Guaranty

Assured Guaranty Corp.

Exhibit 99.1
















Assured Guaranty Corp.

Consolidated Financial Statements

(Unaudited)

June 30, 2017































Assured Guaranty Corp.

Index to Consolidated Financial Statements

June 30, 2017





Assured Guaranty Corp.

Consolidated Balance Sheets (unaudited)

(dollars in millions except per share and share amounts)

 
As of
June 30, 2017
 
As of
December 31, 2016
Assets
 
 
 
Investment portfolio:
 
 
 
Fixed-maturity securities, available-for-sale, at fair value (amortized cost of $2,562 and $2,653)
$
2,796

 
$
2,797

Short-term investments, at fair value
76

 
99

Other invested assets
4

 
91

Equity method investments in affiliates
311

 
306

Total investment portfolio
3,187

 
3,293

Cash
143

 
68

Premiums receivable, net of commissions payable
187

 
213

Ceded unearned premium reserve
272

 
310

Deferred acquisition costs
4

 

Reinsurance recoverable on unpaid losses
198

 
291

Salvage and subrogation recoverable
166

 
125

Credit derivative assets
44

 
58

Deferred tax asset, net
388

 
422

Financial guaranty variable interest entities’ assets, at fair value
132

 
232

Other assets
139

 
215

Total assets   
$
4,860

 
$
5,227

Liabilities and shareholder’s equity
 
 
 
Unearned premium reserve
$
1,057

 
$
1,202

Loss and loss adjustment expense reserve
457

 
479

Reinsurance balances payable, net
84

 
83

Note payable to affiliate
300

 
300

Credit derivative liabilities
278

 
306

Current income tax payable
35

 
11

Financial guaranty variable interest entities’ liabilities with recourse, at fair value
142

 
205

Financial guaranty variable interest entities’ liabilities without recourse, at fair value
2

 
41

Other liabilities
70

 
196

Total liabilities   
2,425

 
2,823

Commitments and contingencies (See Note 15)
 
 
 
Preferred stock ($1,000 liquidation preference, 200,004 shares authorized; none issued and outstanding)

 

Common stock ($720 par value, 500,000 shares authorized; 20,834 shares issued and outstanding)
15

 
15

Additional paid-in capital
1,041

 
1,041

Retained earnings
1,202

 
1,283

Accumulated other comprehensive income, net of tax of $67 and $38
177

 
65

Total shareholder’s equity   
2,435

 
2,404

Total liabilities and shareholder’s equity   
$
4,860

 
$
5,227


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

1


Assured Guaranty Corp.

Consolidated Statements of Operations (unaudited)

(in millions)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Revenues
 
 
 
 
 
 
 
Net earned premiums
$
58

 
$
55

 
$
123

 
$
102

Net investment income
27

 
19

 
75

 
38

Net realized investment gains (losses):
 
 
 
 
 
 
 
Other-than-temporary impairment losses
(1
)
 
(4
)
 
(1
)
 
(8
)
Less: portion of other-than-temporary impairment loss recognized in other comprehensive income
2

 
(4
)
 
2

 
(4
)
Net impairment loss
(3
)
 
0

 
(3
)
 
(4
)
Other net realized investment gains (losses)
5

 
11

 
45

 
11

Net realized investment gains (losses)
2

 
11

 
42

 
7

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

 
10

 
3

 
14

Net unrealized gains (losses)
(9
)
 
24

 
17

 
(33
)
Net change in fair value of credit derivatives
(7
)
 
34

 
20

 
(19
)
Fair value gains (losses) on committed capital securities
1

 
(6
)
 
0

 
(15
)
Fair value gains (losses) on financial guaranty variable interest entities
1

 
3

 
3

 
8

Bargain purchase gain and settlement of pre-existing relationships, net

 

 
58

 

Other income (loss)
1

 
1

 
10

 
21

Total revenues   
83

 
117

 
331

 
142

Expenses   
 
 
 
 
 
 
 
Loss and loss adjustment expenses
23

 
39

 
101

 
68

Amortization of deferred ceding commissions
(1
)
 
(1
)
 
(2
)
 
(1
)
Interest expense
2

 
2

 
5

 
5

Other operating expenses
18

 
21

 
43

 
39

Total expenses   
42

 
61

 
147

 
111

Income (loss) before income taxes and equity in net earnings of investee
41

 
56

 
184

 
31

Provision (benefit) for income taxes
 
 
 
 
 
 
 
Current
(6
)
 
19

 
4

 
22

Deferred
(8
)
 
(3
)
 
9

 
(17
)
Total provision (benefit) for income taxes
(14
)
 
16

 
13

 
5

Equity in net earnings of investee
6

 
14

 
14

 
23

Net income (loss)
$
61

 
$
54

 
$
185

 
$
49


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


2


Assured Guaranty Corp.

Consolidated Statements of Comprehensive Income (unaudited)

(in millions)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)    
$
61

 
$
54

 
$
185

 
$
49

Unrealized holding gains (losses) arising during the period on:
 
 
 
 
 
 
 
Investments with no other-than-temporary impairment, net of tax provision (benefit) of $17, $11, $30 and $21
32

 
22

 
57

 
43

Investments with other-than-temporary impairment, net of tax provision (benefit) of $5, $3, $23 and $1
9

 
5

 
42

 
1

Unrealized holding gains (losses) arising during the period, net of tax
41

 
27

 
99

 
44

Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $1, $3, $24 and $2
1

 
8

 
44

 
5

Change in net unrealized gains (losses) on investments
40

 
19

 
55

 
39

 
 
 
 
 
 
 
 
Change in cumulative translation adjustment arising during the period, net of tax provision (benefit) of $(3), $(4), $(2) and $(5)
9

 
(7
)
 
11

 
(10
)
Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $(5)
(9
)
 

 
(9
)
 

Change in cumulative translation adjustment, net of tax
18

 
(7
)
 
20

 
(10
)
Other comprehensive income (loss)
58

 
12

 
75

 
29

 
 
 
 
 
 
 
 
Comprehensive income (loss)
$
119

 
$
66

 
$
260

 
$
78



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



















3


Assured Guaranty Corp.

Consolidated Statement of Shareholder’s Equity (unaudited)

For the Six Months Ended June 30, 2017

(in millions)



 
Common
Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated Other Comprehensive Income
 
Total
Shareholder’s
Equity
Balance at December 31, 2016
$
15

 
$
1,041

 
$
1,283

 
$
65

 
$
2,404

Net income

 

 
185

 

 
185

Other comprehensive income (see Note 17)

 

 

 
75

 
75

Net impact of sale of the European subsidiaries to affiliate (see Note 1)

 

 
(203
)
 
37

 
(166
)
Dividends - cash

 

 
(51
)
 

 
(51
)
Dividends - transfer of benefit/health/retirement plans to AG US Services

 

 
(12
)
 

 
(12
)
Balance at June 30, 2017
$
15

 
$
1,041

 
$
1,202

 
$
177

 
$
2,435



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


4


Assured Guaranty Corp.

Consolidated Statements of Cash Flows (unaudited)

(in millions)

 
Six Months Ended June 30,
 
2017
 
2016
Net cash flows provided by (used in) operating activities    
$
12

 
$
66

Investing activities
 
 
 
Fixed-maturity securities:
 
 
 
Purchases
(665
)
 
(111
)
Sales
402

 
471

Maturities
102

 
105

Net sales (purchases) of short-term investments
(39
)
 
16

Net proceeds from paydowns on financial guaranty variable interest entities’ assets
19

 
495

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

 

Sale of the European Subsidiaries to affiliates, net of cash sold
127

 

Other
87

 
5

Net cash flows provided by (used in) investing activities    
128

 
981

Financing activities
 
 
 
Dividends paid
(51
)
 
(23
)
Net paydowns of financial guaranty variable interest entities’ liabilities
(19
)
 
(461
)
Net cash flows provided by (used in) financing activities    
(70
)
 
(484
)
Effect of foreign exchange rate changes
4

 
(1
)
Increase (decrease) in cash and restricted cash
74

 
562

Cash and restricted cash at beginning of period (see Note 10)
70

 
22

Cash and restricted cash at end of period (see Note 10)
$
144

 
$
584

Supplemental cash flow information
 
 
 
Cash paid (received) during the period for:
 
 
 
Income taxes
$
0

 
$

Interest
$

 
$


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

5


Assured Guaranty Corp.

Notes to Consolidated Financial Statements (unaudited)

June 30, 2017

1.
Business and Basis of Presentation

Business

Assured Guaranty Corp. (AGC and, together with its subsidiaries, the Company), a Maryland domiciled insurance company, is an indirect and wholly-owned operating subsidiary of Assured Guaranty Ltd. (AGL and, together with its subsidiaries, Assured Guaranty). AGL is a Bermuda-based holding company that provides, through its operating subsidiaries, credit protection products to the United States (U.S.) and international public finance (including infrastructure) and structured finance markets.     

The Company applies its credit underwriting judgment, risk management skills and capital markets experience primarily to offer financial guaranty (FG) insurance that protects holders of debt instruments and other monetary obligations from defaults in scheduled payments. If an obligor defaults on a scheduled payment due on an obligation, including a scheduled principal or interest payment (debt service), the Company is required under its unconditional and irrevocable financial guaranty to pay the amount of the shortfall to the holder of the obligation. The Company markets its financial guaranty insurance directly to issuers and underwriters of public finance and structured finance securities as well as to investors in such obligations. The Company guarantees obligations issued principally in the U.S. and the United Kingdom (U.K.), and also guarantees obligations issued in other countries and regions, including Australia and Western Europe.

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

Management, Service Contracts or Cost Sharing Arrangements

Until December 31, 2016, the Company and various of its affiliates were parties to the Amended and Restated Service Agreement, effective as April 1, 2015 (the Group Service Agreement). Under the Group Service Agreement, the Company was the payroll company for, and employer of, the U.S. employees of the Assured Guaranty group.  In the first quarter of 2017, the Company’s parent, Assured Guaranty US Holdings Inc. (AGUS), formed and capitalized AG US Group Services Inc. (AG Services), a Delaware corporation, to act as the payroll company and employer for all U.S. personnel and the central, dedicated service provider within the Assured Guaranty group in place of the Company.  This structure is consistent with the way in which numerous other insurance holding companies provide inter-company staff and services.  Accordingly, effective January 1, 2017, (i) the Company transferred the employees and the employee benefit, retirement and health plans relating to such employees to AG Services; and (ii) the Group Service Agreement was amended and restated to replace AGC with AG Services as the payroll company and service provider under the agreement.  Such amended and restated agreement is substantially identical to the Group Service Agreement except for a few changes primarily related to operational matters, including pre-funding by affiliates who are the largest consumers of group services and inter-company allocation of expenses.

Until December 31, 2016, the Company also provided services to two of its Bermuda affiliates, AGL and Assured Guaranty Re Ltd. (AG Re), pursuant to two separate service agreements, each effective as of January 1, 2006 (each as amended by Amendment No. 1 thereto, effective June 1, 2013) (the Bermuda Service Agreements). In connection with the transfer of the Company’s employees (and the related employee benefit, retirement and health plans) to AG Services, as described above, the Bermuda Service Agreements were terminated effective as of 11:59 p.m. on December 31, 2016.

The transfer from AGC to AG Services of $12 million in net assets related to benefit, retirement and health plans was recorded as a deemed dividend in the 2017 financial statements.


6


Basis of Presentation

The unaudited interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) and, in the opinion of management, reflect all adjustments that are of a normal recurring nature, necessary for a fair statement of the financial condition, results of operations and cash flows of the Company and its consolidated variable interest entities (VIEs) for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. These unaudited interim consolidated financial statements are as of June 30, 2017 and cover the three-month period ended June 30, 2017 (Second Quarter 2017), the three-month period ended June 30, 2016 (Second Quarter 2016), the six-month period ended June 30, 2017 (Six Months 2017) and the six-month period ended June 30, 2016 (Six Months 2016). Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but is not required for interim reporting purposes, has been condensed or omitted. The year-end balance sheet data was derived from audited financial statements.

The unaudited interim consolidated financial statements include the accounts of AGC and its subsidiaries and its consolidated VIEs. Intercompany accounts and transactions between and among all consolidated entities have been eliminated. Certain prior year balances have been reclassified to conform to the current year's presentation.

These unaudited interim consolidated financial statements should be read in conjunction with the annual consolidated financial statements of AGC included in Exhibit 99.1 in AGL's Form 8-K dated March 29, 2017, filed with the U.S. Securities and Exchange Commission (the SEC).

As of June 30, 2017, AGC owns 39.3% of the outstanding shares of Municipal Assurance Holdings Inc. (MAC Holdings), a Delaware company formed to hold all of the outstanding shares of Municipal Assurance Corp. (MAC), a New York domiciled insurance company.

As an initial step in Assured Guaranty's efforts to combine the operations of its four affiliated European insurance companies, on June 26, 2017, AGC sold to its affiliate Assured Guaranty Municipal Corp. (AGM) all of the shares of its direct, wholly owned subsidiaries, Assured Guaranty (UK) plc (AGUK), CIFG Europe S.A. (CIFGE) and Assured Guaranty (London) plc (AGLN) (the acquisition of which is described in Note 2, Acquisitions) (collectively, the European Subsidiaries). The sale of the European Subsidiaries was approved by the New York State Department of Financial Services, the Maryland Insurance Administration (MIA) and the U.K. Prudential Regulation Authority (PRA). While Assured Guaranty, its European Subsidiaries and Assured Guaranty (Europe) plc (AGE), a subsidiary of AGM, have received certain regulatory approvals for the proposed combination of the European Subsidiaries and AGE, the combination is subject to further regulatory and court approvals. As a result, the Company cannot predict whether, or when, such combination will be completed.

The total consideration of $411 million paid by AGM to purchase AGC's European Subsidiaries consisted of: (i) $344 million gross principal amount of the Series A-1 Floating Rate Guaranteed Notes due December 21, 2035 issued by Orkney Re II plc (the Orkney Bonds) and (ii) $139 million of cash.  The carrying value of the European Subsidiaries, as of June 26, 2017, was approximately $651 million. In addition, AGC's approximately $55 million deferred tax liability on unremitted earnings of its European Subsidiaries was transferred to AGM.

AGUK guarantees the Orkney Bonds through a financial guarantee; it cedes 90% of the exposure to AGC and retains the remaining 10%. The $344 million principal amount of Orkney Bonds had a fair value (inclusive of the Company's financial guarantee) of $272 million and constituted 90% of the total amount of Orkney Bonds owned by AGM. In accordance with the Company's accounting policy, the Orkney Bonds are recorded excluding the value of the Company's financial guarantee, and are carried in the financial statements on the same basis as the common parent, AGUS, with approximately $44 million established in Accumulated other comprehensive income.

In accordance with GAAP guidance on common control transactions, the net loss on the sale of the European Subsidiaries of approximately $166 million is recorded as a direct reduction to shareholder's equity. This reduction consists of a $203 million dividend, and a $37 million reduction to accumulated other comprehensive income (comprising $17 million of cumulative translation adjustment and $20 million of net unrealized gains).
    

7


Impact of Sale of the European Subsidiaries

 
(in millions)
Consideration paid
$
411

 
 
Carrying value of European Subsidiaries
651

Deferred tax liabilities transferred
(55
)
Net carrying value transferred
596

 
 
Impact before other related adjustments
(185
)
Elimination of the financial guarantee on Orkney Bonds
20

Other
(1
)
Net shareholder's equity impact
$
(166
)


Adopted Accounting Standards

Statement of Cash Flows

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

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

Share-Based Payments

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

Future Application of Accounting Standards

Premium Amortization on Purchased Callable Debt Securities

In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Topic 310-20) - Premium Amortization on Purchased Callable Debt Securities.  This ASU shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date. This ASU has no effect on the accounting for purchased callable debt securities held at a discount.  ASU 2017-08 is to be applied using a modified retrospective approach through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption.  The ASU is effective

8


for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  Early adoption is permitted.  The Company does not expect this ASU to have a material effect on its consolidated financial statements.

Income Taxes

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

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

Financial Instruments
    
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities.  The amendments in this ASU are intended to make targeted improvements to GAAP by addressing certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Under the ASU, certain equity securities will need to be accounted for at fair value with changes in fair value recognized through net income instead of other comprehensive income (OCI).  Another amendment pertains to liabilities that an entity has elected to measure at fair value in accordance with the fair value option for financial instruments. For these liabilities, the portion of fair value change related to instrument specific credit risk will be separately presented in OCI as opposed to the income statement. The Company elected the fair value option to account for its consolidated FG VIEs. The Company is evaluating the effect that the ASU will have on its consolidated financial statements. 
           
The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Entities will be required to record a cumulative-effect adjustment to the statement of financial position as of the beginning of the fiscal year in which the guidance is adopted.  Early adoption is permitted only for the amendment related to the change in presentation of financial liabilities that are fair valued using the fair value option. The Company does not expect that the amendment related to certain equity securities will have a material effect on its consolidated financial statements. 

Credit Losses on Financial Instruments

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

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

9


when assessing whether a credit loss exists. For purchased financial assets with credit deterioration, the ASU requires an entity’s method for measuring credit losses to be consistent with its method for measuring expected losses for originated and purchased non-credit-deteriorated assets.

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

2.
    Acquisitions

MBIA UK Insurance Limited

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

MBIA UK was renamed Assured Guaranty (London) Ltd. and on June 1, 2017, was re-registered as a public limited company (plc). Further, AGLN was sold by AGC to AGM on June 26, 2017. Please refer to Note 1, Business and Basis of Presentation for additional information on the Company's European subsidiaries combination.

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

The fair value of the Company's stand-ready obligation on the MBIA UK Acquisition Date is recorded in unearned premium reserve. After the MBIA UK Acquisition Date, loss reserves and loss and loss adjustment expenses (LAE) will be recorded when the expected losses for each contract exceeds the remaining unearned premium reserve, in accordance with the Company's accounting policy described in the annual consolidated financial statements of AGC included in Exhibit 99.1 in AGL's Form 8-K dated March 29, 2017, filed with the SEC. The expected losses acquired by the Company as part of the MBIA UK Acquisition are included in Note 5, Expected Losses to be Paid.

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

10


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

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

 
$

 
$
334

 
 
 
 
 
 
Identifiable assets acquired:
 
 
 
 
 
Investments
459

 

 
459

Cash
72

 

 
72

Premiums receivable, net of commissions payable
274

 
(3
)
 
271

Other assets
17

 
(6
)
 
11

Total assets
822

 
(9
)
 
813

 
 

 
 
 


Liabilities assumed:
 
 

 

Unearned premium reserves
390

 
(6
)
 
384

Current tax payable
25

 

 
25

Other liabilities
4

 
(4
)
 

Total liabilities
419

 
(10
)
 
409

Net assets of MBIA UK
403

 
1

 
404

Cash acquired from MBIA Holdings
23

 

 
23

Deferred tax liability
(36
)
 

 
(36
)
Net asset effect of MBIA UK Acquisition
390

 
1

 
391

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

 
1

 
57

Deferred tax

 
1

 
1

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

 
$
2

 
$
58

_____________________
(1)
The purchase price of $334 million was allocated as follows: (1) $329 million for the purchase of net assets of $385 million, and (2) the settlement of pre-existing relationships between MBIA UK and Assured Guaranty at a fair value of $5 million.
    
Revenue and net income related to MBIA UK from the MBIA UK Acquisition Date through June 26, 2017 (the date of the sale of MBIA UK to AGM) included in the consolidated statement of operations were approximately $149 million and $112 million, respectively, including the bargain purchase gain, settlement of pre-existing relationships, quarterly activity and realized gain on the disposition of AGC's Zohar II Notes. For Second Quarter 2017 and Six Months 2017, the Company recognized transaction expenses related to the MBIA UK Acquisition of $1 million and $7 million, respectively, comprising primarily legal and financial advisors fees.

Unaudited Pro Forma Results of Operations

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

The unaudited pro forma combined financial information is presented for illustrative purposes only and does not indicate the financial results of the combined company had the companies actually been combined as of January 1, 2016, nor is it indicative of the results of operations in future periods. The Company did not include any pro forma combined financial

11


information for 2017 as substantially all of MBIA UK's results of operations for 2017 are included in Six Months 2017 consolidated statements of operations.

Unaudited Pro Forma Results of Operations

 
Six Months 2016
 
(in millions)
Pro forma revenues
$
275

Pro forma net income
152


As indicated in Note 1, Business and Basis of Presentation, AGC sold MBIA UK (renamed AGLN plc) to AGM on June 26, 2017.

Please refer to Note 2, Acquisitions, in the annual consolidated financial statements of AGC included in Exhibit 99.1 in AGL's Form 8-K dated March 29, 2017, filed with the SEC for additional information on other recent acquisitions.

3.
Ratings

     The financial strength ratings (or similar ratings) for the Company, along with the date of the most recent rating action (or confirmation) by the rating agency, are shown in the table below. Ratings are subject to continuous rating agency review and revision or withdrawal at any time.  In addition, the Company periodically assesses the value of each rating assigned to it, and as a result of such assessment may request that a rating agency add or drop a rating.

 
S&P Global Ratings, a division of Standard & Poor’s Financial Services LLC
 
Kroll Bond Rating Agency
 
Moody’s Investors Service, Inc.
AGC
AA(stable) (6/26/17)
 
AA (stable) (9/20/16)
 
(1)
MAC
AA(stable) (6/26/17)
 
AA+(stable) (7/14/17)
 
____________________
(1)
AGC requested that Moody’s Investors Service, Inc. (Moody's) withdraw its financial strength ratings of AGC in January 2017, but Moody's denied that request. Moody’s continues to rate AGC A3 (stable).

There can be no assurance that any of the rating agencies will not take negative action on the financial strength ratings of AGC in the future.

For a discussion of the effects of rating actions on the Company, please refer to Note 6, Contracts Accounted for as Insurance, and Note 14, Reinsurance and Other Monoline Exposures.

4.
Outstanding Exposure

The Company’s financial guaranty contracts are written in either insurance or credit derivative form, but collectively are considered financial guaranty contracts. The Company seeks to limit its exposure to losses by underwriting obligations that it views as investment grade at inception, although, as part of its loss mitigation strategy for existing troubled credits, it may underwrite new issuances that it views as BIG. The Company diversifies its insured portfolio across asset classes and, in the structured finance portfolio, requires rigorous subordination or collateralization requirements. Reinsurance may be used in order to reduce net exposure to certain insured transactions.

     Public finance obligations insured by the Company consist primarily of general obligation bonds supported by the taxing powers of U.S. state or municipal governmental authorities, as well as tax-supported bonds, revenue bonds and other obligations supported by covenants from state or municipal governmental authorities or other municipal obligors to impose and collect fees and charges for public services or specific infrastructure projects. The Company also includes within public finance obligations those obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including utilities, toll roads, health care facilities and government office buildings. The Company also includes within public finance similar obligations issued by territorial and non-U.S. sovereign and sub-sovereign issuers and governmental authorities.


12


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

Surveillance Categories

The Company segregates its insured portfolio into investment grade and BIG surveillance categories to facilitate the appropriate allocation of resources to monitoring and loss mitigation efforts and to aid in establishing the appropriate cycle for periodic review for each exposure. BIG exposures include all exposures with internal credit ratings below BBB-. The Company’s internal credit ratings are based on internal assessments of the likelihood of default and loss severity in the event of default. Internal credit ratings are expressed on a ratings scale similar to that used by the rating agencies and are generally reflective of an approach similar to that employed by the rating agencies, except that the Company's internal credit ratings focus on future performance rather than lifetime performance.

The Company monitors its investment grade credits to determine whether any need to be internally downgraded to BIG and refreshes its internal credit ratings on individual credits in quarterly, semi-annual or annual cycles based on the Company’s view of the credit’s quality, loss potential, volatility and sector. Ratings on credits in sectors identified as under the most stress or with the most potential volatility are reviewed every quarter. The Company’s credit ratings on assumed credits are based on the Company’s reviews of low-rated credits or credits in volatile sectors, unless such information is not available, in which case, the ceding company’s credit ratings of the transactions are used.

Credits identified as BIG are subjected to further review to determine the probability of a loss. Please refer to 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 discount rate of 4%. (A risk-free rate is used for calculating the expected loss for financial statement measurement purposes.)

More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly. The Company expects “future losses” on a transaction when the Company believes there is at least a 50% chance that, on a present value basis, it will pay more claims in the future of that transaction than it will have reimbursed. The three BIG categories are:
 
BIG Category 1: Below-investment-grade transactions showing sufficient deterioration to make future losses possible, but for which none are currently expected.
 
BIG Category 2: Below-investment-grade transactions for which future losses are expected but for which no claims (other than liquidity claims which are claims that the Company expects to be reimbursed within one year) have yet been paid.
 
BIG Category 3: Below-investment-grade transactions for which future losses are expected and on which claims (other than liquidity claims) have been paid.

Components of Outstanding Exposure

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

The Company purchases securities that it has insured, and for which it has expected losses to be paid, in order to
mitigate the economic effect of insured losses (loss mitigation securities). The Company excludes amounts attributable to loss mitigation securities (unless otherwise indicated) from par and debt service outstanding, which amounts are included in the investment portfolio, because it manages such securities as investments and not insurance exposure. As of June 30, 2017 and December 31, 2016, the Company excluded $751 million and $711 million, respectively, of net par related to loss mitigation securities (which are mostly BIG), and other loss mitigation strategies. The following table presents the gross and net debt service for financial guaranty contracts.



13


Financial Guaranty
Debt Service Outstanding

 
Gross Debt Service
Outstanding
 
Net Debt Service
Outstanding
 
June 30,
2017
 
December 31,
2016
 
June 30,
2017
 
December 31,
2016
 
(in millions)
Public finance
$
80,267

 
$
89,942

 
$
40,156

 
$
44,804

Structured finance
9,240

 
13,041

 
6,617

 
9,725

Total financial guaranty
$
89,507

 
$
102,983

 
$
46,773

 
$
54,529


In addition to amounts shown in the tables above, AGC had outstanding commitments to provide guaranties of $14 million for structured finance and $4 million for public finance obligations as of June 30, 2017. All of the public finance commitments expired prior to the date of this filing.

Financial Guaranty Portfolio by Internal Rating (1)
As of June 30, 2017

 
 
Public Finance
U.S.
 
Public Finance
Non-U.S.
 
Structured Finance
U.S.
 
Structured Finance
Non-U.S.
 

Total
Rating
Category
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 

Net Par
Outstanding
 


%
 
 
(dollars in millions)
AAA
 
$
53

 
0.2
%
 
$
738

 
21.1
%
 
$
1,243

 
23.7
%
 
$
170

 
18.9
%
 
$
2,204

 
6.9
%
AA
 
3,080

 
13.8

 
40

 
1.1

 
1,538

 
29.4

 
49

 
5.5

 
4,707

 
14.7
A
 
10,875

 
48.6

 
576

 
16.5

 
1,292

 
24.7

 
205

 
22.8

 
12,948

 
40.4
BBB
 
5,946

 
26.5

 
1,783

 
51.0

 
221

 
4.2

 
432

 
48.0

 
8,382

 
26.2
BIG
 
2,448

 
10.9

 
360

 
10.3

 
945

 
18.0

 
43

 
4.8

 
3,796

 
11.8
Total net par outstanding
 
$
22,402

 
100.0
%
 
$
3,497

 
100.0
%
 
$
5,239

 
100.0
%
 
$
899

 
100.0
%
 
$
32,037

 
100.0
%


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

 
 
Public Finance
U.S.
 
Public Finance
Non-U.S.
 
Structured Finance
U.S.
 
Structured Finance
Non-U.S.
 

Total
Rating Category
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 
Net Par
Outstanding
 
%
 

Net Par
Outstanding
 


%
 
 
(dollars in millions)
AAA
 
$
71

 
0.3
%
 
$
784

 
20.8
%
 
$
3,535

 
43.6
%
 
$
228

 
21.4
%
 
$
4,618

 
12.3
%
AA
 
3,384

 
13.7

 
252

 
6.7

 
1,807

 
22.2

 
77

 
7.3

 
5,520

 
14.7
A
 
11,823

 
48.1

 
566

 
15.1

 
1,148

 
14.1

 
225

 
21.2

 
13,762

 
36.7
BBB
 
6,440

 
26.2

 
1,807

 
48.1

 
336

 
4.1

 
455

 
42.9

 
9,038

 
24.1
BIG
 
2,873

 
11.7

 
349

 
9.3

 
1,297

 
16.0

 
76

 
7.2

 
4,595

 
12.2
Total net par outstanding
 
$
24,591

 
100.0
%
 
$
3,758

 
100.0
%
 
$
8,123

 
100.0
%
 
$
1,061

 
100.0
%
 
$
37,533

 
100.0
%




14


Components of BIG Portfolio

Components of BIG Net Par Outstanding
(Insurance and Credit Derivative Form)
As of June 30, 2017

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
Public finance:
 
 
 
 
 
 


 
 
U.S. public finance
$
714

 
$
302

 
$
1,432

 
$
2,448

 
$
22,402

Non-U.S. public finance
304

 
56

 

 
360

 
3,497

Public finance
1,018

 
358

 
1,432

 
2,808

 
25,899

Structured finance:
 
 
 
 
 
 


 
 
U.S. Residential mortgage-backed
securities (RMBS)
153

 
128

 
379

 
660

 
1,589

Triple-X life insurance transactions

 

 
30

 
30

 
438

Trust preferred securities (TruPS)
188

 

 

 
188

 
1,305

Other structured finance
31

 
76

 
3

 
110

 
2,806

Structured finance
372

 
204

 
412

 
988

 
6,138

Total
$
1,390

 
$
562

 
$
1,844

 
$
3,796

 
$
32,037



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

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG
 
Outstanding
 
 
 
 
 
(in millions)
 
 
 
 
Public finance:
 
 
 
 
 
 


 
 
U.S. public finance
$
873

 
$
1,364

 
$
636

 
$
2,873

 
$
24,591

Non-U.S. public finance
295

 
54

 

 
349

 
3,758

Public finance
1,168

 
1,418

 
636

 
3,222

 
28,349

Structured finance:
 
 
 
 
 
 


 
 
U.S. RMBS
128

 
174

 
425

 
727

 
1,774

Triple-X life insurance transactions

 

 
149

 
149

 
556

TruPS
243

 
95

 

 
338

 
1,607

Other structured finance
40

 
116

 
3

 
159

 
5,247

Structured finance
411

 
385

 
577

 
1,373

 
9,184

Total
$
1,579

 
$
1,803

 
$
1,213

 
$
4,595

 
$
37,533



15


BIG Net Par Outstanding
and Number of Risks
As of June 30, 2017

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

 
 

 
 

 
 

Category 1
 
$
966

 
$
424

 
$
1,390

 
122

 
11

 
133

Category 2
 
510

 
52

 
562

 
46

 
3

 
49

Category 3
 
1,738

 
106

 
1,844

 
114

 
8

 
122

Total BIG
 
$
3,214

 
$
582

 
$
3,796

 
282

 
22

 
304



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

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

 
 

 
 

 
 

 
 

 
 

Category 1
 
$
1,123

 
$
456

 
$
1,579

 
133

 
10

 
143

Category 2
 
1,644

 
159

 
1,803

 
65

 
6

 
71

Category 3
 
1,100

 
113

 
1,213

 
107

 
9

 
116

Total BIG
 
$
3,867

 
$
728

 
$
4,595

 
305

 
25

 
330

 ____________________
(1)
Includes net par outstanding for VIEs.

(2)
A risk represents the aggregate of the financial guaranty policies that share the same revenue source for purposes of making debt service payments.

Exposure to Puerto Rico
         
The Company has insured exposure to general obligation bonds of the Commonwealth of Puerto Rico (Puerto Rico or the Commonwealth) and various obligations of its related authorities and public corporations aggregating $1.7 billion net par as of June 30, 2017, all of which are rated BIG. In recent years, Puerto Rico has experienced significant general fund budget deficits and a challenging economic environment. Beginning on January 1, 2016, a number of Puerto Rico credits have defaulted on bond payments, and the Company has now paid claims on several Puerto Rico credits as shown in the table "Puerto Rico Net Par Outstanding" below.

On November 30, 2015 and December 8, 2015, Governor García Padilla of Puerto Rico (the Former Governor) issued executive orders (Clawback Orders) directing the Puerto Rico Department of Treasury and the Puerto Rico Tourism Company to "claw back" certain taxes pledged to secure the payment of bonds issued by the Puerto Rico Highways and Transportation Authority (PRHTA), Puerto Rico Infrastructure Financing Authority (PRIFA), and Puerto Rico Convention Center District Authority (PRCCDA). The Puerto Rico credits insured by the Company subject to clawback are shown in the table “Puerto Rico Net Par Outstanding” below.
  
On June 30, 2016, the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA) was signed into law by the President of the United States. PROMESA establishes a seven-member federal financial oversight board (Oversight Board) with authority to require that balanced budgets and fiscal plans be adopted and implemented by Puerto Rico.

16


PROMESA provides a legal framework under which the debt of the Commonwealth and its related authorities and public corporations may be voluntarily restructured, and grants the Oversight Board the sole authority to file restructuring petitions in a federal court to restructure the debt of the Commonwealth and its related authorities and public corporations if voluntary negotiations fail, provided that any such restructuring must be in accordance with an Oversight Board approved fiscal plan that respects the liens and priorities provided under Puerto Rico law.

On January 2, 2017, Ricardo Antonio Rosselló Nevares (the Governor) took office, replacing the Former Governor. On January 29, 2017, the Governor signed the Puerto Rico Emergency and Fiscal Responsibility Act (Emergency Act) that, among other things, defined an emergency period that has since been extended to December 31, 2017, continued diversion of collateral away from bonds the Company insures, and defined the powers and duties of the Fiscal Agency and Financial Advisory Authority (FAFAA).

In mid-March 2017, the Oversight Board certified Puerto Rico’s fiscal plan, dated March 13, 2017 (Fiscal Plan). The Fiscal Plan provides only approximately $7.9 billion for Commonwealth debt service over the next ten years, an amount less than scheduled debt service for such period. The Fiscal Plan itself acknowledges that there are a number of legal and contractual issues not addressed by the Fiscal Plan. On April 28, 2017, the Oversight Board approved fiscal plans for Puerto Rico Electric Power Authority (PREPA) and PRHTA, and directed Puerto Rico Aqueduct and Sewer Authority (PRASA) to amend its proposed plan in several ways. The Oversight Board approved the amended PRASA plan on June 30, 2017. The PRHTA plan assumes that PRHTA will not pay any debt service at least through 2026. The PRASA plan assumes it will pay only approximately 65% of its debt service through 2026. The Company does not believe the fiscal plans of PRHTA or PRASA in their current forms comply with certain mandatory requirements of PROMESA.

On May 3, 2017, the Oversight Board filed a petition with the Federal District Court of Puerto Rico for the Commonwealth under Title III of PROMESA. Title III of PROMESA provides for a process analogous to a voluntary bankruptcy process under chapter 9 of the United States Bankruptcy Code (Bankruptcy Code). On May 21, 2017, the Board filed a petition under Title III of PROMESA for PRHTA. On July 2, 2017, after the rejection by the Oversight Board and termination by PREPA of the Restructuring Support Agreement (RSA) described below, the Oversight Board commenced proceedings for PREPA under Title III of PROMESA.
The Company believes that a number of the actions taken by the Commonwealth, the Oversight Board and others with respect to obligations the Company insures are illegal or unconstitutional or both, and has taken legal action, and may take additional legal action in the future, to enforce its rights with respect to these matters. Please see “Puerto Rico Recovery Litigation” below.

Judge Laura Taylor Swain of the Southern District of New York was selected by Chief Justice John Roberts of the United States Supreme Court to preside over any proceedings under PROMESA. Judge Swain has selected a team of five federal judges to act as mediators for certain issues and disputes.

On September 20, 2017, Hurricane Maria made landfall in Puerto Rico as a Category 4 hurricane on the Saffir-Simpson scale, causing tragic loss of life and widespread devastation in the Commonwealth. Damage to the Commonwealth’s infrastructure, including the power grid, water system and transportation system, was extensive, with the entire island being without power in the aftermath of the storm. Officials are still struggling to assess the extent of the damage, but rebuilding and recovery is expected to take years. While the federal government is expected to provide very substantial resources for relief and rebuilding -- which should be helpful for economic activity and addressing the Commonwealth’s infrastructure needs in the intermediate and longer term -- economic activity in general and tourism in particular, as well as tax collections, are all expected to decline in the more immediate term. Out migration to the mainland is also expected to increase, at least initially.

Litigation and mediation related to the Commonwealth’s debt has been delayed by Hurricane Maria. The final shape, timing and validity of responses to Puerto Rico’s financial distress and the devastation of Hurricane Maria eventually taken by the federal government or implemented under the auspices of PROMESA and the Oversight Board or otherwise, and the final impact, after resolution of legal challenges, of any such responses on obligations insured by the Company, are uncertain.

The Company groups its Puerto Rico exposure into three categories:

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


17


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

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

Constitutionally Guaranteed

General Obligation. As of June 30, 2017, the Company had $378 million insured net par outstanding of the general obligations of Puerto Rico, which are supported by the good faith, credit and taxing power of the Commonwealth. On July 1, 2016, despite the requirements of Article VI of its Constitution, the Commonwealth defaulted on most of the debt service payment due that day, and the Company made its first claim payments on these bonds, and has continued to make claim payments on these bonds. As noted above, the Oversight Board filed a petition under Title III of PROMESA with respect to the Commonwealth.

Puerto Rico Public Buildings Authority (PBA). As of June 30, 2017, the Company had $169 million insured net par outstanding of PBA bonds, which are supported by a pledge of the rents due under leases of government facilities to departments, agencies, instrumentalities and municipalities of the Commonwealth, and that benefit from a Commonwealth guaranty supported by a pledge of the Commonwealth’s good faith, credit and taxing power. On July 1, 2016, despite the requirements of Article VI of its Constitution, the PBA defaulted on most of the debt service payment due that day, and the Company made its first claim payments on these bonds and has continued to make claim payments on these bonds.

Public Corporations - Certain Revenues Potentially Subject to Clawback

PRHTA. As of June 30, 2017, the Company had $519 million insured net par outstanding of PRHTA (transportation revenue) bonds and $93 million insured net par of PRHTA (highways revenue) bonds. The transportation revenue bonds are secured by a subordinate gross lien on gasoline and gas oil and diesel oil taxes, motor vehicle license fees and certain tolls, plus a first lien on up to $120 million annually of taxes on crude oil, unfinished oil and derivative products. The highways revenue bonds are secured by a gross lien on gasoline and gas oil and diesel oil taxes, motor vehicle license fees and certain tolls. The non-toll revenues consisting of excise taxes and fees collected by the Commonwealth on behalf of PRHTA and its bondholders that are statutorily allocated to PRHTA and its bondholders are potentially subject to clawback. Despite the presence of funds in relevant debt service accounts that the Company believes should have been employed to fund debt service, PRHTA defaulted on the full July 1, 2017 insured debt service payment, and the Company made its first claim payments on these bonds. As noted above, on April 28, 2017, the Oversight Board approved a fiscal plan for PRHTA that PRHTA will not pay any debt service at least through 2026. The Company does not believe the PRHTA fiscal plan in its current form complies with certain mandatory requirements of PROMESA.

PRCCDA. As of June 30, 2017, the Company had $152 million insured net par outstanding of PRCCDA bonds, which are secured by certain hotel tax revenues. These revenues are sensitive to the level of economic activity in the area and are potentially subject to clawback. There were sufficient funds in the PRCCDA bond accounts to make only partial payments on the July 1, 2017 PRCCDA bond payments guaranteed by the Company, and the Company made its first claim payments on these bonds.

PRIFA. As of June 30, 2017, the Company had $17 million insured net par outstanding of PRIFA bonds, which are secured primarily by the return to Puerto Rico of federal excise taxes paid on rum. These revenues are potentially subject to the clawback. The Company made its first claim payment on PRIFA bonds in January 2016, and has continued to make claim payments on PRIFA bonds.


18


Other Public Corporations

PREPA. As of June 30, 2017, the Company had $73 million insured net par outstanding of PREPA obligations, which are secured by a lien on the revenues of the electric system.

On December 24, 2015, AGM and AGC entered into an RSA with PREPA, an ad hoc group of uninsured bondholders and a group of fuel-line lenders that would, subject to certain conditions, result in, among other things, modernization of the utility and a restructuring of current debt. Upon finalization of the contemplated restructuring transaction, insured PREPA revenue bonds (with no reduction to par or stated interest rate) would be supported by securitization bonds issued by a special purpose corporation and secured by a transition charge assessed on ratepayers.

In March 2017, the Governor indicated a desire to modify certain aspects of the RSA. On April 6, 2017, the Governor announced that an agreement in principle had been reached to supplement the RSA. As supplemented, the RSA called for AGM and AGC to provide surety insurance policies aggregating approximately $113 million ($14 million for AGC and $99 million for AGM) to support the securitization bonds contemplated by the RSA, to extend the maturity of all of the relending financing provided in 2016, and to provide $120 million of principal payment deferrals in 2018 through 2023. In addition, the RSA as supplemented provided for a consensual restructuring under Title VI of PROMESA.

The Oversight Board did not certify the RSA under Title VI of PROMESA as the Company believes is required by PROMESA, but rather, on July 2, 2017, commenced proceedings for PREPA under Title III of PROMESA. PREPA defaulted on its July 1, 2017 debt service payments, and the Company made its first claim payments on these bonds to bondholders as a result of these defaults. The Company believes that a number of the actions taken by the Commonwealth, the Oversight Board and others with respect to the PREPA obligations it insures and the RSA are illegal or unconstitutional or both, and has taken legal action, and may take additional legal action in the future, to enforce its rights with respect to these matters. Please see “Puerto Rico Recovery Litigation” below.

PRASA. As of June 30, 2017, the Company had $285 million of insured net par outstanding to PRASA bonds, which are secured by a lien on the gross revenues of the water and sewer system. On September 15, 2015, PRASA entered into a settlement with the U.S. Department of Justice and the U.S. Environmental Protection Agency that requires it to spend $1.6 billion to upgrade and improve its sewer system island-wide. There were sufficient funds in the PRASA bond accounts to make the July 1, 2016, January 1, 2017 and July 1, 2017 PRASA bond payments guaranteed by the Company, and those payments were made in full. As noted above, on April 28, 2017, the Oversight Board considered a fiscal plan for PRASA that assumes PRASA will pay only approximately 65% of its debt service through 2026, and approved the amended plan on June 30, 2017. Because PRASA has several categories of debt outstanding and the Company insures only PRASA debt with a senior lien on gross revenues of PRASA, it is unclear whether (or to what extent, if any) the payment of only 65% of debt service through 2026 would result in a reduction in PRASA payments of Company-insured debt. The Company does not believe the PRASA fiscal plan in its current form complies with certain mandatory requirements of PROMESA.
    
Municipal Finance Agency (MFA). As of June 30, 2017, the Company had $61 million net par outstanding of bonds issued by MFA secured by a lien on local property tax revenues. There were sufficient funds in the MFA bond accounts to make the July 1, 2016, January 1, 2017 and July 1, 2017 MFA bond payments guaranteed by the Company, and those payments were made in full.

University of Puerto Rico (U of PR). As of June 30, 2017, the Company had $1 million insured net par outstanding of U of PR bonds, which are general obligations of the university and are secured by a subordinate lien on the proceeds, profits and other income of the University, subject to a senior pledge and lien for the benefit of outstanding university system revenue bonds. As of the date of this filing, all debt service payments on U of PR bonds insured by the Company have been made.

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

On January 7, 2016, AGM, AGC and Ambac Assurance Corporation (Ambac) commenced an action for declaratory judgment and injunctive relief in the U.S. District Court for the District of Puerto Rico (Federal District Court in Puerto Rico) to invalidate the executive orders issued by the Former Governor on November 30, 2015 and December 8, 2015 directing that the Secretary of the Treasury of the Commonwealth of Puerto Rico and the Puerto Rico Tourism Company claw back certain

19


taxes and revenues pledged to secure the payment of bonds issued by the PRHTA, the PRCCDA and the PRIFA. The Commonwealth defendants filed a motion to dismiss the action for lack of subject matter jurisdiction, which the Court denied on October 4, 2016. On October 14, 2016, the Commonwealth defendants filed a notice of PROMESA automatic stay. While the PROMESA automatic stay expired on May 1, 2017, on May 17, 2017, the Court stayed the action under Title III of PROMESA.

On May 3, 2017, AGM and AGC filed in the Federal District Court in Puerto Rico an adversary complaint seeking a judgment that the Commonwealth's Fiscal Plan violates various sections of PROMESA and the Contracts, Takings and Due Process Clauses of the U.S. Constitution, an injunction enjoining the Commonwealth and Oversight Board from presenting or proceeding with confirmation of any plan of adjustment based on the Fiscal Plan, and a stay on the confirmation of any plan of adjustment based on the Fiscal Plan pending development of a fiscal plan that complies with PROMESA and the U.S. Constitution. On October 6, 2017, AGC and AGM voluntarily withdrew without prejudice the complaint, based on their expectation that the Fiscal Plan would be modified as a result of Hurricane Maria.
    
On May 16, 2017, The Bank of New York Mellon, as trustee for the bonds issued by COFINA, filed an adversary complaint for interpleader and declaratory relief with the Federal District Court in Puerto Rico to resolve competing and conflicting demands made by various groups of COFINA bondholders, insurers of certain COFINA Bonds and COFINA, regarding funds held by the trustee for certain COFINA bond debt service payments scheduled to occur on and after June 1, 2017. On May 19, 2017, an order to show cause was entered permitting AGC and AGM to intervene in this matter. While AGM has insured COFINA Bonds, AGC has not.

On June 3, 2017, AGC and AGM filed an adversary complaint in Federal District Court in Puerto Rico seeking (i) a judgment declaring that the application of pledged special revenues to the payment of the PRHTA Bonds is not subject to the PROMESA Title III automatic stay and that the Commonwealth has violated the special revenue protections provided to the PRHTA Bonds under the Bankruptcy Code; (ii) an injunction enjoining the Commonwealth from taking or causing to be taken any action that would further violate the special revenue protections provided to the PRHTA Bonds under the Bankruptcy Code; and (iii) an injunction ordering the Commonwealth to remit the pledged special revenues securing the PRHTA Bonds in accordance with the terms of the special revenue provisions set forth in the Bankruptcy Code.

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

On July 18, 2017, AGM and AGC filed a motion for relief from the automatic stay in the PREPA Title III bankruptcy proceeding and a form of complaint seeking the appointment of a receiver for PREPA. That motion was denied on September 14, 2017. AGM and AGC filed a notice of appeal on September 28, 2017.

On August 7, 2017, AGC and AGM filed an adversary complaint in Federal District Court in Puerto Rico seeking, among other things, judgment against defendants (i) declaring that the application of pledged special revenues to the payment of the PREPA Bonds is not subject to the PROMESA Title III automatic stay and that the Commonwealth has violated the special revenue protections provided to the PREPA Bonds under the Bankruptcy Code; (ii) declaring that capital expenditures and all other expenses that do not constitute current, reasonable and necessary operating expenses may not be paid from pledged special revenues prior to the payment of debt service on the PREPA Bonds, and (iii) enjoining defendants from taking or causing to be taken any action that would further violate the special revenue protections provided to the PREPA Bonds under the Bankruptcy Code; and (iv) ordering defendants to remit the pledged special revenues securing the PREPA Bonds in accordance with the terms of the special revenue provisions set forth in the Bankruptcy Code.





20


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

Puerto Rico
Gross Par and Gross Debt Service Outstanding

 
Gross Par Outstanding
 
Gross Debt Service Outstanding
 
June 30,
2017
 
December 31,
2016
 
June 30,
2017
 
December 31,
2016
 
(in millions)
Exposure to Puerto Rico
$
2,128

 
$
2,128

 
$
3,643

 
$
3,697



Puerto Rico
Net Par Outstanding

 
As of
June 30, 2017
 
As of
December 31, 2016
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds (1) (2)
$
378

 
$
378

PBA (1)
169

 
169

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
PRHTA (Transportation revenue) (1) (2)
519

 
519

PRHTA (Highways revenue) (1) (2)
93

 
93

PRCCDA (1)
152

 
152

PRIFA (1)
17

 
17

Other Public Corporations
 
 
 
PREPA (1) (2)
73

 
73

PRASA
285

 
285

MFA
61

 
61

U of PR
1

 
1

Total net exposure to Puerto Rico
$
1,748

 
$
1,748

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

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

21


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

Amortization Schedule of Puerto Rico Net Par Outstanding
and Net Debt Service Outstanding
As of June 30, 2017
 
 
Scheduled Net Par Amortization
 
Scheduled Net Debt Service Amortization
 
(in millions)
2017 (July 1 – September 30)
$
80

 
$
120

2017 (October 1 – December 31)
0

 
0

Subtotal 2017
80

 
120

2018
84

 
170

2019
67

 
149

2020
118

 
195

2021
53

 
127

2022-2026
234

 
562

2027-2031
297

 
535

2032-2036
505

 
670

2037-2041
106

 
177

2042-2047
204

 
255

Total
$
1,748

 
$
2,960



Exposure to the Selected European Countries

The European countries where the Company has exposure and believes heightened uncertainties exist are: Hungary, Italy, Portugal, Spain and Turkey (collectively, the Selected European Countries). The Company’s direct economic exposure to the Selected European Countries, based on par, is shown in the following table, net of ceded reinsurance.

Net Direct Economic Exposure to Selected European Countries(1)
As of June 30, 2017

 
 
Hungary
 
Italy
 
Portugal
 
Spain
 
Turkey
 
Total
 
 
(in millions)
Sub-sovereign exposure(2)
 
$
12

 
$
168

 
$
1

 
$
45

 
$

 
$
226

Non-sovereign exposure(3)
 
3

 
19

 

 

 
180

 
202

Total
 
$
15

 
$
187

 
$
1

 
$
45

 
$
180

 
$
428

Total BIG (See Note 5)
 
$
12

 
$

 
$
1

 
$
45

 
$

 
$
58

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

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

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


22


When the Company directly insures an obligation, it assigns the obligation to a geographic location or locations based on its view of the geographic location of the risk. The Company may also have direct exposures to the Selected European Countries in business assumed from unaffiliated monoline insurance companies, in which case the Company depends upon geographic information provided by the primary insurer.

The Company's $180 million net insured par exposure in Turkey is to DPR securitizations sponsored by a major Turkish bank. These DPR securitizations were established outside of Turkey and involve payment orders in U.S. dollars, pounds sterling and euros from persons outside of Turkey to beneficiaries in Turkey who are customers of the sponsoring bank. The sponsoring bank's correspondent banks have agreed to remit all such payments to a trustee-controlled account outside Turkey, where debt service payments for the DPR securitization are given priority over payments to the sponsoring bank.

The Company has excluded from the exposure tables above its indirect economic exposure to the Selected European Countries through policies it provides on pooled corporate and commercial receivables transactions. The Company calculates indirect exposure to a country by multiplying the par amount of a transaction insured by the Company times the percent of the relevant collateral pool reported as having a nexus to the country. On that basis, the Company has calculated exposure of $37 million to Selected European Countries in transactions with $0.4 billion of net par outstanding.

5.
Expected Loss to be Paid

Loss Estimation Process

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

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

The Company does not use traditional actuarial approaches to determine its estimates of expected losses. Actual losses will ultimately depend on future events or transaction performance and may be influenced by many interrelated factors that are difficult to predict. As a result, the Company's current projections of probable and estimable losses may be subject to considerable volatility and may not reflect the Company's ultimate claims paid. For information on the Company's loss estimation process, please refer to Note 5, Expected Loss to be Paid, of the annual consolidated financial statements of AGC for the year ended December 31, 2016 included in Exhibit 99.1 in AGL's Form 8-K dated March 29, 2017, filed with the SEC.

The following tables present a roll forward of the present value of net expected loss to be paid for all contracts, whether accounted for as insurance, credit derivatives or FG VIEs, by sector, after the expected recoveries/(payables) for breaches of representations and warranties (R&W) and other expected recoveries. The Company used risk-free rates for U.S. dollar denominated obligations that ranged from 0.0% to 2.83% with a weighted average of 2.37% as of June 30, 2017 and 0.0% to 3.23% with a weighted average of 2.77% as of December 31, 2016.

23


Net Expected Loss to be Paid
Roll Forward

 
Second Quarter
 
Six Months
 
2017
 
2016
 
2017
 
2016
 
(in millions)
Net expected loss to be paid, beginning of period
$
428

 
$
381

 
$
337

 
$
419

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

 

 
21

 

Economic loss development (benefit) due to:
 
 
 
 
 
 
 
Accretion of discount
3

 
2

 
5

 
5

Changes in discount rates
5

 
16

 
8

 
36

Changes in timing and assumptions
8

 
8

 
93

 
(3
)
Total economic loss development (benefit)
16

 
26

 
106

 
38

Net (paid) recovered losses
0

 
6

 
(20
)
 
(44
)
Net effect of sale of AGLN, AGUK and CIFGE on June 26, 2017
(75
)
 

 
(75
)
 

Net expected loss to be paid, end of period
$
369

 
$
413

 
$
369

 
$
413



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

 
Net Expected
Loss to be
Paid (Recovered) as of
March 31, 2017
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Effect of Sale of the European Subsidiaries on June 26, 2017
 
Net Expected
Loss to be
Paid (Recovered) as of
June 30, 2017
(2)
 
(in millions)
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
447

 
$
24

 
$
(3
)
 
$

 
$
468

Non-U.S. public finance
18

 
(1
)
 

 
(12
)
 
5

Public finance
465

 
23

 
(3
)
 
(12
)
 
473

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. RMBS
23

 
(14
)
 
1

 

 
10

Triple-X life insurance transactions
(48
)
 
7

 
1

 
(58
)
 
(98
)
Other structured finance
(12
)
 
0

 
1

 
(5
)
 
(16
)
Structured finance
(37
)
 
(7
)
 
3

 
(63
)
 
(104
)
Total
$
428

 
$
16

 
$
0

 
$
(75
)
 
$
369




24


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

 
Net Expected
Loss to be
Paid (Recovered) as of
March 31, 2016
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be
Paid (Recovered) as of
June 30, 2016
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
377

 
$
34

 
$
(3
)
 
$
408

Non-U.S. public finance
6

 
(1
)
 

 
5

Public finance
383

 
33

 
(3
)
 
413

Structured finance:
 
 
 
 
 
 
 
U.S. RMBS
26

 
(8
)
 
11

 
29

Triple-X life insurance transactions
(14
)
 
1

 
(1
)
 
(14
)
Other structured finance
(14
)
 
0

 
(1
)
 
(15
)
Structured finance
(2
)
 
(7
)
 
9

 
0

Total
$
381

 
$
26

 
$
6

 
$
413



Net Expected Loss to be Paid
Roll Forward by Sector
Six Months 2017

 
Net Expected
Loss to be
Paid (Recovered) as of
December 31, 2016 (2)
 
Net Expected
Loss to be
Paid
on MBIA UK as of
January 10, 2017
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Effect of Sale of the European Subsidiaries on June 26, 2017
 
Net Expected
Loss to be
Paid (Recovered) as of
June 30, 2017 (2)
 
(in millions)
Public finance:
 
 
 
 
 
 
 
 
 
 
 
U.S. public finance
$
374

 
$

 
$
110

 
$
(16
)
 
$

 
468

Non-U.S. public finance
6

 
13

 
(2
)
 

 
(12
)
 
5

Public finance
380

 
13

 
108

 
(16
)
 
(12
)
 
473

Structured finance:
 
 
 
 
 
 
 
 
 
 
 
U.S. RMBS
29

 

 
(21
)
 
2

 

 
10

Triple-X life insurance transactions
(57
)
 

 
16

 
1

 
(58
)
 
(98
)
Other structured finance
(15
)
 
8

 
3

 
(7
)
 
(5
)
 
(16
)
Structured finance
(43
)
 
8

 
(2
)
 
(4
)
 
(63
)
 
(104
)
Total
$
337

 
$
21

 
$
106

 
$
(20
)
 
$
(75
)
 
$
369




25


Net Expected Loss to be Paid
Roll Forward by Sector
Six Months 2016

 
Net Expected
Loss to be
Paid (Recovered) as of
December 31, 2015
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be
Paid (Recovered) as of
June 30, 2016
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
353

 
$
58

 
$
(3
)
 
$
408

Non-U.S. public finance
6

 
(1
)
 

 
5

Public finance
359

 
57

 
(3
)
 
413

Structured finance:
 
 
 
 
 
 
 
U.S. RMBS
76

 
(22
)
 
(25
)
 
29

Triple-X life insurance transactions
(14
)
 
1

 
(1
)
 
(14
)
Other structured finance
(2
)
 
2

 
(15
)
 
(15
)
Structured finance
60

 
(19
)
 
(41
)
 
0

Total
$
419

 
$
38

 
$
(44
)
 
$
413

________________
(1)
Net of ceded paid losses, whether or not such amounts have been settled with reinsurers. Ceded paid losses are typically settled 45 days after the end of the reporting period. Such amounts are recorded in reinsurance recoverable on paid losses included in other assets. The Company paid $3 million and $1 million in LAE for Second Quarter 2017 and 2016, respectively, and $4 million and $2 million in LAE for Six Months 2017 and 2016, respectively.

(2)
Includes expected LAE to be paid of $8 million as of June 30, 2017 and $6 million as of December 31, 2016.


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

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

 
Net Expected Loss to be Paid (Recovered)
 
Net Economic Loss Development (Benefit)
 
As of
June 30, 2017
 
As of
December 31, 2016
 
Second Quarter 2017
 
Second Quarter 2016
 
Six Months 2017
 
Six Months 2016
 
(in millions)
Financial guaranty insurance
$
358

 
$
313

 
$
24

 
$
31

 
$
119

 
$
46

FG VIEs (1) and other
14

 
14

 
0

 
0

 
0

 
1

Credit derivatives (2)
(3
)
 
10

 
(8
)
 
(5
)
 
(13
)
 
(9
)
Total
$
369

 
$
337

 
$
16

 
$
26

 
$
106

 
$
38

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

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

26


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 $1.7 billion net par as of June 30, 2017, all of which are BIG. For additional information regarding the Company's exposure to general obligations of Commonwealth of Puerto Rico and various obligations of its related authorities and public corporations, please refer to "Exposure to Puerto Rico" in Note 4, Outstanding Exposure.

The Company projects that its total net expected loss across its troubled U.S. public finance credits as of June 30, 2017 including those mentioned above, which incorporated the likelihood of the various outcomes, will be $468 million, compared with a net expected loss of $374 million as of December 31, 2016. Economic loss development in Second Quarter 2017 was $24 million and economic loss development for Six Months 2017 and $110 million, primarily attributable to Puerto Rico exposures.

Please refer to Note 18, Subsequent Events, regarding several events occurring subsequent to Second Quarter 2017 that may adversely impact economic loss development in the third quarter of 2017 for the Company’s U.S. public finance credits.

Selected Non - U.S. Public Finance Transactions

The non-U.S. public finance insured obligations had expected loss to be paid of $5 million as of June 30, 2017, compared with $6 million as of December 31, 2016. The economic benefit of approximately $1 million during the Second Quarter 2017 and $2 million during Six Months 2017, was due mainly to lower modeled losses for certain transactions, some of which were related to the improved internal outlook of certain European sovereigns and sub-sovereign entities and updated transaction performance data.

Approach to Projecting Losses in U.S. RMBS

The Company projects losses on its insured U.S. RMBS on a transaction-by-transaction basis by projecting the performance of the underlying pool of mortgages over time and then applying the structural features (i.e., payment priorities and tranching) of the RMBS and any expected R&W recoveries to the projected performance of the collateral over time. The resulting projected claim payments or reimbursements are then discounted using risk-free rates.

Second Quarter 2017 U.S. RMBS Loss Projections

Based on its observation during the period of the performance of its insured transactions (including delinquencies, liquidation rates and loss severities) as well as the residential property market and economy in general, the Company chose to make the changes to the assumptions it uses to project RMBS losses shown in the tables of assumptions in the sections below.

U.S. First Lien RMBS Loss Projections: Alt-A First Lien, Option ARM, Subprime and Prime

The majority of projected losses in first lien RMBS transactions are expected to come from non-performing mortgage loans (those that are or in the past twelve months have been two or more payments behind, have been modified, are in foreclosure, or have been foreclosed upon). Changes in the amount of non-performing loans from the amount projected in the previous period are one of the primary drivers of loss development in this portfolio. In order to determine the number of defaults resulting from these delinquent and foreclosed loans, the Company applies a liquidation rate assumption to loans in each of various non-performing categories. The Company arrived at its liquidation rates based on data purchased from a third party provider and assumptions about how delays in the foreclosure process and loan modifications may ultimately affect the rate at which loans are liquidated. Each quarter the Company reviews the most recent twelve months of this data and (if necessary) adjusts its liquidation rates based on its observations. The following table shows liquidation assumptions for various non-performing categories.