(2
)
1

(1
)
(2
)
Total U.S. RMBS
(78
)
(33
)
11

(100
)
TruPS
0

—

(3
)
(3
)
Other structured finance
(10
)
—

8

(2
)
U.S. public finance
7

—

—

7

Non-U.S. public finance
9

—

1

10

Subtotal
$
(72
)
$
(33
)
$
17

(88
)
Other
(10
)
Total
$
(98
)
_________________
(1)    Refer to Note 9, Consolidated Variable Interest Entities.

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


Approach to Projecting Losses in U.S. RMBS
The Company projects losses on its insured U.S. RMBS on a transaction-by-transaction basis by projecting the performance of the underlying pool of mortgages over time and then applying the structural features (i.e., payment priorities and tranching) of the RMBS to the projected performance of the collateral over time. The resulting projected claim payments or reimbursements are then discounted using risk-free rates. For transactions where the Company projects it will receive recoveries from providers of R&W, it projects the amount of recoveries and either establishes a recovery for claims already paid or reduces its projected claim payments accordingly.
The further behind a mortgage borrower falls in making payments, the more likely it is that he or she will default. The rate at which borrowers from a particular delinquency category (number of monthly payments behind) eventually default is referred to as the “liquidation rate.” The Company derives its liquidation rate assumptions from observed roll rates, which are the rates at which loans progress from one delinquency category to the next and eventually to default and liquidation. The Company applies liquidation rates to the mortgage loan collateral in each delinquency category and makes certain timing assumptions to project near-term mortgage collateral defaults from loans that are currently delinquent.
Mortgage borrowers that are not more than one payment behind (generally considered performing borrowers) have demonstrated an ability and willingness to pay throughout the recession and mortgage crisis, and as a result are viewed as less likely to default than delinquent borrowers. Performing borrowers that eventually default will also need to progress through

23

delinquency categories before any defaults occur. The Company projects how many of the currently performing loans will default and when they will default, by first converting the projected near term defaults of delinquent borrowers derived from liquidation rates into a vector of conditional default rates ("CDR"), then projecting how the conditional default rates will develop over time. Loans that are defaulted pursuant to the conditional default rate after the near-term liquidation of currently delinquent loans represent defaults of currently performing loans and projected re-performing loans. A conditional default rate is the outstanding principal amount of defaulted loans liquidated in the current month divided by the remaining outstanding amount of the whole pool of loans (or “collateral pool balance”). The collateral pool balance decreases over time as a result of scheduled principal payments, partial and whole principal prepayments, and defaults.
In order to derive collateral pool losses from the collateral pool defaults it has projected, the Company applies a loss severity. The loss severity is the amount of loss the transaction experiences on a defaulted loan after the application of net proceeds from the disposal of the underlying property. The Company projects loss severities by sector based on its experience to date. Further detail regarding the assumptions and variables the Company used to project collateral losses in its U.S. RMBS portfolio may be found below in the sections “U.S. First Lien RMBS Loss Projections: Alt-A First Lien, Option ARM, Subprime and Prime” and “U.S. Second Lien RMBS Loss Projections: HELOCs and Closed-End Second Lien” These variables are interrelated, difficult to predict and subject to considerable volatility. If actual experience differs from the Company’s assumptions, the losses incurred could be materially different from the estimate. The Company continues to update its evaluation of these exposures as new information becomes available.
The Company is in the process of enforcing claims for breaches of R&W regarding the characteristics of the loans included in the collateral pools. The Company calculates a credit from the RMBS issuer for such recoveries where the R&W were provided by an entity the Company believes to be financially viable and where the Company already has access or believes it will attain access to the underlying mortgage loan files. Where the Company has an agreement with an R&W provider (e.g., the Bank of America Agreement, the Deutsche Bank Agreement or the UBS Agreement) or where it is in advanced discussions on a potential agreement, that credit is based on the agreement or potential agreement. Where the Company does not have an agreement with the R&W provider but the Company believes the R&W provider to be economically viable, the Company estimates what portion of its past and projected future claims it believes will be reimbursed by that provider. Further detail regarding how the Company calculates these credits may be found under “Breaches of Representations and Warranties” below.
The Company projects the overall future cash flow from a collateral pool by adjusting the payment stream from the principal and interest contractually due on the underlying mortgages for (a) the collateral losses it projects as described above, (b) assumed voluntary prepayments and (c) servicer advances. The Company then applies an individual model of the structure of the transaction to the projected future cash flow from that transaction’s collateral pool to project the Company’s future claims and claim reimbursements for that individual transaction. Finally, the projected claims and reimbursements are discounted using risk-free rates. As noted above, the Company runs several sets of assumptions regarding mortgage collateral performance, or scenarios, and probability weights them.

The ultimate performance of the Company’s RMBS transactions remains highly uncertain, may differ from the Company's projections and may be subject to considerable volatility due to the influence of many factors, including the level and timing of loan defaults, changes in housing prices, results from the Company’s loss mitigation activities and other variables. The Company will continue to monitor the performance of its RMBS exposures and will adjust its RMBS loss projection assumptions and scenarios based on actual performance and management’s view of future performance.

First Quarter 2014 U.S. RMBS Loss Projections
The Company's RMBS loss projection methodology assumes that the housing and mortgage markets will continue improving. Each quarter the Company makes a judgment as to whether to change the assumptions it uses to make RMBS loss projections based on its observation during the quarter of the performance of its insured transactions (including early stage delinquencies, late stage delinquencies and, for first liens, loss severity) as well as the residential property market and economy in general. To the extent it observes changes, it makes a judgment as whether those changes are normal fluctuations or part of a trend. Based on such observations the Company chose to use the same general assumptions to project RMBS losses as of March 31, 2014 as it used as of December 31, 2013.


24

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 have been modified in the previous 12 months or are delinquent or in foreclosure or that have been foreclosed and so the RMBS issuer owns the underlying real estate). Changes in the amount of non-performing loans from the amount projected in the previous period are one of the primary drivers of loss development in this portfolio. In order to determine the number of defaults resulting from these delinquent and foreclosed loans, the Company applies a liquidation rate assumption to loans in each of various 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. The following table shows liquidation assumptions for various non-performing categories.
First Lien Liquidation Rates

March 31, 2014
December 31, 2013
Current Loans Modified in Previous 12 Months
Alt A and Prime
35%
35%
Option ARM
35
35
Subprime
35
35
30 – 59 Days Delinquent
Alt A and Prime
50
50
Option ARM
50
50
Subprime
45
45
60 – 89 Days Delinquent
Alt A and Prime
60
60
Option ARM
65
65
Subprime
50
50
90+ Days Delinquent
Alt A and Prime
75
75
Option ARM
70
70
Subprime
60
60
Bankruptcy
Alt A and Prime
60
60
Option ARM
60
60
Subprime
55
55
Foreclosure
Alt A and Prime
85
85
Option ARM
80
80
Subprime
70
70
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 within the last 12 months), it projects defaults on presently current loans by applying a CDR trend. The start of that CDR trend is based on the defaults the Company projects will emerge from currently nonperforming loans. The total amount of expected defaults from the non-performing loans is translated into a constant CDR ( i.e ., the CDR plateau), which, if applied for each of the next 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.

25

In the base case, after the initial 36 -month CDR plateau period, each transaction’s CDR is projected to improve over 12 months to an intermediate CDR (calculated as 20% of its CDR plateau); that intermediate CDR is held constant for 36 months and then trails off in steps to a final CDR of 5% of the CDR plateau. 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 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.
Another important driver of loss projections is loss severity, which is the amount of loss the transaction incurs on a loan after the application of net proceeds from the disposal of the underlying property. Loss severities experienced in first lien transactions have reached historic high levels, and the Company is assuming in the base case that these high levels generally will continue for another 18 months, except that in the case of subprime loans, the Company assumes the unprecedented 90% loss severity rate will continue for another nine months then drop to 80% for nine more months, in each case before following the ramp described below. The Company determines its initial loss severity based on actual recent experience. The Company’s initial loss severity assumptions for March 31, 2014 were the same as it used for December 31, 2013 . 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 of key assumptions used in the calculation of expected loss to be paid for individual transactions for direct vintage 2004 - 2008 first lien U.S. RMBS.
Key Assumptions in Base Case Expected Loss Estimates
First Lien RMBS(1)
As of
March 31, 2014
As of
December 31, 2013
Alt-A First Lien
Plateau CDR
2.3
%
–
18.4%
2.8
%
–
18.4%
Intermediate CDR
0.5
%
–
3.7%
0.6
%
–
3.7%
Period until intermediate CDR
48 months
48 months
Final CDR
0.1
%
–
0.9%
0.1
%
–
0.9%
Initial loss severity
65%
65%
Initial conditional prepayment rate ("CPR")
0.9
%
–
33.9%
0.0
%
–
34.2%
Final CPR
15%
15%
Option ARM
Plateau CDR
3.8
%
–
16.8%
4.9
%
–
16.8%
Intermediate CDR
0.8
%
–
3.4%
1.0
%
–
3.4%
Period until intermediate CDR
48 months
48 months
Final CDR
0.2
%
–
0.8%
0.2
%
–
0.8%
Initial loss severity
65%
65%
Initial CPR
0.8
%
–
12.2%
0.4
%
–
13.1%
Final CPR
15%
15%
Subprime
Plateau CDR
5.9
%
–
16.3%
5.6
%
–
16.2%
Intermediate CDR
1.2
%
–
3.3%
1.1
%
–
3.2%
Period until intermediate CDR
48 months
48 months
Final CDR
0.3
%
–
0.8%
0.3
%
–
0.8%
Initial loss severity
90%
90%
Initial CPR
0.0
%
–
11.6%
0.0
%
–
15.7%
Final CPR
15%
15%
____________________
(1) Represents variables for most heavily weighted scenario (the “base case”).

26

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 conditional default rate, the loss severity and the loan balance over time) as well as the amount of excess spread (the amount by which the interest paid by the borrowers on the underlying loan exceeds the amount of interest owed on the insured obligations). The assumption for the voluntarily CPR follows a similar pattern to that of the conditional default rate. The current level of voluntary prepayments is assumed to continue for the plateau period before gradually increasing over 12 months to the final CPR, which is assumed to be 15% in the base case. For transactions where the initial CPR is higher than the final CPR, the initial CPR is held constant. These assumptions are the same as those the Company used for December 31, 2013.
In estimating expected losses, the Company modeled and probability weighted sensitivities for first lien transactions by varying its assumptions of how fast a recovery is expected to occur. One of the variables used to model sensitivities was how quickly the conditional default rate returned to its modeled equilibrium, which was defined as 5% of the initial conditional default rate. The Company also stressed CPR and the speed of recovery of loss severity rates. The Company probability weighted a total of five scenarios (including its base case) as of March 31, 2014 . The Company used a similar approach to establish its pessimistic and optimistic scenarios as of March 31, 2014 as it used as of December 31, 2013 , increasing and decreasing the periods of stress from those used in the base case. In a somewhat more stressful environment than that of the base case, where the conditional default rate plateau was extended six months (to be 42 months long) before the same more gradual conditional default rate recovery and loss severities were assumed to recover over 4.5 rather than 2.5 years (and subprime loss severities were assumed to recover only to 60% ), expected loss to be paid would increase from current projections by approximately $39 million for Alt-A first liens, $ 13 million for Option ARM, $93 million for subprime and $ 4 million for prime transactions.

In an even more stressful scenario where loss severities were assumed to rise and then recover over nine years and the initial ramp-down of the conditional default rate was assumed to occur over 15 months and other assumptions were the same as the other stress scenario, expected loss to be paid would increase from current projections by approximately $104 million for Alt-A first liens, $ 31 million for Option ARM, $138 million for subprime and $ 11 million for prime transactions. The Company also considered two scenarios where the recovery was faster than in its base case. In a scenario with a somewhat less stressful environment than the base case, where conditional default rate recovery was somewhat less gradual and the initial subprime loss severity rate was assumed to be 80% for 18 months and was assumed to recover to 40% over 2.5 years, expected loss to be paid would increase from current projections by approximately $1 million for Alt-A first lien and would decrease by $ 10 million for Option ARM, $25 million for subprime and $ 1 million for prime transactions. In an even less stressful scenario where the conditional default rate plateau was six months shorter ( 30 months, effectively assuming that liquidation rates would improve) and the conditional default rate recovery was more pronounced, (including an initial ramp-down of the conditional default rate over nine months), expected loss to be paid would decrease from current projections by approximately $36 million for Alt-A first lien, $ 28 million for Option ARM, $78 million for subprime and $ 4 million for prime transactions.

U.S. Second Lien RMBS Loss Projections: HELOCs and Closed-End Second Lien
The Company believes the primary variable affecting its expected losses in second lien RMBS transactions is the amount and timing of future losses in the collateral pool supporting the transactions. Expected losses are also a function of the structure of the transaction; the voluntary prepayment rate (typically also referred to as CPR of the collateral); the interest rate environment; and assumptions about the draw rate and loss severity.
The following table shows the range of key assumptions for the calculation of expected loss to be paid for individual transactions for direct vintage 2004 - 2008 second lien U.S. RMBS.

27

Key Assumptions in Base Case Expected Loss Estimates
Second Lien RMBS(1)

HELOC key assumptions
As of
March 31, 2014
As of
December 31, 2013
Plateau CDR
1.9
%
–
7.3%
2.3
%
–
7.7%
Final CDR trended down to
0.4
%
–
3.2%
0.4
%
–
3.2%
Period until final CDR
34 months
34 months
Initial CPR
2.3
%
–
21.0%
2.7
%
–
21.5%
Final CPR
10%
10%
Loss severity
98%
98%
Closed-end second lien key assumptions
As of
March 31, 2014
As of
December 31, 2013
Plateau CDR
6.7
%
–
15.5%
7.3
%
–
15.1%
Final CDR trended down to
3.5
%
–
9.1%
3.5
%
–
9.1%
Period until final CDR
34 months
34 months
Initial CPR
2.9
%
–
12.8%
3.1
%
–
12.0%
Final CPR
10%
10%
Loss severity
98%
98%
____________________
(1)
Represents variables for most heavily weighted scenario (the “base case”).
In second lien transactions the projection of near-term defaults from currently delinquent loans is relatively straightforward because loans in second lien transactions are generally “charged off” (treated as defaulted) by the securitization’s servicer once the loan is 180 days past due. Most second lien transactions report the amount of loans in five monthly delinquency categories ( i.e. , 30 - 59 days past due, 60 - 89 days past due, 90 - 119 days past due, 120 - 149 days past due and 150 - 179 days past due). The Company estimates the amount of loans that will default over the next five months by calculating current representative liquidation rates (the percent of loans in a given delinquency status that are assumed to ultimately default) from selected representative transactions and then applying an average of the preceding twelve months’ liquidation rates to the amount of loans in the delinquency categories. The amount of loans projected to default in the first through fifth months is expressed as a CDR. The first four months’ CDR is calculated by applying the liquidation rates to the current period past due balances (i.e., the 150 - 179 day balance is liquidated in the first projected month, the 120 - 149 day balance is liquidated in the second projected month, the 90 - 119 day balance is liquidated in the third projected month and the 60 - 89 day balance is liquidated in the fourth projected month). For the fifth month the CDR is calculated using the average 30 - 59 day past due balances for the prior three months, adjusted as necessary to reflect one-time service events. The fifth month CDR is then used as the basis for the plateau period that follows the embedded five months of losses.
As of March 31, 2014 , for the base case scenario, the CDR (the “plateau CDR”) was held constant for one month. Once the plateau period has ended, the CDR is assumed to gradually trend down in uniform increments to its final long-term steady state CDR. (The long-term steady state CDR is calculated as the constant CDR that would have yielded the amount of losses originally expected at underwriting.) In the base case scenario, the time over which the CDR trends down to its final CDR is 28 months. Therefore, the total stress period for second lien transactions is 34 months, comprising five months of delinquent data, a one month plateau period and 28 months of decrease to the steady state CDR. When a second lien loan defaults, there is generally a very low recovery. Based on current expectations of future performance, the Company assumes that it will only recover 2% of the collateral, the same as of December 31, 2013 .
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, the current CPR (based on experience of the most recent three quarters) is assumed to continue until the end of the plateau before gradually increasing to the final CPR over the same period the CDR decreases. For transactions where the initial CPR is higher than the final CPR, the initial CPR is held constant. The final CPR is assumed to be 10% for both HELOC and closed-end second lien transactions. This level is much higher than current rates for most transactions, but lower than the historical average, which reflects the Company’s continued uncertainty about the projected performance of the borrowers in these transactions. This pattern is consistent with how the Company modeled the

28

CPR at December 31, 2013 . To the extent that prepayments differ from projected levels it could materially change the Company’s projected excess spread and losses.
The Company uses a number of other variables in its second lien loss projections, including the spread between relevant interest rate indices, the loss severity, and HELOC draw rates (the amount of new advances provided on existing HELOCs expressed as a percentage of current outstanding advances). These variables have been relatively stable over the past several quarters and in the relevant ranges have less impact on the projection results than the variables discussed above. However, in a number of HELOC transactions the servicers have been modifying poorly performing loans from floating to fixed rates, and rising interest rates would negatively impact the excess spread available from these modified loans to support the transactions. In a number of HELOC transactions the servicers have been modifying poorly performing loans from floating to fixed rates, and as a result, rising interest rates would negatively impact the available excess spread available from these modified loans.  The Company incorporated these modifications in its assumptions.

In estimating expected losses, the Company modeled and probability weighted three possible CDR curves applicable to the period preceding the return to the long-term steady state CDR. The Company believes that the level of the elevated CDR and the length of time it will persist is the primary driver behind the likely amount of losses the collateral will suffer. The Company continues to evaluate the assumptions affecting its modeling results.
As of March 31, 2014 , the Company’s base case assumed a one month CDR plateau and a 28 month ramp-down (for a total stress period of 34 months). The Company also modeled a scenario with a longer period of elevated defaults and another with a shorter period of elevated defaults and weighted them the same as of December 31, 2013 . Increasing the CDR plateau to four months and increasing the ramp-down by five months to 33 months (for a total stress period of 42 months) would increase the expected loss by approximately $24 million for HELOC transactions and $2 million for closed-end second lien transactions. On the other hand, keeping the CDR plateau at one month but decreasing the length of the CDR ramp-down to 18 months (for a total stress period of 24 months) would decrease the expected loss by approximately $22 million for HELOC transactions and $2 million for closed-end second lien transactions.

Breaches of Representations and Warranties

Generally, when mortgage loans are transferred into a securitization, the loan originator(s) and/or sponsor(s) provide R&W that the loans meet certain characteristics, and a breach of such R&W often requires that the loan be repurchased from the securitization. In many of the transactions the Company insures, it is in a position to enforce these R&W provisions. Soon after the Company observed the deterioration in the performance of its insured RMBS following the deterioration of the residential mortgage and property markets, the Company began using internal resources as well as third party forensic underwriting firms and legal firms to pursue breaches of R&W on a loan-by-loan basis. Where a provider of R&W refused to honor its repurchase obligations, the Company sometimes chose to initiate litigation. See “Recovery Litigation” below. The Company's success in pursuing these strategies permitted the Company to enter into agreements with R&W providers under which those providers made payments to the Company, agreed to make payments to the Company in the future, and / or repurchased loans from the transactions, all in return for releases of related liability by the Company. Such agreements provide the Company with many of the benefits of pursuing the R&W claims on a loan by loan basis or through litigation, but without the related expense and uncertainty. The Company continues to pursue these strategies against R&W providers with which it does not yet have agreements.

Using these strategies, through March 31, 2014 the Company has caused entities providing R&Ws to pay or agree to pay approximately $3.7 billion (gross of reinsurance) in respect of their R&W liabilities for transactions in which the Company has provided insurance.
(in millions)
Agreement amounts already received
$
2,716

Agreement amounts projected to be received in the future
402

Repurchase amounts paid into the relevant RMBS prior to settlement (1)
579

Total R&W payments, gross of reinsurance
$
3,697

____________________
(1)
These amounts were paid into the relevant RMBS transactions (rather than to the Company as in most settlements) and distributed in accordance with the priority of payments set out in the relevant transaction documents. Because the Company may insure only a portion of the capital structure of a transaction, such payments will not necessarily directly benefit the Company dollar-for-dollar, especially in first lien transactions.

29


Based on this success, the Company has included in its net expected loss estimates as of March 31, 2014 an estimated net benefit related to breaches of R&W of $721 million , which includes $384 million from agreements with R&W providers and $337 million in transactions where the Company does not yet have such an agreement, all net of reinsurance.
Representations and Warranties Agreements (1)

Agreement Date
Current Net Par Covered
Receipts to March 31, 2014 (net of reinsurance)
Estimated Future Receipts (net of reinsurance)
Eligible Assets Held in Trust (gross of reinsurance)
(in millions)
Bank of America - First Lien
April 2011
$
1,023

$
490

$
195

$
585

Bank of America - Second Lien
April 2011
1,335

968

NA

NA

Deutsche Bank
May 2012 and October 2013
1,649

235

100

142

UBS
May 2013
778

410

33

147

Others
Various
1,019

394

56

NA

Total
$
5,804

$
2,497

$
384

$
874

____________________
(1)
This table relates to past and projected future recoveries under R&W and related agreements. Excluded from this table is the $337 million of future net recoveries the Company projects receiving from R&W counterparties in transactions with $1,379 million of net par outstanding as of March 31, 2014 not covered by current agreements. Also excluded from this table is $773 million of net par partially covered by agreements but for which the Company projects receiving additional amounts.

The Company's agreements with the counterparties specifically named in the table above required an initial payment to the Company to reimburse it for past claims as well as an obligation to reimburse it for a portion of future claims. The named counterparties placed eligible assets in trust to collateralize their future reimbursement obligations, and the amount of collateral they are required to post may be increased or decreased from time to time as determined by rating agency requirements. Reimbursement payments under these agreements are made either monthly or quarterly and have been made timely. With respect to the reimbursement for future claims:

•
Bank of America . Under the Company's agreement with Bank of America Corporation and certain of its subsidiaries (“Bank of America”), Bank of America agreed to reimburse the Company for 80% of claims on the first lien transactions covered by the agreement that the Company pays in the future, until the aggregate lifetime collateral losses (not insurance losses or claims) on those transactions reach $6.6 billion . As of March 31, 2014 aggregate lifetime collateral losses on those transactions was $3.9 billion , and the Company was projecting in its base case that such collateral losses would eventually reach $5.1 billion .

•
Deutsche Bank . Under the Company's May 2012 agreement with Deutsche Bank AG and certain of its affiliates (collectively, “Deutsche Bank”), Deutsche Bank agreed to reimburse the Company for certain claims it pays in the future on eight first and second lien transactions, including 80% of claims it pays on those transactions until the aggregate lifetime claims (before reimbursement) reach $319 million . As of March 31, 2014 , the Company was projecting in its base case that such aggregate lifetime claims would remain below $319 million . In the event aggregate lifetime claims paid exceed $389 million , Deutsche Bank must reimburse Assured Guaranty for 85% of such claims paid (in excess of $389 million ) until such claims paid reach $600 million .

The agreement also requires Deutsche Bank to reimburse AGC for future claims it pays on certain RMBS re-securitizations. The amount available for reimbursement of claim payments is based on a percentage of the losses that occur in certain uninsured tranches (“Uninsured Tranches”) within the eight transactions described above: 60% of losses on the Uninsured Tranches (up to $141 million of losses), 60% of such losses (for losses between $161 million and $185 million ), and 100% of such losses (for losses from $185 million to $248 million ). Losses on the Uninsured Tranches from $141 million to $161 million and above $248 million are not included in the calculation of AGC's reimbursement amount for re-securitization claim payments. As of March 31, 2014 , the Company was projecting in its base case that losses on the Uninsured Tranches would be $153 million . Pursuant to the CDS termination on October 10, 2013 described below, a portion of Deutsche Bank's reimbursement obligation was applied to the terminated CDS. After giving effect to application of the portion of the reimbursement obligation to the terminated

30

CDS, as well as to reimbursements related to other covered RMBS re-securitizations, and based on the Company's base case projections for losses on the Uninsured Tranches, the Company expects that $24 million will be available to reimburse AGC for re-securitization claim payments on the remaining re-securitizations. Except for the reimbursement obligation based on losses occurring on the Uninsured Tranches and the termination agreed to described below, the agreement with Deutsche Bank does not cover transactions where the Company has provided protection to Deutsche Bank on RMBS transactions in CDS form.

On October 10, 2013, the Company and Deutsche Bank terminated one below investment grade transaction under which the Company had provided credit protection to Deutsche Bank through a CDS. The transaction had a net par outstanding of $294 million at the time of termination. In connection with the termination, Assured Guaranty agreed to release to Deutsche Bank $60 million of assets held in trust that was in excess of the amount of assets required to be held in trust for regulatory and rating agency capital relief.

•
UBS. On May 6, 2013, the Company entered into an agreement with UBS Real Estate Securities Inc. and affiliates ("UBS") and a third party resolving the Company’s claims and liabilities related to specified RMBS transactions that were issued, underwritten or sponsored by UBS and insured by AGM or AGC under financial guaranty insurance policies. Under the agreement, UBS agreed to reimburse the Company for 85% of future losses on three first lien RMBS transactions.
The Company calculated an expected recovery of $337 million from breaches of R&W in transactions not covered by agreements with $1,379 million of net par outstanding as of March 31, 2014 and $773 million of net par partially covered by agreements but for which the Company projects receiving additional amounts. The Company did not incorporate any gain contingencies from potential litigation in its estimated repurchases. The amount the Company will ultimately recover related to such contractual R&W is uncertain and subject to a number of factors including the counterparty's ability to pay, the number and loss amount of loans determined to have breached R&W and, potentially, negotiated settlements or litigation recoveries. As such, the Company's estimate of recoveries is uncertain and actual amounts realized may differ significantly from these estimates. In arriving at the expected recovery from breaches of R&W not already covered by agreements, the Company considered the creditworthiness of the provider of the R&W, the number of breaches found on defaulted loans, the success rate in resolving these breaches across those transactions where material repurchases have been made and the potential amount of time until the recovery is realized. The calculation of expected recovery from breaches of such contractual R&W involved a variety of scenarios which ranged from the Company recovering substantially all of the losses it incurred due to violations of R&W to the Company realizing limited recoveries. These scenarios were probability weighted in order to determine the recovery incorporated into the Company's estimate of expected losses. This approach was used for both loans that had already defaulted and those assumed to default in the future. The Company adjusts the calculation of its expected recovery from breaches of R&W based on changing facts and circumstances with respect to each counterparty and transaction.

The Company uses the same RMBS projection scenarios and weightings to project its future R&W benefit as it uses to project RMBS losses on its portfolio. To the extent the Company increases its loss projections, the R&W benefit (whether pursuant to an R&W agreement or not) generally will also increase, subject to the agreement limits and thresholds described above. Similarly, to the extent the Company decreases its loss projections, the R&W benefit (whether pursuant to an R&W agreement or not) generally will also decrease, subject to the agreement limits and thresholds described above.

The Company accounts for the loss sharing obligations under the R&W agreements on financial guaranty insurance contracts as subrogation, offsetting the losses it projects by an R&W benefit from the relevant party for the applicable portion of the projected loss amount. Proceeds projected to be reimbursed to the Company on transactions where the Company has already paid claims are viewed as a recovery on paid losses. For transactions where the Company has not already paid claims, projected recoveries reduce projected loss estimates. In either case, projected recoveries have no effect on the amount of the Company's exposure. See Notes 7, Fair Value Measurement and 9, Consolidated Variable Interest Entities.

31

U.S. RMBS Risks with R&W Benefit
Number of Risks (1) as of
Debt Service as of
March 31, 2014
December 31, 2013
March 31, 2014
December 31, 2013
(dollars in millions)
Prime first lien
1

1

$
36

$
38

Alt-A first lien
20

19

2,791

2,856

Option ARM
10

9

589

641

Subprime
5

5

985

998

Closed-end second lien
4

4

155

158

HELOC
5

4

141

320

Total
45

42

$
4,697

$
5,011

____________________
(1) A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making Debt Service payments. This table shows the full future Debt Service (not just the amount of Debt Service expected to be reimbursed) for risks with projected future R&W benefit, whether pursuant to an agreement or not.

The following table provides a breakdown of the development and accretion amount in the roll forward of estimated recoveries associated with alleged breaches of R&W.
Components of R&W Development
First Quarter
2014
2013
(in millions)
Change in recovery assumptions as the result of additional file review and recovery success
$
10

$
11

Estimated increase (decrease) in defaults that will result in additional (lower) breaches
0

1

Settlements and anticipated settlements
35

142

Accretion of discount on balance
3

3

Total
$
48

$
157

“XXX” Life Insurance Transactions
The Company’s $2.7 billion net par of XXX life insurance transactions as of March 31, 2014 include $598 million rated BIG. The BIG “XXX” life insurance reserve securitizations are based on discrete blocks of individual life insurance business. In each such transaction the monies raised by the sale of the bonds insured by the Company were used to capitalize a special purpose vehicle that provides reinsurance to a life insurer or reinsurer. The monies are invested at inception in accounts managed by third-party investment managers.
The BIG “XXX” life insurance transactions consist of two transactions, notes issued by each of Ballantyne Re p.l.c and Orkney Re II p.l.c. These transactions had material amounts of their assets invested in U.S. RMBS transactions. Based on its analysis of the information currently available, including estimates of future investment performance, and projected credit impairments on the invested assets and performance of the blocks of life insurance business at March 31, 2014 , the Company’s projected net expected loss to be paid is $85 million . The overall increase of approximately $12 million in expected loss to be paid during First Quarter 2014 is due primarily to changes in lapse assumptions on the underlying life insurance policies in the Ballantyne Re p.l.c transaction and a decrease in the risk free rates used to discount the losses.


32

Student Loan Transactions
The Company has insured or reinsured $2.8 billion net par of student loan securitizations, of which $1.9 billion was issued by private issuers and classified as asset-backed and $0.9 billion was issued by public authorities and classified as public finance. Of these amounts, $204 million and $251 million , respectively, are rated BIG. The Company is projecting approximately $68 million of net expected loss to be paid in these portfolios. In general, the losses are due to: (i) the poor credit performance of private student loan collateral and high loss severities, or (ii) high interest rates on auction rate securities with respect to which the auctions have failed. The largest of these losses was approximately $28 million and related to a transaction backed by a pool of private student loans assumed by AG Re from another monoline insurer. The guaranteed bonds were issued as auction rate securities that now bear a high rate of interest due to the downgrade of the primary insurer’s financial strength rating. Further, the underlying loan collateral has performed below expectations. The overall increase of $4 million in net expected loss during First Quarter 2014 is primarily due to a decrease in the risk free rates used to discount the losses along with some deterioration in collateral performance.
Trust Preferred Securities Collateralized Debt Obligations
The Company has insured or reinsured $4.8 billion of net par ( 71% of which is in CDS form) of collateralized debt obligations (“CDOs”) backed by TruPS and similar debt instruments, or “TruPS CDOs.” Of the $4.8 billion , $ 1.6 billion is rated BIG. The underlying collateral in the TruPS CDOs consists of subordinated debt instruments such as TruPS issued by bank holding companies and similar instruments issued by insurance companies, real estate investment trusts (“REITs”) and other real estate related issuers.
The Company projects losses for TruPS CDOs by projecting the performance of the asset pools across several scenarios (which it weights) and applying the CDO structures to the resulting cash flows. At March 31, 2014 , the Company has projected expected losses to be paid for TruPS CDOs of $32 million . The decrease of approximately $19 million in First Quarter 2014 was due primarily to improving collateral performance.

Selected U.S. Public Finance Transactions
The Company insures general obligation bonds of the Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations aggregating $5.3 billion net par. The Company rates $5.1 billion net par of that amount BIG. Information regarding the Company's exposure to general obligations of Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations, please refer "Puerto Rico Exposure" in Note 3, Outstanding Exposure.
Many U.S. municipalities and related entities continue to be under increased pressure, and a few have filed for protection under the U.S. Bankruptcy Code, entered into state processes designed to help municipalities in fiscal distress or otherwise indicated they may consider not meeting their obligations to make timely payments on their debts. Given some of these developments, and the circumstances surrounding each instance, the ultimate outcome cannot be certain and may lead to an increase in defaults on some of the Company's insured public finance obligations. The Company will continue to analyze developments in each of these matters closely. The municipalities whose obligations the Company has insured that have filed for protection under Chapter 9 of the U.S Bankruptcy Code and have not been resolved are: Detroit, Michigan and Stockton, California.

The Company has net par exposure to the City of Detroit, Michigan of $2.1 billion as of March 31, 2014 . On July 18, 2013, the City of Detroit filed for bankruptcy under Chapter 9 of the U.S. Bankruptcy Code. Most of the Company's net par exposure relates to $1.0 billion of sewer revenue bonds and $784 million of water revenue bonds, both of which the Company rates BBB. Both the sewer and water systems provide services to areas that extend beyond the city limits, and the bonds are secured by a lien on "special revenues." The Company also has net par exposure of $146 million to the City's general obligation bonds (which are secured by a pledge of the unlimited tax, full faith, credit and resources of the City and the specific ad valorem taxes approved by the voters solely to pay debt service on the general obligation bonds) and $175 million of the City's Certificates of Participation (which are unsecured unconditional contractual obligations of the City), both of which the Company rates BIG. On April 9, 2014, the City and the Company reached a tentative settlement with respect to the treatment of the unlimited tax general obligation bonds insured by the Company. The agreement provides for the confirmation of both the secured status of such general obligation bonds and the existence of a valid lien on the City’s pledged property tax revenues, a finding that such revenues constitute “special revenues” under the U.S. Bankruptcy Code, and the provision of additional security for such general obligation bonds in the form of a statutory lien on, and intercept of, the City’s distributable state aid. After giving effect to post-petition payments made by Assured Guaranty on such general obligation bonds, the settlement results in a minimum ultimate recovery of approximately 74% on such general obligation bonds, with the ability to

33

achieve a higher ultimate recovery rate over time if other debt creditors’ recoveries reach certain specified thresholds. The settlement is subject to a number of conditions, including confirmation of a plan of adjustment. The City has filed a proposed plan of adjustment and disclosure statement with the Bankruptcy Court, amended most recently on April 16, 2014.

On June 28, 2012, the City of Stockton, California filed for bankruptcy protection under Chapter 9 of the U.S. Bankruptcy Code. The Company's net exposure to the City's general fund is $119 million , consisting of pension obligation bonds. The Company also had exposure to lease obligation bonds; as of March 31, 2014, the Company owned all of such bonds and held them in its investment portfolio. As of March 31, 2014, the Company had paid $32 million in net claims. On October 3, 2013, the Company reached a tentative settlement with the City regarding the treatment of the bonds insured by the Company in the City's proposed plan of adjustment. Under the terms of the settlement, the Company will receive title to an office building, the ground lease of which secures the lease revenue bonds, and will also be entitled to certain fixed payments and certain variable payments contingent on the City's revenue growth. The settlement is subject to a number of conditions, including a sales tax increase (which was approved by voters on November 5, 2013), confirmation of a plan of adjustment that implements the terms of the settlement and definitive documentation. Pursuant to an order of the Bankruptcy Court, the City held a vote of its creditors on its proposed plan of adjustment; all but one of the classes polled voted to accept the plan. The court proceeding to determine whether to confirm the plan of adjustment is expected to begin in May 2014. The Company expects the plan to be confirmed and implemented during 2014.
The Company has $337 million of net par exposure to the Louisville Arena Authority. The bond proceeds were used to construct the KFC Yum Center, home to the University of Louisville men's and women's basketball teams. Actual revenues available for Debt Service are well below original projections, and under the Company's internal rating scale, the transaction is BIG.

The Company projects that its total future expected net loss across its troubled U.S. public finance credits as of March 31, 2014 will be $281 million . As of December 31, 2013 the Company was projecting a net expected loss of $264 million across its troubled U.S. public finance credits. The net increase of $17 million in expected loss was primarily attributable to negative developments with respect to the City of Detroit offset, in part, by the modest reduction in exposure to Puerto Rico.

Certain Selected European Country Transactions

The Company insures and reinsures credits with sub-sovereign exposure to various Spanish and Portuguese issuers where a Spanish and Portuguese sovereign default may cause the regions also to default. The Company's gross exposure to these Spanish and Portuguese credits is €435 million and €92 million , respectively and exposure net of reinsurance for Spanish and Portuguese credits is €312 million and €80 million , respectively. The Company rates most of these issuers in the BB category due to the financial condition of Spain and Portugal and their dependence on the sovereign. The Company's Hungary exposure is to infrastructure bonds dependent on payments from Hungarian governmental entities and covered mortgage bonds issued by Hungarian banks. The Company's gross exposure to these Hungarian credits is $623 million and its exposure net of reinsurance is $587 million , all of which all is rated BIG. The Company estimated net expected losses of $51 million related to these Spanish, Portuguese and Hungarian credits, which is largely unchanged from the amount reported as of December 31, 2013.
Manufactured Housing

The Company insures or reinsures a total of $248 million net par of securities backed by manufactured housing loans, of which $175 million is rated BIG. The Company has expected loss to be paid of $27 million as of March 31, 2014 , up from $26 million as of December 31, 2013, due primarily to the decrease in risk free rates used to discount losses.
Infrastructure Finance

The Company has insured exposure of approximately $3.0 billion to infrastructure transactions with refinancing risk as to which the Company may need to make claim payments that it did not anticipate paying when the policies were issued. Although the Company may not experience ultimate loss on a particular transaction, the aggregate amount of the claim payments may be substantial and reimbursement may not occur for an extended time, if at all. These transactions generally involve long-term infrastructure projects that were financed by bonds that mature prior to the expiration of the project concession. The Company expected the cash flows from these projects to be sufficient to repay all of the debt over the life of the project concession, but also expected the debt to be refinanced in the market at or prior to its maturity. Due to market conditions, the Company may have to pay a claim when the debt matures, and then recover its payment from cash flows produced by the project in the future. The Company generally projects that in most scenarios it will be fully reimbursed for

34

such payments. However, the recovery of the payments is uncertain and may take from 10 to 35 years, depending on the transaction and the performance of the underlying collateral. The Company estimates total claims for the remaining two largest transactions with significant refinancing risk, assuming no refinancing, and based on certain performance assumptions could be $1.8 billion on a gross basis; such claims would be payable from 2017 through 2022.
Recovery Litigation
RMBS Transactions
As of the date of this filing, AGM and AGC have lawsuits pending against providers of representations and warranties in U.S. RMBS transactions insured by them, seeking damages. In all the lawsuits, AGM and AGC have alleged breaches of R&W in respect of the underlying loans in the transactions, and failure to cure or repurchase defective loans identified by AGM and AGC to such persons.
•
Deutsche Bank : AGM has sued Deutsche Bank AG affiliates DB Structured Products, Inc. and ACE Securities Corp. in the Supreme Court of the State of New York on the ACE Securities Corp. Home Equity Loan Trust, Series 2006-GP1 second lien transaction.

•
Credit Suisse : AGM and AGC have sued DLJ Mortgage Capital, Inc. (“DLJ”) and Credit Suisse Securities (USA) LLC (“Credit Suisse”) on first lien U.S. RMBS transactions insured by them. Although DLJ and Credit Suisse successfully dismissed certain causes of action and claims for relief asserted in the complaint, the primary causes of action against DLJ for breach of R&W and breach of its repurchase obligations remained. On May 6, 2014, the Appellate Division, First Department unanimously reversed certain aspects of the partial dismissal by the Supreme Court of the State of New York of certain claims for relief by holding as a matter of law that AGM’s and AGC’s remedies for breach of R&W are not limited to the repurchase remedy. AGM and AGC had filed an amended complaint against DLJ and Credit Suisse (and added Credit Suisse First Boston Mortgage Securities Corp. as a defendant), asserting claims of fraud and material misrepresentation in the inducement of an insurance contract, in addition to their existing breach of contract claims. The defendants have filed a motion to dismiss certain aspects of the fraud claim against DLJ and Credit Suisse, all of the claims against Credit Suisse First Boston Mortgage Securities Corp., and AGM and AGC’s claims for compensatory damages in the form of all claims paid and to be paid by AGM and AGC. The motion to dismiss is currently pending.

On March 26, 2013, AGM filed a lawsuit against RBS Securities Inc., RBS Financial Products Inc. and Financial Asset Securities Corp. (collectively, “RBS”) in the United States District Court for the Southern District of New York on the Soundview Home Loan Trust 2007-WMC1 transaction. The complaint alleges that RBS made fraudulent misrepresentations to AGM regarding the quality of the underlying mortgage loans in the transaction and that RBS's misrepresentations induced AGM into issuing a financial guaranty insurance policy in respect of the Class II-A-1 certificates issued in the transaction. On July 19, 2013, AGM amended its complaint to add a claim under Section 3105 of the New York Insurance Law. On March 17, 2014, the court denied RBS' motion to dismiss AGM's fraudulent misrepresentation claims but granted its motion to dismiss the insurance law claim.

“XXX” Life Insurance Transactions
In December 2008, Assured Guaranty (UK) Ltd. (“AGUK”) filed an action against J.P. Morgan Investment Management Inc. (“JPMIM”), the investment manager in the Orkney Re II transaction, in the Supreme Court of the State of New York alleging that JPMIM engaged in breaches of fiduciary duty, gross negligence and breaches of contract based upon its handling of the investments of Orkney Re II. After AGUK’s claims were dismissed with prejudice in January 2010, AGUK was successful in its subsequent motions and appeals and, as of December 2011, all of AGUK’s claims for breaches of fiduciary duty, gross negligence and contract were reinstated in full. Separately, at the trial court level, discovery is ongoing.


35

6.    Financial Guaranty Insurance Losses

Insurance Contracts' Loss Information

The following table provides balance sheet information on loss and LAE reserves and salvage and subrogation recoverable, net of reinsurance.

Loss and LAE Reserve and Salvage and Subrogation Recoverable
Net of Reinsurance
Insurance Contracts
As of March 31, 2014
As of December 31, 2013
Loss and
LAE
Reserve, net
Salvage and
Subrogation
Recoverable, net
Net Reserve (Recoverable)
Loss and
LAE
Reserve, net
Salvage and
Subrogation
Recoverable, net
Net Reserve (Recoverable)
(in millions)
U.S. RMBS:






First lien:






Prime first lien
$
3

$
—

$
3

$
3

$
—

$
3

Alt-A first lien
112

—

112

108

—

108

Option ARM
19

57

(38
)
22

47

(25
)
Subprime
135

1

134

143

2

141

First lien
269

58

211

276

49

227

Second lien:






Closed-end second lien
5

43

(38
)
5

45

(40
)
HELOC
6

117

(111
)
5

127

(122
)
Second lien
11

160

(149
)
10

172

(162
)
Total U.S. RMBS
280

218

62

286

221

65

TruPS
1

—

1

2

—

2

Other structured finance
159

5

154

145

6

139

U.S. public finance
212

8

204

189

8

181

Non-U.S. public finance
36

—

36

35

—

35

Financial guaranty
688

231

457

657

235

422

Other
1

5

(4
)
2

5

(3
)
Subtotal
689

236

453

659

240

419

Effect of consolidating FG VIEs
(90
)
(17
)
(73
)
(103
)
(85
)
(18
)
Total (1)
$
599

$
219

$
380

$
556

$
155

$
401

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

36

The following table reconciles the reported gross and ceded reserve and salvage and subrogation amount to the financial guaranty net reserves (salvage) in the financial guaranty BIG transaction loss summary tables.
Components of Net Reserves (Salvage)
Insurance Contracts
As of
March 31, 2014
As of
December 31, 2013
(in millions)
Loss and LAE reserve
$
636

$
592

Reinsurance recoverable on unpaid losses
(37
)
(36
)
Loss and LAE reserve, net
599

556

Salvage and subrogation recoverable
(241
)
(174
)
Salvage and subrogation payable(1)
22

19

Salvage and subrogation recoverable, net
(219
)
(155
)
Subtotal
380

401

Other recoverables(2)
(17
)
(15
)
Net reserves (salvage)
363

386

Less: other (non-financial guaranty business)
(4
)
(3
)
Net reserves (salvage)
$
367

$
389

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

(2)
R&W recoverables recorded in other assets on the consolidated balance sheet.
Balance Sheet Classification of
Net Expected Recoveries for Breaches of R&W
Insurance Contracts
As of March 31, 2014
As of December 31, 2013
For all
Financial
Guaranty
Insurance
Contracts
Effect of
Consolidating
FG VIEs
Reported on
Balance Sheet(1)
For all
Financial
Guaranty
Insurance
Contracts
Effect of
Consolidating
FG VIEs
Reported on
Balance Sheet(1)
(in millions)
Salvage and subrogation recoverable, net
$
126

$
—

$
126

$
122

$
(49
)
$
73

Loss and LAE reserve, net
378

(14
)
364

363

(24
)
339

____________________
(1)
The remaining benefit for R&W is either recorded at fair value in FG VIE assets, or not recorded on the balance sheet until the total loss, net of R&W, exceeds unearned premium reserve.

The table below provides a reconciliation of net expected loss to be paid to net expected loss to be expensed. Expected loss to be paid differs from expected loss to be expensed due to: (1) the contra-paid which represent the payments that have been made but have not yet been expensed, (2) salvage and subrogation recoverable for transactions that are in a net recovery position where the Company has not yet received recoveries on claims previously paid (having the effect of reducing net expected loss to be paid by the amount of the previously paid claim and the expected recovery), but will have no future income effect (because the previously paid claims and the corresponding recovery of those claims will offset in income in future periods), and (3) loss reserves that have already been established (and therefore expensed but not yet paid).

37

Reconciliation of Net Expected Loss to be Paid and
Net Expected Loss to be Expensed
Financial Guaranty Insurance Contracts
As of
March 31, 2014
(in millions)
Net expected loss to be paid
$
816

Less: net expected loss to be paid for FG VIEs
108

Total
708

Contra-paid, net
50

Salvage and subrogation recoverable, net of reinsurance
214

Loss and LAE reserve, net of reinsurance
(598
)
Other recoveries (1)
17

Net expected loss to be expensed (2)
$
391

____________________
(1)
R&W recoverables recorded in other assets on the consolidated balance sheet.
(2)
Excludes $84 million as of March 31, 2014 , related to consolidated FG VIEs.

The following table provides a schedule of the expected timing of net expected losses to be expensed. The amount and timing of actual loss and LAE may differ from the estimates shown below due to factors such as refundings, accelerations, commutations, changes in expected lives and updates to loss estimates. This table excludes amounts related to FG VIEs, which are eliminated in consolidation.
Net Expected Loss to be Expensed
Insurance Contracts
As of March 31, 2014
(in millions)
2014 (April 1– June 30)
$
12

2014 (July 1– September 30)
11

2014 (October 1–December 31)
10

2015
42

2016
38

2017
31

2018
28

2019 - 2023
98

2024 - 2028
57

2029 - 2033
37

After 2033
27

Net expected loss to be expensed(1)
391

Discount
419

Total future value
$
810

____________________
(1)
Consolidation of FG VIEs resulted in reductions of $ 84 million in net expected loss to be expensed which is on a present value basis.



38

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

Loss and LAE
Reported on the
Consolidated Statements of Operations
First Quarter
2014
2013
Structured Finance:
(in millions)
U.S. RMBS:
First lien:
Prime first lien
$
0

$
—

Alt-A first lien
7

9

Option ARM
(8
)
(83
)
Subprime
(8
)
11

First lien
(9
)
(63
)
Second lien:
Closed-end second lien
—

20

HELOC
8

3

Second lien
8

23

Total U.S. RMBS
(1
)
(40
)
TruPS
(1
)
—

Other structured finance
16

(12
)
Structured finance
14

(52
)
Public Finance:
U.S. public finance
26

(4
)
Non-U.S. public finance
1

1

Public finance
27

(3
)
Subtotal
41

(55
)
Other
(1
)
—

Loss and LAE insurance contracts before FG VIE consolidation
40

(55
)
Effect of consolidating FG VIEs
1

7

Loss and LAE
$
41

$
(48
)


39

The following table provides information on financial guaranty insurance contracts categorized as BIG.
Financial Guaranty Insurance
BIG Transaction Loss Summary
As of March 31, 2014
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)
193

(74
)
80

(23
)
109

(32
)
382

—

382

Remaining weighted-average contract period (in years)
10.2

7.9

8.3

5.6

10.0

8.5

10.4

—

10.4

Outstanding exposure:









Principal
$
14,981

$
(2,739
)
$
2,412

$
(159
)
$
2,980

$
(108
)
$
17,367

$
—

$
17,367

Interest
7,836

(1,107
)
1,139

(52
)
1,197

(40
)
8,973

—

8,973

Total(2)
$
22,817

$
(3,846
)
$
3,551

$
(211
)
$
4,177

$
(148
)
$
26,340

$
—

$
26,340

Expected cash outflows (inflows)
$
1,901

$
(528
)
$
727

$
(33
)
$
1,695

$
(59
)
$
3,703

$
(358
)
$
3,345

Potential recoveries
Undiscounted R&W
(174
)
10

(108
)
4

(374
)
14

(628
)
15

(613
)
Other(3)
(1,780
)
506

(255
)
17

(302
)
18

(1,796
)
191

(1,605
)
Total potential recoveries
(1,954
)
516

(363
)
21

(676
)
32

(2,424
)
206

(2,218
)
Subtotal
(53
)
(12
)
364

(12
)
1,019

(27
)
1,279

(152
)
1,127

Discount
13

1

(120
)
3

(366
)
6

(463
)
44

(419
)
Present value of expected cash flows
$
(40
)
$
(11
)
$
244

$
(9
)
$
653

$
(21
)
$
816

$
(108
)
$
708

Deferred premium revenue
$
521

$
(93
)
$
148

$
(7
)
$
262

$
(17
)
$
814

$
(128
)
$
686

Reserves (salvage)(4)
$
(137
)
$
5

$
133

$
(5
)
$
458

$
(14
)
$
440

$
(73
)
$
367


40

Financial Guaranty Insurance
BIG Transaction Loss Summary
As of December 31, 2013
BIG Categories
BIG 1
BIG 2
BIG 3
Total
BIG, Net
Effect of
Consolidating
FG VIEs
Total
Gross
Ceded
Gross
Ceded
Gross
Ceded
(dollars in millions)
Number of risks(1)
185

(72
)
80

(24
)
119

(34
)
384

—

384

Remaining weighted-average contract period (in years)
10.5

8.1

8.3

5.9

9.8

7.2

10.5

—

10.5

Outstanding exposure:









Principal
$
15,132

$
(2,741
)
$
2,483

$
(160
)
$
3,189

$
(158
)
$
17,745

$
—

$
17,745

Interest
8,114

(1,144
)
1,181

(53
)
1,244

(52
)
9,290

—

9,290

Total(2)
$
23,246

$
(3,885
)
$
3,664

$
(213
)
$
4,433

$
(210
)
$
27,035

$
—

$
27,035

Expected cash outflows (inflows)
$
1,853

$
(528
)
$
1,038

$
(40
)
$
1,681

$
(62
)
$
3,942

$
(690
)
$
3,252

Potential recoveries
Undiscounted R&W
(105
)
1

(201
)
8

(356
)
13

(640
)
72

(568
)
Other(3)
(1,774
)
513

(470
)
19

(351
)
19

(2,044
)
507

(1,537
)
Total potential recoveries
(1,879
)
514

(671
)
27

(707
)
32

(2,684
)
579

(2,105
)
Subtotal
(26
)
(14
)
367

(13
)
974

(30
)
1,258

(111
)
1,147

Discount
13

—

(126
)
3

(352
)
5

(457
)
51

(406
)
Present value of expected cash flows
$
(13
)
$
(14
)
$
241

$
(10
)
$
622

$
(25
)
$
801

$
(60
)
$
741

Deferred premium revenue
$
517

$
(90
)
$
163

$
(7
)
$
303

$
(27
)
$
859

$
(178
)
$
681

Reserves (salvage)(4)
$
(114
)
$
1

$
117

$
(4
)
$
420

$
(13
)
$
407

$
(18
)
$
389

____________________
(1)
The ceded number of risks represents the number of risks for which the Company ceded a portion of its exposure.

(2)
Includes BIG amounts related to FG VIEs.

(3)
Includes excess spread and draws on HELOCs.

(4)
See table “Components of net reserves (salvage).”

Ratings Impact on Financial Guaranty Business
A downgrade of one of the Company’s insurance subsidiaries may result in increased claims under financial guaranties issued by the Company, if the insured obligors were unable to pay.
For example, AGM has issued financial guaranty insurance policies in respect of the obligations of municipal obligors under interest rate swaps. Under the swaps, AGM insures periodic payments owed by the municipal obligors to the bank counterparties. Under certain of the swaps, AGM also insures termination payments that may be owed by the municipal obligors to the bank counterparties. If (i) AGM has been downgraded below the rating trigger set forth in a swap under which it has insured the termination payment, which rating trigger varies on a transaction by transaction basis; (ii) the municipal obligor has the right to cure by, but has failed in, posting collateral, replacing AGM or otherwise curing the downgrade of AGM; (iii) the transaction documents include as a condition that an event of default or termination event with respect to the municipal obligor has occurred, such as the rating of the municipal obligor being downgraded past a specified level, and such condition has been met; (iv) the bank counterparty has elected to terminate the swap; (v) a termination payment is payable by the municipal obligor; and (vi) the municipal obligor has failed to make the termination payment payable by it, then AGM would be required to pay the termination payment due by the municipal obligor, in an amount not to exceed the policy limit set forth in the financial guaranty insurance policy. At AGM's current financial strength ratings, if the conditions giving rise to the obligation of AGM to make a termination payment under the swap termination policies were all satisfied, then AGM could pay claims in an amount not exceeding approximately $104 million in respect of such termination payments. Taking into

41

consideration whether the rating of the municipal obligor is below any applicable specified trigger, if the financial strength ratings of AGM were further downgraded below "A" by S&P or below "A2" by Moody's, and the conditions giving rise to the obligation of AGM to make a payment under the swap policies were all satisfied, then AGM could pay claims in an additional amount not exceeding approximately $290 million in respect of such termination payments.
As another example, with respect to variable rate demand obligations ("VRDOs") for which a bank has agreed to provide a liquidity facility, a downgrade of AGM or AGC may provide the bank with the right to give notice to bondholders that the bank will terminate the liquidity facility, causing the bondholders to tender their bonds to the bank. Bonds held by the bank accrue interest at a “bank bond rate” that is higher than the rate otherwise borne by the bond (typically the prime rate plus 2.00% — 3.00% , and capped at the lesser of 25% and the maximum legal limit). In the event the bank holds such bonds for longer than a specified period of time, usually 90 - 180 days , the bank has the right to demand accelerated repayment of bond principal, usually through payment of equal installments over a period of not less than five years. In the event that a municipal obligor is unable to pay interest accruing at the bank bond rate or to pay principal during the shortened amortization period, a claim could be submitted to AGM or AGC under its financial guaranty policy. As of March 31, 2014 , AGM and AGC had insured approximately $7.0 billion net par of VRDOs, of which approximately $0.4 billion of net par constituted VRDOs issued by municipal obligors rated BBB- or lower pursuant to the Company’s internal rating. The specific terms relating to the rating levels that trigger the bank’s termination right, and whether it is triggered by a downgrade by one rating agency or a downgrade by all rating agencies then rating the insurer, vary depending on the transaction.

In addition, AGM may be required to pay claims in respect of AGMH’s former financial products business if Dexia SA and its affiliates, from which the Company had purchased AGMH and its subsidiaries, do not comply with their obligations following a downgrade of the financial strength rating of AGM. Most of the guaranteed investment contracts ("GICs") insured by AGM allow for the withdrawal of GIC funds in the event of a downgrade of AGM, unless the relevant GIC issuer posts collateral or otherwise enhances its credit. Most GICs insured by AGM allow for the termination of the GIC contract and a withdrawal of GIC funds at the option of the GIC holder in the event of a downgrade of AGM below a specified threshold, generally below A- by S&P or A3 by Moody’s, with no right of the GIC issuer to avoid such withdrawal by posting collateral or otherwise enhancing its credit. Each GIC contract stipulates the thresholds below which the GIC issuer must post eligible collateral, along with the types of securities eligible for posting and the collateralization percentage applicable to each security type. These collateralization percentages range from 100% of the GIC balance for cash posted as collateral to, typically, 108% for asset-backed securities. If the entire aggregate accreted GIC balance of approximately $2.6 billion as of March 31, 2014 were terminated, the assets of the GIC issuers (which had an aggregate accreted principal of approximately $3.9 billion and an aggregate market value of approximately $3.7 billion ) would be sufficient to fund the withdrawal of the GIC funds.

7.
Fair Value Measurement
The Company carries a significant portion of its assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e., exit price). The price represents the price available in the principal market for the asset or liability. If there is no principal market, then the price is based on a hypothetical market that maximizes the value received for an asset or minimizes the amount paid for a liability (i.e., the most advantageous market).
Fair value is based on quoted market prices, where available. If listed prices or quotes are not available, fair value is based on either internally developed models that primarily use, as inputs, market-based or independently sourced market parameters, including but not limited to yield curves, interest rates and debt prices or with the assistance of an independent third-party using a discounted cash flow approach and the third party’s proprietary pricing models. In addition to market information, models also incorporate transaction details, such as maturity of the instrument and contractual features designed to reduce the Company’s credit exposure, such as collateral rights as applicable.
Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments include amounts to reflect counterparty credit quality, the Company’s creditworthiness and constraints on liquidity. As markets and products develop and the pricing for certain products becomes more or less transparent, the Company may refine its methodologies and assumptions. During First Quarter 2014, no changes were made to the Company’s valuation models that had or are expected to have, a material impact on the Company’s consolidated balance sheets or statements of operations and comprehensive income.
The Company’s methods for calculating fair value produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. The use of different methodologies or assumptions to determine fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

42

The fair value hierarchy is determined based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Company estimates of market assumptions. The fair value hierarchy prioritizes model inputs into three broad levels as follows, with Level 1 being the highest and Level 3 the lowest. An asset or liability’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation.

Level 1—Quoted prices for identical instruments in active markets. The Company generally defines an active market as a market in which trading occurs at significant volumes. Active markets generally are more liquid and have a lower bid-ask spread than an inactive market.
Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and observable inputs other than quoted prices, such as interest rates or yield curves and other inputs derived from or corroborated by observable market inputs.
Level 3—Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation.
Transfers between Levels 1, 2 and 3 are recognized at the end of the period when the transfer occurs. The Company reviews the classification between Levels 1, 2 and 3 quarterly to determine whether a transfer is necessary. During the periods presented, there were no transfers between Level 1, 2 and 3.
Measured and Carried at Fair Value
Fixed-Maturity Securities and Short-term Investments
The fair value of bonds in the investment portfolio is generally based on prices received from third party pricing services or alternative pricing sources with reasonable levels of price transparency. The pricing services prepare estimates of fair value measurements using their pricing models, which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. Additional valuation factors that can be taken into account are nominal spreads and liquidity adjustments. The pricing services evaluate each asset class based on relevant market and credit information, perceived market movements, and sector news. The market inputs used in the pricing evaluation, listed in the approximate order of priority include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data and industry and economic events. Benchmark yields have in many cases taken priority over reported trades for securities that trade less frequently or those that are distressed trades, and therefore may not be indicative of the market. The extent of the use of each input is dependent on the asset class and the market conditions. Given the asset class, the priority of the use of inputs may change or some market inputs may not be relevant. Additionally, the valuation of fixed-maturity investments is more subjective when markets are less liquid due to the lack of market based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur.
Short-term investments, that are traded in active markets, are classified within Level 1 in the fair value hierarchy and are based on quoted market prices. Securities such as discount notes are classified within Level 2 because these securities are typically not actively traded due to their approaching maturity and, as such, their cost approximates fair value.
Prices determined based on models where at least one significant model assumption or input is unobservable, are considered to be Level 3 in the fair value hierarchy. As of March 31, 2014 , the Company used models to price 38 fixed-maturity securities, which was 7.3% or $787 million of the Company’s fixed-maturity securities and short-term investments at fair value. Certain Level 3 securities were priced with the assistance of an independent third-party. The pricing is based on a discounted cash flow approach using the third-party’s proprietary pricing models. The models use inputs such as projected prepayment speeds;  severity assumptions; recovery lag assumptions; estimated default rates (determined on the basis of an analysis of collateral attributes, historical collateral performance, borrower profiles and other features relevant to the evaluation of collateral credit quality); home price depreciation/appreciation rates based on macroeconomic forecasts and recent trading activity. The yield used to discount the projected cash flows is determined by reviewing various attributes of the bond including collateral type, weighted average life, sensitivity to losses, vintage, and convexity, in conjunction with market data on comparable securities. Significant changes to any of these inputs could materially change the expected timing of cash flows within these securities which is a significant factor in determining the fair value of the securities.

43

Other Invested Assets

Other invested assets include investments carried and measured at fair value on a recurring basis of $88 million , and include primarily short-term investments, fixed-maturity securities classified as trading and investments in two vehicles that invest in the global property catastrophe risk market.
Other Assets
Committed Capital Securities
The fair value of committed capital securities ("CCS"), which is recorded in “other assets” on the consolidated balance sheets, represents the difference between the present value of remaining expected put option premium payments under AGC’s CCS (the “AGC CCS”) and AGM’s Committed Preferred Trust Securities (the “AGM CPS”) agreements, and the estimated present value that the Company would hypothetically have to pay currently for a comparable security (see Note 15, Long Term Debt and Credit Facilities). The AGC CCS and AGM CPS are carried at fair value with changes in fair value recorded on the consolidated statement of operations. The estimated current cost of the Company’s CCS is based on several factors, including broker-dealer quotes for the outstanding securities, the U.S. dollar forward swap curve, London Interbank Offered Rate ("LIBOR") curve projections and the term the securities are estimated to remain outstanding.
Supplemental Executive Retirement Plans

The Company classifies the fair value measurement of the assets of the Company's various supplemental executive retirement plans as either Level 1 or Level 2. The fair value of these assets is valued based on the observable published daily values of the underlying mutual fund included in the aforementioned plans (Level 1) or based upon the net asset value of the funds if a published daily value is not available (Level 2). The net asset values are based on observable information.
Financial Guaranty Contracts Accounted for as Credit Derivatives
The Company’s credit derivatives consist primarily of insured CDS contracts, and also include interest rate swaps that fall under derivative accounting standards requiring fair value accounting through the statement of operations. The Company does not enter into CDS with the intent to trade these contracts and the Company may not unilaterally terminate a CDS contract absent an event of default or termination event that entitles the Company to terminate (except for certain rare circumstances); however, the Company has mutually agreed with various counterparties to terminate certain CDS transactions. Such terminations generally are completed for an amount that approximates the present value of future premiums, not at fair value.
The terms of the Company’s CDS contracts differ from more standardized credit derivative contracts sold by companies outside the financial guaranty industry. The non-standard terms include the absence of collateral support agreements or immediate settlement provisions. In addition, the Company employs relatively high attachment points and does not exit derivatives it sells or purchases for credit protection purposes, except under specific circumstances such as mutual agreements with counterparties. Management considers the non-standard terms of its credit derivative contracts in determining the fair value of these contracts.
Due to the lack of quoted prices and other observable inputs for its instruments or for similar instruments, the Company determines the fair value of its credit derivative contracts primarily through internally developed, proprietary models that use both observable and unobservable market data inputs to derive an estimate of the fair value of the Company's contracts in its principal markets (see "Assumptions and Inputs"). There is no established market where financial guaranty insured credit derivatives are actively traded, therefore, management has determined that the exit market for the Company’s credit derivatives is a hypothetical one based on its entry market. Management has tracked the historical pricing of the Company’s deals to establish historical price points in the hypothetical market that are used in the fair value calculation. These contracts are classified as Level 3 in the fair value hierarchy since there is reliance on at least one unobservable input deemed significant to the valuation model, most importantly the Company’s estimate of the value of the non-standard terms and conditions of its credit derivative contracts and of the Company’s current credit standing.

The Company’s models and the related assumptions are continuously reevaluated by management and enhanced, as appropriate, based upon improvements in modeling techniques and availability of more timely and relevant market information.
The fair value of the Company’s credit derivative contracts represents the difference between the present value of remaining premiums the Company expects to receive or pay and the estimated present value of premiums that a financial guarantor of comparable credit-worthiness would hypothetically charge or pay 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

44

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, 2014 were such that market prices of the Company’s CDS contracts were not available.
Management considers factors such as current prices charged for similar agreements, when available, performance of underlying assets, life of the instrument, and the nature and extent of activity in the financial guaranty credit derivative marketplace. The assumptions that management uses to determine the fair value may change in the future due to market conditions. Due to the inherent uncertainties of the assumptions used in the valuation models, actual experience may differ from the estimates reflected in the Company’s consolidated financial statements and the differences may be material.

Assumptions and Inputs
Listed below are various inputs and assumptions that are key to the establishment of the Company’s fair value for CDS contracts.
· Gross spread.
· The allocation of gross spread among:
•
the profit the originator, usually an investment bank, realizes for putting the deal together and funding the transaction (“bank profit”);
•
premiums paid to the Company for the Company’s credit protection provided (“net spread”); and
•
the cost of CDS protection purchased by the originator to hedge their counterparty credit risk exposure to the Company (“hedge cost”).
·      The weighted average life which is based on Debt Service schedules.

The rates used to discount future expected premium cash flows ranged from 0.20% to 3.53% at March 31, 2014 and 0.21% to 3.88% at December 31, 2013 .
The Company obtains gross spreads on its outstanding contracts from market data sources published by third parties (e.g., dealer spread tables for the collateral similar to assets within the Company’s transactions), as well as collateral-specific spreads provided by trustees or obtained from market sources. If observable market credit spreads are not available or reliable for the underlying reference obligations, then market indices are used that most closely resemble the underlying reference obligations, considering asset class, credit quality rating and maturity of the underlying reference obligations. These indices are adjusted to reflect the non-standard terms of the Company’s CDS contracts. Market sources determine credit spreads by reviewing new issuance pricing for specific asset classes and receiving price quotes from their trading desks for the specific asset in question. Management validates these quotes by cross-referencing quotes received from one market source against quotes received from another market source to ensure reasonableness. In addition, the Company compares the relative change in price quotes received from one quarter to another, with the relative change experienced by published market indices for a specific asset class. Collateral specific spreads obtained from third-party, independent market sources are un-published spread quotes from market participants or market traders who are not trustees. Management obtains this information as the result of direct communication with these sources as part of the valuation process.

With respect to CDS transactions for which there is an expected claim payment within the next twelve months, the allocation of gross spread reflects a higher allocation to the cost of credit rather than the bank profit component. In the current market, it is assumed that a bank would be willing to accept a lower profit on distressed transactions in order to remove these transactions from its financial statements.

45

The following spread hierarchy is utilized in determining which source of gross spread to use, with the rule being to use CDS spreads where available. If not available, CDS spreads are either interpolated or extrapolated based on similar transactions or market indices.
•
Actual collateral specific credit spreads (if up-to-date and reliable market-based spreads are available).

•
Deals priced or closed during a specific quarter within a specific asset class and specific rating.

•
Credit spreads interpolated based upon market indices.

•
Credit spreads provided by the counterparty of the CDS.

•
Credit spreads extrapolated based upon transactions of similar asset classes, similar ratings, and similar time to maturity.
Information by Credit Spread Type (1)
As of
March 31, 2014
As of
December 31, 2013
Based on actual collateral specific spreads
6
%
6
%
Based on market indices
88
%
88
%
Provided by the CDS counterparty
6
%
6
%
Total
100
%
100
%
____________________
(1)    Based on par.
Over time the data inputs can change as new sources become available or existing sources are discontinued or are no longer considered to be the most appropriate. It is the Company’s objective to move to higher levels on the hierarchy whenever possible, but it is sometimes necessary to move to lower priority inputs because of discontinued data sources or management’s assessment that the higher priority inputs are no longer considered to be representative of market spreads for a given type of collateral. This can happen, for example, if transaction volume changes such that a previously used spread index is no longer viewed as being reflective of current market levels.
The Company interpolates a curve based on the historical relationship between the premium the Company receives when a credit derivative is closed to the daily closing price of the market index related to the specific asset class and rating of the deal. This curve indicates expected credit spreads at each indicative level on the related market index. For transactions with unique terms or characteristics where no price quotes are available, management extrapolates credit spreads based on a similar transaction for which the Company has received a spread quote from one of the first three sources within the Company’s spread hierarchy. This alternative transaction will be within the same asset class, have similar underlying assets, similar credit ratings, and similar time to maturity. The Company then calculates the percentage of relative spread change quarter over quarter for the alternative transaction. This percentage change is then applied to the historical credit spread of the transaction for which no price quote was received in order to calculate the transactions’ current spread. Counterparties determine credit spreads by reviewing new issuance pricing for specific asset classes and receiving price quotes from their trading desks for the specific asset in question. These quotes are validated by cross-referencing quotes received from one market source with those quotes received from another market source to ensure reasonableness.
The premium the Company receives is referred to as the “net spread.” The Company’s pricing model takes into account not only how credit spreads on risks that it assumes affect pricing, but also how the Company’s own credit spread affects the pricing of its deals. The Company’s own credit risk is factored into the determination of net spread based on the impact of changes in the quoted market price for credit protection bought on the Company, as reflected by quoted market prices on CDS referencing AGC or AGM. For credit spreads on the Company’s name the Company obtains the quoted price of CDS contracts traded on AGC and AGM from market data sources published by third parties. The cost to acquire CDS protection referencing AGC or AGM affects the amount of spread on CDS deals that the Company retains and, hence, their fair value. As the cost to acquire CDS protection referencing AGC or AGM increases, the amount of premium the Company retains on a deal generally decreases. As the cost to acquire CDS protection referencing AGC or AGM decreases, the amount of premium the Company retains on a deal generally increases. In the Company’s valuation model, the premium the Company captures is not permitted to go below the minimum rate that the Company would currently charge to assume similar risks. This assumption can have the effect of mitigating the amount of unrealized gains that are recognized on certain CDS contracts. Given the current market conditions and the Company’s own credit spreads, approximately 24% and 61% , based on number of deals, of the Company's CDS contracts are fair valued using this minimum premium as of March 31, 2014 and December 31, 2013 ,

46

respectively. The change period over period is driven by AGM's and AGC's credit spreads narrowing as a result of the recent S&P upgrades. As a result of this, the cost to hedge AGC's and AGM's name has declined significantly causing more transactions to price above previously established floor levels. The Company corroborates the assumptions in its fair value model, including the portion of exposure to AGC and AGM hedged by its counterparties, with independent third parties each reporting period. The current level of AGC’s and AGM’s own credit spread has resulted in the bank or deal originator hedging a significant portion of its exposure to AGC and AGM. This reduces the amount of contractual cash flows AGC and AGM can capture as premium for selling its protection.

The amount of premium a financial guaranty insurance market participant can demand is inversely related to the cost of credit protection on the insurance company as measured by market credit spreads assuming all other assumptions remain constant. This is because the buyers of credit protection typically hedge a portion of their risk to the financial guarantor, due to the fact that the contractual terms of the Company's contracts typically do not require the posting of collateral by the guarantor. The extent of the hedge depends on the types of instruments insured and the current market conditions.
A fair value resulting in a credit derivative asset on protection sold is the result of contractual cash inflows on in-force deals in excess of what a hypothetical financial guarantor could receive if it sold protection on the same risk as of the reporting date. If the Company were able to freely exchange these contracts (i.e., assuming its contracts did not contain proscriptions on transfer and there was a viable exchange market), it would be able to realize a gain representing the difference between the higher contractual premiums to which it is entitled and the current market premiums for a similar contract. The Company determines the fair value of its CDS contracts by applying the difference between the current net spread and the contractual net spread for the remaining duration of each contract to the notional value of its CDS contracts.
Example
Following is an example of how changes in gross spreads, the Company’s own credit spread and the cost to buy protection on the Company affect the amount of premium the Company can demand for its credit protection. The assumptions used in these examples are hypothetical amounts. Scenario 1 represents the market conditions in effect on the transaction date and Scenario 2 represents market conditions at a subsequent reporting date.
Scenario 1
Scenario 2
bps
% of Total
bps
% of Total
Original gross spread/cash bond price (in bps)
185


500


Bank profit (in bps)
115

62
%
50

10
%
Hedge cost (in bps)
30

16
%
440

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

22
%
10

2
%
In Scenario 1, the gross spread is 185 basis points. The bank or deal originator captures 115 basis points of the original gross spread and hedges 10% of its exposure to AGC, when the CDS spread on AGC was 300 basis points ( 300 basis points × 10% = 30 basis points). Under this scenario the Company receives premium of 40 basis points, or 22% of the gross spread.
In Scenario 2, the gross spread is 500 basis points. The bank or deal originator captures 50 basis points of the original gross spread and hedges 25% of its exposure to AGC, when the CDS spread on AGC was 1,760 basis points ( 1,760 basis points × 25% = 440 basis points). Under this scenario the Company would receive premium of 10 basis points, or 2% of the gross spread. Due to the increased cost to hedge AGC’s name, the amount of profit the bank would expect to receive, and the premium the Company would expect to receive decline significantly.
In this example, the contractual cash flows (the Company premium received per annum above) exceed the amount a market participant would require the Company to pay in today’s market to accept its obligations under the CDS contract, thus resulting in an asset. This credit derivative asset is equal to the difference in premium rates discounted at the corresponding LIBOR over the weighted average remaining life of the contract multiplied by the par outstanding at a given point in time.
Strengths and Weaknesses of Model
The Company’s credit derivative valuation model, like any financial model, has certain strengths and weaknesses.
The primary strengths of the Company’s CDS modeling techniques are:
•
The model takes into account the transaction structure and the key drivers of market value. The transaction structure includes par insured, weighted average life, level of subordination and composition of collateral.


47

•
The model maximizes the use of market-driven inputs whenever they are available. The key inputs to the model are market-based spreads for the collateral, and the credit rating of referenced entities. These are viewed by the Company to be the key parameters that affect fair value of the transaction.

•
The model is a consistent approach to valuing positions. The Company has developed a hierarchy for market-based spread inputs that helps mitigate the degree of subjectivity during periods of high illiquidity.
The primary weaknesses of the Company’s CDS modeling techniques are:
•
There is no exit market or actual exit transactions. Therefore the Company’s exit market is a hypothetical one based on the Company’s entry market.

•
There is a very limited market in which to validate the reasonableness of the fair values developed by the Company’s model.

•
At March 31, 2014 and December 31, 2013, the markets for the inputs to the model were highly illiquid, which impacts their reliability.

•
Due to the non-standard terms under which the Company enters into derivative contracts, the fair value of its credit derivatives may not reflect the same prices observed in an actively traded market of credit derivatives that do not contain terms and conditions similar to those observed in the financial guaranty market.

These contracts were classified as Level 3 in the fair value hierarchy because there is a reliance on at least one unobservable input deemed significant to the valuation model, most significantly the Company's estimate of the value of non-standard terms and conditions of its credit derivative contracts and amount of protection purchased on AGC or AGM's name.

Fair Value Option on FG VIEs’ Assets and Liabilities

The Company elected the fair value option for all the FG VIEs’ assets and liabilities. See Note 9, Consolidated Variable Interest Entities.
The FG VIEs that are consolidated by the Company issued securities collateralized by first lien and second lien RMBS as well as loans and receivables. The lowest level input that is significant to the fair value measurement of these assets and liabilities was a Level 3 input (i.e. unobservable), therefore management classified them as Level 3 in the fair value hierarchy. Prices are generally determined with the assistance of an independent third-party. The pricing is based on a discounted cash flow approach and the third-party’s proprietary pricing models. The models to price the FG VIEs’ liabilities used, where appropriate, inputs such as estimated prepayment speeds; market values of the assets that collateralize the securities; estimated default rates (determined on the basis of an analysis of collateral attributes, historical collateral performance, borrower profiles and other features relevant to the evaluation of collateral credit quality); yields implied by market prices for similar securities; house price depreciation/appreciation rates based on macroeconomic forecasts and, for those liabilities insured by the Company, the benefit from the Company’s insurance policy guaranteeing the timely payment of principal and interest for the FG VIE tranches insured by the Company, taking into account the timing of the potential default and the Company’s own credit rating. The third-party also utilizes an internal model to determine an appropriate yield at which to discount the cash flows of the security, by factoring in collateral types, weighted-average lives, and other structural attributes specific to the security being priced. The expected yield is further calibrated by utilizing algorithms designed to aggregate market color, received by the third-party, on comparable bonds.

The fair value of the Company’s FG VIE assets is generally sensitive to changes related to estimated prepayment speeds; estimated default rates (determined on the basis of an analysis of collateral attributes such as: historical collateral performance, borrower profiles and other features relevant to the evaluation of collateral credit quality); discount rates implied by market prices for similar securities; and house price depreciation/appreciation rates based on macroeconomic forecasts. Significant changes to some of these inputs could materially change the market value of the FG VIE’s assets and the implied collateral losses within the transaction. In general, the fair value of the FG VIE asset is most sensitive to changes in the projected collateral losses, where an increase in collateral losses typically leads to a decrease in the fair value of FG VIE assets, while a decrease in collateral losses typically leads to an increase in the fair value of FG VIE assets. These factors also directly impact the fair value of the Company’s FG VIE liabilities.
The fair value of the Company’s FG VIE liabilities is also generally sensitive to changes relating to estimated prepayment speeds; market values of the underlying assets; estimated default rates (determined on the basis of an analysis of collateral attributes such as: historical collateral performance, borrower profiles and other feat ures relevant to the evaluation of collateral credit quality); discount rates implied by market prices for similar securities; and house price depreciation/

48

appreciation rates based on macroeconomic forecasts. In addition, the Company’s FG VIE liabilities with recourse are also sensitive to changes in the Company’s implied credit worthiness. Significant changes to any of these inputs could materially change the timing of expected losses within the insured transaction which is a significant factor in determining the implied benefit from the Company’s insurance policy guaranteeing the timely payment of principal and interest for the tranches of debt issued by the FG VIE that is insured by the Company. In general, extending the timing of expected loss payments by the Company into the future typically leads to a decrease in the value of the Company’s insurance and a decrease in the fair value of the Company’s FG VIE liabilities with recourse, while a shortening of the timing of expected loss payments by the Company typically leads to an increase in the value of the Company’s insurance and an increase in the fair value of the Company’s FG VIE liabilities with recourse.
Not Carried at Fair Value
Financial Guaranty Insurance Contracts
The fair value of the Company’s financial guaranty contracts accounted for as insurance was based on management’s estimate of what a similarly rated financial guaranty insurance company would demand to acquire the Company’s in-force book of financial guaranty insurance business. This amount was based on the pricing assumptions management has observed for portfolio transfers that have occurred in the financial guaranty market and included adjustments to the carrying value of unearned premium reserve for stressed losses, ceding commissions and return on capital. The significant inputs were not readily observable. The Company accordingly classified this fair value measurement as Level 3.
Long-Term Debt
The Company’s long-term debt, excluding notes payable, is valued by broker-dealers using third party independent pricing sources and standard market conventions. The market conventions utilize market quotations, market transactions for the Company’s comparable instruments, and to a lesser extent, similar instruments in the broader insurance industry. The fair value measurement was classified as Level 2 in the fair value hierarchy.
The fair value of the notes payable that are recorded within long-term debt was determined by calculating the present value of the expected cash flows. The Company determines discounted future cash flows using market driven discount rates and a variety of assumptions, including a projection of the LIBOR rate, prepayment and default assumptions, and AGM CDS spreads. The fair value measurement was classified as Level 3 in the fair value hierarchy because there is a reliance on significant unobservable inputs to the valuation model, including the discount rates, prepayment and default assumptions, loss severity and recovery on delinquent loans.
Other Invested Assets
The fair value of the other invested assets, which consist of assets acquired in refinancing transactions, was determined by calculating the present value of the expected cash flows. The Company uses a market approach to determine discounted future cash flows using market driven discount rates and a variety of assumptions, including a projection of the LIBOR rate and prepayment and default assumptions. The fair value measurement was classified as Level 3 in the fair value hierarchy because there is a reliance on significant unobservable inputs to the valuation model, including the discount rates, prepayment and default assumptions, loss severity and recovery on delinquent loans.
Other Assets and Other Liabilities
The Company’s other assets and other liabilities consist predominantly of accrued interest, receivables for securities sold and payables for securities purchased, the carrying values of which approximate fair value.


49

Financial Instruments Carried at Fair Value
Amounts recorded at fair value in the Company’s financial statements are presented in the tables below.
Fair Value Hierarchy of Financial Instruments Carried at Fair Value
As of March 31, 2014
Fair Value Hierarchy
Fair Value
Level 1
Level 2
Level 3
(in millions)
Assets:




Investment portfolio, available-for-sale:




Fixed-maturity securities




Obligations of state and political subdivisions
$
5,249

$
—

$
5,211

$
38

U.S. government and agencies
701

—

701

—

Corporate securities
1,427

—

1,289

138

Mortgage-backed securities:

RMBS
1,171

—

812

359

Commercial mortgage-backed securities ("CMBS")
670

—

670

—

Asset-backed securities
554

—

302

252

Foreign government securities
322

—

322

—

Total fixed-maturity securities
10,094


—

9,307

787

Short-term investments
720

438

282

—

Other invested assets (1)
94

—

40

54

Credit derivative assets
78

—

—

78

FG VIEs’ assets, at fair value
1,257

—

—

1,257

Other assets
77

29

11

37

Total assets carried at fair value
$
12,320

$
467

$
9,640

$
2,213

Liabilities:




Credit derivative liabilities
$
2,001

$
—

$
—

$
2,001

FG VIEs’ liabilities with recourse, at fair value
1,346

—

—

1,346

FG VIEs’ liabilities without recourse, at fair value
101

—

—

101

Total liabilities carried at fair value
$
3,448

$
—

$
—

$
3,448


50

Fair Value Hierarchy of Financial Instruments Carried at Fair Value
As of December 31, 2013
Fair Value Hierarchy
Fair Value
Level 1
Level 2
Level 3
(in millions)
Assets:




Investment portfolio, available-for-sale:




Fixed-maturity securities




Obligations of state and political subdivisions
$
5,079

$
—

$
5,043

$
36

U.S. government and agencies
700

—

700

—

Corporate securities
1,340

—

1,204

136

Mortgage-backed securities:




RMBS
1,122

—

832

290

CMBS
549

—

549

—

Asset-backed securities
608

—

340

268

Foreign government securities
313

—

313

—

Total fixed-maturity securities
9,711

—

8,981

730

Short-term investments
904

506

398

—

Other invested assets (1)
127

—

119

8

Credit derivative assets
94

—

—

94

FG VIEs’ assets, at fair value
2,565

—

—

2,565

Other assets
84

27

11

46

Total assets carried at fair value
$
13,485

$
533

$
9,509

$
3,443

Liabilities:




Credit derivative liabilities
$
1,787

$
—

$
—

$
1,787

FG VIEs’ liabilities with recourse, at fair value
1,790

—

—

1,790

FG VIEs’ liabilities without recourse, at fair value
1,081

—

—

1,081

Total liabilities carried at fair value
$
4,658

$
—

$
—

$
4,658

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



51

Changes in Level 3 Fair Value Measurements
The table below presents a roll forward of the Company’s Level 3 financial instruments carried at fair value on a recurring basis during First Quarter 2014 and 2013 .

Fair Value Level 3 Rollforward
Recurring Basis
First Quarter 2014
Fixed-Maturity Securities
Obligations
of State and
Political
Subdivisions
Corporate Securities
RMBS
Asset-
Backed
Securities
Other
Invested
Assets
FG VIEs’
Assets at
Fair
Value
Other
Assets
Credit
Derivative
Asset
(Liability),
net(5)
FG VIEs' Liabilities
with
Recourse,
at Fair
Value
FG VIEs’ Liabilities
without
Recourse,
at Fair
Value
(in millions)
Fair value as of December 31, 2013
$
36


$
136

$
290


$
268


$
2

$
2,565


$
46


$
(1,693
)
$
(1,790
)
$
(1,081
)
Total pretax realized and unrealized gains/(losses) recorded in:(1)


























Net income (loss)
1

(2
)
3

(2
)
4

(2
)
7

(2
)
—

82

(3
)
(9
)
(4
)
(211
)
(6
)
(72
)
(3
)
(9
)
(3
)
Other comprehensive income (loss)
1


4

14


8


1

—


—


—


—


—


Purchases
—


—

53


—


45

(8
)
—


—


—


—


—


Settlements
—

(5
)
(15
)
(31
)
0

(286
)
—


(19
)

269


12


FG VIE consolidations
—


—

—


—


—

—


—


—


—

—


FG VIE deconsolidations
—

—

13

—

—

(1,104
)
—

—

247

977

Fair value as of March 31, 2014
$
38


$
138

$
359


$
252


$
48

$
1,257


$
37


$
(1,923
)
$
(1,346
)
$
(101
)
Change in unrealized gains/(losses) related to financial instruments held as of March 31, 2014
$
1

$
4

$
15

$
7

$
1

$
25

$
(9
)
$
(232
)
$
(28
)
$
(10
)


52

Fair Value Level 3 Rollforward
Recurring Basis
First Quarter 2013
Fixed-Maturity Securities
Obligations
of State and
Political
Subdivisions
RMBS
Asset-
Backed
Securities
Other
Invested
Assets
FG VIEs’
Assets at
Fair
Value
Other
Assets
Credit
Derivative
Asset
(Liability),
net(5)
FG VIEs' Liabilities
with
Recourse,
at Fair
Value
FG VIEs’ Liabilities
without
Recourse,
at Fair
Value
(in millions)
Fair value as of December 31, 2012
$
35


$
219


$
306


$
1

$
2,688


$
36


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
























Net income (loss)
1

(2
)
5

(2
)
4

(2
)
0

(7
)
215

(3
)
(10
)
(4
)
(592
)
(6
)
(81
)
(3
)
(74
)
(3
)
Other comprehensive income (loss)
0


7


(22
)

0

—


—


—


—


—


Purchases
—


3


—


—

—


—


—


—


—


Settlements
(1
)
(11
)
(2
)
—

(138
)
—


(8
)

112


55


FG VIE consolidations
—


(2
)

—


—

48


—


—


(12
)
(37
)

Fair value as of March 31, 2013
$
35


$
221

$
286

$
1

$
2,813

$
26

$
(2,393
)
$
(2,071
)
$
(1,107
)
Change in unrealized gains/(losses) related to financial instruments held as of March 31, 2013
$
0

$
9

$
(22
)
$
0

$
199

$
(10
)
$
(611
)
$
(83
)
$
(94
)
______________
(1)
Realized and unrealized gains (losses) from changes in values of Level 3 financial instruments represent gains (losses) from changes in values of those financial instruments only for the periods in which the instruments were classified as Level 3.

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

(3)
Included in fair value gains (losses) on FG VIEs.

(4)
Recorded in fair value gains (losses) on CCS.

(5)
Represents net position of credit derivatives. The consolidated balance sheet presents gross assets and liabilities based on net counterparty exposure.

(6)
Reported in net change in fair value of credit derivatives.

(7)
Reported in other income.

(8)    Non cash transaction.

53

Level 3 Fair Value Disclosures
Quantitative Information About Level 3 Fair Value Inputs
At March 31, 2014
Financial Instrument Description
Fair Value at
March 31, 2014
(in millions)
Valuation
Technique
Significant Unobservable Inputs
Range
Assets:

Fixed-maturity securities:

Obligations of state and political subdivisions
$
38

Discounted
Rate of inflation
1.0
%
-
3.0%
cash flow
Cash flow receipts
0.5
%
-
62.3%
Yield
4.6
%
9.0%
Collateral recovery period
4 months

-
34 years
Corporate
138

Discounted
Yield
8.0%
cash flow
RMBS
359

Discounted
CPR
0.3
%
-
15.8%
cash flow
CDR
4.1
%
-
25.8%
Severity
48.1
%
-
101.8%
Yield
2.6
%
-
8.7%
Asset-backed securities:
Investor owned utility
119

Discounted cash flow
Liquidation value (in millions)

$177

-
$274
Years to liquidation
0 years

-
3 years
Collateral recovery period
9 months

-
5 years
Discount factor
7.0%
XXX life insurance transactions
133

Discounted
Yield
12.5%
cash flow
Other invested assets
54

Discounted cash flow
Discount for lack of liquidity
10.0
%
-
20.0%
Recovery on delinquent loans
20.0
%
-
60.0%
Default rates
0.0
%
-
10.0%
Loss severity
40.0
%
-
90.0%
Prepayment speeds
6.0
%
-
15.0%
Net asset value (per share)
$
1,010

$1,020
FG VIEs’ assets, at fair value
1,257

Discounted
CPR
0.3
%
-
11.8%
cash flow
CDR
3.0
%
-
25.8%
Loss severity
38.1
%
-
102.0%
Yield
3.5
%
-
12.0%


54

Financial Instrument Description
Fair Value at
March 31, 2014
(in millions)
Valuation
Technique
Significant Unobservable Inputs
Range
Other assets
37

Discounted cash flow
Quotes from third party pricing
$
53

-
$57
Term (years)
5 years
Liabilities:

Credit derivative liabilities, net
(1,923
)
Discounted
Year 1 loss estimates
0.0
%
-
48.0%
cash flow
Hedge cost (in bps)
13.8

-
305.0
Bank profit (in bps)
1.0

-
1,435.5
Internal floor (in bps)
7.0

-
100.0
Internal credit rating
AAA

-
CCC
FG VIEs’ liabilities, at fair value
(1,447
)
Discounted
CPR
0.3
%
-
11.8%
cash flow
CDR
3.0
%
-
25.8%
Loss severity
38.1
%
-
102.0%
Yield
3.5
%
-
12.0%



55

Quantitative Information About Level 3 Fair Value Inputs
At December 31, 2013
Financial Instrument Description
Fair Value at
December 31, 2013
(in millions)
Valuation
Technique
Significant Unobservable Inputs
Range
Assets:

Fixed-maturity securities:

Obligations of state and political subdivisions
$
36

Discounted
Rate of inflation
1.0
%
-
3.0%
cash flow
Cash flow receipts
0.5
%
-
60.9%
Discount rates
4.6
%
9.0%
Collateral recovery period
1 month

-
10 years
Corporate securities
136

Discounted
Yield
8.3%
cash flow
RMBS
290

Discounted
CPR
1.0
%
-
15.8%
cash flow
CDR
5.0
%
-
25.8%
Severity
48.1
%
-
102.5%
Yield
2.5
%
-
9.4%
Asset-backed securities:
Investor owned utility
141

Discounted cash flow
Liquidation value (in millions)

$195

-
$245
Years to liquidation
0 years

-
3 years
Collateral recovery period
12 months

6 years
Discount factor
15.3%
XXX life insurance transactions
127

Discounted
Yield
12.5%
cash flow
Other invested assets
8

Discounted cash flow
Discount for lack of liquidity
10.0
%
-
20.0%
Recovery on delinquent loans
20.0
%
-
60.0%
Default rates
1.0
%
-
10.0%
Loss severity
40.0
%
-
90.0%
Prepayment speeds
6.0
%
-
15.0%
FG VIEs’ assets, at fair value
2,565

Discounted
CPR
0.3
%
-
11.8%
cash flow
CDR
3.0
%
-
25.8%
Loss severity
37.5
%
-
102.0%
Yield
3.5
%
-
10.2%



56

Financial Instrument Description
Fair Value at
December 31, 2013
(in millions)
Valuation
Technique
Significant Unobservable Inputs
Range
Other assets
46

Discounted cash flow
Quotes from third party pricing
$47
-
$53
Term (years)
5 years
Liabilities:

Credit derivative liabilities, net
(1,693
)
Discounted
Year 1 loss estimates
0.0
%
-
48.0%
cash flow
Hedge cost (in bps)
46.3

-
525.0
Bank profit (in bps)
1.0

-
1,418.5
Internal floor (in bps)
7.0

-
100.0
Internal credit rating
AAA

-
BIG
FG VIEs’ liabilities, at fair value
(2,871
)
Discounted
CPR
0.3
%
-
11.8%
cash flow
CDR
3.0
%
-
25.8%
Loss severity
37.5
%
-
102.0%
Yield
3.5
%
-
10.2%

The carrying amount and estimated fair value of the Company’s financial instruments are presented in the following table.
Fair Value of Financial Instruments
As of
March 31, 2014
As of
December 31, 2013
Carrying
Amount
Estimated
Fair Value
Carrying
Amount
Estimated
Fair Value
(in millions)
Assets:




Fixed-maturity securities
$
10,094

$
10,094

$
9,711

$
9,711

Short-term investments
720

720

904

904

Other invested assets
113

116

147

155

Credit derivative assets
78

78

94

94

FG VIEs’ assets, at fair value
1,257

1,257

2,565

2,565

Other assets
181

181

179

179

Liabilities:




Financial guaranty insurance contracts(1)
3,693

5,644

3,783

5,128

Long-term debt
812

1,050

816

970

Credit derivative liabilities
2,001

2,001

1,787

1,787

FG VIEs’ liabilities with recourse, at fair value
1,346

1,346

1,790

1,790

FG VIEs’ liabilities without recourse, at fair value
101

101

1,081

1,081

Other liabilities
62

62

36

36

____________________
(1)
Carrying amount includes the assets and liabilities related to financial guaranty insurance contract premiums, losses, and salvage and subrogation and other recoverables net of reinsurance.
8.
Financial Guaranty Contracts Accounted for as Credit Derivatives
Credit Derivatives

The Company has a portfolio of financial guaranty contracts that meet the definition of a derivative in accordance with GAAP (primarily CDS).
Credit derivative transactions are governed by ISDA documentation and have different characteristics from financial guaranty insurance contracts. For example, the Company’s control rights with respect to a reference obligation under a credit

57

derivative may be more limited than when the Company issues a financial guaranty insurance contract. In addition, there are more circumstances under which the Company may be obligated to make payments. Similar to a financial guaranty insurance contract, the Company would be obligated to pay if the obligor failed to make a scheduled payment of principal or interest in full. However, the Company may also be required to pay if the obligor became 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. The Company may not unilaterally terminate a CDS contract; however, the Company on occasion has mutually agreed with various counterparties to terminate certain CDS transactions.
Credit Derivative Net Par Outstanding by Sector
The estimated remaining weighted average life of credit derivatives was 4.0 years at March 31, 2014 and 4.1 years at December 31, 2013 . The components of the Company’s credit derivative net par outstanding are presented below.
Credit Derivatives
Subordination and Ratings
As of March 31, 2014
As of December 31, 2013
Asset Type
Net Par
Outstanding
Original
Subordination(1)
Current
Subordination(1)
Weighted
Average
Credit
Rating
Net Par
Outstanding
Original
Subordination(1)
Current
Subordination(1)
Weighted
Average
Credit
Rating
(dollars in millions)
Pooled corporate obligations:






Collateralized loan obligation/collateral bond obligations
$
17,634

32.4
%
36.1
%
AAA
$
19,323

32.4
%
34.0
%
AAA
Synthetic investment grade pooled corporate
9,759

21.6

20.3

AAA
9,754

21.6

20.0

AAA
Synthetic high yield pooled corporate
2,690

47.2

41.3

AAA
2,690

47.2

41.1

AAA
TruPS CDOs
3,436

45.4

33.7

BB
3,554

45.5

32.9

BB+
Market value CDOs of corporate obligations
1,807

23.6

30.6

AAA
2,000

24.4

30.5

AAA
Total pooled corporate obligations
35,326

31.4

31.6

AAA
37,321

31.5

30.6

AAA
U.S. RMBS:







Option ARM and Alt-A first lien
2,520

19.1

7.6

BB-
2,609

19.2

8.6

BB-
Subprime first lien
2,837

30.6

51.3

AA-
2,930

30.5

51.9

AA-
Prime first lien
258

10.9

1.8

CCC
264

10.9

3.2

CCC
Closed-end second lien and HELOCs
22

—

—

B-
23

—

—

B+
Total U.S. RMBS
5,637

24.4

29.2

BBB
5,826

24.4

30.1

BBB
CMBS
2,822

33.5

42.5

AAA
3,744

33.5

42.5

AAA
Other
7,533

—

—

A-
7,591

—

—

A-
Total
$
51,318



AA+
$
54,482



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

Except for TruPS CDOs, the Company’s exposure to pooled corporate obligations is highly diversified in terms of obligors and industries. Most pooled corporate transactions are structured to limit exposure to any given obligor and industry. The majority of the Company’s pooled corporate exposure consists of collateralized loan obligation (“CLO”) or synthetic

58

pooled corporate obligations. Most of these CLOs have an average obligor size of less than 1% of the total transaction and typically restrict the maximum exposure to any one industry to approximately 10% . The Company’s exposure also benefits from embedded credit enhancement in the transactions which allows a transaction to sustain a certain level of losses in the underlying collateral, further insulating the Company from industry specific concentrations of credit risk on these deals.
The Company’s TruPS CDO asset pools are generally less diversified by obligors and industries than the typical CLO asset pool. Also, the underlying collateral in TruPS CDOs consists primarily of subordinated debt instruments such as TruPS issued by bank holding companies and similar instruments issued by insurance companies, REITs and other real estate related issuers while CLOs typically contain primarily senior secured obligations. However, to mitigate these risks TruPS CDOs were typically structured with higher levels of embedded credit enhancement than typical CLOs.
The Company’s exposure to “Other” CDS contracts is also highly diversified. It includes $ 2.5 billion of exposure to two pooled infrastructure transactions comprising diversified pools of international infrastructure project transactions and loans to regulated utilities. These pools were all structured with underlying credit enhancement sufficient for the Company to attach at AAA levels at origination. The remaining $ 5.0 billion of exposure in “Other” CDS contracts comprises numerous deals across various asset classes, such as commercial receivables, international RMBS, infrastructure, regulated utilities and consumer receivables. Of the total net par outstanding in the "Other" sector, $0.5 billion is rated BIG.

Distribution of Credit Derivative Net Par Outstanding by Internal Rating
As of March 31, 2014
As of December 31, 2013
Ratings
Net Par
Outstanding
% of Total
Net Par
Outstanding
% of Total
(dollars in millions)
AAA
$
35,157

68.5
%
$
38,244

70.2
%
AA
3,660

7.1

3,648

6.7

A
3,621

7.1

3,636

6.7

BBB
4,304

8.4

4,161

7.6

BIG
4,576

8.9

4,793

8.8

Credit derivative net par outstanding
$
51,318

100.0
%
$
54,482

100.0
%

Fair Value of Credit Derivatives
Net Change in Fair Value of Credit Derivatives Gain (Loss)
First Quarter
2014
2013
(in millions)
Realized gains on credit derivatives (1)
$
20

$
28

Net credit derivative losses (paid and payable) recovered and recoverable
(1
)
(10
)
Realized gains (losses) and other settlements on credit derivatives
19

18

Net change in unrealized gains (losses) on credit derivatives (2)
(230
)
(610
)
Net change in fair value of credit derivatives
$
(211
)
$
(592
)
____________________
(1)
Includes accelerations due to terminations of CDS contracts of $0.2 million and $1 million related to net par of $1.1 billion and $1.1 billion for First Quarter 2014 and First Quarter 2013 , respectively.

(2)
Except for net estimated credit impairments (i.e., net expected loss to be paid as discussed in Note 5), the unrealized gains and losses on credit derivatives are expected to reduce to zero as the exposure approaches its maturity date. With considerable volatility continuing in the market, unrealized gains (losses) on credit derivatives may fluctuate significantly in future periods.


59

Net Change in Unrealized Gains (Losses) on Credit Derivatives By Sector
First Quarter
Asset Type
2014
2013
(in millions)
Pooled corporate obligations
$
(58
)
$
(105
)
U.S. RMBS
(140
)
(457
)
CMBS
0

(3
)
Other
(32
)
(45
)
Total (1)
$
(230
)
$
(610
)
____________________
(1)
“Other” includes all other U.S. and international asset classes, such as commercial receivables, international infrastructure, international RMBS securities, and pooled infrastructure securities.
During First Quarter 2014, unrealized fair value losses were generated primarily in the U.S. RMBS prime first lien, Alt-A, Option ARM and subprime sectors, as well as pooled corporate obligations, due to wider implied net spreads. The wider implied net spreads were primarily a result of the decreased cost to buy protection in AGC’s name as the market cost of AGC’s credit protection decreased significantly during the period. These transactions were pricing at or above their floor levels (or the minimum rate at which the Company would consider assuming these risks based on historical experience); therefore when the cost of purchasing CDS protection on AGC, 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. The cost of AGM’s credit protection also decreased during First Quarter 2014 generating unrealized fair value losses on a XXX life insurance securitization transaction, due to wider implied net spreads. This did not have a significant impact on the remainder of AGM’s portfolio, as a significant portion of AGM’s policies continue to price at floor levels.
During First Quarter 2013, unrealized fair value losses were generated primarily in the U.S. RMBS sectors, as well as pooled corporate obligations, due to wider implied net spreads. The wider implied net spreads were primarily a result of the decreased cost to buy protection in AGC's name as the market cost of AGC's credit protection decreased significantly during the period. These transactions were pricing at or above their floor levels. To calculate the fair value of the CDS contracts, the Company matches the tenor of the CDS contracts in the Company's portfolio to the tenor of the CDS spread purchased in AGC's name. The cost of AGM's 5 Year and 1 Year credit protection also decreased during First Quarter 2013, but did not lead to significant fair value losses, as a significant portion of AGM policies continue to price at floor levels. First Quarter 2013 changes in fair value of credit derivatives in the Other category included a $20 million loss for guaranteed interest rate swaps identified during the quarter.

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.
Five-Year CDS Spread
on AGC and AGM
Quoted price of CDS contract (in basis points)

As of
March 31, 2014
As of
December 31, 2013
As of
March 31, 2013
As of
December 31, 2012
AGC
291

460

397

678

AGM
305

525

380

536


60

One-Year CDS Spread
on AGC and AGM
Quoted price of CDS contract (in basis points)
As of
March 31, 2014
As of
December 31, 2013
As of
March 31, 2013
As of
December 31, 2012
AGC
55

185

59

270

AGM
70

220

60

257


Fair Value of Credit Derivatives
and Effect of AGC and AGM
Credit Spreads

As of
March 31, 2014
As of
December 31, 2013
(in millions)
Fair value of credit derivatives before effect of AGC and AGM credit spreads
$
(3,095
)
$
(3,442
)
Plus: Effect of AGC and AGM credit spreads
1,172

1,749

Net fair value of credit derivatives
$
(1,923
)
$
(1,693
)
The fair value of CDS contracts at March 31, 2014 , before considering the implications of AGC’s and AGM’s credit spreads, is a direct result of continued wide credit spreads in the fixed income security markets and ratings downgrades. The asset classes that remain most affected are 2005-2007 vintages of prime first lien, Alt-A, Option ARM, subprime RMBS deals as well as trust-preferred and pooled corporate securities. Comparing March 31, 2014 with December 31, 2013, there was a narrowing of spreads primarily related to Alt-A first lien, Option ARM, and subprime RMBS transactions, as well as the Company's pooled corporate obligations. This narrowing of spreads combined with the runoff of par outstanding and termination of securities, resulted in a gain of approximately $ 347 million , before taking into account AGC’s or AGM’s credit spreads.
Management believes that the trading level of AGC’s and AGM’s credit spreads over the past several years has been due to the correlation between AGC’s and AGM’s risk profile and the current risk profile of the broader financial markets and to increased demand for credit protection against AGC and AGM as the result of its financial guaranty volume, as well as the overall lack of liquidity in the CDS market. Offsetting the benefit attributable to AGC’s and AGM’s credit spread were higher credit spreads in the fixed income security markets. The higher credit spreads in the fixed income security market are due to the lack of liquidity in the high yield CDO, TruPS CDO, and CLO markets as well as continuing market concerns over the 2005-2007 vintages of RMBS.

61

The following table presents the fair value and the present value of expected claim payments or recoveries (i.e. net expected loss to be paid as described in Note 5) for contracts accounted for as derivatives.
Net Fair Value and Expected Losses In Excess of Premiums
of Credit Derivatives by Sector
Fair Value of Credit Derivative
Asset (Liability), net
Present Value of Expected Claim
(Payments) Recoveries In Excess of Premiums (1)
Asset Type
As of
March 31, 2014
As of
December 31, 2013
As of
March 31, 2014
As of
December 31, 2013
(in millions)
Pooled corporate obligations
$
(89
)
$
(30
)
$
(20
)
$
(35
)
U.S. RMBS
(1,448
)
(1,308
)
(154
)
(147
)
CMBS
(2
)
(2
)
—

—

Other
(384
)
(353
)
40

43

Total
$
(1,923
)
$
(1,693
)
$
(134
)
$
(139
)
____________________
(1)
Represents the expected claim payments (recoveries) in excess of the present value of future installment fees to be received of $ 39 million as of March 31, 2014 and $ 45 million as of December 31, 2013 . Includes R&W benefit of $ 175 million as of March 31, 2014 and $ 180 million as of December 31, 2013 .

Ratings Sensitivities of Credit Derivative Contracts
Within the Company’s insured CDS portfolio, the transaction documentation for approximately $ 1.6 billion in CDS gross par insured as of March 31, 2014 provides that a downgrade of AGC's financial strength rating below BBB- or Baa3 would constitute a termination event that would allow the relevant CDS counterparty to terminate the affected transactions. As of December 31, 2013 such amount was $ 1.7 billion . If the CDS counterparty elected to terminate the affected transactions, AGC could be required to make a termination payment (or may be entitled to receive a termination payment from the CDS counterparty). The Company does not believe that it can accurately estimate the termination payments AGC could be required to make if, as a result of any such downgrade, a CDS counterparty terminated the affected transactions. These payments could have a material adverse effect on the Company’s liquidity and financial condition.
The transaction documentation for approximately $9.8 billion in CDS gross par insured as of March 31, 2014 requires AGC and Assured Guaranty Re Overseas Ltd. ("AGRO") to post eligible collateral to secure its obligations to make payments under such contracts. Eligible collateral is generally cash or U.S. government or agency securities; eligible collateral other than cash is valued at a discount to the face amount. For approximately $9.5 billion of such contracts, AGC has negotiated caps such that the posting requirement cannot exceed a certain fixed amount, regardless of the mark-to-market valuation of the exposure or the financial strength ratings of AGC. For such contracts, AGC need not post on a cash basis more than $665 million , although the value of the collateral posted may exceed such fixed amount depending on the advance rate agreed with the counterparty for the particular type of collateral posted. For the remaining approximately $ 341 million of such contracts, AGC or AGRO could be required from time to time to post additional collateral without such cap based on movements in the mark-to-market valuation of the underlying exposure. As of March 31, 2014 , the Company was posting approximately $669 million to secure obligations under its CDS exposure, of which approximately $54 million related to such $341 million of notional. As of December 31, 2013 , the Company was posting approximately $677 million , of which approximately $62 million related to $347 million of notional where AGC or AGRO could be required to post additional collateral based on movements in the mark-to-market valuation of the underlying exposure.


62

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, 2014

Credit Spreads(1)
Estimated Net
Fair Value
(Pre-Tax)
Estimated Change
in Gain/(Loss)
(Pre-Tax)
(in millions)
100% widening in spreads
$
(3,936
)
$
(2,013
)
50% widening in spreads
(2,929
)
(1,006
)
25% widening in spreads
(2,426
)
(503
)
10% widening in spreads
(2,124
)
(201
)
Base Scenario
(1,923
)
—

10% narrowing in spreads
(1,737
)
186

25% narrowing in spreads
(1,457
)
466

50% narrowing in spreads
(991
)
932

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

9.
Consolidated Variable Interest Entities
The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs. AGC and AGM do not sponsor any VIEs when underwriting third party financial guaranty insurance or credit derivative transactions, nor has either of them acted as the servicer or collateral manager for any VIE obligations that it insures. The transaction structure generally provides certain financial protections to the Company. This financial protection can take several forms, the most common of which are overcollateralization, first loss protection (or subordination) and excess spread. In the case of overcollateralization (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by the Company), the structure allows defaults of the securitized assets before a default is experienced on the structured finance obligation guaranteed by the Company. In the case of first loss, the financial guaranty insurance policy only covers a senior layer of losses experienced by multiple obligations issued by special purpose entities, including VIEs. The first loss exposure with respect to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to special purpose entities, including VIEs, generate cash flows that are in excess of the interest payments on the debt issued by the special purpose entity. Such excess spread is typically distributed through the transaction’s cash flow waterfall and may be used to create additional credit enhancement, applied to redeem debt issued by the special purpose entities, including VIEs (thereby, creating additional overcollateralization), or distributed to equity or other investors in the transaction.
AGC and AGM are not primarily liable for the debt obligations issued by the VIEs they insure and would only be required to make payments on these insured debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due. AGL’s and its Subsidiaries’ creditors do not have any rights with regard to the collateral supporting the debt issued by the FG VIEs. Proceeds from sales, maturities, prepayments and interest from such underlying collateral may only be used to pay Debt Service on VIE liabilities. Net fair value gains and losses on FG VIEs are expected to reverse to zero at maturity of the VIE debt, except for net premiums received and net claims paid by AGC or AGM under the financial guaranty insurance contract. The Company’s estimate of expected loss to be paid for FG VIEs is included in Note 5, Expected Loss to be Paid.
As part of the terms of its financial guaranty contracts, the Company obtains certain protective rights with respect to the VIE that are triggered by the occurrence of certain events, such as failure to be in compliance with a covenant due to poor deal performance or a deterioration in a servicer or collateral manager's financial condition. At deal inception, the Company typically is not deemed to control a VIE; however, once a trigger event occurs, the Company's control of the VIE typically increases. The Company continuously evaluates its power to direct the activities that most significantly impact the economic performance of VIEs that have debt obligations insured by the Company and, accordingly, where the Company is obligated to

63

absorb VIE losses or receive benefits that could potentially be significant to the VIE. The Company obtains protective rights under its insurance contracts that give the Company additional controls over a VIE if there is either deterioration of deal performance or in the financial health of the deal servicer. The Company is deemed to be the control party for certain VIEs under GAAP, typically when its protective rights give it the power to both terminate and replace the deal servicer, which are characteristics specific to the Company's financial guaranty contracts. If the protective rights that could make the Company the control party have not been triggered, then the VIE is not consolidated. If the Company is deemed no longer to have those protective rights, the transaction is deconsolidated. As of March 31, 2014 and December 31, 2013 , the Company had issued financial guaranty contracts for approximately 950 and 1,000 VIEs, respectively, that it did not consolidate.

Consolidated FG VIEs
Number of FG VIE's Consolidated

As of
March 31, 2014
As of
December 31, 2013
Beginning of the period
40

33

Consolidated (1)
—

11

Deconsolidated (1)
(7
)
(3
)
Matured
(2
)
(1
)
End of the period
31

40

____________________
(1)
Net gain on deconsolidation was $120 million in First Quarter 2014, and a net loss on consolidation and deconsolidation was $7 million in 2013, and recorded in “fair value gains (losses) on FG VIEs” in the consolidated statement of operations.

The total unpaid principal balance for the FG VIEs’ assets that were over 90 days or more past due was approximately $201 million at March 31, 2014 and $750 million at December 31, 2013 . The aggregate unpaid principal of the FG VIEs’ assets was approximately $1,159 million greater than the aggregate fair value at March 31, 2014 , excluding the effect of R&W settlements. The aggregate unpaid principal of the FG VIEs’ assets was approximately $1,940 million greater than the aggregate fair value at December 31, 2013 , excluding the effect of R&W settlements. The change in the instrument-specific credit risk of the FG VIEs’ assets that was recorded in the consolidated statements of operations for First Quarter 2014 and First Quarter 2013 were gains of $58 million and $71 million , respectively.
The unpaid principal for FG VIE liabilities with recourse was $1,783 million and $2,316 million as of March 31, 2014 and December 31, 2013 , respectively. FG VIE liabilities with recourse will mature at various dates ranging from 2025 to 2038 . The aggregate unpaid principal balance was approximately $954 million greater than the aggregate fair value of the FG VIEs’ liabilities as of March 31, 2014 . The aggregate unpaid principal balance was approximately $1,611 million greater than the aggregate fair value of the FG VIEs' liabilities as of December 31, 2013.
The table below shows the carrying value of the consolidated FG VIEs’ assets and liabilities in the consolidated financial statements, segregated by the types of assets that collateralize their respective debt obligations.


64

Consolidated FG VIEs
By Type of Collateral

As of March 31, 2014
As of December 31, 2013
Assets
Liabilities
Assets
Liabilities
(in millions)
With recourse:




First lien
$
505

$
599

$
630

$
791

Second lien
256

387

460

640

Other
360

360

359

359

Total with recourse
1,121

1,346

1,449

1,790

Without recourse
136

101

1,116

1,081

Total
$
1,257

$
1,447

$
2,565

$
2,871


The consolidation of FG VIEs has a significant effect on net income and shareholder’s equity due to (1) changes in fair value gains (losses) on FG VIE assets and liabilities, (2) the elimination of premiums and losses related to the AGC and AGM FG VIE liabilities with recourse and (3) the elimination of investment balances related to the Company’s purchase of AGC and AGM insured FG VIE debt. Upon consolidation of a FG VIE, the related insurance and, if applicable, the related investment balances, are considered intercompany transactions and therefore eliminated. Such eliminations are included in the table below to present the full effect of consolidating FG VIEs.

Effect of Consolidating FG VIEs on Net Income,
Cash Flows From Operating Activities and Shareholders’ Equity
First Quarter
2014
2013
(in millions)
Net earned premiums
$
(17
)
$
(18
)
Net investment income
(3
)
(3
)
Net realized investment gains (losses)
0

1

Fair value gains (losses) on FG VIEs
157

70

Other income
(2
)
—

Loss and LAE
(1
)
(7
)
Effect on net income before tax provision
134

43

Less: tax provision (benefit)
47

15

Effect on net income (loss)
$
87

$
28

Effect on cash flows from operating activities
$
(8
)
$
21

As of
March 31, 2014
As of
December 31, 2013
(in millions)
Effect on shareholders’ equity (decrease) increase
$
(87
)
$
(172
)


Fair value gains (losses) on FG VIEs represent the net change in fair value on the consolidated FG VIEs’ assets and liabilities. During First Quarter 2014, the Company recorded a pre-tax net fair value gain of consolidated FG VIEs of $157 million . The primary driver of this gain, $120 million , was a result of the deconsolidation of seven VIEs. There was an additional gain of $37 million resulting from the Company exercising its option to accelerate two second lien RMBS VIEs. These two VIEs were treated as maturities during the period.

65

For First Quarter 2013, the Company recorded a pre-tax fair value gain on FG VIEs of $70 million . The majority of this gain, approximately $64 million , was the result of a R&W benefit on two Flagstar policies recognized during the quarter. There was also price appreciation across all of the Company's FG VIE assets and liabilities as a result of the overall financial market continuing to improve in First Quarter 2013. The most significant price appreciation occurred in several HELOC transactions where the price appreciation was slightly greater on the FG VIE assets than on the FG VIE liabilities. This was a result of improved performance in the underlying collateral of these securities during the period.

Non-Consolidated VIEs
To date, the Company’s analyses have indicated that it does not have a controlling financial interest in any other VIEs and, as a result, they are not consolidated in the consolidated financial statements. The Company’s exposure provided through its financial guaranties with respect to debt obligations of special purpose entities is included within net par outstanding in Note 3, Outstanding Exposure.

10.
Investments and Cash
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 on fixed-maturity securities, short-term investments and assets acquired in refinancing transactions was $ 95 million and $ 93 million as of March 31, 2014 and December 31, 2013 , respectively.
Net Investment Income
First Quarter
2014
2013
(in millions)
Income from fixed-maturity securities managed by third parties
$
80

$
79

Income from internally managed securities:




Fixed maturities
20

16

Other invested assets
5

1

Gross investment income
105

96

Investment expenses
(2
)
(2
)
Net investment income
$
103

$
94


Net Realized Investment Gains (Losses)
First Quarter
2014
2013
(in millions)
Gross realized gains on available-for-sale securities
$
4

$
6

Gross realized gains on other assets in investment portfolio
5

33

Gross realized losses on available-for-sale securities
(2
)
(4
)
Gross realized losses on other assets in investment portfolio
0

(2
)
Other-than-temporary impairment
(5
)
(5
)
Net realized investment gains (losses)
$
2

$
28


66

The following table presents the roll-forward of the credit losses of fixed-maturity securities for which the Company has recognized an other-than-temporary-impairment and where the portion of the fair value adjustment related to other factors was recognized in other comprehensive income ("OCI").
Roll Forward of Credit Losses
in the Investment Portfolio

First Quarter
2014
2013
(in millions)
Balance, beginning of period
$
80

$
64

Additions for credit losses on securities for which an other-than-temporary-impairment was not previously recognized
1

1

Additions for credit losses on securities for which an other-than-temporary-impairment was previously recognized
4

4

Balance, end of period
$
85

$
69


Investment Portfolio

Fixed-Maturity Securities and Short-Term Investments
by Security Type
As of March 31, 2014

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






Obligations of state and political subdivisions
48
%
$
4,982

$
281

$
(14
)
$
5,249

$
7

AA
U.S. government and agencies
7

674

32

(5
)
701

—

AA+
Corporate securities
13

1,382

55

(10
)
1,427

0

A
Mortgage-backed securities(4):
0




RMBS
11

1,182

44

(55
)
1,171

(31
)
A
CMBS
6

656

16

(2
)
670

—

AAA
Asset-backed securities
5

544

13

(3
)
554

3

BBB+
Foreign government securities
3

309

14

(1
)
322

—

AA+
Total fixed-maturity securities
93

9,729

455

(90
)
10,094

(21
)
AA-
Short-term investments
7

720

0

0

720

—

AAA
Total investment portfolio
100
%
$
10,449

$
455

$
(90
)
$
10,814

$
(21
)
AA-


67

Fixed-Maturity Securities and Short-Term Investments
by Security Type
As of December 31, 2013

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






Obligations of state and political subdivisions
47
%
$
4,899

$
219

$
(39
)
$
5,079

$
4

AA
U.S. government and agencies
7

674

32

(6
)
700

—

AA+
Corporate securities
13

1,314

44

(18
)
1,340

0

A
Mortgage-backed securities(4):






RMBS
11

1,160

34

(72
)
1,122

(43
)
A
CMBS
5

536

17

(4
)
549

—

AAA
Asset-backed securities
6

605

10

(7
)
608

2

BBB+
Foreign government securities
3

300

14

(1
)
313

—

AA+
Total fixed-maturity securities
91

9,488

370

(147
)
9,711

(37
)
AA-
Short-term investments
9

904

0

0

904

—

AAA
Total investment portfolio
100
%
$
10,392

$
370

$
(147
)
$
10,615

$
(37
)
AA-
____________________
(1)
Based on amortized cost.
(2)
Accumulated OCI ("AOCI"). See also Note 17, Shareholders' Equity.
(3)
Ratings in the tables above represent the lower of the Moody’s and S&P classifications except for bonds purchased for loss mitigation or risk management strategies, which use internal ratings classifications. The Company’s portfolio consists primarily of high-quality, liquid instruments.
(4)
Government-agency obligations were approximately 45% of mortgage backed securities as of March 31, 2014 and 50% as of December 31, 2013 based on fair value.

The Company’s investment portfolio in tax-exempt and taxable municipal securities includes issuances by a wide number of municipal authorities across the U.S. and its territories. Securities rated lower than A-/A3 by S&P or Moody’s are not eligible to be purchased for the Company’s portfolio unless acquired for loss mitigation or risk management strategies.
The majority of the investment portfolio is managed by four outside managers. The Company has established detailed guidelines regarding credit quality, exposure to a particular sector and exposure to a particular obligor within a sector.

68

The following tables summarize, for all securities in an unrealized loss position, the aggregate fair value and gross unrealized loss by length of time the amounts have continuously been in an unrealized loss position.
Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time
As of March 31, 2014
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
$
458

$
(14
)
$
13

$
0

$
471

$
(14
)
U.S. government and agencies
175

(5
)
—

—

175

(5
)
Corporate securities
307

(9
)
10

(1
)
317

(10
)
Mortgage-backed securities:





RMBS
317

(13
)
155

(42
)
472

(55
)
CMBS
93

(2
)
—

—

93

(2
)
Asset-backed securities
21

0

44

(3
)
65

(3
)
Foreign government securities
59

(1
)
—

—

59

(1
)
Total
$
1,430

$
(44
)
$
222

$
(46
)
$
1,652

$
(90
)
Number of securities

307


30


337

Number of securities with other-than-temporary impairment

3


11


14

Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time
As of December 31, 2013

Less than 12 months
12 months or more
Total
Fair
value
Unrealized
loss
Fair
value
Unrealized
loss
Fair
value
Unrealized
loss
(dollars in millions)
Obligations of state and political subdivisions
$
781

$
(39
)
$
5

$
0

$
786

$
(39
)
U.S. government and agencies
173

(6
)
—

—

173

(6
)
Corporate securities
401

(18
)
3

0

404

(18
)
Mortgage-backed securities:








RMBS
414

(21
)
186

(51
)
600

(72
)
CMBS
121

(4
)
—

—

121

(4
)
Asset-backed securities
196

(2
)
42

(5
)
238

(7
)
Foreign government securities
54

(1
)
1

0

55

(1
)
Total
$
2,140

$
(91
)
$
237

$
(56
)
$
2,377

$
(147
)
Number of securities

425


33


458

Number of securities with other-than-temporary impairment

13


11


24

Of the securities in an unrealized loss position for 12 months or more as of March 31, 2014 , nine securities had unrealized losses greater than 10% of book value. The total unrealized loss for these securities as of March 31, 2014 was $ 38 million . The Company has determined that the unrealized losses recorded as of March 31, 2014 are yield related and not the result of other-than-temporary-impairment.

69

The amortized cost and estimated fair value of available-for-sale fixed maturity securities by contractual maturity as of March 31, 2014 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, 2014
Amortized
Cost
Estimated
Fair Value
(in millions)
Due within one year
$
301

$
304

Due after one year through five years
1,767

1,843

Due after five years through 10 years
2,375

2,481

Due after 10 years
3,448

3,625

Mortgage-backed securities:


RMBS
1,182

1,171

CMBS
656

670

Total
$
9,729

$
10,094

Under agreements with its cedants and in accordance with statutory requirements, the Company maintains fixed maturity securities and cash in trust accounts for the benefit of reinsured companies, which amounted to $ 397 million and $ 377 million as of March 31, 2014 and December 31, 2013 , respectively, based on fair value. In addition, to fulfill state licensing requirements the Company has placed on deposit eligible securities of $ 19 million and $ 19 million as of March 31, 2014 and December 31, 2013 , respectively, based on fair value.

The fair value of the Company’s pledged securities under credit derivative contracts totaled $ 669 million and $ 677 million as of March 31, 2014 and December 31, 2013 , respectively.
No material investments of the Company were non-income producing for First Quarter 2014 and 2013 , respectively.
Internally Managed Portfolio

The investment portfolio tables shown above include both assets managed externally and internally. In the table below, more detailed information is provided for the component of the total investment portfolio that is internally managed (excluding short-term investments). The internally managed portfolio, as defined below, represents approximately 9% and 9% of the investment portfolio, on a fair value basis as of March 31, 2014 and December 31, 2013 , respectively. The internally managed portfolio consists primarily of the Company's investments in securities for (i) loss mitigation purposes, (ii) other risk management purposes and (iii) where the Company believes a particular security presents an attractive investment opportunity (the "trading portfolio").
One of the Company's strategies for mitigating losses has been to purchase securities it has insured that have expected losses, at discounted prices (assets purchased for loss mitigation purposes). In addition, the Company holds other invested assets that were obtained or purchased as part of negotiated settlements with insured counterparties or under the terms of our financial guaranties (other risk management assets).

Additional detail about the types and amounts of securities acquired by the Company for loss mitigation, other risk management and in the trading portfolio is set forth in the table below.

70

Internally Managed Portfolio
Carrying Value

As of March 31,
As of December 31,
2014
2013
(in millions)
Assets purchased for loss mitigation purposes:
Fixed maturity securities:
Obligations of state and political subdivisions
$
30

$
28

RMBS
277

284

Asset-backed securities
133

127

Other invested assets
46

47

Other risk management assets:
Fixed maturity securities
401

322

Other
83

35

Trading portfolio (other invested assets)
4

88

Total
$
974

$
931



11.
Insurance Company Regulatory Requirements
Dividend Restrictions and Capital Requirements

Under New York insurance law, AGM may only pay dividends out of "earned surplus", which is the portion of a company's surplus that represents the net earnings, gains or profits (after deduction of all losses) that have not been distributed to shareholders as dividends or transferred to stated capital or capital surplus, or applied to other purposes permitted by law, but does not include unrealized appreciation of assets. AGM may pay dividends without the prior approval of the NYSDFS that, together with all dividends declared or distributed by it during the preceding 12 months, does not exceed the lesser of 10% of its policyholders' surplus (as of the last annual or quarterly statement filed with the New York Superintendent of Financial Services ("New York Superintendent")) or 100% of its adjusted net investment income during that period. The aggregate amount available for AGM to distribute as dividends in 2014 without regulatory approval is estimated to be approximately $175 million . AGM did not distribute any dividends in First Quarter 2014 .

Under Maryland insurance law, AGC may, with prior notice to the Maryland Insurance Commissioner, pay an ordinary dividend that, together with all dividends paid in the prior 12 months, does not exceed 10% of its policyholders' surplus (as of the prior December 31) or 100% of its adjusted net investment income during that period. The aggregate amount available for AGC to distribute as ordinary dividends in 2014 will be approximately $69 million . AGC did not distribute any dividends in First Quarter 2014 .

MAC is subject to the same dividend limitations described above for AGM. The Company does not currently anticipate that MAC will distribute any dividends.

As of March 31, 2014, AG Re had unencumbered assets of $201 million . AG Re maintains unencumbered assets for general corporate purposes, including the payment of dividends and for placing assets in trust for the benefit of cedants to reflect declines in the market value of previously posted assets or additional ceded reserves. Accordingly, the amount of unencumbered assets will fluctuate during a given quarter based upon factors including the market value of previously posted assets and additional ceded reserves, if any. AG Re is an insurance company registered and licensed under the Insurance Act 1978 of Bermuda, amendments thereto and related regulations. Based on regulatory capital requirements, AG Re currently has $600 million in excess capital and surplus. As a Class 3B insurer, AG Re is restricted from paying dividends or distributing capital by the following regulatory requirements:

•
Dividends shall not exceed outstanding statutory surplus which is $276 million .

•
Dividends on an annual basis shall not exceed 25% of its total statutory capital and statutory surplus (as set out in its previous year's financial statements) which is $280 million unless it files (at least seven days before payment of such

71

dividends) with the Bermuda Monetary Authority an affidavit stating that it will continue to meet the required margins.

•
Capital distributions on an annual basis shall not exceed 15% of its total statutory capital (as set out in its previous year's financial statements) which is $127 million , unless approval is granted by the Bermuda Monetary Authority.

•
Dividends are limited by requirements that the subject company must at all times (i) maintain the minimum solvency margin and the Company's applicable enhanced capital requirements required under the Insurance Act of 1978 and (ii) have relevant assets in an amount at least equal to 75% of relevant liabilities, both as defined under the Insurance Act of 1978.
U.K. company law prohibits each of AGE and AGUK from declaring a dividend to its shareholders unless it has “profits available for distribution.” The determination of whether a company has profits available for distribution is based on its accumulated realized profits less its accumulated realized losses. While the U.K. insurance regulatory laws impose no statutory restrictions on a general insurer's ability to declare a dividend, the Prudential Regulation Authority's capital requirements may in practice act as a restriction on dividends. The Company does not expect AGE or AGUK to distribute any dividends at this time.

Dividends and Surplus Notes
By Insurance Company Subsidiaries

First Quarter
2014
2013
(in millions)
Dividends paid by AG Re to AGL
$
62

$
40

Repayment of surplus note by AGM to AGMH
25


25

12.
Income Taxes

Overview
AGL, and its "Bermuda Subsidiaries," which consist of AG Re, AGRO, and Cedar Personnel Ltd., are not subject to any income, withholding or capital gains taxes under current Bermuda law. The Company has received an assurance from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, AGL and its Bermuda Subsidiaries will be exempt from taxation in Bermuda until March 31, 2035. AGL's U.S. and U.K. subsidiaries are subject to income taxes imposed by U.S. and U.K. authorities, respectively, and file applicable tax returns. In addition, AGRO, a Bermuda domiciled company and AGE, a U.K. domiciled company, have elected under Section 953(d) of the U.S. Internal Revenue Code to be taxed as a U.S. domestic corporation.

In November 2013, AGL became tax resident in the U.K. although it will remain a Bermuda-based company and its administrative and head office functions will continue to be carried on in Bermuda. As a company that is not incorporated in the U.K., AGL currently intends to manage the affairs of AGL in such a way as to establish and maintain its status as a company that is tax resident in the U.K. As a U.K. tax resident company, AGL is required to file a corporation tax return with Her Majesty’s Revenue & Customs (“HMRC”).  AGL is subject to U.K. corporation tax in respect of its worldwide profits (both income and capital gains), subject to any applicable exemptions. The main rate of corporation tax is 23% currently; such rate fell 21% as of April 1, 2014 and will fall to 20% as of April 1, 2015.  AGL has also registered in the U.K. to report its Value Added Tax (“VAT”) liability.  The current rate of VAT is 20% . Assured Guaranty does not expect that becoming U.K. tax resident will result in any material change in the group’s overall tax charge.  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.  The U.K. government implemented a new tax regime for “controlled foreign companies” (“CFC regime”) effective January 1, 2013.  Assured Guaranty does not expect any profits of non-U.K. resident members of the group to be taxed under the CFC regime and has obtained a clearance from HMRC confirming this on the basis of current facts.

For the periods beginning on July 1, 2009 and forward, AGMH files a consolidated federal income tax return with AGUS, AGC, AG Financial Products Inc. ("AGFP") and AG Analytics Inc. (“AGUS consolidated tax group”). Beginning on

72

May 12, 2012, MAC also joined the the AGUS consolidated tax group. Assured Guaranty Overseas US Holdings Inc. 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 fair value of its credit derivatives, which prevents the Company from projecting a reliable estimated annual effective tax rate and pretax income for the full year 2014. A discrete calculation of the provision is calculated for each interim period.

The effective tax rates reflect the proportion of income recognized by each of the Company’s operating subsidiaries, with U.S. subsidiaries taxed at the U.S. marginal corporate income tax rate of 35% , U.K. subsidiaries taxed at the U.K. blended marginal corporate tax rate of 21.5% unless subject to U.S. tax by election or as a U.S. controlled foreign corporation, and no taxes for the Company’s Bermuda subsidiaries unless subject to U.S. tax by election or as a U.S. controlled foreign corporation. For periods subsequent to April 1, 2014, the U.K. corporation tax rate has been reduced to 21% , for the period April 1, 2013 to April 1, 2014 the U.K. corporation tax rate was 23% resulting in a blended tax rate of 21.5% in 2014, and prior to April 1, 2013, the U.K. corporation tax rate was 24% resulting in a blended tax rate of 23.25% in 2013. The Company’s overall corporate effective tax rate fluctuates based on the distribution of income across jurisdictions.
A reconciliation of the difference between the provision for income taxes and the expected tax provision at statutory rates in taxable jurisdictions is presented below.

Effective Tax Rate Reconciliation
First Quarter
2014
2013
(in millions)
Expected tax provision (benefit) at statutory rates in taxable jurisdictions
$
38

$
(48
)
Tax-exempt interest
(14
)
(14
)
Change in liability for uncertain tax positions
1

(8
)
Other
2

2

Total provision (benefit) for income taxes
$
27

$
(68
)
Effective tax rate
38.8
%
31.8
%

The expected tax provision at statutory rates in taxable jurisdictions is calculated as the sum of pretax income in each jurisdiction multiplied by the statutory tax rate of the jurisdiction by which it will be taxed. Pretax income of the Company’s subsidiaries which are not U.S. or U.K. domiciled but are subject to U.S. or U.K. tax by election, establishment of tax residency or as controlled foreign corporations are included at the U.S. or U.K. statutory tax rate. Where there is a pretax loss in one jurisdiction and pretax income in another, the total combined expected tax rate may be higher or lower than any of the individual statutory rates.
The following table presents pretax income and revenue by jurisdiction.
Pretax Income (Loss) by Tax Jurisdiction

First Quarter
2014
2013
(in millions)
United States
$
113

$
(134
)
Bermuda
(37
)
(78
)
U.K.
(7
)
0

Total
$
69

$
(212
)

73

Revenue by Tax Jurisdiction

First Quarter
2014
2013
(in millions)
United States
$
195

$
(127
)
Bermuda
1

(49
)
U.K.
(1
)
0

Total
$
195

$
(176
)
Pretax income by jurisdiction may be disproportionate to revenue by jurisdiction to the extent that insurance losses incurred are disproportionate.

Valuation Allowance
The Company came to the conclusion that it is more likely than not that its net deferred tax asset will be fully realized after weighing all positive and negative evidence available as required under GAAP. The positive evidence that was considered included the cumulative operating income the Company has earned over the last three years, and the significant unearned premium income to be included in taxable income. The positive evidence outweighs any negative evidence that exists. As such, the Company believes that no valuation allowance is necessary in connection with this deferred tax asset. The Company will continue to analyze the need for a valuation allowance on a quarterly basis.

Audits

AGUS has open tax years with the U.S. Internal Revenue Service (“IRS”) for 2009 forward and is currently under audit for the 2009-2012 tax years. The IRS concluded its field work with respect to tax years 2006 through 2008 without adjustment. On February 20, 2013 the IRS notified AGUS that the Joint Committee on Taxation completed its review of the 2006 through 2008 tax years and has accepted the results of the IRS examination without exception. Assured Guaranty Oversees US Holdings Inc. has open tax years of 2009 forward. AGMH and subsidiaries have separate open tax years with the IRS of January 1, 2009 through the July 1, 2009 when they joined the AGUS consolidated group. The IRS concluded its field work with respect to tax year 2008 for AGMH and subsidiaries while members of the Dexia Holdings Inc. consolidated tax group without adjustment. The Company is indemnified by Dexia SA and Dexia Crédit Local S.A. for any potential liability associated with this audit of any periods prior to the Company's acquisition of AGMH on July 1, 2009. The Company's U.K. subsidiaries are not currently under examination and have open tax years of 2011 forward.
Uncertain Tax Positions

The Company's policy is to recognize interest and penalties related to uncertain tax positions in income tax expense and has accrued $0.3 million for First Quarter 2014 and $1 million for 2013. For First Quarter 2013, an amount of $9 million was released following the closing of an IRS audit. As of March 31, 2014 and December 31, 2013, the Company has accrued $3 million and $3 million of interest, respectively.

The total amount of unrecognized tax benefits as of March 31, 2014 and December 31, 2013, that would affect the effective tax rate, if recognized, was $21 million and $20 million , respectively.
13.
Reinsurance and Other Monoline Exposures
The Company assumes exposure on insured obligations (“Assumed Business”) and cedes portions of its exposure on obligations it has insured (“Ceded Business”) in exchange for premiums, net of ceding commissions. The Company has historically entered into ceded reinsurance contracts in order to obtain greater business diversification and reduce the net potential loss from large risks.
Assumed and Ceded Business
The Company assumes business from other monoline financial guaranty companies. Under these relationships, the Company assumes a portion of the ceding company’s insured risk in exchange for a premium. The Company may be exposed to risk in this portfolio in that the Company may be required to pay losses without a corresponding premium in circumstances

74

where the ceding company is experiencing financial distress and is unable to pay premiums. The Company’s facultative and treaty agreements are generally subject to termination at the option of the ceding company:
•
if the Company fails to meet certain financial and regulatory criteria and to maintain a specified minimum financial strength rating, or

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

Upon the occurrence of the conditions set forth in the first bullet above, whether or not an agreement is terminated, the Company may be required to obtain a letter of credit or alternative form of security to collateralize its obligation to perform under such agreement or it may be obligated to increase the level of ceding commission paid.
The downgrade of the financial strength ratings of AG Re or of AGC gives certain reinsurance counterparties the right to recapture ceded business, which would lead to a reduction in the Company's unearned premium reserve and related earnings on such reserve. With respect to a significant portion of the Company's in-force financial guaranty assumed business, based on AG Re's and AGC's current ratings and subject to the terms of each reinsurance agreement, the third party ceding company may have the right to recapture assumed business ceded to AG Re and/or AGC, and in connection therewith, to receive payment from the assuming reinsurer of an amount equal to the reinsurer’s statutory unearned premium (net of ceding commissions) and statutory loss reserves (if any) associated with that business, plus, in certain cases, an additional ceding commission. As of March 31, 2014 , 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 $283 million and $57 million , respectively.

The Company has Ceded Business to non-affiliated companies to limit its exposure to risk. Under these relationships, the Company cedes a portion of its insured risk in exchange for a premium paid to the reinsurer. The Company remains primarily liable for all risks it directly underwrites and is required to pay all gross claims. It then seeks reimbursement from the reinsurer for its proportionate share of claims. The Company may be exposed to risk for this exposure if it were required to pay the gross claims and not be able to collect ceded claims from an assuming company experiencing financial distress. A number of the financial guaranty insurers to which the Company has ceded par have experienced financial distress and been downgraded by the rating agencies as a result. In addition, state insurance regulators have intervened with respect to some of these insurers. The Company’s ceded contracts generally allow the Company to recapture Ceded Business after certain triggering events, such as reinsurer downgrades.
In First Quarter 2014, the Company entered into commutation agreements to reassume previously ceded business consisting of approximately $ 856 million par of almost exclusively U.S. public finance and European (predominantly UK) utility and infrastructure exposures outstanding as of February 28, 2014. For such reassumptions, the Company received the statutory unearned premium outstanding as of the commutation dates plus, in one case, a commutation premium. There were no commutations in First Quarter 2013.

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


75

Effect of Reinsurance on Statement of Operations

First Quarter
2014
2013
(in millions)
Premiums Written:
Direct
$
31

$
19

Assumed(1)
(1
)
(2
)
Ceded
(24
)
(2
)
Net
$
6

$
15

Premiums Earned:
Direct
$
140

$
267

Assumed
11

13

Ceded
(19
)
(32
)
Net
$
132

$
248

Loss and LAE:
Direct
$
34

$
(27
)
Assumed
6

(14
)
Ceded
1

(7
)
Net
$
41

$
(48
)
____________________
(1)
Negative assumed premiums written were due to changes in expected Debt Service schedules.
Reinsurer Exposure
In addition to assumed and ceded reinsurance arrangements, the Company may also have exposure to some financial guaranty reinsurers (i.e., monolines) in other areas. Second-to-pay insured par outstanding represents transactions the Company has insured that were previously insured by other monolines. The Company underwrites such transactions based on the underlying insured obligation without regard to the primary insurer. Another area of exposure is in the investment portfolio where the Company holds fixed-maturity securities that are wrapped by monolines and whose value may decline based on the rating of the monoline. At March 31, 2014 , based on fair value, the Company had fixed-maturity securities in its investment portfolio consisting of $ 435 million insured by National Public Finance Guarantee Corporation, $ 455 million insured by Ambac Assurance Corporation ("Ambac") and $ 29 million insured by other guarantors.

76

Exposure by Reinsurer
Ratings at
Par Outstanding
May 5, 2014
As of March 31, 2014
Reinsurer
Moody’s
Reinsurer
Rating
S&P
Reinsurer
Rating
Ceded Par
Outstanding(1)
Second-to-
Pay Insured
Par
Outstanding
Assumed Par
Outstanding
(dollars in millions)
American Overseas Reinsurance Company Limited (f/k/a Ram Re)
WR (2)
WR
$
8,113

$
—

$
30

Tokio Marine & Nichido Fire Insurance Co., Ltd.
Aa3 (3)
AA- (3)
6,273

—

—

Radian Asset Assurance Inc.
Ba1
B+
4,696

24

987

Syncora Guarantee Inc.
WR
WR
4,192

1,769

161

Mitsui Sumitomo Insurance Co. Ltd.
A1
A+ (3)
2,139

—

—

ACA Financial Guaranty Corp.
NR (5)
WR
809

3

8

Federal Insurance Company
Aa2
AA
382

—

—

Swiss Reinsurance Co.
Aa3
AA-
347

—

—

Security Life of Denver Insurance Company
A3
A-
239

—

—

Ambac (4)
WR
WR
85

6,013

17,578

CIFG Assurance North America Inc.
WR
WR
—

114

4,883

MBIA Inc.
(4)
(4)
—

10,208

7,221

Financial Guaranty Insurance Co.
WR
WR
—

2,273

1,237

Other
Various
Various
251

2,114

45

Total
$
27,526

$
22,518

$
32,150

____________________
(1)
Includes $ 3,038 million in ceded par outstanding related to insured credit derivatives.
(2)    Represents “Withdrawn Rating.”
(3)    The Company has structural collateral agreements satisfying the triple-A credit requirement of S&P and/or Moody’s.

(4)
MBIA Inc. includes various subsidiaries which are rated AA- and B by S&P and Baa1, B1 and B3 by Moody’s. Ambac includes policies in their general and segregated account.
(5)
Represents “Not Rated.”

77

Amounts Due (To) From Reinsurers
As of March 31, 2014
Assumed
Premium, net
of Commissions
Ceded
Premium, net
of Commissions
Assumed
Expected
Loss and LAE
Ceded
Expected
Loss and LAE
(in millions)
American Overseas Reinsurance Company Limited
$
—

$
(9
)
$
—

$
7

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

(18
)
—

18

Radian Asset Assurance Inc.
—

(17
)
—

14

Syncora Guarantee Inc.
—

(39
)
—

1

Mitsui Sumitomo Insurance Co. Ltd.
—

(3
)
—

3

Federal Insurance Company
—

(17
)
—

—

Swiss Reinsurance Co.
—

(3
)
—

1

Security Life of Denver Insurance Company
—

(10
)
—

—

Ambac
66

—

(82
)
—

CIFG Assurance North America Inc.
—

—

(6
)
—

MBIA Inc.
13

—

(10
)
—

Financial Guaranty Insurance Co.
6

—

(104
)
—

Other
0

(25
)
—

—

Total
$
85

$
(141
)
$
(202
)
$
44

Excess of Loss Reinsurance Facility
AGC, AGM and MAC entered into an aggregate excess of loss reinsurance facility with a number of reinsurers, effective as of January 1, 2014. The facility covers losses occurring either from January 1, 2014 through December 31, 2021, or January 1, 2015 through December 31, 2022, at the option of AGC, AGM and MAC. It terminates on January 1, 2016, unless AGC, AGM and MAC choose to extend it. The facility covers certain U.S. public finance credits insured or reinsured by AGC, AGM and MAC as of September 30, 2013, excluding credits that were rated non-investment grade as of December 31, 2013 by Moody’s or S&P or internally by AGC, AGM or MAC and is subject to certain per credit limits. Among the credits excluded are those associated with the Commonwealth of Puerto Rico and its related authorities and public corporations. The facility attaches when AGC’s, AGM’s and MAC’s net losses (net of AGC’s and AGM's reinsurance (including from affiliates) and net of recoveries) exceed $1.5 billion in the aggregate. The facility covers a portion of the next $500 million of losses, with the reinsurers assuming pro rata in the aggregate $450 million of the $500 million of losses and AGC, AGM and MAC jointly retaining the remaining $50 million of losses. The reinsurers are required to be rated at least AA- or to post collateral sufficient to provide AGM, AGC and MAC with the same reinsurance credit as reinsurers rated AA-. AGM, AGC and MAC are obligated to pay the reinsurers their share of recoveries relating to losses during the coverage period in the covered portfolio. AGC, AGM and MAC have paid approximately $19 million of premiums during 2014 for the term January 1, 2014 through December 31, 2014 and deposited approximately $19 million of securities into trust accounts for the benefit of the reinsurers to be used to pay the premium for January 1, 2015 through December 31, 2015. This facility replaces the $435 million aggregate excess of loss reinsurance facility that AGC and AGM had entered into on January 22, 2012.

14.
Commitments and Contingencies
Legal Proceedings
Litigation
Lawsuits arise in the ordinary course of the Company’s business. It is the opinion of the Company’s management, based upon the information available, that the expected outcome of litigation against the Company, individually or in the aggregate, will not have a material adverse effect on the Company’s financial position or liquidity, although an adverse resolution of litigation against the Company in a fiscal quarter or year could have a material adverse effect on the Company’s results of operations in a particular quarter or year.
The Company establishes accruals for litigation and regulatory matters to the extent it is probable that a loss has been incurred and the amount of that loss can be reasonably estimated. For litigation and regulatory matters where a loss may be

78

reasonably possible, but not probable, or is probable but not reasonably estimable, no accrual is established, but if the matter is material, it is disclosed, including matters discussed below. The Company reviews relevant information with respect to its litigation and regulatory matters on a quarterly, and annual basis and updates its accruals, disclosures and estimates of reasonably possible loss based on such reviews.
In addition, in the ordinary course of their respective businesses, certain of the Company’s subsidiaries assert claims in legal proceedings against third parties to recover losses paid in prior periods. For example, as described in the "Recovery Litigation" section of Note 5, Expected Loss to be Paid, as of the date of this filing, AGC and AGM have filed complaints against certain sponsors and underwriters of RMBS securities that AGC or AGM had insured, alleging, among other claims, that such persons had breached R&W in the transaction documents, failed to cure or repurchase defective loans and/or violated state securities laws. The amounts, if any, the Company will recover in proceedings to recover losses are uncertain, and recoveries, or failure to obtain recoveries, in any one or more of these proceedings during any quarter or year could be material to the Company’s results of operations in that particular quarter or year.
Proceedings Relating to the Company’s Financial Guaranty Business
The Company receives subpoenas duces tecum and interrogatories from regulators from time to time.
Beginning in July 2008, AGM and various other financial guarantors were named in complaints filed in the Superior Court for the State of California, City and County of San Francisco by a number of plaintiffs. Subsequently, plaintiffs' counsel filed amended complaints against AGM and AGC and added additional plaintiffs. These complaints alleged that the financial guaranty insurer defendants (i) participated in a conspiracy in violation of California's antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and created market demand for municipal bond insurance, (ii) participated in risky financial transactions in other lines of business that damaged each insurer's financial condition (thereby undermining the value of each of their guaranties), and (iii) failed to adequately disclose the impact of those transactions on their financial condition. In addition to their antitrust claims, various plaintiffs asserted claims for breach of the covenant of good faith and fair dealing, fraud, unjust enrichment, negligence, and negligent misrepresentation. At hearings held in July and October 2011 relating to AGM, AGC and the other defendants' demurrer, the court overruled the demurrer on the following claims: breach of contract, violation of California's antitrust statute and of its unfair business practices law, and fraud. The remaining claims were dismissed. On December 2, 2011, AGM, AGC and the other bond insurer defendants filed an anti-SLAPP ("Strategic Lawsuit Against Public Participation") motion to strike the complaints under California's Code of Civil Procedure. On July 9, 2013, the court entered its order denying in part and granting in part the bond insurers' motion to strike. As a result of the order, the causes of action that remain against AGM and AGC are: claims of breach of contract and fraud, brought by the City of San Jose, the City of Stockton, East Bay Municipal Utility District and Sacramento Suburban Water District, relating to the failure to disclose the impact of risky financial transactions on their financial condition; and a claim of breach of the unfair business practices law brought by The Jewish Community Center of San Francisco. On September 9, 2013, plaintiffs filed an appeal of the anti-SLAPP ruling on the California antitrust statute. On September 30, 2013, AGC, AGM and the other bond insurer defendants filed a notice of cross-appeal. The complaints generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss, if any, that may arise from these lawsuits.
On November 28, 2011, Lehman Brothers International (Europe) (in administration) (“LBIE”) sued AGFP, an affiliate of AGC which in the past had provided credit protection to counterparties under credit default swaps. AGC acts as the credit support provider of AGFP under these credit default swaps. LBIE’s complaint, which was filed in the Supreme Court of the State of New York, alleged that AGFP improperly terminated nine credit derivative transactions between LBIE and AGFP and improperly calculated the termination payment in connection with the termination of 28 other credit derivative transactions between LBIE and AGFP. With respect to the 28 credit derivative transactions, AGFP calculated that LBIE owes AGFP approximately $ 25 million , whereas LBIE asserted in the complaint that AGFP owes LBIE a termination payment of approximately $ 1.4 billion . LBIE is seeking unspecified damages. On February 3, 2012, AGFP filed a motion to dismiss certain of the counts in the complaint, and on March 15, 2013, the court granted AGFP's motion to dismiss the count relating to improper termination of the nine credit derivative transactions and denied AGFP's motion to dismiss the count relating to the remaining transactions. The Company cannot reasonably estimate the possible loss, if any, that may arise from this lawsuit.
On November 19, 2012, Lehman Brothers Holdings Inc. (“LBHI”) and Lehman Brothers Special Financing Inc. (“LBSF") commenced an adversary complaint and claim objection in the United States Bankruptcy Court for the Southern District of New York against Credit Protection Trust 283 (“CPT 283”), FSA Administrative Services, LLC, as trustee for CPT 283, and AGM, in connection with CPT 283's termination of a CDS between LBSF and CPT 283. CPT 283 terminated the CDS as a consequence of LBSF failing to make a scheduled payment owed to CPT 283, which termination occurred after LBHI filed for bankruptcy but before LBSF filed for bankruptcy. The CDS provided that CPT 283 was entitled to receive from

79

LBSF a termination payment in that circumstance of approximately $43.8 million (representing the economic equivalent of the future fixed payments CPT 283 would have been entitled to receive from LBSF had the CDS not been terminated), and CPT 283 filed proofs of claim against LBSF and LBHI (as LBSF's credit support provider) for such amount. LBHI and LBSF seek to disallow and expunge (as impermissible and unenforceable penalties) CPT 283's proofs of claim against LBHI and LBSF and recover approximately $67.3 million , which LBHI and LBSF allege was the mark-to-market value of the CDS to LBSF (less unpaid amounts) on the day CPT 283 terminated the CDS, plus interest, attorney's fees, costs and other expenses. On the same day, LBHI and LBSF also commenced an adversary complaint and claim objection against Credit Protection Trust 207 (“CPT 207”), FSA Administrative Services, LLC, as trustee for CPT 207, and AGM, in connection with CPT 207's termination of a CDS between LBSF and CPT 207. Similarly, the CDS provided that CPT 207 was entitled to receive from LBSF a termination payment in that circumstance of $492,555 . LBHI and LBSF seek to disallow and expunge CPT 207's proofs of claim against LBHI and LBSF and recover approximately $1.5 million . AGM believes the terminations of the CDS and the calculation of the termination payment amounts were consistent with the terms of the ISDA master agreements between the parties. The Company cannot reasonably estimate the possible loss, if any, that may arise from this lawsuit.
On September 25, 2013, Wells Fargo Bank, N.A., as trust administrator, filed an interpleader complaint in the U.S. District Court for the Southern District of New York against AGM, among others, relating to the right of AGM to be reimbursed from certain cashflows for principal claims paid on insured certificates issued in the MASTR Adjustable Rate Mortgages Trust 2007-3 securitization. The Company estimates that an adverse outcome to the interpleader proceeding could increase losses on the transaction by approximately $10 - $20 million , net of expected settlement payments and reinsurance in force.

Proceedings Related to AGMH’s Former Financial Products Business
The following is a description of legal proceedings involving AGMH’s former Financial Products Business. Although the Company did not acquire AGMH’s former Financial Products Business, which included AGMH’s former GIC business, medium term notes business and portions of the leveraged lease businesses, certain legal proceedings relating to those businesses are against entities that the Company did acquire. While Dexia SA and Dexia Crédit Local S.A., jointly and severally, have agreed to indemnify the Company against liability arising out of the proceedings described below in the “—Proceedings Related to AGMH’s Former Financial Products Business” section, such indemnification might not be sufficient to fully hold the Company harmless against any injunctive relief or civil or criminal sanction that is imposed against AGMH or its subsidiaries.
Governmental Investigations into Former Financial Products Business
AGMH and/or AGM have received subpoenas duces tecum and interrogatories or civil investigative demands from the Attorneys General of the States of Connecticut, Florida, Illinois, Massachusetts, Missouri, New York, Texas and West Virginia relating to their investigations of alleged bid rigging of municipal GICs. AGMH is responding to such requests. AGMH may receive additional inquiries from these or other regulators and expects to provide additional information to such regulators regarding their inquiries in the future. In addition,
•
AGMH received a subpoena from the Antitrust Division of the Department of Justice in November 2006 issued in connection with an ongoing criminal investigation of bid rigging of awards of municipal GICs and other municipal derivatives; and
•
AGM received a subpoena from the SEC in November 2006 related to an ongoing industry-wide investigation concerning the bidding of municipal GICs and other municipal derivatives,

Pursuant to the subpoenas, AGMH has furnished to the Department of Justice and SEC records and other information with respect to AGMH’s municipal GIC business. The ultimate loss that may arise from these investigations remains uncertain.
In addition AGMH had received a “Wells Notice” from the staff of the Philadelphia Regional Office of the SEC in February 2008 relating to the investigation concerning the bidding of municipal GICs and other municipal derivatives. The Wells Notice indicated that the SEC staff was considering recommending that the SEC authorize the staff to bring a civil injunctive action and/or institute administrative proceedings against AGMH, alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 17(a) of the Securities Act. On January 8, 2014, the SEC issued a letter stating that it had concluded the investigation as to AGMH and, based on the information it had as of such date, it did not intend to recommend an enforcement action by the SEC against AGMH.

80

In July 2010, a former employee of AGM who had been involved in AGMH's former Financial Products Business was indicted along with two other persons with whom he had worked at Financial Guaranty Insurance Company. Such former employee and the other two persons were convicted on fraud conspiracy counts. After appeal, their convictions were reversed by a three-judge panel of the U.S. Court of Appeals for the Second Circuit in November 2013. In January 2014, the Department of Justice petitioned the U.S. Court of Appeals for the Second Circuit for a panel rehearing and a rehearing en banc of the appeal.

Lawsuits Relating to Former Financial Products Business
During 2008, nine putative class action lawsuits were filed in federal court alleging federal antitrust violations in the municipal derivatives industry, seeking damages and alleging, among other things, a conspiracy to fix the pricing of, and manipulate bids for, municipal derivatives, including GICs. These cases have been coordinated and consolidated for pretrial proceedings in the U.S. District Court for the Southern District of New York as MDL 1950, In re Municipal Derivatives Antitrust Litigation, Case No. 1:08-cv-2516 (“MDL 1950”).
Five of these cases named both AGMH and AGM: (a) Hinds County, Mississippi v. Wachovia Bank, N.A. ; (b) Fairfax County, Virginia v. Wachovia Bank, N.A. ; (c) Central Bucks School District, Pennsylvania v. Wachovia Bank, N.A. ; (d) Mayor and City Council of Baltimore, Maryland v. Wachovia Bank, N.A. ; and (e) Washington County, Tennessee v. Wachovia Bank, N.A. In April 2009, the MDL 1950 court granted the defendants’ motion to dismiss on the federal claims, but granted leave for the plaintiffs to file an amended complaint. The Corrected Third Consolidated Amended Class Action Complaint, filed on October 9, 2013, lists neither AGM nor AGMH as a named defendant or a co-conspirator. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys’ fees and other costs. The Company cannot reasonably estimate the possible loss, if any, or range of loss that may arise from these lawsuits.
Four of the cases named AGMH (but not AGM) and also alleged that the defendants violated California state antitrust law and common law by engaging in illegal bid-rigging and market allocation, thereby depriving the cities or municipalities of competition in the awarding of GICs and ultimately resulting in the cities paying higher fees for these products: (f) City of Oakland, California v. AIG Financial Products Corp. ; (g) County of Alameda, California v. AIG Financial Products Corp. ; (h) City of Fresno, California v. AIG Financial Products Corp. ; and (i) Fresno County Financing Authority v. AIG Financial Products Corp . When the four plaintiffs filed a consolidated complaint in September 2009, the plaintiffs did not name AGMH as a defendant. However, the complaint does describe some of AGMH’s and AGM’s activities. The consolidated complaint generally seeks unspecified monetary damages, interest, attorneys’ fees and other costs. In April 2010, the MDL 1950 court granted in part and denied in part the named defendants’ motions to dismiss this consolidated complaint.
In 2008, AGMH and AGM also were named in five non-class action lawsuits originally filed in the California Superior Courts alleging violations of California law related to the municipal derivatives industry: (a) City of Los Angeles, California v. Bank of America, N.A. ; (b) City of Stockton, California v. Bank of America, N.A. ; (c) County of San Diego, California v. Bank of America, N.A. ; (d) County of San Mateo, California v. Bank of America, N.A. ; and (e) County of Contra Costa, California v. Bank of America, N.A. Amended complaints in these actions were filed in September 2009, adding a federal antitrust claim and naming AGM (but not AGMH) and AGUS, among other defendants. These cases have been transferred to the Southern District of New York and consolidated with MDL 1950 for pretrial proceedings.
In late 2009, AGM and AGUS, among other defendants, were named in six additional non-class action cases filed in federal court, which also have been coordinated and consolidated for pretrial proceedings with MDL 1950: (f) City of Riverside, California v. Bank of America, N.A. ; (g) Sacramento Municipal Utility District v. Bank of America, N.A. ; (h) Los Angeles World Airports v. Bank of America, N.A. ; (i) Redevelopment Agency of the City of Stockton v. Bank of America, N.A. ; (j) Sacramento Suburban Water District v. Bank of America, N.A. ; and (k) County of Tulare, California v. Bank of America, N.A.
The MDL 1950 court denied AGM and AGUS’s motions to dismiss these eleven complaints in April 2010. Amended complaints were filed in May 2010. On October 29, 2010, AGM and AGUS were voluntarily dismissed with prejudice from the Sacramento Municipal Utility District case only. The complaints in these lawsuits generally seek or sought unspecified monetary damages, interest, attorneys’ fees, costs and other expenses. The Company cannot reasonably estimate the possible loss, if any, or range of loss that may arise from the remaining lawsuits.
In May 2010, AGM and AGUS, among other defendants, were named in five additional non-class action cases filed in federal court in California: (a) City of Richmond, California v. Bank of America, N.A. (filed on May 18, 2010, N.D. California); (b) City of Redwood City, California v. Bank of America, N.A . (filed on May 18, 2010, N.D. California); (c) Redevelopment Agency of the City and County of San Francisco, California v. Bank of America, N.A. (filed on May 21, 2010, N.D. California);

81

(d) East Bay Municipal Utility District, California v. Bank of America, N.A. (filed on May 18, 2010, N.D. California); and (e) City of San Jose and the San Jose Redevelopment Agency, California v. Bank of America, N.A (filed on May 18, 2010, N.D. California). These cases have also been transferred to the Southern District of New York and consolidated with MDL 1950 for pretrial proceedings. In September 2010, AGM and AGUS, among other defendants, were named in a sixth additional non-class action filed in federal court in New York, but which alleges violation of New York’s Donnelly Act in addition to federal antitrust law: Active Retirement Community, Inc. d/b/a Jefferson’s Ferry v. Bank of America, N.A. (filed on September 21, 2010, E.D. New York), which has also been transferred to the Southern District of New York and consolidated with MDL 1950 for pretrial proceedings. In December 2010, AGM and AGUS, among other defendants, were named in a seventh additional non-class action filed in federal court in the Central District of California, Los Angeles Unified School District v. Bank of America, N.A. , and in an eighth additional non-class action filed in federal court in the Southern District of New York, Kendal on Hudson, Inc. v. Bank of America, N.A. These cases also have been consolidated with MDL 1950 for pretrial proceedings. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys’ fees, costs and other expenses. The Company cannot reasonably estimate the possible loss, if any, or range of loss that may arise from these lawsuits.
In January 2011, AGM and AGUS, among other defendants, were named in an additional non-class action case filed in federal court in New York, which alleges violation of New York’s Donnelly Act in addition to federal antitrust law: Peconic Landing at Southold, Inc. v. Bank of America, N.A. This case has been consolidated with MDL 1950 for pretrial proceedings. The complaint in this lawsuit generally seeks unspecified monetary damages, interest, attorneys’ fees, costs and other expenses. The Company cannot reasonably estimate the possible loss, if any, or range of loss that may arise from this lawsuit.
In September 2009, the Attorney General of the State of West Virginia filed a lawsuit (Circuit Ct. Mason County, W. Va.) against Bank of America, N.A. alleging West Virginia state antitrust violations in the municipal derivatives industry, seeking damages and alleging, among other things, a conspiracy to fix the pricing of, and manipulate bids for, municipal derivatives, including GICs. An amended complaint in this action was filed in June 2010, adding a federal antitrust claim and naming AGM (but not AGMH) and AGUS, among other defendants. This case has been removed to federal court as well as transferred to the S.D.N.Y. and consolidated with MDL 1950 for pretrial proceedings. AGM and AGUS answered West Virginia's Second Amended Complaint on November 11, 2013. The complaint in this lawsuit generally seeks civil penalties, unspecified monetary damages, interest, attorneys’ fees, costs and other expenses. The Company cannot reasonably estimate the possible loss, if any, or range of loss that may arise from this lawsuit.
15.
Long-Term Debt and Credit Facilities
The principal and carrying values of the Company’s long-term debt are presented in the table below.
Principal and Carrying Amounts of Debt

As of March 31, 2014
As of December 31, 2013
Principal

Carrying
Value

Principal

Carrying
Value
(in millions)
AGUS:







7.0% Senior Notes
$
200

$
198


$
200

$
198

Series A Enhanced Junior Subordinated Debentures
150

150


150

150

Total AGUS
350

348


350

348

AGMH:





6 7 / 8 % QUIBS
100

68


100

68

6.25% Notes
230

138


230

138

5.60% Notes
100

55


100

55

Junior Subordinated Debentures
300

170


300

169

Total AGMH
730

431


730

430

AGM:





AGM Notes Payable
29

33


34

38

Total
$
1,109

$
812


$
1,114

$
816




82

Recourse Credit Facilities

2009 Strip Coverage Facility
In connection with the Company's acquisition of AGMH and its subsidiaries from Dexia Holdings Inc., AGM agreed to retain the risks relating to the debt and strip policy portions of the leveraged lease business. The liquidity risk to AGM related to the strip policy portion of the leveraged lease business is mitigated by the strip coverage facility described below.
In a leveraged lease transaction, a tax-exempt entity (such as a transit agency) transfers tax benefits to a tax-paying entity by transferring ownership of a depreciable asset, such as subway cars. The tax-exempt entity then leases the asset back from its new owner.
If the lease is terminated early, the tax-exempt entity must make an early termination payment to the lessor. A portion of this early termination payment is funded from monies that were pre-funded and invested at the closing of the leveraged lease transaction (along with earnings on those invested funds). The tax-exempt entity is obligated to pay the remaining, unfunded portion of this early termination payment (known as the “strip coverage”) from its own sources. AGM issued financial guaranty insurance policies (known as “strip policies”) that guaranteed the payment of these unfunded strip coverage amounts to the lessor, in the event that a tax-exempt entity defaulted on its obligation to pay this portion of its early termination payment. AGM can then seek reimbursement of its strip policy payments from the tax-exempt entity, and can also sell the transferred depreciable asset and reimburse itself from the sale proceeds.
Currently, all the leveraged lease transactions in which AGM acts as strip coverage provider are breaching a rating trigger related to AGM and are subject to early termination. However, early termination of a lease does not result in a draw on the AGM policy if the tax-exempt entity makes the required termination payment. If all the leases were to terminate early and the tax-exempt entities do not make the required early termination payments, then AGM would be exposed to possible liquidity claims on gross exposure of approximately $ 1.4 billion as of March 31, 2014 . To date, none of the leveraged lease transactions that involve AGM has experienced an early termination due to a lease default and a claim on the AGM policy. It is difficult to determine the probability that AGM will have to pay strip provider claims or the likely aggregate amount of such claims. At March 31, 2014 , approximately $ 1.4 billion of cumulative strip par exposure had been terminated since 2008 on a consensual basis. The consensual terminations have resulted in no claims on AGM.
On July 1, 2009, AGM and Dexia Crédit Local S.A., acting through its New York Branch (“Dexia Crédit Local (NY)”), entered into a credit facility (the “Strip Coverage Facility”). Under the Strip Coverage Facility, Dexia Crédit Local (NY) agreed to make loans to AGM to finance all draws made by lessors on AGM strip policies that were outstanding as of November 13, 2008, up to the commitment amount. The commitment amount of the Strip Coverage Facility was $ 1 billion at closing of the Company's acquisition of AGMH, and is scheduled to amortize over time. On February 7, 2014, AGM reduced the maximum commitment amount by $ 460 million to approximately $500 million, after taking into account its experience with its exposure to leveraged lease transactions to date. The maximum commitment amount of the Strip Coverage Facility had amortized to approximately $ 499 million as of March 31, 2014.
Fundings under this facility are subject to certain conditions precedent, and their repayment is collateralized by a security interest that AGM granted to Dexia Crédit Local (NY) in amounts that AGM recovers—from the tax-exempt entity, or from asset sale proceeds—following its payment of strip policy claims. The Strip Coverage Facility will terminate upon the earliest to occur of an AGM change of control, the reduction of the commitment amount to $ 0 , and January 31, 2042.
The Strip Coverage Facility’s financial covenants require that AGM and its subsidiaries maintain a maximum debt-to-capital ratio of 30% and maintain a minimum net worth of 75% of consolidated net worth as of July 1, 2009, plus, beginning July 1, 2015:

•
the product of (i) 25% of the aggregate consolidated net income (or loss) for the period beginning July 2, 2009 and ending on June 30, 2014 or (ii) a fraction, the numerator of which is the commitment amount as of such date and the denominator of which is $1 billion , or

•
zero, if the consolidated net worth of AGM and its subsidiaries as of June 30, 2014 is less than the sum of (i) 75% of consolidated net worth as of July 1, 2009 plus (ii) the product of (x) 25% of the aggregate consolidated net income (or loss) for the period beginning July 2, 2009 and ending on June 20, 2014 and (y) a fraction, the numerator of which is the commitment amount as of June 30, 2014 and the denominator of which is $1 billion .
The Company is in compliance with all financial covenants as of March 31, 2014 .

83


The Strip Coverage Facility contains restrictions on AGM, including, among other things, in respect of its ability to incur debt, permit liens, pay dividends or make distributions, dissolve or become party to a merger or consolidation. Most of these restrictions are subject to exceptions. The Strip Coverage Facility has customary events of default, including (subject to certain materiality thresholds and grace periods) payment default, bankruptcy or insolvency proceedings and cross-default to other debt agreements.
As of March 31, 2014 , no amounts were outstanding under this facility, nor have there been any borrowings during the life of this facility.

Intercompany Credit Facility

On October 25, 2013, AGL, as borrower, and AGUS, as lender, entered into a revolving credit facility pursuant to which AGL may, from time to time, borrow for general corporate purposes. Under the credit facility, AGUS committed to lend a principal amount not exceeding $225 million in the aggregate. Such commitment terminates on the October 25, 2018 (the “loan termination date”). The unpaid principal amount of each loan will bear interest at a fixed rate equal to 100% of the then applicable Federal short-term or mid-term interest rate, as the case may be, as determined under Internal Revenue Code Sec. 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 by the third anniversary of the loan termination date. No amounts are currently outstanding under the credit facility.
Committed Capital Securities
On April 8, 2005, AGC entered into separate agreements (the “Put Agreements”) with four custodial trusts (each, a “Custodial Trust”) pursuant to which AGC may, at its option, cause each of the Custodial Trusts to purchase up to $ 50 million of perpetual preferred stock of AGC (the “AGC Preferred Stock”). The custodial trusts were created as a vehicle for providing capital support to AGC by allowing AGC to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option. If the put options were exercised, AGC would receive $ 200 million in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose, including the payment of claims. The put options have not been exercised through the date of this filing.
Distributions on the AGC CCS are determined pursuant to an auction process. On April 7, 2008 this auction process failed, thereby increasing the annualized rate on the AGC CCS to one-month LIBOR plus 250 basis points. Distributions on the AGC preferred stock will be determined pursuant to the same process.
In June 2003, $ 200 million of “AGM CPS”, money market preferred trust securities, were issued by trusts created for the primary purpose of issuing the AGM CPS, investing the proceeds in high-quality commercial paper and selling put options to AGM, allowing AGM to issue the trusts non-cumulative redeemable perpetual preferred stock (the “AGM Preferred Stock”) of AGM in exchange for cash. There are four trusts, each with an initial aggregate face amount of $ 50 million . These trusts hold auctions every 28 days, at which time investors submit bid orders to purchase AGM CPS. If AGM were to exercise a put option, the applicable trust would transfer the portion of the proceeds attributable to principal received upon maturity of its assets, net of expenses, to AGM in exchange for AGM Preferred Stock. AGM pays a floating put premium to the trusts, which represents the difference between the commercial paper yield and the winning auction rate (plus all fees and expenses of the trust). If an auction does not attract sufficient clearing bids, however, the auction rate is subject to a maximum rate of one-month LIBOR plus 200 basis points for the next succeeding distribution period. Beginning in August 2007, the AGM CPS Securities required the maximum rate for each of the relevant trusts. AGM continues to have the ability to exercise its put option and cause the related trusts to purchase AGM Preferred Stock. The trusts provide AGM access to new capital at its sole discretion through the exercise of the put options. As of March 31, 2014 the put option had not been exercised. The Company does not consider itself to be the primary beneficiary of the trusts. See Note 7, Fair Value Measurement, –Other Assets–Committed Capital Securities, for a fair value measurement discussion.


84

16.
Earnings Per Share
Computation of Earnings Per Share

First Quarter
2014
2013
(in millions, except per share amounts)
Basic earnings per share ("EPS"):
Net income (loss) attributable to AGL
$
42

$
(144
)
Less: Distributed and undistributed income (loss) available to nonvested shareholders
0

0

Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic
$
42

$
(144
)
Basic shares
182.1

193.9

Basic EPS
$
0.23

$
(0.74
)
Diluted EPS:
Distributed and undistributed income (loss) available to common shareholders of AGL and subsidiaries, basic
$
42

$
(144
)
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
$
42

$
(144
)
Basic shares
182.1

193.9

Effect of dilutive securities:
Options and restricted stock awards
1.0

—

Diluted shares
183.1

193.9

Diluted EPS
$
0.23

$
(0.74
)
Potentially dilutive securities excluded from computation of EPS because of antidilutive effect
1.5

5.1



85

17.
Shareholders' Equity

Other Comprehensive Income
The following tables present the changes in each component of accumulated other comprehensive income and the effect of significant reclassifications out of AOCI on the respective line items in net income.
Changes in Accumulated Other Comprehensive Income by Component
First Quarter 2014

Net Unrealized
Gains (Losses) on
Investments with no Other-Than-Temporary Impairment
Net Unrealized
Gains (Losses) on
Investments with Other-Than-Temporary Impairment
Cumulative
Translation
Adjustment
Cash Flow Hedge
Total Accumulated
Other
Comprehensive
Income
(in millions)
Balance, December 31, 2013
$
178

$
(24
)
$
(3
)
$
9

$
160

Other comprehensive income (loss) before reclassified
94

8

1

—

103

Amounts reclassified from AOCI to:
Other net realized investment gains (losses)
(2
)
5

—

—

3

Interest expense
—

—

—

0

0

Total before tax
(2
)
5

—

0

3

Tax (provision) benefit
1

(2
)
—

(1
)
(2
)
Total amount reclassified from AOCI, net of tax
(1
)
3

—

(1
)
1

Net current period other comprehensive income
93

11

1

(1
)
104

Balance, March 31, 2014
$
271

$
(13
)
$
(2
)
$
8

$
264




86

First Quarter 2013

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

$
(5
)
$
(6
)
$
9

$
515

Other comprehensive income (loss) before reclassified
(50
)
(16
)
(5
)
—

(71
)
Amounts reclassified from AOCI to:


Other net realized investment gains (losses)
(1
)
6

—

—

5

Interest expense
—

—

—

0

0

Total before tax
(1
)
6

—

0

5

Tax (provision) benefit
—

(2
)
—

0

(2
)
Total amount reclassified from AOCI, net of tax
(1
)
4

—

0

3

Net current period other comprehensive income
(51
)
(12
)
(5
)
0

(68
)
Balance, March 31, 2013
$
466

$
(17
)
$
(11
)
$
9

$
447


Share Repurchase

Under the $400 million share repurchase authorization approved in November 2013, the Company repurchased 1.4 million common shares in First Quarter 2014 for $35 million at an average price of $25.92 per share. On a year-to-date basis through May 7, 2014, the Company has repurchased a total of 3.0 million common shares for $75 million at an average price of $25.19 per share. In First Quarter 2013, the Company repurchased approximately 1.9 million common shares for $39 million at an average price of $20.46 per share.

Related Party

On March 19, 2014, funds associated with WL Ross & Co. LLC and its affiliates (collectively, the “WLR Funds”) and AGL director Wilbur L. Ross, Jr. sold an aggregate of 4,000,000 shares. The WLR Funds and Mr. Ross currently own approximately 6% of Assured Guaranty's total common shares outstanding.



87

18.
Subsidiary Information
The following tables present the condensed consolidating financial information for AGUS and AGMH, wholly-owned subsidiaries of AGL, which have issued publicly traded debt securities (see Note 15, Long-Term Debt and Credit Facilities) as of March 31, 2014 and December 31, 2013 and for First Quarter 2014 and 2013. The information for AGUS and AGMH presents its subsidiaries on the equity method of accounting.
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF MARCH 31, 2014
(in millions)
Assured
Guaranty Ltd.
(Parent)
AGUS
(Issuer)
AGMH
(Issuer)
Other
Entities
Consolidating
Adjustments
Assured
Guaranty Ltd.
(Consolidated)
ASSETS






Total investment portfolio and cash
$
36

$
186

$
61

$
11,184

$
(300
)
$
11,167

Investment in subsidiaries
5,158

4,360

3,769

304

(13,591
)
—

Premiums receivable, net of commissions payable
—

—

—

997

(134
)
863

Ceded unearned premium reserve
—

—

—

1,582

(1,128
)
454

Deferred acquisition costs
—

—

—

194

(72
)
122

Reinsurance recoverable on unpaid losses
—

—

—

187

(150
)
37

Credit derivative assets
—

—

—

510

(432
)
78

Deferred tax asset, net
—

108

—

618

(89
)
637

Intercompany receivable
—

—

—

90

(90
)
—

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

—

—

1,257

—

1,257

Other
20

9

35

603

(176
)
491

TOTAL ASSETS
$
5,214

$
4,663

$
3,865

$
17,526

$
(16,162
)
$
15,106

LIABILITIES AND SHAREHOLDERS’ EQUITY






Unearned premium reserves
$
—

$
—

$
—

$
5,611

$
(1,107
)
$
4,504

Loss and LAE reserve
—

—

—

791

(155
)
636

Long-term debt
—

348

431

33

—

812

Intercompany payable
—

90

—

300

(390
)
—

Credit derivative liabilities
—

—

—

2,433

(432
)
2,001

Deferred tax liabilities, net
—

—

95

—

(95
)
—

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

—

—

1,447

—

1,447

Other
5

14

21

762

(305
)
497

TOTAL LIABILITIES
5

452

547

11,377

(2,484
)
9,897

TOTAL SHAREHOLDERS’ EQUITY ATTRIBUTABLE TO ASSURED GUARANTY LTD.
5,209

4,211

3,318

5,845

(13,374
)
5,209

Noncontrolling interest
—

—

—

304

(304
)
—

TOTAL SHAREHOLDERS' EQUITY
5,209

4,211

3,318

6,149

(13,678
)
5,209

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
5,214

$
4,663

$
3,865

$
17,526

$
(16,162
)
$
15,106


88

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2013
(in millions)
Assured
Guaranty Ltd.
(Parent)
AGUS
(Issuer)
AGMH
(Issuer)
Other
Entities
Consolidating
Adjustments
Assured
Guaranty Ltd.
(Consolidated)
ASSETS






Total investment portfolio and cash
$
33

$
186

$
42

$
11,008

$
(300
)
$
10,969

Investment in subsidiaries
5,066

4,191

3,574

289

(13,120
)
—

Premiums receivable, net of commissions payable
—

—

—

1,025

(149
)
876

Ceded unearned premium reserve
—

—

—

1,598

(1,146
)
452

Deferred acquisition costs
—

—

—

198

(74
)
124

Reinsurance recoverable on unpaid losses
—

—

—

170

(134
)
36

Credit derivative assets
—

—

—

482

(388
)
94

Deferred tax asset, net
—

97

—

681

(90
)
688

Intercompany receivable
—

—

—

90

(90
)
—

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

—

—

2,565

—

2,565

Other
23

17

31

638

(226
)
483

TOTAL ASSETS
$
5,122

$
4,491

$
3,647

$
18,744

$
(15,717
)
$
16,287

LIABILITIES AND SHAREHOLDERS’ EQUITY






Unearned premium reserves
$
—

$
—

$
—

$
5,720

$
(1,125
)
$
4,595

Loss and LAE reserve
—

—

—

733

(141
)
592

Long-term debt
—

348

430

38

—

816

Intercompany payable
—

90

—

300

(390
)
—

Credit derivative liabilities
—

—

—

2,175

(388
)
1,787

Deferred tax liabilities, net
—

—

95

—

(95
)
—

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

—

—

2,871

—

2,871

Other
7

7

16

853

(372
)
511

TOTAL LIABILITIES
7

445

541

12,690

(2,511
)
11,172

TOTAL SHAREHOLDERS’ EQUITY ATTRIBUTABLE TO ASSURED GUARANTY LTD.
5,115

4,046

3,106

5,765

(12,917
)
5,115

Noncontrolling interest
—

—

—

289

(289
)
—

TOTAL SHAREHOLDERS’ EQUITY
5,115

4,046

3,106

6,054

(13,206
)
5,115

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
5,122

$
4,491

$
3,647

$
18,744

$
(15,717
)
$
16,287




89

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2014
(in millions)
Assured
Guaranty Ltd.
(Parent)
AGUS
(Issuer)
AGMH
(Issuer)
Other
Entities
Consolidating
Adjustments
Assured
Guaranty Ltd.
(Consolidated)
REVENUES






Net earned premiums
$
—

$
—

$
—

$
131

$
1

$
132

Net investment income
0

0

0

105

(2
)
103

Net realized investment gains (losses)
0

—

0

4

(2
)
2

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

—

—

19

0

19

Net unrealized gains (losses)
—

—

—

(230
)
—

(230
)
Net change in fair value of credit derivatives
—

—

—

(211
)
0

(211
)
Other
—

—

—

169

—

169

TOTAL REVENUES
0

0

0

198

(3
)
195

EXPENSES






Loss and LAE
—

—

—

39

2

41

Amortization of deferred acquisition costs
—

—

—

6

(1
)
5

Interest expense
—

7

13

5

(5
)
20

Other operating expenses
8

0

0

53

(1
)
60

TOTAL EXPENSES
8

7

13

103

(5
)
126

INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN NET EARNINGS OF SUBSIDIARIES
(8
)
(7
)
(13
)
95

2

69

Total (provision) benefit for income taxes
—

2

5

(33
)
(1
)
(27
)
Equity in net earnings of subsidiaries
50

87

169

8

(314
)
—

NET INCOME (LOSS)
$
42

$
82

$
161

$
70

$
(313
)
$
42

Less: noncontrolling interest
—

—

—

8

(8
)
—

NET INCOME (LOSS) ATTRIBUTABLE TO ASSURED GUARANTY LTD.
$
42

$
82

$
161

$
62

$
(305
)
$
42

COMPREHENSIVE INCOME (LOSS)
$
146

$
165

$
212

$
258

$
(635
)
$
146


90

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2013
(in millions)

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






Net earned premiums
$
—

$
—

$
—

$
246

$
2

$
248

Net investment income
0

0

0

99

(5
)
94

Net realized investment gains (losses)
0

—

0

28

—

28

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

—

—

18

—

18

Net unrealized gains (losses)
—

—

—

(610
)
—

(610
)
Net change in fair value of credit derivatives
—

—

—

(592
)
—

(592
)
Other
—

—

—

47

(1
)
46

TOTAL REVENUES
0

0

0

(172
)
(4
)
(176
)
EXPENSES






Loss and LAE
—

—

—

(44
)
(4
)
(48
)
Amortization of deferred acquisition costs
—

—

—

8

(5
)
3

Interest expense
—

7

13

6

(5
)
21

Other operating expenses
5

0

—

58

(3
)
60

TOTAL EXPENSES
5

7

13

28

(17
)
36

INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN NET EARNINGS OF SUBSIDIARIES
(5
)
(7
)
(13
)
(200
)
13

(212
)
Total (provision) benefit for income taxes
—

3

5

65

(5
)
68

Equity in net earnings of subsidiaries
(139
)
(82
)
162

—

59

—

NET INCOME (LOSS)
$
(144
)
$
(86
)
$
154

$
(135
)
$
67

$
(144
)
COMPREHENSIVE INCOME (LOSS)
$
(212
)
$
(137
)
$
117

$
(253
)
$
273

$
(212
)


91

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2014
(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
$
58

$
0

$
(6
)
$
111

$
(62
)
$
101

Cash flows from investing activities






Fixed-maturity securities:






Purchases
—

(1
)
(3
)
(513
)
—

(517
)
Sales
—

—

—

155

—

155

Maturities
—

—

—

148

—

148

Sales (purchases) of short-term investments, net
(3
)
—

(16
)
203

—

184

Net proceeds from financial guaranty variable entities’ assets
—

—

—

286

—

286

Investment in subsidiary
—

—

25

—

(25
)
—

Other
—

—

—

19

—

19

Net cash flows provided by (used in) investing activities
(3
)
(1
)
6

298

(25
)
275

Cash flows from financing activities






Return of capital
—

—

—

(25
)
25

—

Dividends paid
(20
)
—

—

(62
)
62

(20
)
Repurchases of common stock
(35
)
—

—

—

—

(35
)
Share activity under option and incentive plans
0

—

—

—

—

0

Net paydowns of financial guaranty variable entities’ liabilities
—

—

—

(281
)
—

(281
)
Payment of long-term debt
—

—

—

(6
)
—

(6
)
Net cash flows provided by (used in) financing activities
(55
)
—

—

(374
)
87

(342
)
Effect of exchange rate changes
—

—

—

1

—

1

Increase (decrease) in cash
—

(1
)
—

36

—

35

Cash at beginning of period
0

67

0

117

—

184

Cash at end of period
$
0

$
66

$
0

$
153

$
—

$
219


92

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2013
(in millions)
Assured
Guaranty Ltd.
(Parent)
AGUS
(Issuer)
AGMH
(Issuer)
Other
Entities
Consolidating
Adjustments
Assured
Guaranty Ltd.
(Consolidated)
Net cash flows provided by (used in) operating activities
$
36

$
1

$
(6
)
$
(5
)
$
(40
)
$
(14
)
Cash flows from investing activities






Fixed-maturity securities:






Purchases
—

(1
)
—

(509
)
—

(510
)
Sales
40

—

7

136

—

183

Maturities
18

—

1

264

—

283

Sales (purchases) of short-term investments, net
(34
)
—

(27
)
149

—

88

Net proceeds from financial guaranty variable entities’ assets
—

—

—

138

—

138

Investment in subsidiary
—

—

25

—

(25
)
—

Other
—

—

—

55

—

55

Net cash flows provided by (used in) investing activities
24

(1
)
6

233

(25
)
237

Cash flows from financing activities





Return of capital
—

—

—

(25
)
25

—

Dividends paid
(19
)
—

—

(40
)
40

(19
)
Repurchases of common stock
(39
)
—

—

—

—

(39
)
Share activity under option and incentive plans
(2
)
—

—

—

—

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

—

—

(167
)
—

(167
)
Payment of long-term debt
—

—

—

(6
)
—

(6
)
Net cash flows provided by (used in) financing activities
(60
)
—

—

(238
)
65

(233
)
Effect of exchange rate changes
—

—

—

(3
)
—

(3
)
Increase (decrease) in cash
—

—

—

(13
)
—

(13
)
Cash at beginning of period
—

13

0

125

—

138

Cash at end of period
$
—

$
13

$
0

$
112

$
—

$
125



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

This Form 10-Q contains information that includes or is based upon forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward looking statements give the expectations or forecasts of future events of Assured Guaranty Ltd. (“AGL” and, together with its subsidiaries, “Assured Guaranty” or the “Company”). These statements can be identified by the fact that they do not relate strictly to historical or current facts and relate to future operating or financial performance.
Any or all of Assured Guaranty’s forward looking statements herein are based on current expectations and the current economic environment and may turn out to be incorrect. Assured Guaranty’s actual results may vary materially. Among factors that could cause actual results to differ materially are:

93

•
rating agency action, including a ratings downgrade, a change in outlook, the placement of ratings on watch for downgrade, or a change in rating criteria, at any time, of Assured Guaranty or any of its subsidiaries and/or of transactions that Assured Guaranty’s subsidiaries have insured;
•
reduction in the amount of available insurance opportunities and/or in the demand for Assured Guaranty's insurance;
•
developments in the world’s financial and capital markets that adversely affect obligors’ payment rates, Assured Guaranty’s loss experience, or its exposure to refinancing risk in transactions (which could result in substantial liquidity claims on its guarantees);
•
the possibility that budget shortfalls or other factors will result in credit losses or impairments on obligations of state and local governments that the Company insures or reinsures;
•
the failure of Assured Guaranty to realize insurance loss recoveries or damages through loan putbacks, settlement negotiations or litigation;
•
deterioration in the financial condition of Assured Guaranty’s reinsurers, the amount and timing of reinsurance recoverables actually received and the risk that reinsurers may dispute amounts owed to Assured Guaranty under its reinsurance agreements;
•
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 the Company’s investment portfolio and in collateral posted by and to the Company;
•
the inability of Assured Guaranty to access external sources of capital on acceptable terms;
•
changes in the world’s credit markets, segments thereof or general economic conditions;
•
the impact of market volatility on the mark-to-market of Assured Guaranty’s contracts written in credit default swap form;
•
changes in applicable accounting policies or practices;
•
changes in applicable laws or regulations, including insurance and tax laws;
•
other governmental actions;
•
difficulties with the execution of Assured Guaranty’s business strategy;
•
contract cancellations;
•
loss of key personnel;
•
adverse technological developments;
•
the effects of mergers, acquisitions and divestitures;
•
natural or man-made catastrophes;
•
other risks and uncertainties that have not been identified at this time;
•
management’s response to these factors; and
•
other risk factors identified in Assured Guaranty’s filings with the U.S. Securities and Exchange Commission (the “SEC”).
The foregoing review of important factors should not be construed as exhaustive, and should be read in conjunction with the other cautionary statements that are included in this Form 10-Q. The Company undertakes no obligation to update publicly or review any forward looking statement, whether as a result of new information, future developments or otherwise,

94

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 (at www.assuredguaranty.com/investor-information/by-company/assured-guaranty-ltd/sec-filings) the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13 (a) or 15 (d) of the Exchange Act as soon as reasonably practicable after the Company files such material with, or furnishes it to, the SEC. The Company also makes available, free of charge, through its web site (at www.assuredguaranty.com/governance) links to the Company’s Corporate Governance Guidelines, its Code of Conduct and the charters for its Board Committees.
The Company routinely posts important information for investors on its web site (at www.assuredguaranty.com/about-us/company-statements). The Company uses this web site as a means of disclosing material information and for complying with its disclosure obligations under SEC Regulation FD. Accordingly, investors should monitor the Investor Information portion of the Company’s web site, in addition to following the Company’s press releases, SEC filings, public conference calls, presentations and webcasts.
The information contained on, or that may be accessed through, the Company’s web site is not incorporated by reference into, and is not a part of, this report.

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

Economic Environment

The overall economic environment in the United States ("U.S.") has consistently, albeit slowly, recovered over the last few years in a volatile market environment. Weak job growth in December 2013 and January 2014 appeared to result from extreme weather conditions, as job growth rebounded in February and March of 2014. The stock market remained near record levels during the three-month period ended March 31, 2014 (" First Quarter 2014 ") but was volatile and finished little higher than at December 31, 2013. Although the Federal Reserve began to taper its quantitative easing program in December 2013, management expects the Federal Reserve to do so at a measured pace and to employ conventional methods to maintain a low interest environment until it considers unemployment sufficiently reduced. A persistently low interest rate environment would continue to present challenges for the financial guaranty industry. Low interest rates tend to suppress demand for bond insurance as the potential savings for issuers are less compelling and some investors prefer to forgo insurance in favor of greater yield.

Although few municipalities have fully rebuilt reserves to pre-recession levels, most have been taking steps to address the ongoing fiscal challenges they have experienced since the global credit crisis of 2008 and the ensuing recession. This includes, in many cases, significant underfunded pension and retiree healthcare liabilities. Stock market gains have recently relieved some pressure on underfunded pension plans, but such gains could be reversed and are no substitute for prudent public policy. Revenues at the state level have been rebounding in general, and while the strength of the housing recovery varies from region to region, property tax and other revenues have stabilized for most local governments. Although municipal defaults remain rare, a small number of municipal credits have sought, though not always obtained, bankruptcy protection.

95

The publicity surrounding high-profile defaults and bankruptcy filings, especially those few where bond insurers are paying claims, provides evidence of the value of bond insurance; the Company believes this may stimulate demand for its product, especially at the retail level.
Business conditions have been difficult for the entire financial guaranty insurance industry since mid-2007 and the onset of the financial crisis, during which a number of the Company’s competitors ceased writing business. While the industry continues to face challenges in maintaining its market penetration, there have been recent signs of improvement in market perception of bond insurance and the Company. After a number of years in which Assured Guaranty was essentially the only active financial guarantor, a second monoline guarantor insured a number of small and medium-size issuances in 2013 and was active during First Quarter 2014. There has also been market acceptance of Municipal Assurance Corp. ("MAC"), Assured Guaranty’s U.S.-only municipal bond insurance company launched in July of 2013. MAC insured approximately 20% of the par amount of new municipal issues sold with Assured Guaranty insurance in First Quarter 2014.
Additionally, in March 2014, Standard and Poor’s Ratings Services ("S&P") upgraded the financial strength ratings of Assured Guaranty Municipal Corp. ("AGM"), MAC and Assured Guaranty Corp. ("AGC") to AA (stable outlook) from AA- (stable outlook), citing the Company’s reduced exposure to its legacy residential mortgage-backed securities ("RMBS") portfolio and noting that the Company’s full payment of claims in “high-profile” municipal bankruptcies “demonstrates and reiterates to various constituents the value of bond insurance and the credit position and capacity of the company.” Also in March, S&P upgraded an inactive legacy insurer that had been a competitor of the Company to AA- (stable outlook), a level that may allow that company to reenter the municipal bond insurance market.
Perception of the Company has also improved based on credit spread data. AGM’s and AGC's credit spreads narrowed during the twelve months ended March 31, 2014 by 20% and 27%, respectively. The wider the Company's credit spread, the lower the perceived benefit of the Company’s guaranty is to certain investors. If investors view the Company as being only marginally less risky, or perhaps even as risky, as the uninsured security, they may require almost as much, or as much, yield on a security insured by the Company as on a comparable security offered without insurance by the same issuer. Accordingly, issuers may be unwilling to pay a premium for the Company to insure their securities if the insurance does not lower the costs of borrowing.
During First Quarter 2014, the Company continued to guarantee the majority of insured par sold in the U.S. municipal bond market as a result of its financial strength and its ability to attract investors through its default protection, credit selection, underwriting and surveillance, as well as the increased market liquidity associated with its insured paper. During First Quarter 2014, $1.4 billion in par amount of new municipal issues was sold with Assured Guaranty insurance, compared with $1.2 billion in the three-month period ended March 31, 2013 ("First Quarter 2013"), a 21% increase. The Company increased production in a quarter when market issuance was down 26% compared with issuance in First Quarter 2013 and the pricing environment continued to be unfavorable, with interest rates remaining low and credit spreads remaining tight. Industry insurance penetration of the municipal market was 4.6% of par volume issued, compared with 2.6% in First Quarter 2013, an increase that may reflect increasing market recognition of the value of insurance, especially in light of evidence that insured bonds of Detroit and Puerto Rico tended to hold their market value better than comparable uninsured bonds of these distressed credits.

The Company has been active in efforts to resolve municipal bankruptcy or receivership cases involving Jefferson County, Alabama and the cities of Harrisburg, Pennsylvania; Stockton, California; and Detroit, Michigan, and it has reached final or preliminary settlements with each of these municipalities. Harrisburg, Pennsylvania emerged from receivership on March 1, 2014. A tentative settlement with Detroit regarding unlimited tax general obligation bonds insured by the Company was announced on April 9, 2014.
The Company is also closely following developments in the Commonwealth of Puerto Rico, which has significant economic challenges. Puerto Rico faces high debt levels, a declining population and an economy that has been in recession since 2006. While there can be no assurance the Company will not incur losses on its Puerto Rico exposure, announcements and actions by the current Governor and his administration indicate the island’s officials are focused on measures that are intended to help Puerto Rico operate within its financial resources and maintain its access to capital. Despite decisions by three rating agencies in February 2014 to downgrade Puerto Rico below investment grade, the Commonwealth issued $3.5 billion of debt the following month, which should allow it more time to find solutions. For additional information on the Company's exposure to Puerto Rico, please refer to "Insured Portfolio-Exposure to Puerto Rico" below.
In the international arena, the economic environment since 2008 has had a significant negative impact on the demand by investors for financial guaranty policies, and it is uncertain when or if demand for financial guaranties will return to their

96

pre-economic crisis level. There was limited new issue activity and also limited demand for financial guaranties in First Quarter 2014 and the years 2013 and 2012 in both the global structured finance and international infrastructure finance markets.
Europe began an economic recovery during 2013, described by the European Commission as “slow and fragile” and uneven across countries. The Company continues to monitor closely its exposures in Italy, Ireland, Spain, Hungary and Portugal. The Company’s exposure to troubled Eurozone countries is described below under “Results of Operations-Consolidated Results of Operations-Losses in the Insured Portfolio” and “Insured Portfolio-Selected European Exposures.” The United Kingdom, which saw four consecutive quarters of economic growth during 2013, currently presents the best international opportunities for the Company. From July 2013 to March 2014, the Company guaranteed four United Kingdom ("U.K.") public-private partnership transactions, the first such wrapped infrastructure bonds issued since 2008.
Management believes that, following the success of these U.K. transactions, there may be growing demand in a number of countries for financial guarantees of infrastructure financings, which have typically required such guarantees for capital market access. Assured Guaranty is currently the only company offering such guarantees outside the United States.
In general, the Company expects that global structured finance and international infrastructure opportunities will increase in the future as the global economy recovers, interest rates rise, more issuers return to the capital markets for financings and institutional investors again utilize financial guaranties. The Company considers its involvement in such transactions to be a competitive advantage because such transactions diversify both the Company's business opportunities and its risk profile.

Financial Performance of Assured Guaranty

Financial Results

First Quarter
2014
2013
(in millions, except per share amounts)
Selected income statement data
Net earned premiums
$
132

$
248

Net investment income
103

94

Realized gains (losses) and other settlements on credit derivatives
19

18

Net unrealized gains (losses) on credit derivatives
(230
)
(610
)
Fair value gains (losses) on financial guaranty variable interest entities
157

70

Loss and loss adjustment (expenses) benefit
(41
)
48

Other operating expenses
(60
)
(60
)
Net income (loss)
42

(144
)
Diluted earnings (loss) per share
$
0.23

$
(0.74
)
Selected non-GAAP measures(1)
Operating income
$
132

$
260

Operating income per share
$
0.72

$
1.34

Present value of new business production (“PVP”)
$
31

$
18

____________________
(1)
Please refer to “—Non-GAAP Financial Measures” for a definition of the financial measures that were not promulgated in accordance with accounting principles generally accepted in the United States of America ("GAAP") and a reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure, if available.
Net Income (Loss)

There are several primary drivers of volatility in reported net income or loss that are not necessarily indicative of credit impairment or improvement, or ultimate economic gains or losses: changes in credit spreads of insured credit derivative obligations and financial guaranty variable interest entities' ("FG VIEs") assets and liabilities, changes in the Company's own credit spreads, and changes in risk-free rates used to discount expected losses. Changes in credit spreads have the most

97

significant effect on changes in fair value of credit derivatives and FG VIE assets and liabilities. In addition to these factors, changes in expected losses, the timing of refundings and terminations, realized gains and losses on the investment portfolio (including other-than-temporary impairments), the effects of large settlements or transactions, and the effects of the Company's various loss mitigation strategies, among other factors, may also have a significant effect on reported net income or loss in a given reporting period.

Net income for First Quarter 2014 was $42 million compared with net loss of $144 million in First Quarter 2013. The increase in net income was primarily attributable to lower unrealized losses on credit derivatives, the increase in fair value gains on FG VIEs due primarily to deconsolidation of seven VIEs, and higher other income due to commutation gains on previously ceded business. These were partially offset by lower net earned premiums and higher loss and loss adjustment expenses ("LAE"). Net earned premiums decreased in First Quarter 2014 due to lower accelerations and the scheduled amortization of the insured portfolio. Loss and LAE were higher in First Quarter 2014 due primarily to a representations and warranties ("R&W") settlement in First Quarter 2013 and higher U.S. public finance losses in First Quarter 2014.

Non-GAAP Financial Measures

Non-GAAP operating income in First Quarter 2014 was $132 million, compared with $260 million in First Quarter 2013. The decrease in operating income was driven primarily by the decrease in net earned premiums and credit derivative revenues due to lower accelerations and scheduled amortization on the insured portfolio, and higher losses due primarily to an R&W settlement in First Quarter 2013 and higher U.S. public finance losses in First Quarter 2014. This was partially offset by commutation gains in First Quarter 2014. The effective tax rate in First Quarter 2014 was higher than First Quarter 2013 due to a higher proportion of loss expense in non-taxable jurisdictions.

Adjusted book value per share was $49.79 as of March 31, 2014, as compared with $49.58 per share as of December 31, 2013. Adjusted book value value per share increased primarily due to share repurchases, PVP and reassumptions of ceded business during First Quarter 2014.

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

Key Business Strategies
In First Quarter 2014, the Company’s key business strategies were comprised of: new business development; loss mitigation and the continuation of the Company's capital management strategy.

New Business Production and Commutations
In First Quarter 2014, the Company continued to focus on new business production. During the quarter, it issued financial guaranty insurance policies and financial guarantees in all of its markets: U.S. public finance, structured finance, and international infrastructure. The average internal rating of the gross par written by the Company in First Quarter 2014 was BBB+. MAC, the Company's U.S. public finance-only insurance subsidiary, has obtained financial strength ratings of AA+ (stable outlook) from Kroll Bond Rating Agency and AA (stable outlook) from S&P. MAC issued its first financial guaranty insurance policy in August 2013 and has been increasing its market share since.


98

New Business Production
First Quarter
2014
2013
(in millions)
PVP (1):
Public Finance—U.S.
$
23

$
16

Public Finance—non-U.S.
7

—

Structured Finance—U.S.
1

2

Total PVP
$
31

$
18

Gross Par Written:
Public Finance—U.S.
$
1,737

$
1,580

Public Finance—non-U.S.
128

—

Structured Finance—U.S.
4

14

Total gross par written
$
1,869

$
1,594

____________________
(1)
PVP represents the present value of estimated future earnings primarily on new financial guaranty contracts written in the period, before consideration of cessions to reinsurers. PVP and Gross Par Written in the table above are based on close date. See “—Non-GAAP Measures—PVP or Present Value of New Business Production.”
In U.S. public finance, the Company achieved a 10% increase in gross par written and a 44% increase in PVP, despite a 26% decline in new issue volume. This was due primarily to overall improving demand for financial guaranty insurance products. In the U.K, the Company guaranteed another infrastructure bond during First Quarter 2014.

The following tables present summarized information about the U.S. municipal market's new debt issuance volume and the Company's share of that market.

U.S. Municipal Market Data
Based on Sale Date
First Quarter 2014
First Quarter 2013
Year Ended December 31, 2013
Par
Number of
issues
Par
Number of
issues
Par
Number of
issues
(dollars in billions, except number of issues)
New municipal bonds issued
$
60.4

1,955

$
81.3

2,785

$
311.9

10,558

Total insured
2.8

252

2.1

261

12.1

1,025

Insured by AGC, AGM and MAC
1.4

117

1.2

129

7.5

488


Industry Penetration Rates
U.S. Municipal Market

First Quarter
Year Ended December 31,
2014
2013
2013
Market penetration par
4.6%
2.6%
3.9%
Market penetration based on number of issues
12.9
9.4
9.7
% of single A par sold
15.2
7.9
11.0
% of single A transactions sold
39.8
29.0
30.6
% of under $25 million par sold
15.5
10.8
10.9
% of under $25 million transactions sold
14.6
11.1
10.7


99

In addition to PVP, in First Quarter 2014, the Company entered into commutation agreements to reassume ceded business consisting of approximately $ 856 million par of almost exclusively U.S. public finance and European (predominantly U.K.) utility and infrastructure exposures outstanding as of February 28, 2014. For such reassumptions, the Company received the statutory unearned premium outstanding as of the commutation dates plus, in one case, a commutation premium.
Loss Mitigation
The Company continued its risk remediation strategies in First Quarter 2014, which lowered losses and improved its rating agency capital position. The Company believes that it is often in a better position to manage the risks in its insured portfolio and to mitigate losses from troubled credits than a bondholder or security holder would be, due to its knowledge about the terms of the insured transactions, its surveillance and workout resources and, in some instances, the remedies available to it as an insurer.

In an effort to recover losses the Company experienced in its insured U.S. RMBS portfolio, the Company pursues R&W providers by enforcing R&W provisions in contracts, negotiating agreements with R&W providers relating to those provisions and, where appropriate, initiating litigation against R&W providers. See Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of the R&W settlements the Company has entered into and the litigation proceedings the Company has initiated against R&W providers and other parties. In First Quarter 2014, the Company made progress on several RMBS settlements that contributed $35 million to the R&W development. The Company's loss mitigation efforts on its U.S. RMBS exposure over the past several years have resulted in R&W providers paying or agreeing to pay, pursuant to settlement agreements and/or following favorable court decisions, an aggregate of $3.7 billion (gross of reinsurance) in respect of R&W. The Company believes these results are significant and will enable it to pursue more effectively R&W providers for U.S. RMBS transactions it has insured.
In addition, the Company has been focused on the quality of servicing of the mortgage loans underlying its insured RMBS transactions. Servicing influences collateral performance and ultimately the amount (if any) of the Company's insured losses. The Company has established a group to mitigate RMBS losses by influencing mortgage servicing, including, if possible, causing the transfer of servicing or establishing special servicing arrangements. “Special servicing” is an industry term referencing more intense servicing applied to delinquent loans aimed at mitigating losses; special servicing arrangements provide incentives to a servicer to achieve better performance on the mortgage loans it services. As of March 31, 2014, the Company's net insured par of the transactions subject to a servicing transfer was $2.0 billion and the net insured par of the transactions subject to a special servicing arrangement was $961 million.

In the public finance and infrastructure finance arena, the Company has been able to negotiate consensual restructurings with various obligors. During 2013, the Company reached agreements with respect to its exposures to Mashantucket Pequot Tribe; Jefferson County, Alabama; Stockton, California and Harrisburg, Pennsylvania. The agreement with respect to Stockton, California is still subject to bankruptcy court confirmation of Stockton's plan of adjustment. In connection with the Jefferson County and Harrisburg settlements, the Company insured new revenue bonds for both municipalities, and the premium it was paid was included as part of the 2013 PVP below. See “Selected U.S. Public Finance Transactions” in Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of the respective arrangements reached.

The Company is also continuing to purchase attractively priced below-investment-grade ("BIG") obligations that it has insured. These purchases resulted in a reduction of net expected loss to be paid of $465 million as of March 31, 2014. The fair value of assets purchased for loss mitigation purposes in our investment portfolio as of March 31, 2014, (excluding the value of the Company's insurance) was $527 million, with a par of $1,607 million (including bonds related to FG VIEs of $87 million in fair value and $662 million in par).

Capital Management

Under the $400 million share repurchase authorization approved in November 2013, the Company repurchased 1.4 million common shares in First Quarter 2014 for $35 million at an average price of $25.92 per share. On a year-to-date basis through May 7, 2014, the Company has repurchased a total of 3.0 million common shares for $75 million at an average price of $25.19 per share. The Company intends to use the remaining capacity under this share repurchase authorization by the end of the third quarter of 2014 and, at that time, to request a new share repurchase authorization from its Board of Directors, in each case, subject to market conditions, the Company's capital position, the amount of funds available at the holding companies, its financial strength ratings, and other factors.

100

In order to reduce leverage and, possibly, rating agency capital charges, the Company has mutually agreed with beneficiaries to terminate selected financial guaranty insurance and credit derivative contracts. In particular, the Company has targeted investment grade securities for which claims are not expected but which carry a disproportionately large rating agency capital charge. The Company terminated $1.5 billion and $1.7 billion in net par in First Quarter 2014 and First Quarter 2013, respectively.

Results of Operations
Estimates and Assumptions
The Company’s consolidated financial statements include amounts that are determined using estimates and assumptions. The actual amounts realized could ultimately be materially different from the amounts currently provided for in the Company’s consolidated financial statements. Management believes the most significant items requiring inherently subjective and complex estimates are expected losses, including assumptions for breaches of R&W, fair value estimates, other-than-temporary impairment, deferred income taxes, and premium revenue recognition. The following discussion of the results of operations includes information regarding the estimates and assumptions used for these items and should be read in conjunction with the notes to the Company’s consolidated financial statements.
An understanding of the Company’s accounting policies is of critical importance to understanding its consolidated financial statements. See Part II, Item 8. “Financial Statements and Supplementary Data” of the Company's Annual Report on Form 10-K for a discussion of significant accounting policies 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, consisting primarily of financial guaranty variable interest entities’ assets, credit derivative assets and investments, represented approximately 18% and 25% of total assets measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013, respectively. All of the Company's liabilities that are measured at fair value are Level 3. See Note 7, Fair Value Measurement, of the Financial Statements for additional information about assets and liabilities classified as Level 3.


101

Consolidated Results of Operations

Consolidated Results of Operations
First Quarter
2014
2013
(in millions)
Revenues:
Net earned premiums
$
132

$
248

Net investment income
103

94

Net realized investment gains (losses)
2

28

Net change in fair value of credit derivatives:
Realized gains (losses) and other settlements
19

18

Net unrealized gains (losses)
(230
)
(610
)
Net change in fair value of credit derivatives
(211
)
(592
)
Fair value gains (losses) on committed capital securities ("CCS")
(9
)
(10
)
Fair value gains (losses) on FG VIEs
157

70

Other income (loss)
21

(14
)
Total revenues
195

(176
)
Expenses:
Loss and loss adjustment expenses
41

(48
)
Amortization of deferred acquisition costs
5

3

Interest expense
20

21

Other operating expenses
60

60

Total expenses
126

36

Income (loss) before provision for income taxes
69

(212
)
Provision (benefit) for income taxes
27

(68
)
Net income (loss)
$
42

$
(144
)


102

Net Earned Premiums
Net earned premiums are recognized over the contractual lives, or in the case of homogeneous pools of insured obligations, the remaining expected lives, of financial guaranty insurance contracts. The Company estimates remaining expected lives of its insured obligations and makes prospective adjustments for such changes in expected lives.
Net Earned Premiums
First Quarter
2014
2013
(in millions)
Financial guaranty:
Public finance
Scheduled net earned premiums and accretion
$
72

$
77

Accelerations(1)
19

66

Total public finance
91

143

Structured finance(2)
Scheduled net earned premiums and accretion
41

58

Accelerations(1)
0

47

Total structured finance
41

105

Other
—

0

Total net earned premiums
$
132

$
248

____________________
(1)
Reflects the unscheduled refunding of an insured obligation or the termination of the insurance on an insured obligation.
(2)
Excludes $17 million and $18 million for First Quarter 2014 and 2013, respectively, related to consolidated FG VIEs.

Net earned premiums decreased in First Quarter 2014 compared with First Quarter 2013 due primarily to lower accelerations and the scheduled decline in structured finance par outstanding , as shown in the table above.

At March 31, 2014, $4.1 billion of net deferred premium revenue remained to be earned over the life of the insurance contracts. Scheduled net earned premiums are expected to decrease each year unless replaced by a higher amount of new business or reassumptions of previously ceded business. See Note 4, Financial Guaranty Insurance Premiums, of the Financial Statements, for the expected timing of future premium earnings.


103

Net Investment Income
Net investment income is a function of the yield that the Company earns on invested assets and the size of the portfolio. The investment yield is a function of market interest rates at the time of investment as well as the type, credit quality and maturity of the invested assets.

Net Investment Income (1)
First Quarter
2014
2013
(in millions)
Income from fixed-maturity securities managed by third parties
$
80

$
79

Income from internally managed securities:




Fixed maturities
20

16

Other invested assets
5

1

Gross investment income
105

96

Investment expenses
(2
)
(2
)
Net investment income
$
103

$
94

____________________
(1)
Net investment income excludes $3 million for First Quarter 2014 and 2013 related to consolidated FG VIEs.

Income earned in the internally managed portfolio increased primarily due to improvement in expected underlying cash flow. The overall pre-tax book yield was 3.66% at March 31, 2014 and 3.85% at March 31, 2013 , respectively. Excluding internally managed portfolio, pre-tax yield was 3.41% as of March 31, 2014 compared with 3.51% as of March 31, 2013 .

Net Realized Investment Gains (Losses)

The table below presents the components of net realized investment gains (losses). See Note 10, Investments and Cash, of the Financial Statements.

Net Realized Investment Gains (Losses)(1)
First Quarter
2014
2013
(in millions)
Gross realized gains on investment portfolio
$
9

$
39

Gross realized losses on investment portfolio
(2
)
(6
)
Other-than-temporary impairment (1)
(5
)
(5
)
Net realized investment gains (losses)
$
2

$
28

____________________
(1)
Net realized investment gains (losses) reported in accordance with GAAP exclude other-than-temporary impairment related to consolidated FG VIEs of $ 1 million for First Quarter 2013. The amount of other-than-temporary impairment related to consolidated FG VIEs is de minimis for First Quarter 2014.

Other-than-temporary impairment for First Quarter 2014 and 2013 was primarily attributable to securities that were acquired for loss mitigation purposes. Realized gains in First Quarter 2013 included sales of assets acquired as part of negotiated settlements, bonds purchased for loss mitigation purposes and other invested assets.

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

104

Other Income (Loss)

First Quarter
2014
2013
(in millions)
Foreign exchange gain (loss) on remeasurement of premium receivable and loss reserves
$
1

$
(16
)
Commutation gains
19

—

Other
1

2

Total other income (loss)
$
21

$
(14
)
In First Quarter 2014, the Company entered into commutation agreements to reassume ceded business. This increased net par by approximately $856 million and related unearned premium reserve by approximately $19 million . There were no reassumptions in First Quarter 2013.

Losses in the Insured Portfolio
The insured portfolio includes policies accounted for under three separate accounting models depending on the characteristics of the contract and the Company’s control rights. Please refer to Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of the assumptions and methodologies used in calculating the expected loss to be paid for all contracts. For a discussion of the measurement and recognition accounting policies under GAAP for each type of contract, see the following in Item 8, Financial Statements and Supplementary Data of the Company's Annual Report on Form 10-K:
• Notes 4, 5 and 7 for financial guaranty insurance,
• Note 9 for credit derivatives,
• Note 10 for consolidated FG VIE, and
• Note 8 for fair value methodologies for credit derivatives and FG VIE assets and liabilities.

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

The surveillance process for identifying transactions with expected losses is described in the notes to the consolidated financial statements. More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly.

Net Expected Loss

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

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

105


Economic Loss Development (1)

First Quarter
2014
2013
(in millions)
U.S. RMBS before benefit for recoveries for breaches of R&W
$
38

$
57

Net benefit for recoveries for breaches of R&W
(48
)
(157
)
U.S. RMBS after benefit for recoveries for breaches of R&W
(10
)
(100
)
Other structured finance
0

(5
)
Public finance
23

17

Other
(1
)
(10
)
Total
$
12

$
(98
)
____________________
(1)
Economic loss development includes the effects of changes in assumptions based on observed market trends, changes in discount rates, accretion of discount and the economic effects of loss mitigation efforts.

Net Expected Loss to be Paid
As of
March 31, 2014
As of
December 31, 2013
(in millions)
U.S. RMBS before benefit for recoveries for breaches of R&W
$
1,201

$
1,205

Net benefit for recoveries for breaches of R&W
(721
)
(712
)
U.S. RMBS after benefit for recoveries for breaches of R&W
480

493

Other structured finance
170

171

Public finance
338

321

Other
(4
)
(3
)
Total
$
984

$
982

First Quarter 2014 Net Economic Loss Development

Total economic loss development was $12 million in First Quarter 2014, primarily due to developments in certain public finance credits, partially offset by a net benefit from U.S. RMBS. The net benefit attributable to U.S. RMBS was due primarily to R&W developments in 2014, offset in part by lower risk-free rates used to discount reserves. The risk-free rates used to discount expected losses ranged from 0.0% to 3.97% as of March 31, 2014 compared with 0.0% to 4.44% as of December 31, 2013. The effect of changes in discount rates that is included in total economic loss development is not indicative of credit impairment or improvement.

U.S. Public Finance Economic Loss Development: The net par outstanding for U.S. public finance obligations rated BIG by the Company was $9.0 billion as of March 31, 2014 and $9.1 billion as of December 31, 2013. The Company projects that its total future expected net loss across its troubled U.S. public finance credits as of March 31, 2014 will be $281 million , up from $264 million as of December 31, 2013. The change related primarily to developments in Detroit's bankruptcy proceedings. See Note 5, Expected Loss to be paid, of the Financial Statements for further information.

U.S. RMBS Economic Loss Development: The Company's RMBS loss projection methodology assumes that the housing and mortgage markets will continue improving. Each quarter the Company makes a judgment as to whether to change the assumptions it uses to make RMBS loss projections based on its observation during the quarter of the performance of its insured transactions (including early stage delinquencies, late stage delinquencies and, for first liens, loss severity) as well as the residential property market and economy in general, and, to the extent it observes changes, it makes a judgment as whether those changes are normal fluctuations or part of a trend. Based on such observations the Company chose to use the same general approach to project RMBS losses as of March 31, 2014 as it used as of December 31, 2013. The methodology and assumptions the Company uses to project first lien RMBS losses and the scenarios it employs are described in more detail Note 5, Expected Loss to be Paid, of the Financial Statements.

106


Generally, when mortgage loans are transferred into a securitization, the loan originator(s) and/or sponsor(s) provide R&W that the loans meet certain characteristics, and a breach of such R&W often requires that the loan be repurchased from the securitization. In many of the transactions the Company insures, it is in a position to enforce these R&W provisions. Soon after the Company observed the deterioration in the performance of its insured RMBS following the deterioration of the residential mortgage and property markets, the Company began using internal resources as well as third party forensic underwriting firms and legal firms to pursue breaches of R&W on a loan-by-loan basis. Where a provider of R&W refused to honor its repurchase obligations, the Company sometimes chose to initiate litigation. See “Recovery Litigation—RMBS Transactions," section of Note 5, Expected Loss to be Paid, of the Financial Statements. The Company's success in pursuing these strategies permitted the Company to enter into agreements with R&W providers under which those providers made payments to the Company, agreed to make payments to the Company in the future, and / or repurchased loans from the transactions, all in return for releases of related liability by the Company. Such agreements provide the Company with many of the benefits of pursuing the R&W claims on a loan by loan basis or through litigation, but without the related expense and uncertainty. The Company continues to pursue these strategies against R&W providers with which it does not yet have agreements.
Using these strategies, through March 31, 2014 the Company has caused entities providing R&Ws to pay or agree to pay approximately $3.7 billion (gross of reinsurance) in respect of their R&W liabilities for transactions in which the Company has provided insurance.
(in millions)
Agreement amounts already received
$
2,716

Agreement amounts projected to be received in the future
402

Repurchase amounts paid into the relevant RMBS prior to settlement (1)
579

Total R&W payments, gross of reinsurance
$
3,697

____________________
(1)
These amounts were paid into the relevant RMBS transactions (rather than to the Company as in most settlements) and distributed in accordance with the priority of payments set out in the relevant transaction documents. Because the Company may insure only a portion of the capital structure of a transaction, such payments will not necessarily directly benefit the Company dollar-for-dollar, especially in first lien transactions.

Based on this success, the Company has included in its net expected loss estimates as of March 31, 2014 an estimated net benefit related to breaches of R&W of $721 million , which includes $384 million from agreements with R&W providers and $337 million in transactions where the Company does not yet have such an agreement, all net of reinsurance.
Developments in the Company's R&W recovery efforts are included in economic loss development. The following table provides a breakdown of the development and accretion amount in the roll forward of estimated recoveries associated with alleged breaches of R&W.
Components of R&W Development
First Quarter 2014
(in millions)
Change in recovery assumptions as the result of additional file review and recovery success
$
10

Estimated increase (decrease) in defaults that will result in additional (lower) breaches
0

Settlements and anticipated settlements
35

Accretion of discount on balance
3

Total
$
48


First Quarter 2013 Net Economic Loss Development

Total economic loss development in First Quarter 2013 was a favorable $98 million, which was primarily driven by U.S. RMBS. In the U.S. RMBS portfolio, the $100 million favorable development was mainly due to the R&W settlement agreement with UBS Real Estate Securities Inc. and affiliates ("UBS"). Partially offsetting this benefit was worsening economic conditions in Hungary and potential bankruptcy of Harrisburg which contributed to economic loss development in public finance. Changes in discount rates had a favorable effect of approximately $25 million on economic loss development in

107

First Quarter 2013 as the risk-free rates used to discount expected losses ranged from 0.0% to 3.72% as of March 31, 2013 compared with 0.0% to 3.28% as of December 31, 2012.

U.S. RMBS Economic Loss Development: The Company's RMBS loss projection methodology assumes that the housing and mortgage markets will improve. Each quarter the Company makes a judgment as to whether to change the assumptions it uses to make RMBS loss projections based on its observation during the quarter of the performance of its insured transactions (including early stage delinquencies, late stage delinquencies and, for first liens, loss severity) as well as the residential property market and economy in general, and, to the extent it observes changes, it makes a judgment as whether those changes are normal fluctuations or part of a trend. Based on such observations, the Company chose to use essentially the same assumptions and scenarios to project RMBS loss as of March 31, 2013 as it used as of December 31, 2012, except for the following:

•
in its most optimistic scenario, it reduced by three months the period it assumed it would take the mortgage market to recover; and

•
in its most pessimistic scenario, it increased by three months the period it assumed it would take the mortgage market to recover.

The Company's use of essentially the same assumptions and scenarios to project RMBS losses as of March 31, 2013 as at December 31, 2012 was consistent with its view at March 31, 2013 that the housing and mortgage market recovery is occurring at a slower pace than it anticipated at December 31, 2012. The Company's changes during 2012 to the period it would take the mortgage market to recover in its most optimistic scenario and its most pessimistic scenario allowed it to consider a wider range of possibilities for the speed of the recovery. Since the Company's projections for each RMBS transaction are based on the delinquency performance of the loans in that individual RMBS transaction, improvement or deterioration in that aspect of a transaction's performance impacts the projections for that transaction. The methodology the Company uses to project RMBS losses and the scenarios it employs are described in more detail in Note 5, Expected Loss to be Paid, of the Financial Statements.

Developments in the Company's R&W recovery efforts are included in economic loss development. The following table provides a breakdown of the development and accretion amount in the roll forward of estimated recoveries associated with alleged breaches of R&W.
Components of R&W Development
First Quarter 2013
(in millions)
Change in recovery assumptions as the result of additional file review and recovery success
$
11

Estimated increase (decrease) in defaults that will result in additional (lower) breaches
1

Results of settlements and judgments
142

Accretion of discount on balance
3

Total
$
157

U.S. Public Finance Economic Loss Development: The net par outstanding for all BIG rated U.S. public finance obligations was $4.6 billion as of March 31, 2013 and December 31, 2012. The Company projected full or partial recovery on the claims it had already paid on its troubled U.S. public finance credits and that its total future expected net recovery across its troubled U.S. public finance credits (after projected recoveries of claims already paid) would be $9 million as of March 31, 2013.

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


108

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

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

Loss and LAE Reported
on the Consolidated Statements of Operations

First Quarter
2014
2013
(in millions)
U.S. RMBS
$
(1
)
$
(40
)
Other structured finance
15

(12
)
Public finance
27

(3
)
Other
(1
)
—

Total insurance contracts before FG VIE consolidation
40

(55
)
Effect of consolidating FG VIEs
1

7

Total loss and LAE
$
41

$
(48
)

Loss Expense Reported in
Non-GAAP Operating Income

First Quarter
2014
2013
(in millions)
U.S. RMBS
$
5

$
(16
)
Other structured finance
2

(16
)
Public finance
26

(3
)
Other
(1
)
(10
)
Total
$
32

$
(45
)


Reconciliation of Loss and LAE to Non-GAAP Loss Expense

First Quarter
2014
2013
(in millions)
Loss and LAE
$
41

$
(48
)
Credit derivative loss expense
(8
)
10

FG VIE loss expense
(1
)
(7
)
Loss expense included in operating income
$
32

$
(45
)


109

In 2014, losses incurred were due primarily to U.S public finance exposures, mainly related to developments in the Company's Detroit exposures. Losses incurred on RMBS during First Quarter 2014 includes positive R&W development.

In First Quarter 2013, loss benefit was due primarily to U.S. RMBS. The positive development in U.S. RMBS was due primarily to a R&W settlement agreement with UBS. Changes in risk-free rates used to discount losses also affected loss expense for long-dated transactions, however this component of loss expense does not reflect actual credit impairment or improvement in the period.

For financial guaranty contracts accounted for as insurance, the amounts reported in the GAAP financial statements may only reflect a portion of the current period’s economic development and may also include a portion of prior-period economic development. The difference between economic loss development on financial guaranty insurance contracts and loss and LAE recognized in GAAP income is essentially loss development and accretion for financial guaranty insurance contracts that is, or was previously, absorbed in unearned premium reserve. Such amounts have not yet been recognized in income.

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

Financial Guaranty Insurance
Net Expected Loss to be Expensed
As of March 31, 2014
In GAAP
Reported
Income
In Non-GAAP
Operating
Income
(in millions)
2014 (April 1 - June 30)
$
12

$
13

2014 (July 1 - September 30)
11

13

2014 (October 1 - December 31)
10

13

2015
42

51

2016
38

45

2017
31

37

2018
28

35

2019-2023
98

119

2024-2028
57

68

2029-2033
37

45

After 2033
27

36

Net expected loss to be expensed (1)
391

475

Discount
419

463

Total future value
$
810

$
938

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

Net Change in Fair Value of Credit Derivatives
Changes in the fair value of credit derivatives occur primarily because of changes in interest rates, credit spreads, notional amounts, credit ratings of the referenced entities, expected terms, realized gains (losses) and other settlements, and the issuing company's own credit rating and credit spreads, and other market factors. With considerable volatility continuing in the market, unrealized gains (losses) on credit derivatives may fluctuate significantly in future periods.

Except for net estimated credit impairments (i.e., net expected payments), the unrealized gains and losses on credit derivatives are expected to reduce to zero as the exposure approaches its maturity date. Changes in the fair value of the Company’s credit derivatives that do not reflect actual or expected claims or credit losses have no impact on the Company’s statutory claims paying resources, rating agency capital or regulatory capital positions. Expected losses to be paid in respect of contracts accounted for as credit derivatives are included in the discussion above “—Losses in the Insured Portfolio.”

110

The valuation of the Company’s credit derivative contracts requires the use of models that contain significant, unobservable inputs, and are classified as Level 3 in the fair value hierarchy. There has been very limited new issuance activity in this market over the past three years and as of March 31, 2014, market prices for the Company’s credit derivative contracts were generally not available. Inputs to the estimate of fair value include various market indices, credit spreads, the Company’s own credit spread, and estimated contractual payments. See Note 7, Fair Value Measurement, of the Financial Statements.
Net Change in Fair Value of Credit Derivatives Gain (Loss)
First Quarter
2014
2013
(in millions)
Realized gains on credit derivatives
$
20

$
28

Net credit derivative losses (paid and payable) recovered and recoverable
(1
)
(10
)
Realized gains (losses) and other settlements on credit derivatives
19

18

Net change in unrealized gains (losses) on credit derivatives
(230
)
(610
)
Net change in fair value of credit derivatives
$
(211
)
$
(592
)


Net credit derivative premiums have declined in First Quarter 2014 and 2013 due primarily to the decline in the net par outstanding to $51.3 billion at March 31, 2014 from $65.9 billion at March 31, 2013.
Net Change in Unrealized Gains (Losses)
on Credit Derivatives
By Sector
First Quarter
Asset Type
2014
2013
(in millions)
Pooled corporate obligations
$
(58
)
$
(105
)
U.S. RMBS
(140
)
(457
)
Commercial mortgage-backed securities ("CMBS")
—

(3
)
Other (1)
(32
)
(45
)
Total
$
(230
)
$
(610
)
____________________
(1)
“Other” includes all other U.S. and international asset classes, such as commercial receivables, international infrastructure, international RMBS securities, and pooled infrastructure securities.
During First Quarter 2014, unrealized fair value losses were generated primarily in the U.S. RMBS prime first lien, Alt-A, Option ARM and subprime sectors, as well as pooled corporate obligations, due to wider implied net spreads. The wider implied net spreads were primarily a result of the decreased cost to buy protection in AGC’s name as the market cost of AGC’s credit protection decreased significantly during the period. These transactions were pricing at or above their floor levels (or the minimum rate at which the Company would consider assuming these risks based on historical experience); therefore when the cost of purchasing credit default swap ("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. The cost of AGM’s credit protection also decreased during First Quarter 2014 generating unrealized fair value losses on a XXX life insurance securitization transaction, due to wider implied net spreads. This did not have a significant impact on the remainder of AGM’s portfolio, as a significant portion of AGM’s policies continue to price at floor levels.
During First Quarter 2013, unrealized fair value losses were generated primarily in the U.S. RMBS sectors, as well as pooled corporate obligations, due to wider implied net spreads. The wider implied net spreads were primarily a result of the decreased cost to buy protection in AGC's name as the market cost of AGC's credit protection decreased significantly during the period. These transactions were pricing at or above their floor levels. To calculate the fair value of the CDS contracts, the Company matches the tenor of the CDS contracts in the Company's portfolio to the tenor of the CDS spread purchased in AGC's name. The cost of AGM's 5 Year and 1 Year credit protection also decreased during First Quarter 2013, but did not lead to significant fair value losses, as a significant portion of AGM policies continue to price at floor levels. First Quarter 2013

111

changes in fair value of credit derivatives in the Other category includes a $20 million loss for guaranteed interest rate swaps identified during the quarter.
Five-Year CDS Spread
on AGC and AGM
Quoted price of CDS contract (in basis points)
As of
March 31, 2014
As of
December 31, 2013
As of
March 31, 2013
As of
December 31, 2012
AGC
291

460

397

678

AGM
305

525

380

536

One-Year CDS Spread
on AGC and AGM
Quoted price of CDS contract (in basis points)
As of
March 31, 2014
As of
December 31, 2013
As of
March 31, 2013
As of
December 31, 2012
AGC
55

185

59

270

AGM
70

220

60

257


Effect of Changes in the Company’s Credit Spread on
Unrealized Gains (Losses) on Credit Derivatives
First Quarter
2014
2013
(in millions)
Change in unrealized gains (losses) of credit derivatives:
Before considering implication of the Company’s credit spreads
$
347

$
504

Resulting from change in the Company’s credit spreads
(577
)
(1,114
)
After considering implication of the Company’s credit spreads
$
(230
)
$
(610
)
Management believes that the trading level of AGC’s and AGM’s credit spreads is due to the correlation between AGC’s and AGM’s risk profile, the current risk profile of the broader financial markets, and to increased demand for credit protection against AGC and AGM, relative to pre-financial crisis levels, as the result of its financial guaranty volume, as well as the overall lack of liquidity in the CDS market. Offsetting the benefit attributable to AGC’s and AGM’s credit spread were higher credit spreads in the fixed income security markets relative to pre-financial crisis levels. The higher credit spreads in the fixed income security market are due to the lack of liquidity in the high-yield collateralized debt obligations ("CDO"), trust preferred securities CDO ("TruPS CDOs"), and collateralized loan obligation ("CLO") markets as well as continuing market concerns over the 2005-2007 vintages of RMBS.

Provision for Income Tax
Provision for Income Taxes and Effective Tax Rates
First Quarter
2014
2013
(in millions)
Total provision (benefit) for income taxes
$
27

$
(68
)
Effective tax rate
38.8
%
31.8
%

112

The Company’s effective tax rates reflect the proportion of income recognized by each of the Company’s operating subsidiaries, with U.S. subsidiaries taxed at the U.S. marginal corporate income tax rate of 35% , U.K. subsidiaries taxed at the U.K. blended marginal corporate tax rate of 21.5% unless subject to U.S. tax by election or as a U.S. controlled foreign corporation, and no taxes for the Company’s Bermuda subsidiaries unless subject to U.S tax by election or as a U.S. controlled foreign corporation. The Company’s overall corporate effective tax rate fluctuates based on the distribution of taxable income across these jurisdictions. First Quarter 2014 and First Quarter 2013 had disproportionate losses and income across jurisdictions, offset by tax-exempt interest, and are the primary reasons for the effective tax rates.

Financial Guaranty Variable Interest Entities
As of March 31, 2014 and December 31, 2013, the Company consolidated 31 and 40 VIEs, respectively. The table below presents the effects on reported GAAP income resulting from consolidating these FG VIEs and eliminating their related insurance and investment accounting accounts and, in total, represents a difference between GAAP reported net income and non-GAAP operating income attributable to FG VIEs. The consolidation of FG VIEs has a significant effect on net income and shareholders' equity due to (1) changes in fair value gains (losses) on FG VIE assets and liabilities, (2) the eliminations of premiums and losses related to the AGC and AGM FG VIE liabilities with recourse and (3) the elimination of investment balances related to the Company’s purchase of AGC and AGM insured FG VIE debt. Upon consolidation of a FG VIE, the related insurance and, if applicable, the related investment balances, are considered intercompany transactions and therefore eliminated. See “—Non-GAAP Financial Measures—Operating Income” below.
Effect of Consolidating FG VIEs on Net Income (Loss)

First Quarter
2014
2013
(in millions)
Net earned premiums
$
(17
)
$
(18
)
Net investment income
(3
)
(3
)
Net realized investment gains (losses)
0

1

Fair value gains (losses) on FG VIEs
157

70

Other income
(2
)
—

Loss and LAE
(1
)
(7
)
Effect on net income before tax provision
134

43

Less: tax provision (benefit)
47

15

Effect on net income (loss)
$
87

$
28

Fair value gains (losses) on FG VIEs represent the net change in fair value on the consolidated FG VIEs’ assets and liabilities. During First Quarter 2014, the Company recorded a pre-tax net fair value gain on consolidated FG VIEs of $157 million . The primary driver of this gain, $120 million , was a result of the deconsolidation of seven VIEs. There was an additional gain of $37 million resulting from the Company exercising its option to accelerate two second lien RMBS VIEs.
For First Quarter 2013, the Company recorded a pre-tax fair value gain on FG VIEs of $70 million . The majority of this gain, approximately $64 million , was the result of a R&W benefit on two Flagstar policies recognized during the quarter. There was also price appreciation across all of the Company's FG VIE assets and liabilities as a result of the overall financial market continuing to improve in First Quarter 2013. The most significant price appreciation occurred in several home equity lines of credit ("HELOC") transactions where the price appreciation was slightly greater on the FG VIE assets than on the FG VIE liabilities. This was a result of improved performance in the underlying collateral of these securities during the period.

Expected losses to be paid (recovered) in respect of consolidated FG VIEs, were $108 million of expected loss to be paid as of March 31, 2014 and $60 million of expected losses to be paid as of December 31, 2013 , and are included in the discussion of “—Losses in the Insured Portfolio.”


113

Non-GAAP Financial Measures
To reflect the key financial measures management analyzes in evaluating the Company’s operations and progress towards long-term goals, the Company discusses both measures promulgated in accordance with GAAP and measures not promulgated in accordance with GAAP (“non-GAAP financial measures”). Although the financial measures identified as non-GAAP should not be considered substitutes for GAAP measures, management considers them key performance indicators and employs them as well as other factors in determining compensation. Non-GAAP financial measures, therefore, provide investors with important information about the key financial measures management utilizes in measuring its business. The primary limitation of non-GAAP financial measures is the potential lack of comparability to those of other companies, which may define non-GAAP measures differently because there is limited literature with respect to such measures. Three of the primary non-GAAP financial measures analyzed by the Company’s senior management are: operating income, adjusted book value and PVP.
Management and the board of directors utilize non-GAAP financial measures in evaluating the Company’s financial performance and as a basis for determining senior management incentive compensation. By providing these non-GAAP financial measures, investors, analysts and financial news reporters have access to the same information that management reviews internally. In addition, Assured Guaranty’s presentation of non-GAAP financial measures is consistent with how analysts calculate their estimates of Assured Guaranty’s financial results in their research reports on Assured Guaranty and with how investors, analysts and the financial news media evaluate Assured Guaranty’s financial results.
The following paragraphs define each non-GAAP financial measure and describe why it is useful. A reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure, if available, is also presented below.
Operating Income
Reconciliation of Net Income (Loss)
to Operating Income
First Quarter
2014
2013
(in millions)
Net income (loss)
$
42

$
(144
)
Less after-tax adjustments:
Realized gains (losses) on investments
(1
)
19

Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(171
)
(434
)
Fair value gains (losses) on CCS
(5
)
(6
)
Foreign exchange gains (losses) on remeasurement of premiums receivable and loss and LAE reserves
0

(11
)
Effect of consolidating FG VIEs
87

28

Operating income
$
132

$
260

Effective tax rate on operating income
26.7
%
25.8
%

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

114


2) Elimination of the after-tax non-credit impairment unrealized fair value gains (losses) on credit derivatives, which is the amount in excess of the present value of the expected estimated economic credit losses, and non-economic payments. Such fair value adjustments are heavily affected by, and in part fluctuate with, changes in market interest rates, credit spreads and other market factors and are not expected to result in an economic gain or loss. Additionally, such adjustments present all financial guaranty contracts on a more consistent basis of accounting, whether or not they are subject to derivative accounting rules.
3) Elimination of the after-tax fair value gains (losses) on the Company’s CCS. Such amounts are heavily affected by, and in part fluctuate with, changes in market interest rates, credit spreads and other market factors and are not expected to result in an economic gain or loss.
4) Elimination of the after-tax foreign exchange gains (losses) on remeasurement of net premium receivables and loss and LAE reserves. Long-dated receivables constitute a significant portion of the net premium receivable balance and represent the present value of future contractual or expected collections. Therefore, the current period’s foreign exchange remeasurement gains (losses) are not necessarily indicative of the total foreign exchange gains (losses) that the Company will ultimately recognize.
5) Elimination of the effects of consolidating FG VIEs in order to present all financial guaranty contracts on a more consistent basis of accounting, whether or not GAAP requires consolidation. GAAP requires the Company to consolidate certain VIEs that have issued debt obligations insured by the Company even though the Company does not own such VIEs.
Adjusted Book Value and Operating Shareholders’ Equity
Management also uses adjusted book value to measure the intrinsic value of the Company, excluding franchise value. Growth in adjusted book value is one of the key financial measures used in determining the amount of certain long term compensation to management and employees and used by rating agencies and investors.
Reconciliation of Shareholders’ Equity
to Adjusted Book Value
As of March 31, 2014
As of December 31, 2013
Total
Per Share
Total
Per Share
(dollars in millions, except per share amounts)
Shareholders’ equity
$
5,209

$
28.76

$
5,115

$
28.07

Less after-tax adjustments:
(0.95
)
Effect of consolidating FG VIEs
(87
)
(0.48
)
(172
)
(0.95
)
Non-credit impairment unrealized fair value gains (losses) on credit derivatives
(1,219
)
(6.72
)
(1,052
)
(5.77
)
Fair value gains (losses) on CCS
24

0.13

30

0.16

Unrealized gain (loss) on investment portfolio excluding foreign exchange effect
250

1.38

145

0.80

Operating shareholders’ equity
6,241

34.45

6,164

33.83

After-tax adjustments:



Less: Deferred acquisition costs
159

0.87

161

0.88

Plus: Net present value of estimated net future credit derivative revenue
138

0.76

146

0.80

Plus: Net unearned premium reserve on financial guaranty contracts in excess of expected loss to be expensed
2,800

15.45

2,884

15.83

Adjusted book value
$
9,020

$
49.79

$
9,033

$
49.58



115

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

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


116

PVP or Present Value of New Business Production
Reconciliation of PVP to Gross Written Premiums
First Quarter
2014
2013
( in millions)
Total PVP
$
31

$
18

Less: Financial guaranty installment premium PVP
10

1

Total: Financial guaranty upfront gross written premiums
21

17

Plus: Financial guaranty installment gross written premiums and other GAAP adjustments
9

—

Total gross written premiums
$
30

$
17

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


117

Net Par Outstanding and Average Internal Rating by Sector
As of March 31, 2014
As of December 31, 2013
Sector
Net Par Outstanding (including loss mitigation bonds)
Loss Mitigation Bonds
Net Par
Outstanding (excluding loss mitigation bonds)
Avg.
Rating
Net Par Outstanding (including loss mitigation bonds)
Loss Mitigation Bonds
Net Par
Outstanding (excluding loss mitigation bonds)
Avg.
Rating
(dollars in millions)
Public finance:


U.S.:


General obligation
$
152,621

$
—

$
152,621

A
$
155,277

$
—

$
155,277

A+
Tax backed
65,505

32

65,473

A+
66,856

32

66,824

A+
Municipal utilities
55,567

—

55,567

A
56,324

—

56,324

A
Transportation
30,213

—

30,213

A
30,830

—

30,830

A
Healthcare
16,060

—

16,060

A
16,132

—

16,132

A
Higher education
13,867

—

13,867

A
14,071

—

14,071

A
Infrastructure finance
4,108

—

4,108

BBB
4,114

—

4,114

BBB
Housing
3,349

—

3,349

A+
3,386

—

3,386

A+
Investor-owned utilities
985

—

985

A-
991

—

991

A-
Other public finance—U.S.
4,185

—

4,185

A
4,232

—

4,232

A
Total public finance—U.S.
346,460

32

346,428

A
352,213

32

352,181

A
Non-U.S.:


Infrastructure finance
14,961

—

14,961

BBB
14,703

—

14,703

BBB
Regulated utilities
11,752

—

11,752

BBB+
11,205

—

11,205

BBB+
Pooled infrastructure
2,533

—

2,533

A
2,520

—

2,520

A
Other public finance—non-U.S.
5,580

—

5,580

A
5,570

—

5,570

A
Total public finance—non-U.S.
34,826

—

34,826

BBB+
33,998

—

33,998

BBB+
Total public finance
381,286

32

381,254

A
386,211

32

386,179

A
Structured finance:


U.S.:


Pooled corporate obligations
29,803

—

29,803

AAA
31,325

—

31,325

AAA
RMBS
13,904

879

13,025

BBB-
14,559

838

13,721

BBB-
Insurance securitizations
3,360

325

3,035

A-
3,360

325

3,035

A-
CMBS and other commercial real estate related exposures
3,017

—

3,017

AAA
3,952

—

3,952

AAA
Financial products
2,585

—

2,585

AA-
2,709

—

2,709

AA-
Consumer receivables
2,175

—

2,175

BBB+
2,198

—

2,198

BBB+
Commercial receivables
739

—

739

A-
911

—

911

A-
Structured credit
69

—

69

BB
69

—

69

BB
Other structured finance—U.S.
945

—

945

A-
987

—

987

A-
Total structured finance—U.S.
56,597

1,204

55,393

AA-
60,070

1,163

58,907

AA-
Non-U.S.:


Pooled corporate obligations
10,375

—

10,375

AAA
11,058

—

11,058

AAA
Commercial receivables
1,201

—

1,201

BBB+
1,263

—

1,263

BBB+
RMBS
941

—

941

A
1,146

—

1,146

AA-
Structured credit
84

—

84

BBB
176

—

176

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

—

377

AAA
378

—

378

AAA
Total structured finance—non-U.S.
12,978

—

12,978

AA+
14,021

—

14,021

AA+
Total structured finance
69,575

1,204

68,371

AA-
74,091

1,163

72,928

AA
Total net par outstanding
$
450,861

$
1,236

$
449,625

A
$
460,302

$
1,195

$
459,107

A


118

The March 31, 2014 and December 31, 2013 amounts above include $36.2 billion and $38.1 billion, respectively, of AGM structured finance net par outstanding. AGM has not insured a mortgage-backed transaction since January 2008 and announced in August 2008 that it would no longer issue new policies on structured finance obligations. The structured finance transactions that remain in AGM’s insured portfolio have an average internal rating by the Company of double-A. Management expects AGM’s structured finance portfolio to run-off rapidly: 26% by year-end 2014, 59% by year-end 2016, and 84% by year-end 2018.
The following tables set forth the Company’s net financial guaranty portfolio by internal rating.
Financial Guaranty Portfolio by Internal Rating
As of March 31, 2014

Public Finance
U.S.
Public Finance
Non-U.S.
Structured Finance
U.S
Structured Finance
Non-U.S
Total
Rating
Category
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
(dollars in millions)
AAA
$
4,658

1.3
%
$
1,020

2.9
%
$
29,868

53.9
%
$
8,856

68.2
%
$
44,402

9.9
%
AA
104,577

30.2

427

1.2

9,396

17.0

570

4.4

114,970

25.6

A
187,433

54.1

9,595

27.6

2,340

4.2

661

5.1

200,029

44.4

BBB
40,783

11.8

22,173

63.7

3,496

6.3

1,829

14.1

68,281

15.2

BIG
8,977

2.6

1,611

4.6

10,293

18.6

1,062

8.2

21,943

4.9

Total net par outstanding (excluding loss mitigation bonds)
$
346,428

100.0
%
$
34,826

100.0
%
$
55,393

100.0
%
$
12,978

100.0
%
$
449,625

100.0
%
Loss Mitigation Bonds
32

—

1,204

—

1,236

Net Par Outstanding (including loss mitigation bonds)
$
346,460

$
34,826

$
56,597

$
12,978

$
450,861

Financial Guaranty Portfolio by Internal Rating
As of December 31, 2013

Public Finance
U.S.
Public Finance
Non-U.S.
Structured Finance
U.S
Structured Finance
Non-U.S
Total
Rating
Category
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
Net Par
Outstanding
%
(dollars in millions)
AAA
$
4,998

1.4
%
$
1,016

3.0
%
$
32,317

54.9
%
$
9,684

69.1
%
$
48,015

10.5
%
AA
107,503

30.5

422

1.2

9,431

16.0

577

4.1

117,933

25.7

A
192,841

54.8

9,453

27.9

2,580

4.4

742

5.3

205,616

44.8

BBB
37,745

10.7

21,499

63.2

3,815

6.4

1,946

13.9

65,005

14.1

BIG
9,094

2.6

1,608

4.7

10,764

18.3

1,072

7.6

22,538

4.9

Total net par outstanding (excluding loss mitigation bonds)
$
352,181

100.0
%
$
33,998

100.0
%
$
58,907

100.0
%
$
14,021

100.0
%
$
459,107

100.0
%
Loss Mitigation Bonds
32

—

1,163

—

1,195

Net Par Outstanding (including loss mitigation bonds)
$
352,213

$
33,998

$
60,070

$
14,021

$
460,302


In addition, under the terms of certain credit derivative contracts, the referenced obligations in such contracts have been delivered to the Company and therefore are included in the investment portfolio. Such amounts are still included in the financial guaranty insured portfolio and totaled $ 165 million and $ 195 million in gross par outstanding as of March 31, 2014 and December 31, 2013, respectively.

119


Selected European Exposure

Several European countries have experienced significant economic, fiscal and / or political strains such that the likelihood of default on obligations with a nexus to those countries may be higher than the Company anticipated when such factors did not exist. The Company has identified those European countries where it has exposure and where it believes heightened uncertainties exist to be: Hungary, Ireland, Italy, Portugal and Spain (the “Selected European Countries”). The Company selected these European countries based on its view that their credit fundamentals have weakened as a result of the global financial crisis, as well as on published reports identifying countries that may be experiencing reduced demand for their sovereign debt in the current environment. See “—Selected European Countries” below for an explanation of the circumstances in each country leading the Company to select that country for further discussion.
Direct Economic Exposure to the Selected European Countries
The Company’s direct economic exposure to the Selected European Countries (based on par for financial guaranty contracts and notional amount for financial guaranty contracts accounted for as derivatives) is shown in the following tables, both gross and net of ceded reinsurance:
Gross Direct Economic Exposure
to Selected European Countries(1)
March 31, 2014
Hungary
Ireland
Italy
Portugal
Spain
Total
(in millions)
Sovereign and sub-sovereign exposure:






Non-infrastructure public finance (2)
$
—

$
—

$
1,374

$
114

$
440

$
1,928

Infrastructure finance
396

—

19

12

159

586

Sub-total
396

—

1,393

126

599

2,514

Non-sovereign exposure:






Regulated utilities
—

—

255

—

—

255

RMBS
227

145

377

—

—

749

Sub-total
227

145

632

—

—

1,004

Total
$
623

$
145

$
2,025

$
126

$
599

$
3,518

Total BIG
$
623

$
—

$
—

$
126

$
598

$
1,347


120

Net Direct Economic Exposure
to Selected European Countries(1)
March 31, 2014

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






Non-infrastructure public finance (2)
$
—

$
—

$
1,026

$
98

$
274

$
1,398

Infrastructure finance
370

—

18

12

156

556

Sub-total
370

—

1,044

110

430

1,954

Non-sovereign exposure:






Regulated utilities
—

—

235

—

—

235

RMBS
217

145

312

—

—

674

Sub-total
217

145

547

—

—

909

Total
$
587

$
145

$
1,591

$
110

$
430

$
2,863

Total BIG
$
587

$
—

$
—

$
110

$
429

$
1,126

____________________
(1)
While the Company’s exposures are shown in U.S. dollars, the obligations the Company insures are in various currencies, including U.S. dollars and Euros. Included in both tables above is $ 145 million of reinsurance assumed on a 2004 - 2006 pool of Irish residential mortgages that is part of the Company’s remaining legacy mortgage reinsurance business. One of the residential mortgage-backed securities included in the table above includes residential mortgages in both Italy and Germany, and only the portion of the transaction equal to the portion of the original mortgage pool in Italian mortgages is shown in the tables.

(2)
The exposure shown in the "Non-infrastructure public finance" category is from transactions backed by receivable payments from sub-sovereigns in Italy, Spain and Portugal.
The tables above include the par amount of financial guaranty contracts accounted for as derivatives of $141 million with a fair value of $6 million, net of reinsurance. The Company’s credit derivative transactions are governed by International Swaps and Derivatives Association, Inc. ("ISDA") documentation, and the Company is required to make a loss payment on them only upon the occurrence of one or more defined credit events with respect to the referenced securities or loans.
The Company purchases reinsurance in the ordinary course to cover both its financial guaranty insurance and credit derivative exposures. Aside from this type of coverage the Company does not purchase credit default protection to manage the risk in its financial guaranty business. Rather, the Company has reduced its risks by ceding a portion of its business (including its financial guaranty contracts accounted for as derivatives) to third-party reinsurers that are generally required to pay their proportionate share of claims paid by the Company, and the net amounts shown above are net of such third-party reinsurance (reinsurance of financial guaranty contracts accounted for as derivatives is accounted for as a purchased derivative). See Note 13, Reinsurance and Other Monoline Exposures, of the Financial Statements.
Indirect Exposure to Selected European Countries
The Company has excluded from the exposure tables above its indirect economic exposure to the Selected European Countries through insurance it provides on (a) pooled corporate and (b) commercial receivables transactions. The Company considers economic exposure to a Selected European Country to be indirect when that exposure relates to only a small portion of an insured transaction that otherwise is not related to that Selected European Country.
The Company’s pooled corporate obligations are highly diversified in terms of obligors and, except in the case of TruPS CDOs or transactions backed by perpetual preferred securities highly diversified in terms of industry. Most pooled corporate obligations are structured to limit exposure to any given obligor and any given non-U.S. country or region. The insured pooled corporate transactions generally benefit from embedded credit enhancement which allows a transaction a certain level of losses in the underlying collateral without causing the Company to pay a claim. Some pooled corporate obligations include investments in companies with a nexus to the Selected European Countries.

121

The Company’s commercial receivable transactions excluded from the exposure tables above are rail car lease transactions and aircraft lease transactions where some of the lessees have a nexus with the Selected European Countries. Like the pooled corporate transactions, the commercial receivable transactions generally benefit from embedded credit enhancement which allows a transaction a certain level of losses in the underlying collateral without causing the Company to pay a claim.

The following table shows the Company’s indirect economic exposure to the Selected European Countries in pooled corporate obligations and commercial receivable transactions. The amount shown in the table is calculated by multiplying the amount insured by the Company (based on par for financial guaranty contracts and notional amount for financial guaranty contracts accounted for as derivatives) times the percent of the relevant collateral pool reported as having a nexus to the Selected European Countries:

Indirect Exposure to Selected European Countries
As of March 31, 2014
Greece
Ireland
Italy
Portugal
Spain
Total
(dollars in millions)
Pooled corporate






Gross par ($ millions)
$
17

$
101

$
153

$
15

$
500

$
786

Net par ($ millions)
$
16

$
86

$
141

$
15

$
452

$
710

Average proportion
2.3
%
1.8
%
2.6
%
1.0
%
4.7
%
3.2
%
Commercial receivables

Gross par ($ millions)
$
—

$
22

$
55

$
13

$
2

$
92

Net par ($ millions)
$
—

$
22

$
53

$
12

$
2

$
89

Average proportion
—
%
4.8
%
9.2
%
2.3
%
1.8
%
5.3
%
The table above includes, in the pooled corporate category, exposure from primarily non-U.S. pooled corporate transactions insured by the Company. Many primarily U.S. pooled corporate obligations permit investments of up to 10% or 15% (or occasionally 20%) of the pool in non-U.S. (or non-U.S. or -Canadian) collateral. Given the relatively low level of permitted international investments in these transactions and their generally high current credit quality, they are excluded from the table above.
Selected European Countries
The Company follows and analyzes public information regarding developments in countries to which the Company has exposure, including the Selected European Countries, and utilizes this information to evaluate risks in its financial guaranty portfolio. Because the Company guarantees payments under its financial guaranty contracts, its analysis is focused primarily on the risk of payment defaults by these countries or obligors in these countries. However, material developments having an economic impact with respect to the Selected European Countries would also impact the fair value of insurance contracts accounted for as derivatives and with a nexus to those countries.
The Republic of Hungary is rated “BB” and “Ba1” by S&P and Moody’s Investor Services, Inc. ("Moody’s"), respectively. The country continues to face significant economic and political challenges. The Company’s sovereign and sub-sovereign exposure to Hungarian credits includes an infrastructure financing dependent on payments by government agencies. The Company rates this exposure ($370 million net par) below investment grade. The Company is closely monitoring developments with respect to the ability and willingness of these entities to meet their payment obligations. The Company’s non-sovereign exposure to Hungary comprises primarily covered mortgage bonds issued by Hungarian banks. The Company rates the covered bonds ($217 million net par) below investment grade.
The Kingdom of Spain is rated “BBB-” by S&P and was upgraded to “Baa2” on February 21, 2014 by Moody’s. The key drivers for the upgrade included: (1) the rebalancing of the Spanish economy towards a more sustainable growth model; (2) the progress made in implementing broad structural reforms; and (3) the improvement in the government’s funding conditions since the height of the euro area sovereign debt crisis in mid-2012. The Company’s sovereign and sub-sovereign exposure to Spanish credits includes infrastructure financings dependent on payments by sub-sovereigns and government agencies, financings dependent on lease and other payments by sub-sovereigns and government agencies, and an issuance by a regulated utility. The Company rates most ($429 million aggregate net par) of its exposure to sovereign and sub-sovereign

122

credits in Spain below investment grade. The Company is closely monitoring developments with respect to the ability and willingness of these entities to meet their payment obligations.
The Republic of Portugal is rated “BB” and “Ba3” by S&P and Moody's, respectively. The country continues to face difficulties regarding its fiscal imbalances, high indebtedness and the difficult macroeconomic situation but has made progress in terms of fiscal consolidation and structural reforms. The Company’s exposure to sovereign and sub-sovereign Portuguese credits includes financings dependent on lease payments by sub-sovereigns and government agencies and infrastructure financings dependent on payments by sub-sovereigns and government agencies. The Company rates four of these transactions ($110 million aggregate net par) below investment grade. The Company is closely monitoring developments with respect to the ability and willingness of these entities to meet their payment obligations.
The Republic of Ireland is currently rated “BBB+” and “Baa3” by S&P and Moody’s, respectively. Moody’s upgraded its rating from “Ba1” in January 2014, the two main drivers for the upgrade being: (1) the growth potential of the Irish economy, which together with ongoing fiscal consolidation is expected to bring government debt ratios down from their recent peak; and (2) the Irish government's exit from its EU/International Monetary Fund support program on schedule, with improved solvency and restored market access. The Company’s exposure to Irish credits includes exposure in a pool of infrastructure financings dependent on payments by a sub-sovereign and mortgage reinsurance on a pool of Irish residential mortgages originated in 2004-2006 left from its legacy mortgage reinsurance business. Only $7 million of the Company’s exposure to Ireland is below investment grade, and it is indirect in non-sovereign pooled corporate transactions.

The Republic of Italy is rated “BBB” and “Baa2” by S&P and Moody’s, respectively. Even though its economy is growing again, the country continues to face significant economic and political challenges. The Company’s sovereign and sub-sovereign exposure to Italy depends on payments by Italian governmental entities in connection with infrastructure financings or for services already rendered. The Company’s non-sovereign Italian exposure is comprised primarily of securities backed by Italian residential mortgages or in one case a government-sponsored water utility. The Company is closely monitoring the ability and willingness of these obligors to make timely payments on their obligations.

The Hellenic Republic of Greece is rated “B-” and “Caa3” by S&P and Moody’s, respectively. Despite improvements in its medium-term economic outlook and the government’s success with fiscal consolidation, Greece continues to face significant economic and political challenges. As of March 31, 2014 the Company no longer had any direct economic exposure to Greece, although it does still have small, indirect exposures as described above under "Indirect Exposure to Selected European Countries".

Identifying Exposure to Selected European Countries
When the Company directly insures an obligation, it assigns the obligation to a geographic location or locations based on its view of the geographic location of the risk. For most exposures this can be a relatively straight-forward determination as, for example, a debt issue supported by availability payments for a toll road in a particular country. The Company may also assign portions of a risk to more than one geographic location as it has, for example, in a residential mortgage backed security backed by residential mortgage loans in both Germany and Italy. The Company may also have exposures to the Selected European Countries in business assumed from other monoline insurance companies. In the case of assumed business, the Company depends upon geographic information provided by the primary insurer.
The Company also has indirect exposure to the Selected European Countries through structured finance transactions backed by pools of corporate obligations or receivables, such as lease payments, with a nexus to such countries. In most instances, the trustees and/or servicers for such transactions provide reports that identify the domicile of the underlying obligors in the pool (and the Company relies on such reports), although occasionally such information is not available to the Company. The Company has reviewed transactions through which it believes it may have indirect exposure to the Selected European Countries that is material to the transaction and included in the tables above the proportion of the insured par equal to the proportion of obligors so identified as being domiciled in a Selected European Country. The Company may also have indirect exposures to Selected European Countries in business assumed from other monoline insurance companies. However, in the case of assumed business, the primary insurer generally does not provide information to the Company permitting it to geographically allocate the exposure proportionally to the domicile of the underlying obligors.


123

Exposure to Puerto Rico
The Company insures general obligation bonds of the Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations aggregating $5.3 billion net par and $6.7 billion gross par. The Company rates $5.1 billion net par and $6.4 billion gross par of those amounts BIG. The following table shows the Company’s exposure to general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations as of March 31, 2014 .
Net Exposure to Puerto Rico
As of March 31, 2014

Net Par Outstanding
AGM Consolidated
AGC Consolidated
AG Re Consolidated
Eliminations (1)
Total
Internal Rating
(in millions)
Commonwealth of Puerto Rico - General Obligation Bonds
$
844

$
476

$
532

$
—

$
1,852

BB
Puerto Rico Highways and Transportation Authority (Transportation revenue)
236

400

236

—

872

BB-
Puerto Rico Electric Power Authority
480

81

291

—

852

BB-
Puerto Rico Municipal Finance Authority
252

49

149

—

450

BB-
Puerto Rico Aqueduct and Sewer Authority
—

288

96

—

384

BB-
Puerto Rico Highways and Transportation Authority (Highway revenue)
296

28

58

(80
)
302

BB
Puerto Rico Sales Tax Financing Corporation
261

—

7

—

268

A-
Puerto Rico Convention Center District Authority
—

93

92

—

185

BB-
Puerto Rico Public Buildings Authority
32

46

46

—

124

BB
Government Development Bank for Puerto Rico
—

33

—

—

33

BB
Puerto Rico Infrastructure Financing Authority
—

10

8

—

18

BB-
University of Puerto Rico
—

1

—

—

1

BB-
Total
$
2,401

$
1,505

$
1,515

$
(80
)
$
5,341

BB
____________________
(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.

The following table shows the net par and estimated amortization of the general obligation bonds of Puerto Rico and various obligations of its related authorities and public corporations insured and rated BIG 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. The column labeled “Estimated BIG Net Debt Service Amortization” shows the total amount of principal and interest due in the period indicated and represents the maximum net amount the Company would be required to pay on BIG Puerto Rico exposures in a given period assuming the obligors paid nothing on all of those obligations in that period. The column labeled “Estimated BIG Ending Net Debt Service Outstanding” is simply the arithmetic total of all of the principal and interest payments remaining for the remaining life of such obligations, and represents the maximum amount the Company would be required to pay if none of the obligors ever paid anything for the remaining life of the obligations.

124

BIG Net Par Outstanding
and BIG Net Debt Service Outstanding of Puerto Rico
Amortization Schedule
As of March 31, 2014

Estimated BIG Net Par Amortization
Estimated BIG Ending Net Par Outstanding
Estimated BIG Net Debt Service Amortization
Estimated BIG Ending Net Debt Service Outstanding
(in millions)
2014 (as of March 31)
$
5,073

$
8,306

2014 (April 1 – June 30)
$
—

5,073

$
64

8,242

2014 (July 1 – September 30)
254

4,819

315

7,927

2014 (October 1 – December 31)
—

4,819

61

7,866

2015
364

4,455

601

7,265

2016
289

4,166

509

6,756

2017
208

3,958

415

6,341

2018
159

3,799

358

5,983

2014-2018
1,274

3,799

2,323

5,983

2019-2023
884

2,915

1,718

4,265

2024-2028
937

1,978

1,566

2,699

2029-2033
697

1,281

1,125

1,574

After 2033
1,281

—

1,574

—

Total
$
5,073

$
8,306

Recent announcements and actions by the Governor and his administration indicate officials of the Commonwealth are focused on measures to help Puerto Rico operate within its financial resources and maintain its access to the capital markets. All Puerto Rico credits insured by the Company are current on their principal and interest ("Debt Service") payments, and we expect them to continue to make their Debt Service payments. Neither Puerto Rico nor its related authorities and public corporations are eligible debtors under Chapter 9 of the U.S. Bankruptcy Code. However, Puerto Rico faces high debt levels, a declining population and an economy that has been in recession since 2006. Puerto Rico has been operating with a structural budget deficit in recent years, and its two largest pension funds are significantly underfunded.

In January 2014 the Company downgraded most of its insured Puerto Rico credits to BIG, reflecting the economic and financial challenges facing the Commonwealth and due to concerns that the rating agencies would downgrade Puerto Rico and limit its access to credit. Subsequently, in February 2014, S&P, Moody's and Fitch Ratings downgraded much of the debt of Puerto Rico and its related authorities and public corporations to BIG, citing various factors including limited liquidity and market access risk. On March 11, 2014, the Commonwealth of Puerto Rico sold $3.5 billion of general obligation bonds. The Company believes the proceeds of the issuance have helped the Commonwealth address certain short-term liquidity needs.

Following Moody's downgrade of Puerto Rico, Moody's formally affirmed the financial strength ratings of AGM (A2, stable outlook) and AGC (A3, stable outlook). Moody's also affirmed the financial strength rating of Assured Guaranty Re Ltd. ("AG Re") (Baa1) but changed the outlook on such rating to negative. Similarly, S&P published an analysis of Assured Guaranty's Puerto Rico exposure, which concluded that, following S&P's downgrade of the Commonwealth, Assured Guaranty's stress case capital charge would increase by approximately $65 million and that Assured Guaranty continued to have substantial excess capital.

Exposure to Residential Mortgage-Backed Securities
The tables below provide information on the risk ratings and certain other risk characteristics of the Company’s financial guaranty insurance and credit derivative RMBS exposures as of March 31, 2014 . U.S. RMBS exposures represent 3% of the total net par outstanding, and BIG U.S. RMBS represent 34% of total BIG net par outstanding. The tables presented provide information with respect to the underlying performance indicators of this book of business. See Note 5, Expected Loss to be Paid, of the Financial Statements, for a discussion of expected losses to be paid on U.S. RMBS exposures.

125

All performance information such as pool factor, subordination, cumulative losses and delinquency is based on March 31, 2014 information obtained from third parties and/or provided by the trustee prior to the date of this filing. It is possible that the Company may receive updated or additional information for this period in the future.
Pool factor in the following tables is the percentage of the current collateral balance divided by the original collateral balance of the transactions at inception. Subordination in the following tables represents the sum of subordinate tranches and overcollateralization, expressed as a percentage of total transaction size and does not include any benefit from excess spread collections that may be used to absorb losses. Many of the closed-end-second lien RMBS transactions insured by the Company have unique structures whereby the collateral may be written down for losses without a corresponding write-down of the obligations insured by the Company. Many of these transactions are currently undercollateralized, with the principal amount of collateral being less than the principal amount of the obligation insured by the Company. The Company is not required to pay principal shortfalls until legal maturity (rather than making timely principal payments), and takes the undercollateralization into account when estimating expected losses for these transactions. Cumulative losses in the following tables are defined as net charge-offs on the underlying loan collateral divided by the original collateral balance. 60+ day delinquencies in the following tables are defined as loans that are greater than 60 days delinquent and all loans that are in foreclosure, bankruptcy or real estate owned divided by current collateral balance.
Distribution of U.S. RMBS by Rating and Type of Exposure as of March 31, 2014
Ratings:
Prime First Lien
Closed-End Second Lien
HELOC
Alt-A First Lien
Option ARMs
Subprime First Lien
Total Net Par Outstanding
(dollars in millions)
AAA
$
1

$
0

$
17

$
212

$
4

$
2,125

$
2,358

AA
94

95

91

536

254

1,680

2,751

A
1

0

8

1

20

121

152

BBB
36

—

133

17

33

139

358

BIG
395

144

1,734

2,713

565

1,856

7,406

Total exposures
$
528

$
239

$
1,983

$
3,478

$
877

$
5,921

$
13,025


Distribution of Financial Guaranty Direct U.S. RMBS
Insured January 1, 2005 or Later by Exposure Type, Average Pool Factor, Subordination,
Cumulative Losses and 60+ Day Delinquencies
As of March 31, 2014

Net Par
Outstanding
Pool
Factor
Subordination
Cumulative
Losses
60+ Day
Delinquencies
Number of
Transactions
(dollars in millions)
U.S. Prime First Lien
$
504

30.7
%
4.0
%
4.6
%
16.7
%
8

U.S. Closed-End Second Lien
229

11.2
%
—
%
68.9
%
5.8
%
9

U.S. HELOC
1,750

16.3
%
3.4
%
37.2
%
3.8
%
18

U.S. Alt-A First Lien
3,403

32.5
%
5.1
%
17.2
%
26.3
%
43

U.S. Option ARMs
843

33.7
%
6.3
%
22.5
%
27.7
%
19

U.S. Subprime First Lien
4,725

26.9
%
14.3
%
19.4
%
32.6
%
21


Exposures by Reinsurer
Ceded par outstanding represents the portion of insured risk ceded to other reinsurers. Under these relationships, the Company cedes a portion of its insured risk in exchange for a premium paid to the reinsurer. The Company remains primarily liable for all risks it directly underwrites and is required to pay all gross claims. It then seeks reimbursement from the reinsurer for its proportionate share of claims. The Company may be exposed to risk for this exposure if it were required to pay the gross claims and not be able to collect ceded claims from an assuming company experiencing financial distress. A number of the financial guaranty insurers to which the Company has ceded par have experienced financial distress and as a result been downgraded by the rating agencies. In addition, state insurance regulators have intervened with respect to some of these insurers.

126

Assumed par outstanding represents the amount of par assumed by the Company from other monolines. Under these relationships, the Company assumes a portion of the ceding company’s insured risk in exchange for a premium. The Company may be exposed to risk in this portfolio in that the Company may be required to pay losses without a corresponding premium in circumstances where the ceding company is experiencing financial distress and is unable to pay premiums.
In addition to assumed and ceded reinsurance arrangements, the Company may also have exposure to some financial guaranty reinsurers (i.e. monolines) in other areas. Second-to-pay insured par outstanding represents transactions the Company has insured that were previously insured by other monolines. The Company underwrites such transactions based on the underlying insured obligation without regard to the primary insurer.
Exposure by Reinsurer
Ratings at
Par Outstanding
May 5, 2014
As of March 31, 2014
Reinsurer
Moody’s
Reinsurer
Rating
S&P
Reinsurer
Rating
Ceded Par
Outstanding(1)
Second-to-
Pay Insured
Par
Outstanding
Assumed Par
Outstanding
(dollars in millions)
American Overseas Reinsurance Company Limited (f/k/a Ram Re)
WR (2)
WR
$
8,113

$
—

$
30

Tokio Marine & Nichido Fire Insurance Co., Ltd.
Aa3 (3)
AA- (3)
6,273

—

—

Radian Asset Assurance Inc. ("Radian")
Ba1
B+
4,696

24

987

Syncora Guarantee Inc.
WR
WR
4,192

1,769

161

Mitsui Sumitomo Insurance Co. Ltd.
A1
A+ (3)
2,139

—

—

ACA Financial Guaranty Corp.
NR (5)
WR
809

3

8

Federal Insurance Company
Aa2
AA
382

—

—

Swiss Reinsurance Co.
Aa3
AA-
347

—

—

Security Life of Denver Insurance Company
A3
A-
239

—

—

Ambac Assurance Corporation ("Ambac")(4)
WR
WR
85

6,013

17,578

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

114

4,883

MBIA Inc.
(4)
(4)
—

10,208

7,221

Financial Guaranty Insurance Co.
WR
WR
—

2,273

1,237

Other
Various
Various
251

2,114

45

Total
$
27,526

$
22,518

$
32,150

____________________
(1)
Includes $ 3,038 million in ceded par outstanding related to insured credit derivatives.
(2)    Represents “Withdrawn Rating.”
(3)    The Company has structural collateral agreements satisfying the triple-A credit requirement of S&P and/or Moody’s.

(4)
MBIA Inc. includes various subsidiaries which are rated AA- and B by S&P and Baa1, B1 and B3 by Moody’s. Ambac Assurance Corporation includes policies in their general and segregated account.

(5)    Represents “Not Rated.”




127

Ceded Par Outstanding by Reinsurer and Credit Rating
As of March 31, 2014

Internal Credit Rating
Reinsurer
AAA
AA
A
BBB
BIG
Total
(in millions)
American Overseas Reinsurance Company Limited (f/k/a Ram Re)
$
879

$
2,843

$
2,428

$
1,399

$
564

$
8,113

Tokio Marine & Nichido Fire Insurance Co., Ltd.
1,052

1,109

1,719

1,471

922

6,273

Radian
233

294

2,356

1,245

568

4,696

Syncora Guarantee Inc.
—

223

768

2,349

852

4,192

Mitsui Sumitomo Insurance Co. Ltd.
145

687

818

286

203

2,139

ACA Financial Guaranty Corp
—

466

324

19

—

809

Federal Insurance Company
—

—

382

—

—

382

Swiss Reinsurance Co.
—

2

241

28

76

347

Security Life of Denver Insurance Company
—

—

239

—

—

239

Ambac
—

—

85

—

—

85

Other
—

91

124

36

—

251

Total
$
2,309

$
5,715

$
9,484

$
6,833

$
3,185

$
27,526



In accordance with U.S. statutory accounting requirements and U.S. insurance laws and regulations, in order for the Company to receive credit for liabilities ceded to reinsurers domiciled outside of the U.S., such reinsurers must secure their liabilities to the Company. All of the unauthorized reinsurers in the table above post collateral for the benefit of the Company in an amount at least equal to the sum of their ceded unearned premium reserve, loss reserves and contingency reserves all calculated on a statutory basis of accounting. In addition, certain authorized reinsurers in the table above post collateral on terms negotiated with the Company. Collateral may be in the form of letters of credit or trust accounts. The total collateral posted by all non-affiliated reinsurers as of March 31, 2014 is approximately $ 654 million .

Second-to-Pay
Insured Par Outstanding by Internal Rating
As of March 31, 2014
Public Finance
Structured Finance
AAA
AA
A
BBB
BIG
AAA
AA
A
BBB
BIG
Total
(in millions)
Radian
$
—

$
—

$
2

$
14

$
8

$
—

$
—

$
—

$
—

$
—

$
24

Syncora Guarantee Inc.
—

25

372

776

312

66

53

—

—

165

1,769

ACA Financial Guaranty Corp.
—

1

—

2

—

—

—

—

—

—

3

Ambac
30

1,326

3,072

1,061

76

—

41

69

204

134

6,013

CIFG
—

5

56

22

31

—

—

—

—

—

114

MBIA Inc.
225

2,322

4,008

1,642

—

—

1,588

24

173

226

10,208

Financial Guaranty Insurance Co.
—

77

994

303

340

477

—

35

—

47

2,273

Other
—

—

2,114

—

—

—

—

—

—

—

2,114

Total
$
255

$
3,756

$
10,618

$
3,820

$
767

$
543

$
1,682

$
128

$
377

$
572

$
22,518




128

Liquidity and Capital Resources
Liquidity Requirements and Sources
AGL and its Holding Company Subsidiaries
The liquidity of AGL, Assured Guaranty US Holdings Inc. ("AGUS") and Assured Guaranty Municipal Holdings Inc. ("AGMH") is largely dependent on dividends from their operating subsidiaries and their access to external financing. The liquidity requirements of these entities include the payment of operating expenses, interest on debt issued by AGUS and AGMH, and dividends on AGL's common shares. AGL and its holding company subsidiaries may also require liquidity to make periodic capital investments in their operating subsidiaries or, in the case of AGL, to repurchase its common shares pursuant to its share repurchase authorization. In the ordinary course of business, the Company evaluates its liquidity needs and capital resources in light of holding company expenses and dividend policy, as well as rating agency considerations. The Company also subjects its cash flow projections and its assets to a stress test, maintaining a liquid asset balance of one time its stressed operating company net cash flows. Management believes that AGL will have sufficient liquidity to satisfy its needs over the next twelve months. See “—Insurance Company Regulatory Restrictions” below for a discussion of the dividend restrictions of its insurance company subsidiaries.

AGL and Holding Company Subsidiaries
Significant Cash Flow Items
First Quarter
2014
2013
(in millions)
Dividends paid by AG Re to AGL
$
62

$
40

Repayment of surplus note by AGM to AGMH
25

25

Dividends paid to AGL shareholders
(20
)
(19
)
Repurchases of common shares
(35
)
(39
)
Interest paid
(7
)
(7
)
Dividends

The Company anticipates that for the next twelve months, amounts paid by AGL’s direct and indirect insurance company subsidiaries as dividends or other distributions will be a major source of its liquidity. The insurance company subsidiaries’ ability to pay dividends depends upon their financial condition, results of operations, cash requirements, and compliance with rating agency requirements, and is also subject to restrictions contained in the insurance laws and related regulations of their states of domicile. Dividend restrictions applicable to AGC and AGM, and to AG Re and Assured Guaranty Re Overseas Ltd. ("AGRO"), are described under Note 11, Insurance Company Regulatory Requirements.

•
Under New York's insurance law, AGM may only pay dividends out of "earned surplus" and may pay dividends without the prior approval of the New York Superintendent of Financial Services ("New York Superintendent") that, together with all dividends paid in the prior 12 months, does not exceed 10% of its policyholders' surplus (as of its last annual or quarterly statement filed with the New York Superintendent) or 100% of its adjusted net investment income during that period. The aggregate amount available for AGM to distribute as dividends in 2014 without regulatory approval is estimated to be approximately $175 million . AGM did not distribute any dividends in First Quarter 2014 .

•
Under Maryland's insurance law, AGC may, with prior notice to the Maryland insurance commissioner, pay an ordinary dividend that, together with all dividends paid in the prior 12 months, does not exceed 10% of its policyholders' surplus (as of the prior December 31) or 100% of its adjusted net investment income during that period. The aggregate amount available for AGC to distribute as ordinary dividends in 2014 will be approximately $69 million . AGC did not distribute any dividends in First Quarter 2014 .

•
MAC is a New York domiciled insurance company subject to the same dividend limitations described above for AGM. The Company does not currently anticipate that MAC will distribute any dividends.


129

•
AG Re, based on regulatory capital requirements, has $600 million in excess capital and surplus. However, dividends are paid out of an insurer's statutory surplus and cannot exceed that surplus; AG Re's outstanding statutory surplus is $276 million . In addition, annual dividends cannot exceed 25% of total statutory capital and surplus, which is $280 million , without AG Re certifying to the Bermuda Monetary Authority that it will continue to meet required margins. As of March 31, 2014, AG Re had unencumbered assets of approximately $201 million . Such amount will fluctuate during the quarter based upon factors including the market value of previously posted assets and additional ceded reserves, if any.

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 United Kingdom, 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

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 up to $225 million in the aggregate from AGUS for general corporate purposes. Such commitment terminates on October 25, 2018 (the “loan termination date”). The unpaid principal amount of each loan will bear interest at a fixed rate equal to 100% of the then applicable Federal short-term or mid-term interest rate, as the case may be, as determined under Internal Revenue Code Sec. 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 by the third anniversary of the loan termination date. No amounts are currently outstanding under the credit facility.

In addition, in connection with the acquisition of MAC, AGUS entered into a loan agreement with its affiliate AGRO in 2012 to borrow $90 million in order to fund the purchase price. That loan remained outstanding as of March 31, 2014.

Cash and Investments

As of March 31, 2014, AGL had $36 million in cash and short-term investments with a weighted average duration of 0.3 years. AGUS and AGMH had a total of $128 million in cash and short-term investments. In addition, the U.S. holding companies have $119 million in fixed-maturity securities with weighted average duration of 1.4 years.

Liquidity Requirements and Sources -- Insurance Company Subsidiaries

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

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

Management believes that its subsidiaries’ liquidity needs for the next twelve months can be met from current cash, short-term investments and operating cash flow, including premium collections and coupon payments as well as scheduled maturities and paydowns from their respective investment portfolios. The Company targets a balance of its most liquid assets including cash and short-term securities, Treasuries, agency RMBS and pre-refunded municipal bonds equal to 1.5 times its projected operating company cash flow needs over the next four quarters. The Company intends to hold and has the ability to hold temporarily impaired debt securities until the date of anticipated recovery.

130

Beyond the next twelve months, the ability of the operating subsidiaries to declare and pay dividends may be influenced by a variety of factors, including market conditions, insurance regulations and rating agency capital requirements and general economic conditions.
Insurance policies issued provide, in general, that payments of principal, interest and other amounts insured may not be accelerated by the holder of the obligation. Amounts paid by the Company therefore are typically in accordance with the obligation’s original payment schedule, unless the Company accelerates such payment schedule, at its sole option. CDS may provide for acceleration of amounts due upon the occurrence of certain credit events, subject to single-risk limits specified in the insurance laws of the State of New York. These constraints prohibit or limit acceleration of certain claims according to Article 69 of the New York Insurance Law and serve to reduce the Company’s liquidity requirements.
Payments made in settlement of the Company’s obligations arising from its insured portfolio may, and often do, vary significantly from year-to-year, depending primarily on the frequency and severity of payment defaults and whether the Company chooses to accelerate its payment obligations in order to mitigate future losses.

Claims (Paid) Recovered

First Quarter
2014
2013
(in millions)
U.S. RMBS before benefit for recoveries for breaches of R&W
$
(42
)
$
(154
)
Net benefit for recoveries for breaches of R&W
39

89

U.S. RMBS after benefit for recoveries for breaches of R&W
(3
)
(65
)
Other structured finance
(1
)
(4
)
Public finance
(6
)
(23
)
Claims (paid) recovered, net of reinsurance(1)
$
(10
)
$
(92
)
____________________
(1)
Includes $1 million and $9 million paid for consolidated FG VIEs for First Quarter 2014 and 2013 , respectively. Claims recovered include invested assets received as part of a restructuring. See Note 5, Expected Loss to be Paid, of the Financial Statements.

The Company has exposure to infrastructure transactions with refinancing risk as to which the Company may need to make claim payments that it did not anticipate paying when the policies were issued. Although the Company may not experience ultimate loss on a particular transaction, the aggregate amount of the claim payments may be substantial and reimbursement may not occur for an extended time, if at all. As of March 31, 2014, the Company's insured exposure to such transactions was approximately $3.0 billion . The Company generally projects that in most scenarios it will be fully reimbursed for claim payments it makes on such exposure. However, the recovery of the payments is uncertain and may take from 10 to 35 years, depending on the transaction and the performance of the underlying collateral. For the Company's two largest transactions with significant refinancing risk, assuming no refinancing of the insured obligations, the Company estimates, based on certain performance assumptions could be $1.8 billion on a gross basis; such claims would be payable from 2017 through 2022.

In addition, the Company has net par exposure of $5.3 billion to the Commonwealth of Puerto Rico, of which $5.1 billion net par is rated BIG by the Company. Although the Commonwealth has not defaulted on any of its debt, it faces significant challenges, including high debt levels, a declining population and an economy that has been in recession since 2006. In February 2014, S&P, Moody's and Fitch Ratings downgraded much of the debt of Puerto Rico and its related authorities and public corporations to below investment grade, citing various factors including limited liquidity and market access risk. Information regarding the Company's exposure to the Commonwealth of Puerto Rico and its related authorities and public corporations is set forth in "Insured Portfolio-Exposure to Puerto Rico" above.

The terms of the Company’s CDS contracts generally are modified from standard CDS contract forms approved by ISDA in order to provide for payments on a scheduled basis and to replicate the terms of a traditional financial guaranty insurance policy. Some contracts the Company entered into as the credit protection seller, however, utilize standard ISDA settlement mechanics of cash settlement (i.e., a process to value the loss of market value of a reference obligation) or physical settlement (i.e., delivery of the reference obligation against payment of principal by the protection seller) in the event of a

131

“credit event,” as defined in the relevant contract. Cash settlement or physical settlement generally requires the payment of a larger amount, prior to the maturity of the reference obligation, than would settlement on a “pay-as-you-go” basis, under which the Company would be required to pay scheduled interest shortfalls during the term of the reference obligation and scheduled principal shortfall only at the final maturity of the reference obligation. The Company’s CDS contracts also generally provide that if events of default or termination events specified in the CDS documentation were to occur, the non-defaulting or the non-affected party, which may be either the Company or the counterparty, depending upon the circumstances, may decide to terminate the CDS contract prior to maturity. The Company may be required to make a termination payment to its swap counterparty upon such termination. In addition, under certain of the Company's CDS, the Company may be obligated to collateralize its obligations under the CDS if it does not maintain financial strength ratings above the negotiated rating level specified in the CDS documentation.
Consolidated Cash Flows
Consolidated Cash Flow Summary
First Quarter
2014
2013
(in millions)
Net cash flows provided by (used in) operating activities
$
101

$
(14
)
Net cash flows provided by (used in) investing activities
275

237

Net cash flows provided by (used in) financing activities
(342
)
(233
)
Effect of exchange rate changes
1

(3
)
Cash at beginning of period
184

138

Total cash at the end of the period
$
219

$
125

The effect of FG VIEs on cash flows from operating activities was $ (8) million and $ 21 million in First Quarter 2014 and First Quarter 2013, respectively. Claims paid on consolidated FG VIEs are presented in the consolidated cash flow statements as a component of paydowns on FG VIE liabilities in financing activities as opposed to operating activities.

First Quarter 2014 included $84 million in net proceeds from purchases and sales in the trading portfolio, compared with $27 million in First Quarter 2013. Excluding net cash flows from purchases and sales of the trading portfolio and the effect of consolidating FG VIEs, cash flows from operating activities increased for First Quarter 2014 compared to First Quarter 2013 due primarily to lower claim payments, and cash received on commutation agreements, offset in part by lower premium cash receipts.
Investing activities were primarily net sales (purchases) of fixed maturity and short-term investment securities. Investing cash flows in First Quarter 2014 and 2013 include inflows of $ 286 million and $ 138 million for FG VIEs, respectively. First Quarter 2013 included proceeds from sales of third party surplus notes and other invested assets.

Financing activities consisted primarily of paydowns of FG VIE liabilities and share repurchases. Financing cash flows in First Quarter 2014 and 2013 include outflows of $ 281 million and $ 167 million for FG VIEs, respectively.

Under the $400 million share repurchase authorization approved in November 2013, the Company repurchased 1.4 million common shares in First Quarter 2014 for $35 million at an average price of $25.92 per share. On a year-to-date basis through May 7, 2014, the Company has repurchased a total of 3.0 million common shares for $75 million at an average price of $25.19 per share. The Company intends to use the remaining capacity under this share repurchase authorization by the end of the third quarter of 2014 and, at that time, to request a new share repurchase authorization from its Board of Directors, in each case, subject to market conditions, the Company's capital position, the amount of funds available at the holding companies, its financial strength rating, and other factors.


132

Commitments and Contingencies
Leases
AGL and its subsidiaries are party to various lease agreements. Future cash payments associated with contractual obligations pursuant to operating leases for office space have not materially changed since December 31, 2013.

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
2014
2013
2014
2013
(in millions)
AGUS:


7.0% Senior Notes
$
200

$
200

$
—

$
—

Series A Enhanced Junior Subordinated Debentures
150

150

—

—

Total AGUS
350

350

—

—

AGMH:


6 7 / 8 % QUIBS
100

100

2

2

6.25% Notes
230

230

4

4

5.60% Notes
100

100

1

1

Junior Subordinated Debentures
300

300

—

—

Total AGMH
730

730

7

7

AGM(1):


AGM Notes Payable
29

34

1

2

Total
$
1,109

$
1,114

$
8

$
9

____________________
(1)
Principal amounts vary from carrying amounts due primarily to acquisition method fair value adjustments at the AGMH acquisition date, which are accreted or amortized into interest expense over the remaining terms of these obligations.

AGL fully and unconditionally guarantees the following obligations:

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

In addition, AGL guarantees, on a junior subordinated basis, AGUS’s Series A, Enhanced Junior Subordinated Debentures and AGMH’s outstanding Junior Subordinated Debentures.
7.0 % Senior Notes issued by AGUS. On May 18, 2004, AGUS issued $ 200 million of 7.0 % senior notes due 2034 (“ 7.0 % Senior Notes”) for net proceeds of $ 197 million . Although the coupon on the Senior Notes is 7.0 %, the effective rate is approximately 6.4 %, taking into account the effect of a cash flow hedge.
Series A Enhanced Junior Subordinated Debentures issued by AGUS. On December 20, 2006, AGUS issued $ 150 million of the Debentures due 2066. The Debentures pay a fixed 6.40% rate of interest until December 15, 2016, and thereafter pay a floating rate of interest, reset quarterly, at a rate equal to three month London Interbank Offered Rate ("LIBOR") plus a margin equal to 2.38% . AGUS may select at one or more times to defer payment of interest for one or more consecutive periods

133

for up to ten years. Any unpaid interest bears interest at the then applicable rate. AGUS may not defer interest past the maturity date.
6 7/8 % QUIBS issued by AGMH. On December 19, 2001, AGMH issued $ 100 million face amount of 6 7/8 % QUIBS due December 15, 2101, which are callable without premium or penalty.
6.25 % Notes issued by AGMH. On November 26, 2002, AGMH issued $ 230 million face amount of 6.25 % Notes due November 1, 2102, which are callable without premium or penalty in whole or in part.
5.60 % Notes issued by AGMH. On July 31, 2003, AGMH issued $ 100 million face amount of 5.60 % Notes due July 15, 2103, which are callable without premium or penalty in whole or in part.
Junior Subordinated Debentures issued by AGMH. On November 22, 2006, AGMH issued $ 300 million face amount of Junior Subordinated Debentures with a scheduled maturity date of December 15, 2036 and a final repayment date of December 15, 2066. The final repayment date of December 15, 2066 may be automatically extended up to four times in five -year increments provided certain conditions are met. The debentures are redeemable, in whole or in part, at any time prior to December 15, 2036 at their principal amount plus accrued and unpaid interest to the date of redemption or, if greater, the make-whole redemption price. Interest on the debentures will accrue from November 22, 2006 to December 15, 2036 at the annual rate of 6.40% . If any amount of the debentures remains outstanding after December 15, 2036, then the principal amount of the outstanding debentures will bear interest at a floating interest rate equal to one -month LIBOR plus 2.215% until repaid. AGMH may elect at one or more times to defer payment of interest on the debentures for one or more consecutive interest periods that do not exceed ten years. In connection with the completion of this offering, AGMH entered into a replacement capital covenant for the benefit of persons that buy, hold or sell a specified series of AGMH long-term indebtedness ranking senior to the debentures. Under the covenant, the debentures will not be repaid, redeemed, repurchased or defeased by AGMH or any of its subsidiaries on or before the date that is twenty years prior to the final repayment date, except to the extent that AGMH has received proceeds from the sale of replacement capital securities. The proceeds from this offering were used to pay a dividend to the shareholders of AGMH.
Notes Payable issued by AGM. In order to mitigate certain financial guaranty insurance losses, special purpose entities that AGM consolidates ("refinancing vehicles") borrowed funds from the former AGMH subsidiaries that conducted AGMH’s Financial Products Business (the “Financial Products Companies”). The Company refers to such debt as the "Notes Payable." The Financial Products Companies issued guaranteed investment contracts that AGM insured, and loaned the proceeds to the refinancing vehicles. The refinancing vehicles used the proceeds from the Notes Payable to purchase certain obligations insured by AGM or collateral underlying such obligations and reimbursed AGM for its claim payments, in exchange for AGM assigning to the refinancing vehicles certain of its rights against the trusts in the applicable transactions.

Recourse Credit Facility
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. The liquidity risk to AGM related to the strip policy portion of the leveraged lease business is mitigated by the strip coverage facility described below.
In a leveraged lease transaction, a tax-exempt entity (such as a transit agency) transfers tax benefits to a tax-paying entity by transferring ownership of a depreciable asset, such as subway cars. The tax-exempt entity then leases the asset back from its new owner.
If the lease is terminated early, the tax-exempt entity must make an early termination payment to the lessor. A portion of this early termination payment is funded from monies that were pre-funded and invested at the closing of the leveraged lease transaction (along with earnings on those invested funds). The tax-exempt entity is obligated to pay the remaining, unfunded portion of this early termination payment (known as the “strip coverage”) from its own sources. AGM issued financial guaranty insurance policies (known as “strip policies”) that guaranteed the payment of these unfunded strip coverage amounts to the lessor, in the event that a tax-exempt entity defaulted on its obligation to pay this portion of its early termination payment. AGM can then seek reimbursement of its strip policy payments from the tax-exempt entity, and can also sell the transferred depreciable asset and reimburse itself from the sale proceeds.
Currently, all the leveraged lease transactions in which AGM acts as strip coverage provider are breaching a rating trigger related to AGM and are subject to early termination. However, early termination of a lease does not result in a draw on the AGM policy if the tax-exempt entity makes the required termination payment. If all the leases were to terminate early and the tax-exempt entities do not make the required early termination payments, then AGM would be exposed to possible liquidity

134

claims on gross exposure of approximately $ 1.4 billion as of March 31, 2014 . To date, none of the leveraged lease transactions that involve AGM has experienced an early termination due to a lease default and a claim on the AGM policy. It is difficult to determine the probability that AGM will have to pay strip provider claims or the likely aggregate amount of such claims. At March 31, 2014 , approximately $ 1.4 billion of cumulative strip par exposure had been terminated since 2008 on a consensual basis. The consensual terminations have resulted in no claims on AGM.
On July 1, 2009, AGM and Dexia Crédit Local S.A., acting through its New York Branch (“Dexia Crédit Local (NY)”), entered into a credit facility (the “Strip Coverage Facility”). Under the Strip Coverage Facility, Dexia Crédit Local (NY) agreed to make loans to AGM to finance all draws made by lessors on AGM strip policies that were outstanding as of November 13, 2008, up to the commitment amount. The commitment amount of the Strip Coverage Facility was $ 1 billion at closing of the Company's acquisition of AGMH and its subsidiaries but is scheduled to amortize over time. On February 7, 2014, AGM reduced the maximum commitment amount by $ 460 million to approximately $500 million, after taking into account its experience with its exposure to leveraged lease transactions to date. The maximum commitment amount of the Strip Coverage Facility had amortized to approximately $ 499 million as of March 31, 2014.
Fundings under this facility are subject to certain conditions precedent, and their repayment is collateralized by a security interest that AGM granted to Dexia Crédit Local (NY) in amounts that AGM recovers – from the tax-
exempt entity, or from asset sale proceeds – following its payment of strip policy claims. The Strip Coverage Facility will terminate upon the earliest to occur of an AGM change of control, the reduction of the commitment amount to $ 0 , and January 31, 2042.
The Strip Coverage Facility’s financial covenants require that AGM and its subsidiaries maintain a maximum debt-to-capital ratio of 30% and maintain a minimum net worth of 75% of consolidated net worth as of July 1, 2009, plus, beginning July 1, 2015:

•
the product of (i) 25% of the aggregate consolidated net income (or loss) for the period beginning July 2, 2009 and ending on June 30, 2014 or (ii) a fraction, the numerator of which is the commitment amount as of such date and the denominator of which is $1 billion , or

•
zero, if the consolidated net worth of AGM and its subsidiaries as of June 30, 2014 is less than the sum of (i) 75% of consolidated net worth as of July 1, 2009 plus (ii) the product of (x) 25% of the aggregate consolidated net income (or loss) for the period beginning July 2, 2009 and ending on June 20, 2014 and (y) a fraction, the numerator of which is the commitment amount as of June 30, 2014 and the denominator of which is $1 billion .
The Company is in compliance with all financial covenants as of March 31, 2014 .

The Strip Coverage Facility contains restrictions on AGM, including, among other things, in respect of its ability to incur debt, permit liens, pay dividends or make distributions, dissolve or become party to a merger or consolidation. Most of these restrictions are subject to exceptions. The Strip Coverage Facility has customary events of default, including (subject to certain materiality thresholds and grace periods) payment default, bankruptcy or insolvency proceedings and cross-default to other debt agreements.
As of March 31, 2014 , no amounts were outstanding under this facility, nor have there been any borrowings during the life of this facility.
Committed Capital Securities

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

The trusts provide AGC and AGM access to new capital at their respective sole discretion through the exercise of the put options. Upon AGC's or AGM's exercise of its put option, the relevant trust will liquidate its portfolio of eligible assets and use the proceeds to purchase the AGC or AGM preferred stock, as applicable. AGC or AGM may use the proceeds from such

135

sale of its preferred stock to the trusts for any purpose, including the payment of claims. The put agreements have no scheduled termination date or maturity. However, each put agreement will terminate if (subject to certain grace periods) in the event specified events occur.

AGC Committed Capital Securities . AGC entered into separate put agreements with four custodial trusts with respect to its committed capital securities in April 2005. The AGC put options have not been exercised through the date of this filing. Initially, all of AGC committed capital securities were issued to a special purpose pass-through trust (the “Pass-Through Trust”). The Pass-Through Trust was dissolved in April 2008 and the AGC committed capital securities were distributed to the holders of the Pass-Through Trust's securities. Neither the Pass-Through Trust nor the custodial trusts are consolidated in the Company's financial statements.  Income distributions on the Pass-Through Trust securities and committed capital securities were equal to an annualized rate of one-month LIBOR plus 110 basis points for all periods ending on or prior to April 8, 2008. Following dissolution of the Pass-Through Trust, distributions on the AGC committed capital securities are determined pursuant to an auction process. On April 7, 2008 this auction process failed, thereby increasing the annualized rate on the AGC committed capital securities to one-month LIBOR plus 250 basis points. Distributions on the AGC preferred stock will be determined pursuant to the same process. AGC continues to have the ability to exercise its put option and cause the related trusts to purchase AGC Preferred Stock.
AGM Committed Capital Securities . AGM entered into separate put agreements with four custodial trusts with respect to its committed capital securities in June 2003. The AGM put options have not been exercised through the date of this filing. AGM pays a floating put premium to the trusts, which represents the difference between the commercial paper yield and the winning auction rate (plus all fees and expenses of the trust). If an auction does not attract sufficient clearing bids, however, the auction rate is subject to a maximum rate of one-month LIBOR plus 200 basis points for the next succeeding distribution period. Beginning in August 2007, the AGM committed capital securities required the maximum rate for each of the relevant trusts. AGM continues to have the ability to exercise its put option and cause the related trusts to purchase AGM Preferred Stock.

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

The Company’s fixed-maturity securities and short-term investments had a duration of 4.9 years as of both March 31, 2014 and December 31, 2013 . 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 Note 10, Investments and Cash, of the Financial Statements.


136

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

As of March 31, 2014
As of December 31, 2013
Amortized
Cost
Estimated
Fair Value
Amortized
Cost
Estimated
Fair Value
(in millions)
Fixed-maturity securities:




Obligations of state and political subdivisions
$
4,982

$
5,249

$
4,899

$
5,079

U.S. government and agencies
674

701

674

700

Corporate securities
1,382

1,427

1,314

1,340

Mortgage-backed securities(1):

RMBS
1,182

1,171

1,160

1,122

CMBS
656

670

536

549

Asset-backed securities
544

554

605

608

Foreign government securities
309

322

300

313

Total fixed-maturity securities
9,729

10,094

9,488

9,711

Short-term investments
720

720

904

904

Total fixed-maturity and short-term investments
$
10,449

$
10,814

$
10,392

$
10,615

____________________
(1)
Government-agency obligations were approximately 45% of mortgage backed securities as of March 31, 2014 and 50% as of December 31, 2013 , based on fair value.
The following tables summarize, for all fixed-maturity securities in an unrealized loss position as of March 31, 2014 and December 31, 2013 , 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, 2014

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
$
458

$
(14
)
$
13

$
0

$
471

$
(14
)
U.S. government and agencies
175

(5
)
—

—

175

(5
)
Corporate securities
307

(9
)
10

(1
)
317

(10
)
Mortgage-backed securities:

RMBS
317

(13
)
155

(42
)
472

(55
)
CMBS
93

(2
)
—

—

93

(2
)
Asset-backed securities
21

0

44

(3
)
65

(3
)
Foreign government securities
59

(1
)
—

—

59

(1
)
Total
$
1,430

$
(44
)
$
222

$
(46
)
$
1,652

$
(90
)
Number of securities

307


30


337

Number of securities with other-than-temporary impairment

3


11


14


137

Fixed-Maturity Securities
Gross Unrealized Loss by Length of Time
As of December 31, 2013

Less than 12 months
12 months or more
Total
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
(dollars in millions)
Obligations of state and political subdivisions
$
781

$
(39
)
$
5

$
0

$
786

$
(39
)
U.S. government and agencies
173

(6
)
—

—

173

(6
)
Corporate securities
401

(18
)
3

0

404

(18
)
Mortgage-backed securities:




—

—

RMBS
414

(21
)
186

(51
)
600

(72
)
CMBS
121

(4
)
—

—

121

(4
)
Asset-backed securities
196

(2
)
42

(5
)
238

(7
)
Foreign government securities
54

(1
)
1

0

55

(1
)
Total
$
2,140

$
(91
)
$
237

$
(56
)
$
2,377

$
(147
)
Number of securities

425


33


458

Number of securities with other-than-temporary impairment

13


11


24

Of the securities in an unrealized loss position for 12 months or more as of March 31, 2014 , nine securities had an unrealized loss greater than 10% of book value. The total unrealized loss for these securities as of March 31, 2014 was $38 million . The Company has determined that the unrealized losses recorded as of March 31, 2014 are yield related and not the result of other-than-temporary impairment.
Changes in interest rates affect the value of the Company’s fixed-maturity portfolio. As interest rates fall, the fair value of fixed-maturity securities increases and as interest rates rise, the fair value of fixed-maturity securities decreases. The Company’s portfolio of fixed maturity securities consists primarily of high-quality, liquid instruments.
The 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, 2014
Amortized
Cost
Estimated
Fair Value
(in millions)
Due within one year
$
301

$
304

Due after one year through five years
1,767

1,843

Due after five years through 10 years
2,375

2,481

Due after 10 years
3,448

3,625

Mortgage-backed securities:


RMBS
1,182

1,171

CMBS
656

670

Total
$
9,729

$
10,094


138

The following table summarizes the ratings distributions of the Company’s investment portfolio as of March 31, 2014 and December 31, 2013 . Ratings reflect the lower of the Moody’s and S&P classifications, except for bonds purchased for loss mitigation or risk management strategies, which use Assured Guaranty’s internal ratings classifications.
Distribution of Fixed Maturity Securities by Rating
Rating
As of
March 31, 2014
As of
December 31, 2013
AAA
16.3
%
16.5
%
AA
57.6

57.5

A
18.0

17.6

BBB
1.1

0.9

BIG(1)
7.0

7.5

Total
100.0
%
100.0
%
____________________
(1)
Comprised primarily of loss mitigation and other risk management assets. See Note 10, Investments and Cash, of the Financial Statements.
The following table presents the fair value of securities with third-party guaranties.
Summary of Investments with
Third-Party Guaranties (1)
at Fair Value
Guarantor
As of
March 31, 2014
(in millions)
Ambac
$
455

National Public Finance Guarantee Corporation
435

CIFG
21

Berkshire Hathaway Assurance Corporation
5

Syncora Guarantee Inc.
3

Total
$
919

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

Under agreements with its cedants and in accordance with statutory requirements, the Company maintains fixed-maturity securities and cash in trust accounts for the benefit of reinsured companies, which amounted to $397 million and $377 million as of March 31, 2014 and December 31, 2013 , respectively, based on fair value. In addition, to fulfill state licensing requirements the Company has placed on deposit eligible securities of $19 million and $19 million as of March 31, 2014 and December 31, 2013 , respectively.
The fair market value of the Company’s pledged securities totaled $669 million and $677 million as of March 31, 2014 and December 31, 2013 , respectively.
Liquidity Arrangements with respect to AGMH’s former Financial Products Business
AGMH’s former financial products segment had been in the business of borrowing funds through the issuance of guaranteed investment contracts ("GICs") and medium term notes and reinvesting the proceeds in investments that met AGMH’s investment criteria. The financial products business also included the equity payment undertaking agreement portion of the leveraged lease business, as described further below in “—Leveraged Lease Business.”
The GIC Business

139

Until November 2008, AGMH, through its financial products business, offered GICs to municipalities and other market participants. The GICs were issued through AGMH’s non-insurance subsidiaries (the “GIC Issuers”) FSA Capital Management Services LLC, FSA Capital Markets Services LLC and FSA Capital Markets Services (Caymans) Ltd. In return for an initial payment, each GIC entitles its holder to receive the return of the holder’s invested principal plus interest at a specified rate, and to withdraw principal from the GIC as permitted by its terms. AGM insures the GIC Issuer’s payment obligations on all GICs issued by the applicable GIC Issuer.
The proceeds of GICs issued by the GIC Issuers were loaned to AGMH’s former subsidiary FSA Asset Management LLC ("FSAM"). FSAM in turn invested these funds in fixed-income obligations (primarily residential mortgage-backed securities, but also short-term investments, securities issued or guaranteed by U.S. government sponsored agencies, taxable municipal bonds, securities issued by utilities, infrastructure-related securities, collateralized debt obligations, other asset-backed securities and foreign currency denominated securities) (the “FSAM assets”).
Prior to the completion of the Company's acquisition of AGMH from Dexia Holdings Inc., AGMH sold its ownership interest in the GIC Issuers and FSAM to Dexia Holdings Inc. Even though AGMH no longer owns the GIC Issuers or FSAM, AGM’s guarantees of the GICs remain in place, and must remain in place until each GIC is terminated.
In June 2009, in connection with the Company's acquisition of AGMH from Dexia Holdings Inc., Dexia SA, the ultimate parent of Dexia Holdings Inc., and certain of its affiliates, entered into a number of agreements intended to mitigate the credit, interest rate and liquidity risks associated with the GIC business and the related AGM guarantees. Some of those agreements have since terminated or expired, or been modified. In addition to the surviving agreements described below, AGM benefits from a guaranty jointly and severally issued by Dexia SA and Dexia Crédit Local S.A. to AGM that guarantees the payment obligations of AGM under its policies related to the GIC business, and an indemnification agreement between AGM, Dexia SA and Dexia Crédit Local S.A. that protects AGM from other losses arising out of or as a result of the GIC business.
To support the payment obligations of FSAM and the GIC Issuers, each of Dexia SA and Dexia Crédit Local S.A. are party to an ISDA Master Agreement, including an associated schedule, confirmation and credit support annex (the “Non-Guaranteed Put Contract”), the economic effect of which is that Dexia SA and Dexia Crédit Local S.A. jointly and severally guarantee (i) the scheduled payments of interest and principal in relation to a specified portfolio of FSAM assets, (ii) the obligation of certain Dexia affiliates to provide liquidity or liquid collateral under committed liquidity lending facilities, and (iii) the obligation to make certain payments in the event of an insolvency of Dexia S.A. Pursuant to the Non-Guaranteed Put Contract, FSAM may put an amount of FSAM assets to Dexia SA and Dexia Crédit Local S.A. in exchange for funds. The amount that could be put varies depending on the type of trigger event in question. In an asset default scenario, the amount payable generally covers at least the amount of the losses on the FSAM assets (by non-payment, writedown or realized loss). For other trigger events, the amount payable generally is at least the amount due and unpaid under the committed liquidity facilities, the principal amount of the FSAM assets, and the outstanding principal balance of the GICs. Dexia S.A. and Dexia Crédit Local S.A. also benefit from certain grace periods and procedural rights under the Non-Guaranteed Put Contract. To secure the Non-Guaranteed Put Contract, Dexia SA and Dexia Crédit Local S.A. will, pursuant to the credit support annex thereto, post eligible highly liquid collateral having an aggregate value (subject to agreed reductions) equal to at least the excess of (i) the aggregate principal amount of all outstanding GICs over (ii) the aggregate mark-to-market value of FSAM’s assets. The agreed-to advance rates applicable to the value of FSAM assets range from 98% to 82% percent for obligations backed by the full faith and credit of the United States, sovereign obligations of the United Kingdom, Germany, the Netherlands, France or Belgium, obligations guaranteed by the Federal Deposit Insurance Corporation (FDIC) and for mortgage securities issued or guaranteed by U.S. sponsored agencies, and range from 75% to 0% for the other FSAM assets. As of March 31, 2014, approximately 28.2% of the FSAM Assets (measured by aggregate principal balance) was in cash or were obligations backed by the full faith and credit of the United States.

As of March 31, 2014, the aggregate accreted GIC balance was approximately $2.6 billion. As of the same date and with respect to the FSAM assets that are covered by the primary put contract, the aggregate accreted principal was approximately $3.9 billion, the aggregate market value was approximately $3.7 billion and the aggregate market value after agreed reductions was approximately $2.6 billion. Cash and positive derivative value roughly offset the negative derivative values and other projected costs. Accordingly, as of March 31, 2014, the aggregate fair value (after agreed reductions) of the assets supporting the GIC business exceeded the aggregate principal amount of all outstanding GICs and certain other business and hedging costs of the GIC business. Therefore, no posting of collateral was required under the credit support annex applicable to the primary put contract. Under the terms of that credit support annex, the collateral posting is recalculated on a weekly basis according to the formula set forth in the credit support annex, and a collateral posting is required whenever the collateralization levels tested by the formula are not satisfied, subject to a threshold of $5 million.


140

To provide additional support, Dexia affiliates provide liquidity commitments to lend against the FSAM assets, generally until the GICs have been paid in full. The liquidity commitments comprise:
•
an amended and restated revolving credit agreement (the “Liquidity Facility”) pursuant to which Dexia Crédit Local S.A. commits to provide funds to FSAM. As a result of agreed reductions and GIC amortization as of March 31, 2014 the commitments totaled $3.8 billion of (which approximately $1.3 billion was drawn), and

•
a master repurchase agreement (the “Repurchase Facility Agreement” and, together with the Liquidity Facility, the “Guaranteed Liquidity Facilities”) pursuant to which Dexia Crédit Local S.A. will provide up to $3.5 billion of funds in exchange for the transfer by FSAM to Dexia Crédit Local S.A. of FSAM securities that are not eligible to satisfy collateralization obligations of the GIC Issuers under the GICs. As of March 31, 2014, no amounts were outstanding under the Repurchase Facility Agreement.

Despite the execution of the Non-Guaranteed Put Contract and the Guaranteed Liquidity Facilities, and the significant portion of FSAM assets comprised of highly liquid securities backed by the full faith and credit of the United States, AGM remains subject to the risk that Dexia SA and its affiliates may not make payments or securities available (i) on a timely basis, which is referred to as “liquidity risk,” or (ii) at all, which is referred to as “credit risk,” because of the risk of default. Even if the Dexia entities have sufficient assets to pay all amounts when due, concerns regarding Dexia’s financial condition or willingness to comply with their obligations could cause one or more rating agencies to view negatively the ability or willingness of Dexia SA and its affiliates to perform under their various agreements and could negatively affect AGM’s ratings.
If Dexia SA or its affiliates do not fulfill the contractual obligations, the GIC issuers may not have the financial ability to pay upon the withdrawal of GIC funds or post collateral or make other payments in respect of the GICs, thereby resulting in claims upon the AGM financial guaranty insurance policies. If AGM is required to pay a claim due to a failure of the GIC issuers to pay amounts in respect of the GICs, AGM is subject to the risk that the GICs will not be paid from funds received from Dexia SA and its affiliates before it is required to make payment under its financial guaranty policies or that it will not receive the guaranty payment at all.
One situation in which AGM may be required to pay claims in respect of AGMH's former financial products business if Dexia SA and its affiliates do not comply with their obligations is following a downgrade of the financial strength rating of AGM. Most of the GICs insured by AGM allow for the withdrawal of GIC funds in the event of a downgrade of AGM, unless the relevant GIC issuer posts collateral or otherwise enhances its credit. Most GICs insured by AGM allow for the termination of the GIC contract and a withdrawal of GIC funds at the option of the GIC holder in the event of a downgrade of AGM below a specified threshold, generally below A- by S&P or A3 by Moody's, with no right of the GIC issuer to avoid such withdrawal by posting collateral or otherwise enhancing its credit. Each GIC contract stipulates the thresholds below which the GIC issuer must post eligible collateral, along with the types of securities eligible for posting and the collateralization percentage applicable to each security type. These collateralization percentages range from 100% of the GIC balance for cash posted as collateral to, typically, 108% for asset-backed securities. There are expected to be sufficient eligible and liquid assets within the GIC business to satisfy any withdrawal and collateral posting obligations that would be expected to arise as a result of potential future rating action affecting AGM.
The Medium Term Notes Business
In connection with the acquisition of AGMH, Dexia Crédit Local S.A. agreed to fund, on behalf of AGM and Assured Guaranty (Bermuda) Ltd. ("AGBM"), 100% of all policy claims made under financial guaranty insurance policies issued by AGM and AGBM in relation to the medium term notes issuance program of FSA Global Funding Limited. Such agreement is set out in a Separation Agreement, dated as of July 1, 2009, between Dexia Crédit Local S.A., AGM, AGBM, FSA Global Funding and Premier International Funding Co., and in a funding guaranty and a reimbursement guaranty that Dexia Crédit Local S.A. issued for the benefit of AGM and AGBM. Under the funding guaranty, Dexia Crédit Local S.A. guarantees to pay to or on behalf of AGM or AGBM amounts equal to the payments required to be made under policies issued by AGM or AGBM relating to the medium term notes business. Under the reimbursement guaranty, Dexia Crédit Local S.A. guarantees to pay reimbursement amounts to AGM or AGBM for payments they make following a claim for payment under an obligation insured by a policy they have issued. Notwithstanding Dexia Crédit Local S.A.’s obligation to fund 100% of all policy claims under those policies, AGM and AGBM have a separate obligation to remit to Dexia Crédit Local S.A. a certain percentage (ranging from 0% to 25%) of those policy claims. AGM, the Company and related parties are also protected against losses arising out of or as a result of the medium term note business through an indemnification agreement with Dexia Crédit Local S.A. As of March 31, 2014, FSA Global Funding Limited had approximately $1.5 billion of notes outstanding.
Leveraged Lease Business

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Under the Strip Coverage Facility entered into in connection with the acquisition of AGMH, Dexia Credit Local (NY) agreed to make loans to AGM to finance all draws made by lessors on certain AGM strip policies issued in connection with the leveraged lease business. AGM may request advances under the Strip Coverage Facility without any explicit limit on the number of loan requests, provided that the aggregate principal amount of loans outstanding as of any date may not initially exceed the commitment amount. The leveraged lease business, the AGM strip policies and the Strip Coverage Facility are described further under “Commitments and Contingencies—Recourse Credit Facility" above.

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for an updated sensitivity analysis for credit derivatives and expected losses on contracts accounted for as insurance. There were no material changes in market risk since December 31, 2013.


ITEM 4.
CONTROLS AND PROCEDURES

Assured Guaranty’s management, with the participation of AGL’s President and Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) that are effective in recording, processing, summarizing and reporting, within the time periods specified in the Commission’s rules and forms, information required to be disclosed by AGL in the reports that it files or submits under the Exchange Act and ensuring that such information is accumulated and communicated to management, including the President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
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, 2014. Based on their evaluation as of March 31, 2014 covered by this Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective.
There have been no changes in the Company’s internal controls over financial reporting during the Company’s quarter ended March 31, 2014, that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II.
OTHER INFORMATION

ITEM 1.
LEGAL PROCEEDINGS
The Company is subject to legal proceedings and claims, as described in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. There have been no material developments to such proceedings during the three months ended March 31, 2014.
ITEM 1A.
RISK FACTORS

Please refer to “Risk Factors" under Part I, “Item 1A. Risk Factors” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. 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, 2014.
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 2014.

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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
—

$
—

—

$
400,000,000

February 1 - February 28
—

$
—

—

$
400,000,000

March 1 - March 31
1,350,443

$
25.92

1,350,443

$
365,000,021

Total
1,350,443

$
25.92

1,350,443


____________________
(1)
On November 11, 2013, the Company's share repurchase authorization of $400 million replaced the prior authorization.

(2)
Excludes commissions.

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


143

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 9, 2014
By:
/s/ ROBERT A. BAILENSON
Robert A. Bailenson
Chief Financial Officer (Principal Financial and
Accounting Officer and Duly Authorized Officer)


144

EXHIBIT INDEX
Exhibit
Number
Description of Document
10.1

Director Compensation Summary*
10.2

Assured Guaranty Ltd. 2004 Long-Term Incentive Plan, as amended and restated as of May 7, 2009 and as amended through the Third Amendment*
31.1

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

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

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

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

The following financial information from Assured Guaranty Ltd.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014 formatted in XBRL: (i) Consolidated Balance Sheets at March 31, 2014 and December 31, 2013; (ii) Consolidated Statements of Operations for the Three Months ended March 31, 2014 and 2013; (iii) Consolidated Statements of Comprehensive Income for the Three Months ended March 31, 2014 and 2013 (iv) Consolidated Statement of Shareholders’ Equity for the Three Months ended March 31, 2014; (v) Consolidated Statements of Cash Flows for the Three Months ended March 31, 2014 and 2013; and (vi) Notes to Consolidated Financial Statements.

* Management contract or compensatory plan


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