Guaranty

Assured Guaranty Municipal Corp.




Exhibit 99.1






Assured Guaranty Municipal Corp.

Condensed Consolidated and Combined Financial Statements

(Unaudited)

September 30, 2017








ASSURED GUARANTY MUNICIPAL CORP.
INDEX TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS






Assured Guaranty Municipal Corp.
Condensed Consolidated and Combined Balance Sheets (unaudited)
(dollars in millions except per share and share amounts)
 
As of
September 30, 2017
 
As of
December 31, 2016
 
 
 
As Adjusted
Assets
 
 
 
Investment portfolio:
 
 
 
Fixed-maturity securities, available-for-sale, at fair value (amortized cost of $5,462 and $5,475)
$
5,648

 
$
5,547

Short-term investments, at fair value
629

 
165

Other invested assets (includes Surplus Note from affiliate of $300 and $300)
378

 
357

Total investment portfolio
6,655

 
6,069

Cash
25

 
32

Premiums receivable
726

 
358

Ceded unearned premium reserve
759

 
827

Reinsurance recoverable on unpaid losses
198

 
310

Salvage and subrogation recoverable
320

 
249

Credit derivative assets
3

 
7

Deferred tax asset, net

 
166

Financial guaranty variable interest entities’ assets, at fair value
580

 
644

Other assets
225

 
151

Total assets   
$
9,491

 
$
8,813

Liabilities and shareholder's equity
 
 
 
Unearned premium reserve
$
2,802

 
$
2,530

Loss and loss adjustment expense reserve
844

 
816

Reinsurance balances payable, net
191

 
153

Credit derivative liabilities
87

 
97

Deferred tax liability, net
52

 

Current income tax payable
118

 
75

Financial guaranty variable interest entities’ liabilities with recourse, at fair value
519

 
602

Financial guaranty variable interest entities’ liabilities without recourse, at fair value
109

 
110

Other liabilities
359

 
249

Total liabilities   
5,081

 
4,632

Commitments and contingencies (See Note 14)
 
 
 
Preferred stock ($1,000 par value, 5,000.1 shares authorized; 0 shares issued and outstanding)

 

Common stock ($73,171 par value, 205 shares authorized; issued and outstanding)
15

 
77

Additional paid-in capital
802

 
778

Retained earnings
3,284

 
3,019

Accumulated other comprehensive income, net of tax of $53 and $17
100

 
12

Total shareholder's equity attributable to Assured Guaranty Municipal Corp.
4,201

 
3,886

Noncontrolling interest
209

 
295

Total shareholder's equity
4,410

 
4,181

Total liabilities and shareholder's equity   
$
9,491

 
$
8,813

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

1



Assured Guaranty Municipal Corp.
Condensed Consolidated and Combined Statements of Operations (unaudited)
(in millions)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenues
 
 
 
 
 
 
 
Net earned premiums
$
96

 
$
106

 
$
261

 
$
343

Net investment income
53

 
56

 
171

 
185

Net realized investment gains (losses):
 
 
 
 
 
 
 
Other-than-temporary impairment losses
(18
)
 
(2
)
 
(20
)
 
(23
)
Less: portion of other-than-temporary impairment loss recognized in other comprehensive income
(7
)
 
1

 
4

 
(3
)
Net impairment loss
(11
)
 
(3
)
 
(24
)
 
(20
)
Other net realized investment gains (losses)
18

 
1

 
42

 
9

Net realized investment gains (losses)
7

 
(2
)
 
18

 
(11
)
Net change in fair value of credit derivatives:
 
 
 
 
 
 
 
Realized gains (losses) and other settlements
0

 
3

 
16

 
13

Net unrealized gains (losses)
(1
)
 
9

 
5

 
18

Net change in fair value of credit derivatives
(1
)
 
12

 
21

 
31

Fair value gains (losses) on committed capital securities
(2
)
 
(11
)
 
(2
)
 
(23
)
Fair value gains (losses) on financial guaranty variable interest entities
3

 
(12
)
 
21

 
2

Other income (loss)
272

 
9

 
381

 
38

Total revenues   
428

 
158

 
871

 
565

Expenses
 
 
 
 
 
 
 
Loss and loss adjustment expenses
129

 
8

 
185

 
99

Amortization of deferred ceding commissions
(5
)
 
(4
)
 
(12
)
 
(11
)
Other operating expenses
32

 
30

 
100

 
91

Total expenses   
156

 
34

 
273

 
179

Income (loss) before income taxes   
272

 
124

 
598

 
386

Provision (benefit) for income taxes
 
 
 
 
 
 
 
Current
(56
)
 
3

 
21

 
80

Deferred
142

 
30

 
147

 
25

Total provision (benefit) for income taxes   
86

 
33

 
168

 
105

Net income (loss)
186

 
91

 
430

 
281

Less: Noncontrolling interest
8

 
11

 
22

 
34

Net income (loss) attributable to Assured Guaranty Municipal Corp.
$
178

 
$
80

 
$
408

 
$
247


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


2



Assured Guaranty Municipal Corp.
Condensed Consolidated and Combined Statements of Comprehensive Income (unaudited)
(in millions)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)   
$
186

 
$
91

 
$
430

 
$
281

Unrealized holding gains (losses) arising during the period on:
 
 
 
 
 
 
 
Investments with no other-than-temporary impairment, net of tax provision (benefit) of $6, $(13), $40 and $25
22

 
(26
)
 
90

 
43

Investments with other-than-temporary impairment, net of tax provision (benefit) of $(7), $3, $0 and $(11)
(14
)
 
6

 
(1
)
 
(19
)
Unrealized holding gains (losses) arising during the period, net of tax
8

 
(20
)
 
89

 
24

Less: reclassification adjustment for gains (losses) included in net income (loss), net of tax provision (benefit) of $2, $(1), $6 and $(3)
5

 
(2
)
 
13

 
(6
)
Change in net unrealized gains (losses) on investments
3

 
(18
)
 
76

 
30

Change in cumulative translation adjustment, net of tax provision (benefit) of $3, $1, $2 and $(4)
2

 
(5
)
 
14

 
(14
)
Other comprehensive income (loss)
5

 
(23
)
 
90

 
16

Comprehensive income (loss)
191

 
68

 
520

 
297

Less: Comprehensive income (loss) attributable to noncontrolling interest
8

 
9

 
24

 
34

Comprehensive income (loss) attributable to Assured Guaranty Municipal Corp.
$
183

 
$
59

 
$
496

 
$
263


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


3



Assured Guaranty Municipal Corp.
Condensed Consolidated and Combined Statements of Shareholder’s Equity (unaudited)

For the Nine Months Ended September 30, 2017
(dollars in millions, except share data)

 
Assured Guaranty Municipal Corp. Common Shares Outstanding
 
Common Stock Par Value
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive Income
 
Total
Shareholder's
Equity
Attributable to Assured Guaranty Municipal Corp.
 
Noncontrolling
Interest
 
Total
Shareholder's
Equity
Balance at December 31, 2016
205

 
$
77

 
$
778

 
$
3,019

 
$
12

 
$
3,886

 
$
295

 
$
4,181

Net income

 

 

 
408

 

 
408

 
22

 
430

Dividends

 

 

 
(143
)
 

 
(143
)
 
(42
)
 
(185
)
Other comprehensive income

 

 

 

 
88

 
88

 
2

 
90

Return of capital

 

 

 

 

 

 
(68
)
 
(68
)
Effect of common control acquisitions (see Note 2)

 
(62
)
 
24

 

 

 
(38
)
 

 
(38
)
Balance at September 30, 2017
205

 
$
15

 
$
802

 
$
3,284

 
$
100

 
$
4,201

 
$
209

 
$
4,410




For the Nine Months Ended September 30, 2016
(dollars in millions, except share data)

 
Assured Guaranty Municipal Corp. Common Shares Outstanding
 
Common Stock Par Value
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive Income
 
Total
Shareholder's
Equity
Attributable to Assured Guaranty Municipal Corp.
 
Noncontrolling
Interest
 
Total
Shareholder's
Equity
Balance at December 31, 2015
330

 
$
30

 
$
1,088

 
$
2,992

 
$
106

 
$
4,216

 
$
377

 
$
4,593

Net income

 

 

 
247

 

 
247

 
34

 
281

Dividends

 

 

 
(192
)
 

 
(192
)
 
(114
)
 
(306
)
Other comprehensive income

 

 

 

 
16

 
16

 
0

 
16

Return of capital

 

 

 

 

 

 
(4
)
 
(4
)
Effect of common control acquisitions (see Note 2)

 
47

 
(11
)
 

 

 
36

 

 
36

Balance at September 30, 2016
330

 
$
77

 
$
1,077

 
$
3,047

 
$
122

 
$
4,323

 
$
293

 
$
4,616




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


4



Assured Guaranty Municipal Corp.
Condensed Consolidated and Combined Statements of Cash Flows (unaudited)
(in millions)

 
Nine Months Ended September 30,
 
2017
 
2016
Net cash flows provided by (used in) operating activities
$
472

 
$
(18
)
Investing activities
 
 
 
Fixed-maturity securities:
 
 
 
Purchases
(847
)
 
(502
)
Sales
671

 
232

Maturities
424

 
564

Net sales (purchases) of short-term investments
(381
)
 
54

Net proceeds from paydowns on financial guaranty variable interest entities’ assets
93

 
89

Effect of common control combination for acquisitions (see Note 2)
72

 
1

Cash paid to acquire European Subsidiaries from affiliate (see Note 2)
(139
)
 

Other
(28
)
 
(12
)
Net cash flows provided by (used in) investing activities   
(135
)
 
426

Financing activities
 
 
 
Dividends paid to Assured Guaranty Municipal Holdings Inc.
(142
)
 
(192
)
Dividends paid to AGC (see Note 11)
(42
)
 
(114
)
Return of capital to AGC (see Note 11)
(70
)
 
(4
)
Repayment of notes payable
(2
)
 
(2
)
Net paydowns of financial guaranty variable interest entities' liabilities
(100
)
 
(101
)
Net cash flows provided by (used in) financing activities   
(356
)
 
(413
)
Effect of foreign exchange rate changes
4

 
(2
)
Increase (decrease) in cash and restricted cash
(15
)
 
(7
)
Cash and restricted cash at beginning of period (see Note 10)
40

 
23

Cash and restricted cash at end of period (see Note 10)
$
25

 
$
16

Supplemental cash flow information
 
 
 
Cash paid (received) during the period for:
 
 
 
Income taxes
$
6

 
$
1

Interest
$
0

 
$
0


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

5



Assured Guaranty Municipal Corp.
Notes to the Condensed Consolidated and Combined Financial Statements (unaudited)
September 30, 2017

1.    Business and Basis of Presentation

Business

Assured Guaranty Municipal Corp. (AGM, or together with its direct and indirect subsidiaries, the Company), a New York domiciled insurance company, is a wholly owned subsidiary of Assured Guaranty Municipal Holdings Inc. (AGMH). AGMH is an indirect and wholly owned 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. AGM was formerly known as Financial Security Assurance Inc.

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. Obligations insured by the Company include bonds issued by U.S. state or municipal governmental authorities and notes issued to finance international infrastructure projects. AGM had previously offered insurance and reinsurance in the global structured finance market, but has not done so since mid-2008. AGM and its indirect subsidiary Municipal Assurance Corp. (MAC) each markets its financial guaranty insurance directly to issuers and underwriters of, and investors in, public finance securities. In addition, AGM's direct subsidiary, Assured Guaranty (Europe) plc (formerly Assured Guaranty (Europe) Ltd. or AGE), provides financial guarantees for the international public finance (including infrastructure) market and, with the approval of the U.K. Prudential Regulation Authority (PRA), the asset-backed and other structured finance market. 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 2008. Guidelines were issued in 2009 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.

On June 26, 2017, AGM purchased from its affiliate, Assured Guaranty Corp. (AGC), all of the shares of AGC’s direct, wholly owned subsidiaries, Assured Guaranty (UK) plc (AGUK), CIFG Europe S.A. (CIFGE) and Assured Guaranty (London) plc (AGLN) (collectively, the European Subsidiaries), and then immediately contributed the European Subsidiaries to AGM’s wholly owned subsidiary, AGE. Please refer to Note 2, Common Control Acquisition.

Basis of Presentation

The unaudited interim condensed 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 condensed financial statements are as of September 30, 2017 and cover the three-month period ended September 30, 2017 (Third Quarter 2017), the three-month period ended September 30, 2016 (Third Quarter 2016), the nine-

6



month period ended September 30, 2017 (Nine Months 2017) and the nine-month period ended September 30, 2016 (Nine 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 comprises amounts derived from the AGM consolidated audited financial statements, combined with the corresponding amounts attributable to the European Subsidiaries purchased on June 26, 2017. Please refer to Note 2, Common Control Acquisition for additional information.

The unaudited interim condensed financial statements include the accounts of AGM, its direct and indirect subsidiaries (collectively, the Subsidiaries), and its consolidated VIEs. Amounts for all periods prior to June 26, 2017 have been retrospectively adjusted on a combined basis to include the European Subsidiaries from the date the common control began for each subsidiary. Please refer to Note 2, Common Control Acquisition for additional information.

Intercompany accounts and transactions between and among all consolidated and combined entities have been eliminated. Certain prior year balances have been reclassified to conform to the current year's presentation.

These unaudited interim condensed financial statements should be read in conjunction with the annual consolidated financial statements of AGM included in Exhibit 99.1 in AGL's Form 8-K dated March 17, 2017, filed with the U.S. Securities and Exchange Commission (the SEC).

AGM's direct and indirect subsidiaries are as follows:

AGE, organized in the U.K. and 100% owned by AGM, and its direct subsidiaries: AGUK, CIFGE and AGLN;
Municipal Assurance Holdings Inc. (MAC Holdings), incorporated in Delaware and 60.7% owned by AGM and 39.3% owned by AGM's affiliate, AGC. MAC Holdings owns 100% of MAC domiciled in New York.
    
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. The ASU was adopted on January 1, 2017 and did not have an effect on the Company’s condensed 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 with no material effect on the financial statements.


7



Future Application of Accounting Standards

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.  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 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). The Company does not expect that the amendment related to certain equity securities will have a material effect on its financial statements. 

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 FG VIEs.

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.

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 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 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 financial statements.



8



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 be required to 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 by which the security’s fair value is less than its amortized cost basis, may not consider the length of time fair value has been less than amortized cost, and may not consider recoveries in fair value after the balance sheet date when assessing whether a credit loss exists. For purchased financial assets with credit deterioration, the ASU requires an entity’s method for measuring credit losses to be consistent with its method for measuring expected losses for originated and purchased non-credit-deteriorated assets.

The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. For 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. The Company is evaluating the effect that this ASU will have on its financial statements.

2.
    Common Control Acquisition

The purchase of the European Subsidiaries was an initial step in Assured Guaranty's efforts to merge the operations of its four affiliated European insurance companies (the European Subsidiaries and AGE). It was approved by the New York State Department of Financial Services, the Maryland Insurance Administration (MIA) and the PRA. While Assured Guaranty, the European Subsidiaries and AGE have received certain regulatory approvals for this initial step of the proposed combination of the European Subsidiaries and AGE, that combination is subject to further regulatory approvals and to certain court approvals. As a result, the Company cannot predict whether, or when, such combination will be completed.

As the Company and the European Subsidiaries were under common control at the time of the acquisition, it is required under U.S. GAAP to account for this acquisition in a method that is similar to the pooling-of-interests method. Under this method of accounting, AGM's consolidated and combined financial statements and disclosures reflect the European Subsidiaries' historical carryover basis in the assets and liabilities instead of reflecting the fair value of the assets and liabilities.

In accordance with ASC 250-10-45-21, the financial statements and disclosures for all prior periods presented in this report have been retrospectively adjusted to reflect the combination of AGM and the European Subsidiaries as if the combinations had been in effect from the date common control began for each of the subsidiaries. As such, AGUK is reflected within these financial statements for all periods presented, while CIFGE is reflected for all periods subsequent to its purchase by Assured Guaranty on July 1, 2016, and AGLN is reflected for all periods subsequent to its purchase by Assured Guaranty on January 10, 2017. The consideration paid is reflected on June 26, 2017, the date of transfer.
    
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), with a fair value of $272 million; and (ii) $139 million of cash.  The GAAP book value of the European Subsidiaries transferred to AGM as of June 26, 2017 was $651 million. In addition, AGC's $55 million deferred tax liability on unremitted earnings of the European Subsidiaries was transferred to AGM resulting in net assets transferred to AGM of $596 million.

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 included in consideration transferred constituted 90%

9



of the total $383 million of Orkney Bonds owned by AGM. AGM sold the remaining 10% of the Orkney Bonds it held to AGUK. As AGUK is now an indirect subsidiary of AGM, in accordance with the Company's accounting policy, the 10% of the Orkney Bonds owned by AGUK are recorded excluding the value of the AGUK's financial guarantee, and are carried in the financial statements on the same basis as the common parent, Assured Guaranty US Holdings Inc. (AGUS).
    
The net gain on the purchase of the European Subsidiaries of approximately $185 million is recorded as a direct increase to shareholder's equity. As of June 30, 2017, the cumulative effect on shareholder's equity is shown in the table below. As previously discussed, the financial statements for prior periods have been presented on a combined basis as if the European Subsidiaries had been part of the AGM group as of the inception of common control. As each of the European Subsidiaries came under common control on a different date, the components of the net carrying value transferred are reflected in the financial statements in various periods. The consideration paid is reflected on the date of the transfer (June 26, 2017).

Impact of Purchase of the European Subsidiaries

 
(in millions)
Consideration paid
$
411

 
 
Carrying value of European Subsidiaries (1)
651

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

 
 
Net increase in shareholders equity
$
185

_____________________
(1)
Includes a $2.4 million gain related to the elimination of the AGUK financial guaranty on its 10% net retained exposure on Orkney Bonds


3.    Ratings

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

 
S&P Global Ratings, a division of Standard & Poor’s Financial Services LLC
 
Kroll Bond Rating Agency
 
Moody’s Investors Service Inc.
AGM
AA (stable) (6/26/17)
 
AA+ (stable) (12/14/16)
 
A2 (stable) (8/8/16)
MAC
AA (stable) (6/26/17)
 
AA+ (stable) (7/14/17)
 
AGE
AA (stable) (6/26/17)
 
 
A2 (stable) (8/8/16)
AGUK
AA (stable) (6/26/17)
 
 
(1)
AGLN
BB (positive) (1/12/17)
 
 
(2)
CIFGE
 
 
____________________
(1)
AGC requested that Moody’s Investors Service, Inc. (Moody's) withdraw its financial strength ratings of AGC and AGUK in January 2017, but Moody's denied that request. Moody’s continues to rate AGC A3 (stable) and AGUK A3. Moody's put AGUK on review for upgrade on June 27, 2017, following its transfer to AGM.

(2)
Assured Guaranty did not request that Moody's rate AGLN. Moody's continues to rate AGLN, and upgraded its rating to Baa2 (stable) on January 13, 2017, following its acquisition by AGC, and then to Baa1 on review for further upgrade on June 27, 2017, following its transfer to AGM.


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


10



For a discussion of the effects of rating actions on the Company, please refer to Note 6, Contracts Accounted for as Insurance, and Note 13, Reinsurance and Other Monoline Exposures.
4.    Outstanding Exposure

The Company’s financial guaranty contracts are written in either insurance or credit derivative form, but collectively are considered financial guaranty contracts. The Company seeks to limit its exposure to losses by underwriting obligations that it views as investment grade at inception, although, as part of its loss mitigation strategy for existing troubled credits, it may underwrite new issuances that it views as below-investment-grade (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.

The Company has issued financial guaranty insurance policies on public finance obligations and, prior to mid-2008, 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. The Company also includes within public finance similar obligations issued by territorial and non-U.S. sovereign and sub-sovereign issuers and governmental authorities.

Structured finance obligations insured by the Company are generally issued by special purpose entities, including VIEs, and backed by pools of assets having an ascertainable cash flow or market value or other specialized financial obligations. Some of these VIEs are consolidated as described in Note 9, Consolidated Variable Interest Entities. Unless otherwise specified, the outstanding par and debt service amounts presented in this note include outstanding exposures on VIEs whether or not they are consolidated. While AGM has ceased insuring new originations of asset-backed securities, a significant portfolio of such obligations remains outstanding. AGM's wholly owned subsidiary, AGE, provides financial guarantees in the international public finance market and intends to provide such guarantees in the international structured finance market, subject to regulatory approval.

Debt service and par outstanding exposures presented in these financial statements are presented on a consolidated and combined basis. That is, amounts presented include 100% of the exposures of AGM, AGE, the European Subsidiaries and MAC, despite the fact that AGM indirectly owns only 60.7% of MAC.

Surveillance Categories

The Company segregates its insured portfolio into investment grade and BIG surveillance categories to facilitate the appropriate allocation of resources to monitoring and loss mitigation efforts and to aid in establishing the appropriate cycle for periodic review for each exposure. BIG exposures include all exposures with internal credit ratings below BBB-. The Company’s internal credit ratings are based on internal assessments of the likelihood of default and loss severity in the event of default. Internal credit ratings are expressed on a ratings scale similar to that used by the rating agencies and are generally reflective of an approach similar to that employed by the rating agencies, except that the Company's internal credit ratings focus on future performance, rather than lifetime performance.
 
The Company monitors its insured portfolio and refreshes its internal credit ratings on individual 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.
 
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 generally calculates present value using a discount rate of 5%. (Risk-free rates are used for calculating the expected loss for financial statement measurement purposes.)
 
More extensive monitoring and intervention is employed for all BIG surveillance categories, with internal credit ratings reviewed quarterly. The Company expects “future losses” on a transaction when the Company believes there is at least a 50% chance that, on a present value basis, it will pay more claims on that transaction in the future than it will have reimbursed. The three BIG categories are:

11



 
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 September 30, 2017 and December 31, 2016, the Company excluded $698 million and $752 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.

Financial Guaranty
Debt Service Outstanding

 
Gross Debt Service Outstanding
 
Net Debt Service Outstanding(1)
 
September 30, 2017
 
December 31, 2016
 
September 30, 2017
 
December 31, 2016
 
(in millions)
Public finance
$
348,940

 
$
351,989

 
$
253,897

 
$
248,518

Structured finance
8,523

 
15,979

 
7,879

 
14,299

Total financial guaranty
$
357,463

 
$
367,968

 
$
261,776

 
$
262,817

_____________________
(1)
Includes 100% of MAC's gross and net debt service outstanding. However, AGM's indirect ownership of MAC is only 60.7%. The net debt service outstanding amount includes $61.0 billion and $77.5 billion as of September 30, 2017 and December 31, 2016, respectively, from MAC.

    
All of the outstanding commitments AGM had as of September 30, 2017 have expired as of the date of this filing.


12



Financial Guaranty Portfolio by Internal Rating
As of September 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
$
736

 
0.6
%
 
$
801

 
2.6
%
 
$
1,334

 
24.7
%
 
$
231

 
33.8
%
 
$
3,102

 
1.8
%
AA
22,133

 
16.4

 
226

 
0.7

 
1,887

 
34.9

 
28

 
4.1

 
24,274

 
14.0

A
78,249

 
57.9

 
11,900

 
37.6

 
76

 
1.5

 
71

 
10.4

 
90,296

 
52.3

BBB
30,529

 
22.6

 
17,037

 
53.8

 
67

 
1.2

 
250

 
36.6

 
47,883

 
27.7

BIG
3,402

 
2.5

 
1,693

 
5.3

 
2,040

 
37.7

 
103

 
15.1

 
7,238

 
4.2

Total net par outstanding (1)
$
135,049

 
100.0
%
 
$
31,657

 
100.0
%
 
$
5,404

 
100.0
%
 
$
683

 
100.0
%
 
$
172,793

 
100.0
%
_____________________
(1)
Includes $44.8 billion of net par outstanding as of September 30, 2017, from MAC, which represents 100% of MAC's net par outstanding. However, AGM's indirect ownership of MAC is only 60.7%.


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
$
1,684

 
1.1
%
 
$
546

 
3.4
%
 
$
5,727

 
54.5
%
 
$
1,177

 
67.4
%
 
$
9,134

 
5.1
%
AA
30,808

 
20.5

 
165

 
1.0

 
2,465

 
23.4

 
32

 
1.8

 
33,470

 
18.7

A
83,901

 
55.5

 
4,557

 
28.4

 
67

 
0.6

 
144

 
8.2

 
88,669

 
49.4

BBB
31,887

 
21.1

 
9,969

 
62.3

 
80

 
0.8

 
223

 
12.7

 
42,159

 
23.5

BIG
2,789

 
1.8

 
781

 
4.9

 
2,175

 
20.7

 
174

 
9.9

 
5,919

 
3.3

Total net par outstanding (1)
$
151,069

 
100.0
%
 
$
16,018

 
100.0
%
 
$
10,514

 
100.0
%
 
$
1,750

 
100.0
%
 
$
179,351

 
100.0
%
_____________________
(1)
Includes $56.6 billion of net par outstanding as of December 31, 2016, from MAC, which represents 100% of MAC's net par outstanding. However, AGM's indirect ownership of MAC is only 60.7%.

 

13



Components of BIG Portfolio

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

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1
 
BIG 2
 
BIG 3
 
Total BIG (1)
 
Outstanding
 
(in millions)
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
1,334

 
$
263

 
$
1,805

 
$
3,402

 
$
135,049

Non-U.S. public finance
1,477

 
216

 

 
1,693

 
31,657

Public finance
2,811

 
479

 
1,805

 
5,095

 
166,706

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. Residential mortgage-backed securities (RMBS)
27

 
167

 
1,768

 
1,962

 
3,042

Other structured finance
102

 
39

 
40

 
181

 
3,045

Structured finance
129

 
206

 
1,808

 
2,143

 
6,087

Total
$
2,940

 
$
685

 
$
3,613

 
$
7,238

 
$
172,793

____________________
(1)
There is no BIG net par outstanding for credit derivatives as of September 30, 2017.


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

 
BIG Net Par Outstanding
 
Net Par
 
BIG 1 (1)
 
BIG 2
 
BIG 3
 
Total BIG (1)
 
Outstanding
 
(in millions)
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
967

 
$
1,082

 
$
740

 
$
2,789

 
$
151,069

Non-U.S. public finance
781

 

 

 
781

 
16,018

Public finance
1,748

 
1,082

 
740

 
3,570

 
167,087

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. RMBS
45

 
255

 
1,793

 
2,093

 
3,293

Other structured finance
174

 
48

 
34

 
256

 
8,971

Structured finance
219

 
303

 
1,827

 
2,349

 
12,264

Total
$
1,967

 
$
1,385

 
$
2,567

 
$
5,919

 
$
179,351

____________________
(1)
Includes $53 million of BIG net par outstanding comprising 3 risks for credit derivatives.



14



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 $2.3 billion net par as of September 30, 2017. Of that amount, $2.2 billion is rated BIG, while the remainder is rated AA since it relates to second-to-pay policies on obligations insured by an affiliate of the Company. The amount, as of September 30, 2017, includes $391 million related to the 2017 commutations of previously ceded business. Please refer to Note 13, Reinsurance and Other Monoline Exposures, for more information. 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 most of its 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). 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. 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 to amend its proposed plan in several ways. The PRHTA plan assumes that PRHTA will not pay any debt service at least through 2026. The Company does not believe the fiscal plans of PRHTA in its current form complies 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 5, 2017, the Oversight Board certified a filing under Title III of PROMESA for the Puerto Rico Sales Tax Financing Corporation (COFINA). 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.
    

15



On September 20, 2017, Hurricane Maria made landfall in Puerto Rico as a Category 4 hurricane on the Saffir-Simpson scale, causing 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 continue to assess the extent of the damage, but rebuilding and economic recovery are expected to take years. While the federal government is expected to provide very substantial resources for relief and rebuilding -- which is expected to help economic activity and address 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 short term. Out migration to the mainland is also expected to increase, at least initially.

Litigation and mediation related to the Commonwealth’s debt have been delayed by Hurricane Maria. The final form and timing of responses to Puerto Rico’s financial distress and the devastation of Hurricane Maria eventually taken by the federal government or implemented under the auspices of PROMESA and the Oversight Board or otherwise, and the final impact, after resolution of legal challenges, of any such responses on obligations insured by the Company, are uncertain. In addition, federal income tax reform and related legislation being reconciled in the U.S. Congress, if enacted, may adversely impact Puerto Rico's economy, and the final form of any such legislation and its impact on obligations insured by the Company are also uncertain.

The Company groups its Puerto Rico exposure into three categories:

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

Public Corporations – Certain Revenues Potentially Subject to Clawback. The Company includes in this category the debt of public corporations for which applicable law permits the Commonwealth to claw back, subject to certain conditions and for the payment of public debt, at least a portion of the revenues supporting the bonds the Company insures. As a constitutional condition to clawback, available Commonwealth revenues for any fiscal year must be insufficient to pay Commonwealth debt service before the payment of any appropriations for that year.  The Company believes that this condition has not been satisfied to date, and accordingly that the Commonwealth has not to date been entitled to claw back revenues supporting debt insured by the Company. 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 September 30, 2017, the Company had $670 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 September 30, 2017, the Company had $9 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 September 30, 2017, the Company had $252 million insured net par outstanding of PRHTA (transportation revenue) bonds and $358 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

16



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.

Other Public Corporations

PREPA. As of September 30, 2017, the Company had $547 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.

Municipal Finance Agency (MFA). As of September 30, 2017, the Company had $221 million net par outstanding of bonds issued by MFA secured by a lien on local property tax revenues. The MFA bond accounts contained sufficient funds to make the MFA bond payments due through the date of this filing that were guaranteed by the Company, and those payments were made in full.

COFINA. As of September 30, 2017, the Company had $263 million insured net par outstanding of junior COFINA bonds, which are secured primarily by a second lien on certain sales and use taxes. As noted above, the Oversight Board filed a petition on behalf of the Commonwealth under Title III of PROMESA. On August 1, 2017, certain insured debt service payments on junior COFINA bonds were not made, and the Company made its first claim payments on these bonds.
  
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 taxes and revenues pledged to secure the payment of bonds issued by the PRHTA, Puerto Rico Convention Center District Authority and Puerto Rico Infrastructure Financing Authority. 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

17



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.

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. On October 13, 2017, AGC and AGM voluntarily withdrew without prejudice the complaint, in order to allow PREPA to focus on emergency efforts to restore electricity to the island's residents and businesses in the wake of Hurricane Maria.
    
All Puerto Rico exposures are internally rated BIG, except the General Obligation, PBA and PRHTA (Transportation revenue) second-to-pay policies on an affiliate exposure which are rated AA based on the obligation of the Company's affiliate to pay under its insurance policy if the obligor fails to pay. 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.


18



Puerto Rico
Gross Par and Gross Debt Service Outstanding

 
Gross Par Outstanding
 
Gross Debt Service Outstanding
 
September 30, 2017
 
December 31, 2016
 
September 30, 2017
 
December 31, 2016
 
(in millions)
Exposure to Puerto Rico
$
3,368

 
$
3,542

 
$
5,321

 
$
5,672



Puerto Rico
Net Par Outstanding (1)
 
As of
September 30, 2017
 
As of
December 31, 2016
 
(in millions)
Commonwealth Constitutionally Guaranteed
 
 
 
Commonwealth of Puerto Rico - General Obligation Bonds (2) (3)
$
669

 
$
677

Commonwealth of Puerto Rico - General Obligation Bonds (Second-to-pay policies on affiliate exposure)
1

 
3

Commonwealth of Puerto Rico - General Obligation Bonds total
670

 
680

PBA (Second-to-pay policies on affiliate exposure)
9

 
11

Public Corporations - Certain Revenues Potentially Subject to Clawback
 
 
 
PRHTA (Transportation revenue) (2) (3)
167

 
190

PRHTA (Transportation revenue) (Second-to-pay policies on affiliate exposure)
85

 
83

PRHTA (Transportation revenue) total
252

 
273

PRHTA (Highways revenue) (2) (3)
358

 
213

Other Public Corporations
 
 
 
PREPA (2) (3)
547

 
417

COFINA (2) (3)
263

 
262

MFA
221

 
175

Total net exposure to Puerto Rico
$
2,320

 
$
2,031

__________________
(1)
The September 30, 2017 amounts include $391 million (which comprises $36 million of General Obligation Bonds, $134 million of PREPA, $144 million of PRHTA (Highways revenue), $75 million of MFA, and $2 million of PRHTA (Transportation revenue)) related to 2017 commutations of previously ceded business. Please refer to Note 13, Reinsurance and Other Monoline Exposures, for more information.

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

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


19



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 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. 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 BIG Net Par Outstanding
and Net Debt Service Outstanding
As of September 30, 2017

 
Scheduled BIG Net Par Amortization
 
Scheduled BIG Net Debt Service Amortization
 
(in millions)
2017 (October 1 – December 31)
$
0

 
$
2

2018 (January 1 - March 31)
0

 
54

2018 (April 1 - June 30)
0

 
2

2018 (July 1 - September 30)
77

 
131

2018 (October 1 - December 31)
0

 
2

Subtotal 2018
77

 
189

2019
107

 
215

2020
111

 
214

2021
69

 
167

2022-2026
581

 
994

2027-2031
495

 
776

2032-2036
470

 
626

2037-2041
164

 
227

2042-2043
151

 
159

Total
$
2,225

 
$
3,569



Exposure to the U.S. Virgin Islands

The Company has $331 million insured net par outstanding to the U.S. Virgin Islands and its related authorities (USVI), of which it rates $148 million BIG. The $183 million USVI net par the Company rates investment grade is comprised primarily of bonds secured by a lien on matching fund revenues related to excise taxes on products produced in the USVI and exported to the U.S., primarily rum. The $148 million BIG USVI net par comprises (a) Public Finance Authority bonds secured by a gross receipts tax and the general obligation, full faith and credit pledge of the USVI and (b) bonds of the Virgin Islands Water and Power Authority secured by a net revenue pledge of the electric system.

Hurricane Irma caused significant damage in St. John and St. Thomas, while Hurricane Maria made landfall on St. Croix as a Category 4 hurricane on the Saffir-Simpson scale, causing loss of life and substantial damage to St. Croix’s businesses and infrastructure, including the power grid. The USVI is benefiting from the federal response to this year’s hurricanes and has made its debt service payments to date.


20



Exposure to the Selected European Countries

The European countries where the Company has exposure and believes heightened uncertainties exist are: Hungary, Italy, Portugal, and Spain (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 September 30, 2017

 
Hungary
 
Italy
 
Portugal
 
Spain
 
Total
 
(in millions)
Sub-sovereign exposure(2)
$
166

 
$
728

 
$
73

 
$
370

 
$
1,337

Non-sovereign exposure(3)
121

 
338

 

 

 
459

Total
$
287

 
$
1,066

 
$
73

 
$
370

 
$
1,796

Total BIG (See Note 5)
$
214

 
$

 
$
73

 
$
370

 
$
657

____________________
(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 and RMBS.

    
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 has excluded from the exposure table above its indirect economic exposure to the Selected European Countries through policies it provides on pooled corporate 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 $3 million to Selected European Countries in transactions with $0.2 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. 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

21



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 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 4, Expected Loss to be Paid, of the annual consolidated financial statements of AGM for the year ended December 31, 2016 included in Exhibit 99.1 in AGL's Form 8-K dated March 17, 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 2.94% with a weighted average of 2.28% as of September 30, 2017 and 0.0% to 3.23% with a weighted average of 2.69% as of December 31, 2016.

Net Expected Loss to be Paid
Roll Forward

 
Third Quarter
 
Nine Months
 
2017
 
2016
 
2017
 
2016
 
(in millions)
Net expected loss to be paid, beginning of period
$
587

 
$
512

 
$
521

 
$
584

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

 

 
21

 

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

 
2

 
10

 
8

Changes in discount rates
(3
)
 
(12
)
 
12

 
26

Changes in timing and assumptions
107

 
(9
)
 
110

 
(33
)
Total economic loss development (benefit)
107

 
(19
)
 
132

 
1

Net (paid) recovered losses
(63
)
 
(69
)
 
(43
)
 
(161
)
Net expected loss to be paid, end of period
$
631

 
$
424

 
$
631

 
$
424



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

 
Net Expected
Loss to be Paid (Recovered) as of
June 30, 2017
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be Paid (Recovered) as of
September 30, 2017 (2)
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
389

 
$
121

 
$
(79
)
 
$
431

Non-U.S. public finance
32

 
0

 
5

 
37

Public finance
421

 
121

 
(74
)
 
468

Structured finance:
 
 
 
 
 
 
 
U.S. RMBS
149

 
(13
)
 
11

 
147

Other structured finance
17

 
(1
)
 
0

 
16

Structured finance
166

 
(14
)
 
11

 
163

Total
$
587

 
$
107

 
$
(63
)
 
$
631



22



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

 
Net Expected
Loss to be Paid (Recovered) as of
June 30, 2016
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be Paid (Recovered) as of
September 30, 2016
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
316

 
$
13

 
$
(65
)
 
$
264

Non-U.S. public finance
25

 
(1
)
 

 
24

Public finance
341

 
12

 
(65
)
 
288

Structured finance:
 
 
 
 
 
 
 
U.S. RMBS
133

 
(23
)
 
(5
)
 
105

Other structured finance
38

 
(8
)
 
1

 
31

Structured finance
171

 
(31
)
 
(4
)
 
136

Total
$
512

 
$
(19
)
 
$
(69
)
 
$
424



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

 
Net Expected
Loss to be Paid (Recovered) as of
December 31, 2016 (2)
 
Net Expected
Loss to be Paid
on AGLN as of
January 10, 2017
 
Economic Loss
Development / (Benefit)
 
(Paid)
Recovered
Losses (1)
 
Net Expected
Loss to be Paid (Recovered) as of
September 30, 2017 (2)
 
(in millions)
Public finance:
 
 
 
 
 
 
 
 
 
U.S. public finance
$
323

 
$

 
$
188

 
$
(80
)
 
$
431

Non-U.S. public finance
22

 
13

 
(3
)
 
5

 
37

Public finance
345

 
13

 
185

 
(75
)
 
468

Structured finance:
 
 
 
 
 
 
 
 
 
U.S. RMBS
147

 

 
(35
)
 
35

 
147

Other structured finance
29

 
8

 
(18
)
 
(3
)
 
16

Structured finance
176

 
8

 
(53
)
 
32

 
163

Total
$
521

 
$
21

 
$
132

 
$
(43
)
 
$
631




23



Net Expected Loss to be Paid
Roll Forward by Sector
Nine 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
September 30, 2016
 
(in millions)
Public finance:
 
 
 
 
 
 
 
U.S. public finance
$
214

 
$
124

 
$
(74
)
 
$
264

Non-U.S. public finance
26

 
(2
)
 

 
24

Public finance
240

 
122

 
(74
)
 
288

Structured finance:
 
 
 
 
 
 
 
U.S. RMBS
302

 
(110
)
 
(87
)
 
105

Other structured finance
42

 
(11
)
 
0

 
31

Structured finance
344

 
(121
)
 
(87
)
 
136

Total
$
584

 
$
1

 
$
(161
)
 
$
424

____________________
(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 loss adjustment expenses (LAE) for Third Quarter 2017 and 2016, respectively, and $6 million and $5 million in LAE for Nine Months 2017 and 2016, respectively.

(2)    Includes expected LAE to be paid of $9 million as of September 30, 2017 and $3 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
September 30, 2017
 
As of
December 31, 2016
 
Third Quarter 2017
 
Third Quarter 2016
 
Nine Months 2017
 
Nine Months 2016
 
(in millions)
Financial guaranty insurance
$
551

 
$
434

 
$
108

 
$
(8
)
 
$
143

 
$
14

FG VIEs (1) and other
80

 
90

 
(1
)
 
(3
)
 
(3
)
 
(5
)
Credit derivatives (2)

 
(3
)
 

 
(8
)
 
(8
)
 
(8
)
Total
$
631

 
$
521

 
$
107

 
$
(19
)
 
$
132

 
$
1

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

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



24



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 $2.3 billion net par as of September 30, 2017, $2.2 billion of which is rated 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.

As of September 30, 2017, the Company has insured $213 million net par outstanding of general obligation bonds issued by the City of Hartford, Connecticut, which has recently experienced financial distress.  The Company rates $212 million net par of that BIG, with the remainder being a second-to-pay policy rated investment grade. The mayor of Hartford announced that the city would be unable to meet its financial obligations by early November 2017 if the State of Connecticut failed to enact a budget, and hired bankruptcy consultants.  On October 31, 2017, the State adopted a budget providing for substantial payments to the City, placing the City under State oversight and providing an avenue for the City to issue debt backed by the State.

On February 25, 2015, a plan of adjustment resolving the bankruptcy filing of the City of Stockton, California under chapter 9 of the U.S. Bankruptcy Code became effective. As of September 30, 2017, the Company’s net par subject to the plan consists of $61 million of pension obligation bonds. As part of the plan of adjustment, the City will repay any claims paid on the pension obligation bonds from certain fixed payments and certain variable payments contingent on the City’s revenue growth. 
    
The Company projects that its total net expected loss across its troubled U.S. public finance credits as of September 30, 2017, including those mentioned above, which incorporated the likelihood of the various outcomes, will be $431 million, compared with a net expected loss of $323 million as of December 31, 2016. Economic loss development in Third Quarter 2017 was $121 million and economic loss development for Nine Months 2017 was $188 million which was primarily attributable to Puerto Rico exposures.
    
Selected Non - U.S. Public Finance Transactions

The Company insures credits with sub-sovereign exposure to various Spanish and Portuguese issuers where a Spanish and Portuguese sovereign default may cause the related sub-sovereigns also to default. The Company's exposure net of reinsurance to these Spanish and Portuguese credits is $370 million and $73 million, respectively. The Company rates all of these exposures BIG due to the financial condition of Spain and Portugal and their dependence on the sovereign. The Company's Hungary exposure is to infrastructure bonds dependent on payments from Hungarian governmental entities. The Company's exposure net of reinsurance to these Hungarian credits is $166 million, all of which is rated BIG.

As part of the acquisition of the European Subsidiaries, the Company now also insures an obligation backed by the availability and toll revenues of a major arterial road into a city in the U.K. with $216 million of net par outstanding as of September 30, 2017. This transaction has been underperforming due to lower traffic volume and higher costs compared with expectations at underwriting.

These transactions, together with other non-U.S. public finance insured obligations, had expected loss to be paid of $37 million as of September 30, 2017, compared with $22 million as of December 31, 2016. The common control acquisition of AGLN added $13 million of net expected loss as of January 2017. The economic loss development during Third Quarter 2017 was flat. The economic benefit of approximately $3 million during Nine Months 2017 was due mainly to the improved internal outlook of certain European sovereigns and sub-sovereign entities.
 
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.
 

25



Third 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 and Subprime

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.

First Lien Liquidation Rates

 
September 30, 2017
 
June 30, 2017
 
December 31, 2016
Delinquent/Modified in the Previous 12 Months
 
 
 
 
 
Alt-A
20%
 
20%
 
25%
Option ARM
20
 
20
 
25
Subprime
20
 
20
 
25
30 - 59 Days Delinquent
 
 
 
 
 
Alt-A
30
 
30
 
35
Option ARM
35
 
35
 
35
Subprime
40
 
40
 
40
60 - 89 Days Delinquent
 
 
 
 
 
Alt-A
40
 
40
 
45
Option ARM
45
 
45
 
50
Subprime
50
 
45
 
50
90 + Days Delinquent
 
 
 
 
 
Alt-A
50
 
50
 
55
Option ARM
55
 
55
 
55
Subprime
55
 
55
 
55
Bankruptcy
 
 
 
 
 
Alt-A
45
 
45
 
45
Option ARM
50
 
50
 
50
Subprime
40
 
40
 
40
Foreclosure
 
 
 
 
 
Alt-A
65
 
60
 
65
Option ARM
65
 
65
 
65
Subprime
65
 
65
 
65
Real Estate Owned
 
 
 
 
 
All
100
 
100
 
100


26



While the Company uses liquidation rates as described above to project defaults of non-performing loans (including current loans modified or delinquent within the last 12 months), it projects defaults on presently current loans by applying a conditional default rate (CDR) trend. The start of that CDR trend is based on the defaults the Company projects will emerge from currently nonperforming, recently nonperforming and modified loans. The total amount of expected defaults from the non-performing loans is translated into a constant CDR (i.e., the CDR plateau), which, if applied for each of the next 36 months, would be sufficient to produce approximately the amount of defaults that were calculated to emerge from the various delinquency categories. The CDR thus calculated individually on the delinquent collateral pool for each RMBS is then used as the starting point for the CDR curve used to project defaults of the presently performing loans.
 
In the most heavily weighted scenario (the base case), after the initial 36-month CDR plateau period, each transaction’s CDR is projected to improve over 12 months to an intermediate CDR (calculated as 20% of its CDR plateau); that intermediate CDR is held constant for 36 months and then trails off in steps to a final CDR of 5% of the CDR plateau. In the base case, the Company assumes the final CDR will be reached 5.75 years after the initial 36-month CDR plateau period. Under the Company’s methodology, defaults projected to occur in the first 36 months represent defaults that can be attributed to loans that were modified or delinquent in the last 12 months or that are currently delinquent or in foreclosure, while the defaults projected to occur using the projected CDR trend after the first 36 month period represent defaults attributable to borrowers that are currently performing or are projected to reperform.

Another important driver of loss projections is loss severity, which is the amount of loss the transaction incurs on a loan after the application of net proceeds from the disposal of the underlying property. Loss severities experienced in first lien transactions have reached historically high levels, and the Company is assuming in the base case that these high levels generally will continue for another 18 months. The Company determines its initial loss severity based on actual recent experience. Each quarter the Company reviews available data and (if necessary) adjusts its severities based on its observations. The Company then assumes that loss severities begin returning to levels consistent with underwriting assumptions beginning after the initial 18 month period, declining to 40% in the base case over 2.5 years.
 
The following table shows the range as well as the average, weighted by outstanding net insured par, for key assumptions used in the calculation of expected loss to be paid for individual transactions for direct vintage 2004 - 2008 first lien U.S. RMBS.


27



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

 
As of
September 30, 2017
 
As of
June 30, 2017
 
As of
December 31, 2016
 
Range
 
Weighted Average
 
Range
 
Weighted Average
 
Range
 
Weighted Average
Alt-A First Lien
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
3.6% - 11.0%
 
5.5%
 
3.4% - 10.1%
 
5.5%
 
3.9% - 10.5%
 
6.1%
Final CDR
0.2% - 0.5%
 
0.3%
 
0.2% - 0.5%
 
0.3%
 
0.2% - 0.5%
 
0.3%
Initial loss severity:
 
 
 
 
 
 
 
 
 
 
 
2005 and prior
60%
 
 
 
60%
 
 
 
60%
 
 
2006
80%
 
 
 
80%
 
 
 
80%
 
 
2007+
70%
 
 
 
70%
 
 
 
70%
 
 
Option ARM
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
3.2% - 6.6%
 
5.4%
 
3.7% - 6.7%
 
5.5%
 
3.2% - 7.0%
 
5.7%
Final CDR
0.2% - 0.3%
 
0.3%
 
0.2% - 0.3%
 
0.3%
 
0.2% - 0.3%
 
0.3%
Initial loss severity:
 
 
 
 
 
 
 
 
 
 
 
2005 and prior
60%
 
 
 
60%
 
 
 
60%
 
 
2006
70%
 
 
 
70%
 
 
 
70%
 
 
2007+
75%
 
 
 
75%
 
 
 
75%
 
 
Subprime
 
 
 
 
 
 
 
 
 
 
 
Plateau CDR
4.3% - 11.4%
 
7.9%
 
4.4% - 11.3%
 
7.9%
 
4.3% - 10.1%
 
8.1%
Final CDR
0.2% - 0.6%
 
0.4%
 
0.2% - 0.6%