Financial Guaranty Contracts Accounted for as Insurance

3 Months Ended

Mar. 31, 2011

Financial Guaranty Contracts Accounted for as Insurance

Financial Guaranty Contracts Accounted for as Insurance

5. Financial Guaranty Contracts Accounted for as Insurance

The following tables present net premium earned, premium receivable activity, expected collections of future premiums and expected future earnings on the existing book of business. The tables below provide the expected timing of premium revenue recognition, before accretion, and the expected timing of loss and loss adjustment expenses (“LAE”) recognition, before accretion. Actual collections may differ from expected collections in the tables below due to factors such as foreign exchange rate fluctuations and counterparty collectability issues. The amount and timing of actual premium earnings and loss expense may differ from the estimates shown below due to factors such as refundings, accelerations, future commutations, and updates to loss estimates.

Net Earned Premiums

	First Quarter
	2011		2010
	(in millions)
			(restated)
Scheduled net earned premiums	$	214.9	$	286.6
Acceleration of premium earnings(1)	29.6		15.4
Accretion of discount on net premiums receivable	9.0		12.1
Total financial guaranty	253.5		314.1
Other	0.5		0.6
Total net earned premiums(2)	$	254.0	$	314.7

(1) Reflects the unscheduled refundings of underlying insured obligations.

(2) Excludes $19.1 million and $10.9 million in First Quarter 2011 and 2010, respectively, related to consolidated VIEs.

Gross Premium Receivable, Net of Ceding Commissions Roll Forward

	First Quarter
	2011			2010
	(in millions)
				(restated)
Balance beginning of period	$	1,167.6		$	1,418.2
Change in accounting(1)	—			(19.0		)
Balance beginning of the period, adjusted	1,167.6			1,399.2
Premium written, net	48.0			83.7
Premium payments received, net	(72.8		)	(113.3		)
Adjustments to the premium receivable:
Changes in the expected term of financial guaranty insurance contracts	(51.1		)	9.6
Accretion of the discount	9.2			13.9
Foreign exchange translation	15.9			(38.6		)
Other adjustments	1.2			2.4
Balance, end of period	$	1,118.0		$	1,356.9

(1) Represents elimination of premium receivable related to consolidated financial guaranty VIEs.

Gains or losses due to foreign exchange rate changes relate to installment premium receivables denominated in currencies other than the U.S. dollar. Approximately 45% and 42% of the Company’s installment premiums at March 31, 2011 and December 31, 2010, respectively, are denominated in currencies other than the U.S. dollar, primarily in euro and British Pound Sterling.

For premiums received in installments, premium receivable is the present value of premiums due or expected to be collected over the life of the contract. Installment premiums typically relate to structured finance transactions, where the insurance premium rate is determined at the inception of the contract but the insured par is subject to prepayment throughout the life of the deal. Premium receipts are typically made from insured deal cash flows that are senior to payments made to the holders of the insured securities. When there are significant changes to expected premium collections, an adjustment is recorded to premium receivable, with a corresponding adjustment to deferred premium revenue.

Expected Collections of Gross Premiums Receivable,

Net of Ceding Commissions

	March 31, 2011(1)
	(in millions)
Gross premium collections expected:
2011 (April 1 - June 30)	$	67.7
2011 (July 1 - September 30)	34.7
2011 (October 1 - December 31)	57.3
2012	120.5
2013	105.3
2014	93.8
2015	84.5
2016 - 2020	339.4
2021 - 2025	237.6
2026 - 2030	170.6
After 2030	217.7
Total gross expected collections	$	1,529.1

(1) Represents undiscounted amounts expected to be collected.

The unearned premium reserve is comprised of deferred premium revenue and the contra-paid as presented in the table below.

Net Unearned Premium Reserve

	As of March 31, 2011									As of December 31, 2010
	Gross Unearned Premium Reserve			Ceded Unearned Premium Reserve			Net Unearned Premium Reserve			Gross Unearned Premium Reserve			Ceded Unearned Premium Reserve			Net Unearned Premium Reserve
	(in millions)
Deferred premium revenue	$	6,823.5		$	816.5		$	6,007.0		$	7,108.6		$	846.6		$	6,262.0
Contra-paid	(195.9		)	(22.2		)	(173.7		)	(146.1		)	(24.8		)	(121.3		)
Total financial guaranty	6,627.6			794.3			5,833.3			6,962.5			821.8			6,140.7
Other	9.6			—			9.6			10.4			—			10.4
Total	$	6,637.2		$	794.3		$	5,842.9		$	6,972.9		$	821.8		$	6,151.1

Net deferred premium revenue will be recognized as net earned premiums. Amounts expected to be recognized in net earned premiums differ significantly from expected cash collections due primarily to amounts in deferred premium revenue representing cash already collected on policies paid upfront and fair value adjustments recorded in connection with the acquisition of AGHM on July 1, 2009 (“AGMH Acquisition”).

The following table provides a schedule of the expected timing of the income statement recognition of financial guaranty insurance net deferred premium revenue and present value of net expected losses to be expensed, pre-tax. This table excludes amounts related to consolidated VIEs.

Expected Timing of Financial Guaranty Insurance

Premium and Loss Recognition

	As of March 31, 2011
	Scheduled Net Earned Premium		Net Expected Loss to be Expensed(1)		Net
	(in millions)
			(restated)		(restated)
2011 (April 1 - June 30)	$	200.4	$	48.1	$	152.3
2011 (July 1 - September 30)	185.1		49.2		135.9
2011 (October 1 - December 31)	171.6		40.3		131.3
2012	589.9		111.1		478.8
2013	491.2		62.0		429.2
2014	434.7		46.0		388.7
2015	385.4		37.4		348.0
2016 - 2020	1,451.2		139.1		1,312.1
2021 - 2025	918.3		68.5		849.8
2026 - 2030	567.9		54.9		513.0
After 2030	611.3		53.6		557.7
Total present value basis(2)(3)	6,007.0		710.2		5,296.8
Discount	358.4		517.5		(159.1		)
Total future value	$	6,365.4	$	1,227.7	$	5,137.7

(1)	These amounts reflect the Company’s estimate as of March 31, 2011 of expected losses to be expensed and are not included in loss and LAE reserve because loss and LAE is only recorded for the amount total loss exceeds deferred premium revenue, determined on a contract-by-contract basis.
(2)	Balances represent discounted amounts.
(3)	The effect of consolidating financial guaranty VIEs resulted in a reduction of $294.0 million in future scheduled net earned premium and $196.6 million in expected loss and LAE to be expensed, excluding accretion of discount.

Selected Information for Policies Paid in Installments

	As of March 31, 2011			As of December 31, 2010
	(dollars in millions)
Premiums receivable, net of ceding commission payable	$	1,118.0		$	1,167.6
Gross deferred premium revenue	2,733.0			2,933.6
Weighted-average risk-free rate used to discount premiums	3.6		%	3.5		%
Weighted-average period of premiums receivable (in years)	10.1			10.1

Loss Estimation Process

The Company’s loss reserve committees estimate expected losses for the Company’s financial guaranty exposures. Surveillance personnel present analysis related to potential losses to the Company’s loss reserve committees for consideration in estimating the expected loss of the Company. Such analysis includes the consideration of various scenarios with potential 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, judgmental assessment or, in the case of its assumed business, loss estimates provided by ceding insurers. The Company’s loss reserve committees review and refresh the Company’s expected loss estimates each quarter. The Company’s estimate of ultimate loss on a policy is subject to significant uncertainty over the life of the insured transaction due to the potential for significant variability in credit performance due to changing economic, fiscal and financial market variability over the long duration of most contracts. The determination of expected loss is an inherently subjective process involving numerous estimates, assumptions and judgments by management.

The following table presents a roll forward of the present value of net expected loss and LAE to be paid for financial guaranty contracts accounted for as insurance by sector. Expected loss to be paid is the Company’s estimate of the present value of future claim payments, net of reinsurance and net of salvage and subrogation which includes the present value benefit of estimated recoveries for breaches of R&W.

Financial Guaranty Insurance

Present Value of Net Expected Loss and LAE to be paid

Roll Forward by Sector(1)

	Expected Loss to be Paid as of December 31, 2010			Development and Accretion of Discount(2)			Less: Paid Losses		Expected Loss to be Paid as of March 31, 2011
	(in millions)
	(restated)			(restated)					(restated)
U.S. RMBS:
First lien:
Prime first lien	$	1.4		$	0.1		$	—	$	1.5
Alt-A first lien	184.4			6.5			19.5		171.4
Option ARM	523.7			(114.7		)	86.9		322.1
Subprime	200.4			(17.8		)	15.1		167.5
Total first lien	909.9			(125.9		)	121.5		662.5
Second lien:
Closed end second lien	56.6			(106.4		)	27.1		(76.9		)
HELOCs	(805.7		)	77.6			64.6		(792.7		)
Total second lien	(749.1		)	(28.8		)	91.7		(869.6		)
Total U.S. RMBS	160.8			(154.7		)	213.2		(207.1		)
Other structured finance	159.1			16.3			2.4		173.0
Public finance	88.9			(13.6		)	9.0		66.3
Total	$	408.8		$	(152.0	)	$	224.6	$	32.2

	Expected Loss to be Paid as of December 31, 2009			Development and Accretion of Discount(2)			Less: Paid Losses		Expected Loss to be Paid as of March 31, 2010
	(in millions)
	(restated)			(restated)					(restated)
U.S. RMBS:
First lien:
Prime first lien	$	—		$	0.4		$	—	$	0.4
Alt-A first lien	204.4			9.0			14.0		199.4
Option ARM	545.2			31.8			16.4		560.6
Subprime	77.5			50.0			0.9		126.6
Total first lien	827.1			91.2			31.3		887.0
Second lien:
Closed end second lien	199.3			(42.3		)	20.5		136.5
HELOCs	(206.6		)	63.6			149.0		(292.0		)
Total second lien	(7.3		)	21.3			169.5		(155.5		)
Total U.S. RMBS	819.8			112.5			200.8		731.5
Other structured finance	115.7			0.9			3.7		112.9
Public finance	130.9			20.1			24.4		126.6
Total	$	1,066.4		$	133.5		$	228.9	$	971.0

(1) Amounts include all expected payments whether or not the insured transaction VIE is consolidated. Amounts exclude expected losses for mortgage business of $2.1 million as of March 31, 2011 and December 31, 2010.

(2) Represents economic loss development plus accretion of discount in the period.

The Company’s expected LAE for mitigating claim liabilities were $16.5 million and $17.2 million as of March 31, 2011 and December 31, 2010, respectively. The Company used weighted-average risk free rates ranging from 0% to 5.29% and 0% to 5.34% to discount expected losses as of March 31, 2011 and December 31, 2010, respectively.

The table below provides a reconciliation of the Company’s expected loss to be paid to expected loss to be expensed. Expected loss to be paid differs from expected loss to be expensed due to: (1) the contra-paid because the payments have been made but have not yet been expensed, (2) for transactions with a net expected recovery, the addition of claim payments that have been made (and therefore are not included in expected loss to be paid) that are expected to be recovered in the future (and therefore have also reduced expected loss to be paid), and (3) loss reserves that have already been established and therefore expensed but not yet paid.

Reconciliation of Present Value of Net Expected Loss to be Paid

and Present Value of Net Expected Loss to be Expensed

	As of March 31, 2011			As of December 31, 2010
	(in millions)
	(restated)			(restated)
Net expected loss to be paid	$	32.2		$	408.8
Less: net expected loss to be paid for financial guaranty VIEs	24.9			49.2
Total	7.3			359.6
Contra-paid, net	173.7			121.3
Salvage and subrogation recoverable, net(1)	928.1			903.0
Loss and LAE reserve, net(2)	(398.9		)	(550.0		)
Net expected loss to be expensed(3)	$	710.2		$	833.9

(1) The March 31, 2011 amount consists of gross salvage and subrogation amounts of $1,057.0 million net of ceded amounts of $128.9 million which is recorded in reinsurance balances payable. The December 31, 2010 amount consists of gross salvage and subrogation amounts of $1,032.4 million net of ceded amounts of $129.4 million which is recorded in reinsurance balances payable.

(2) Represents loss and LAE reserves, net of reinsurance recoverable on unpaid losses, excluding $2.1 million in reserves for other run off lines of business as of March 31, 2011 and December 31, 2010.

(3) Excludes $196.6 million and $211.9 million as of March 31, 2011 and December 31, 2010, respectively, related to consolidated financial guaranty VIEs.

The Company’s Approach to Projecting Losses in U.S. RMBS

The Company projects losses in U.S. RMBS on a transaction-by-transaction basis by projecting the performance of the underlying pool of mortgages over time and then applying the structural features (i.e., payment priorities and tranching) of the RMBS to the projected performance of the collateral over time. The resulting projected claim payments or reimbursements are then discounted to a present value using a risk free rate. For transactions where the Company projects it will receive recoveries from providers of R&W, the projected amount of recoveries is included in the projected cash flows from the collateral. The Company runs, and probability-weights, several sets of assumptions (referred to as”scenarios”) regarding potential mortgage collateral performance.

The further behind a mortgage borrower falls in payments, the more likely it is that he or she will default. The rate at which borrowers from a particular delinquency category (number of monthly payments behind) eventually default is referred to as the “liquidation rate.” Liquidation rates may be derived from observed roll rates, which are the rates at which loans progress from one delinquency category to the next and eventually to default and liquidation. The Company applies liquidation rates to the mortgage loan collateral in each delinquency category and makes certain timing assumptions to project near-term mortgage collateral defaults from loans that are currently delinquent.

Mortgage borrowers that are not more than one payment behind (generally considered performing borrowers) have demonstrated an ability and willingness to pay throughout the recession and mortgage crisis, and as a result are viewed as less likely to default than delinquent borrowers. Performing borrowers that eventually default will also need to progress through delinquency categories before any defaults occur. The Company projects how much of the currently performing loans will default and when by first converting the projected near term defaults of delinquent borrowers derived from liquidation rates into a vector of conditional default rates, then projecting how the conditional default rates will develop over time. Loans that are defaulted pursuant to the conditional default rate after the liquidation of currently delinquent loans represent defaults of currently performing loans. A conditional default rate is the outstanding principal amount of loans defaulting in a given month divided by the remaining outstanding amount of the whole pool of loans (or “collateral pool balance”). The collateral pool balance decreases over time as a result of scheduled principal payments, partial and whole principal repayments, and defaults.

In order to derive collateral pool losses from the collateral pool defaults it has projected, the Company applies a loss severity. The loss severity is the amount of loss the transaction experiences on a defaulted loan after the application of net proceeds from the disposal of the underlying property. The Company projects loss severities by sector based on experience to date. Further detail regarding the assumptions and variables the Company used to project collateral losses in its U.S. RMBS portfolio may be found below in the sections “U.S. Second Lien RMBS Loss Projections: HELOCs and Closed-End Second Lien” and “U.S. First Lien RMBS Loss Projections: Alt-A First Lien, Option ARM, Subprime and Prime”.

The Company is in the process of enforcing claims for breaches of R&W regarding the characteristics of the loans included in the collateral pools. The Company calculates a credit to the RMBS issuer for such recoveries where the R&W were provided by an entity the Company believes to be financially viable and where the Company already has access or believes it will attain access to the underlying mortgage loan files. In second liens this credit is based on a factor of actual repurchase rates achieved, while in first liens this credit is estimated by reducing collateral losses projected by the Company to reflect a factor of the recoveries the Company believes it will achieve, which factor is derived based on the number of breaches identified to date and incorporated scenarios based on the amounts the Company was able to negotiate under the Bank of America Agreement. The first lien approach is different than the second lien approach because of the Company’s first lien transactions have multiple tranches and a more complicated method is required to correctly allocate credit to each tranche. In each case, the credit is a function of the projected lifetime collateral losses in the collateral pool, so an increase in projected collateral losses increases the representation and warranty credit calculated by the Company for the RMBS issuer. Further detail regarding how the Company calculates these credits may be found under “Breaches of Representations and Warranties” below.

The Company projects the overall future cash flow from a collateral pool by adjusting the payment stream from the principal and interest contractually due on the underlying mortgages for (a) the collateral losses it projects as described above, (b) assumed voluntary prepayments and (c) recoveries for breaches of R&W as described above. The Company then applies an individual model of the structure of the transaction to the projected future cash flow from that transaction’s collateral pool to project the Company’s future claims and claim reimbursements for that individual transaction. Finally, the projected claims and reimbursements are discounted to a present value using a risk free rate. As noted above, the Company runs several sets of assumptions regarding mortgage collateral performance, or scenarios, and probability weights them.

First Quarter-End 2011 U.S. RMBS Loss Projections

The Company’s RMBS projection methodology assumes that the housing and mortgage markets will eventually recover. Accordingly, the Company retaining the initial plateau period used in the previous quarter reflects an assumption that the recovery in the housing and mortgage markets will be delayed by another three months.

The scenarios used to project RMBS collateral losses in first quarter of 2011, with the exception of an increase in the recovery time for second lien transactions and an increase to the initial Alt-A first lien and Option ARM loss severities, were the same as those employed at year-end 2010. During the First Quarter 2011, the Company observed continued elevated levels of early stage delinquencies. As a result, it adjusted its second lien loss projection curves to reflect its view that the recovery would be longer and more gradual than it had anticipated at year-end 2010. The Company also adjusted its probability weights to reflect that this adjustment was made to each of its second lien scenarios. Additionally, during the First Quarter 2011, the Company noted that Alt-A first lien and Option ARM loss severities appeared to be trending higher. As a result, it increased its initial loss severity for Alt-A first lien and Option ARM collateral from 60% to 65%.

The Company also used generally the same methodology to project the credit received by the RMBS issuers for recoveries in R&W in First Quarter 2011 as it used at year-end 2010. The primary difference relates to the Company’s execution of the Bank of America Agreement and the inclusion of the terms of the agreement as a potential scenario in transactions not sponsored by Bank of America. The Company also added R&W credits for two second lien transactions where the Company concluded it had the right to obtain loan files that it had not previously concluded were accessible. The Company also added R&W credits for ten first lien transactions where either it concluded it had the right to obtain loan files that it had not previously concluded were accessible or where it anticipates receiving a benefit due to the Bank of America Agreement. See “Bank of America Agreement” in Note 3.

U.S. Second Lien RMBS Loss Projections: HELOCs and Closed-End Second Lien

The Company insures two types of second lien RMBS: those secured by HELOCs and those secured by closed end second lien mortgages. HELOCs are revolving lines of credit generally secured by a second lien on a one to four family home. A mortgage for a fixed amount secured by a second lien on a one to four family home is generally referred to as a closed end second lien. Both first lien RMBS and second lien RMBS sometimes include a portion of loan collateral with a different priority than the majority of the collateral. The Company has material exposure to second lien mortgage loans originated and serviced by a number of parties, but the Company’s most significant second lien exposure is to HELOCs originated and serviced by Countrywide, a subsidiary of Bank of America. See “Breaches of Representations and Warranties.”

The delinquency performance of HELOC and closed end second lien exposures included in transactions insured by the Company began to deteriorate in 2007, and such transactions, particularly those originated in the period from 2005 through 2007, continue to perform below the Company’s original underwriting expectations. While insured securities benefit from structural protections within the transactions designed to absorb collateral losses in excess of previous historical high levels, in many second lien RMBS projected losses now exceed those structural protections.

The Company believes the primary variables impacting its expected losses in second lien RMBS transactions are the amount and timing of future losses in the collateral pool supporting the transactions and the amount of loans repurchased for breaches of R&W. Expected losses are also a function of the structure of the transaction; the voluntary prepayment rate (typically also referred to as conditional prepayment rate of the collateral); the interest rate environment; and assumptions about the draw rate and loss severity. These variables are interrelated, difficult to predict and subject to considerable volatility. If actual experience differs from the Company’s assumptions, the losses incurred could be materially different from the estimate. The Company continues to update its evaluation of these exposures as new information becomes available.

The following table shows the Company’s key assumptions used in its calculation of estimated expected losses for the Company’s direct vintage 2004 - 2008 second lien U.S. RMBS as of March 31, 2011, December 31, 2010, and March 31, 2010:

Assumptions in Base Case Expected Loss Estimates

Second Lien RMBS(1)

HELOC Key Variables	As of March 31, 2011	As of December 31, 2010	As of March 31, 2010
Plateau conditional default rate	4.7% - 21.4%	4.2% - 22.1%	11.5% - 38.0%
Final conditional default rate trended down to	0.4% - 3.2%	0.4% - 3.2%	0.5% - 3.2%
Expected period until final conditional default rate	36 months	24 months	21 months
Initial conditional prepayment rate	0.9% - 12.6%	3.3% - 17.5%	0.4% - 13.4%
Final conditional prepayment rate	10%	10%	10%
Loss severity	98%	98%	95%
Initial draw rate	0.0% - 5.2%	0.0% - 6.8%	0.2% - 4.8%

Closed end second lien Key Variables	As of March 31, 2011	As of December 31, 2010	As of March 31, 2010
Plateau conditional default rate	7.2% - 28.9%	7.3% - 27.1%	21.5% - 44.2%
Final conditional default rate trended down to	2.9% - 8.1%	2.9% - 8.1%	2.9% - 8.1%
Expected period until final conditional default rate achieved	36 months	24 months	21 months
Initial conditional prepayment rate	0.9% - 12.7%	1.3% - 9.7%	0.8% - 3.6%
Final conditional prepayment rate	10%	10%	10%
Loss severity	98%	98%	95%

(1) Represents assumptions for most heavily weighted scenario (the “base case”).

In second lien transactions the projection of near-term defaults from currently delinquent loans is relatively straightforward because loans in second lien transactions are generally “charged off” (treated as defaulted) by the securitization’s servicer once the loan is 180 days past due. Most second lien transactions report the amount of loans in five monthly delinquency categories (i.e., 30-59 days past due, 60-89 days past due, 90-119 days past due, 120-149 days past due and 150-179 days past due). The Company estimates the amount of loans that will default over the next five months by calculating current representative liquidation rates (the percent of loans in a given delinquency status that are assumed to ultimately default) from selected representative transactions and then applying an average of the preceding 12 months’ liquidation rates to the amount of loans in the delinquency categories. The amount of loans projected to default in the first through fifth months is expressed as a conditional default rate. The first four months’ conditional default rate is calculated by applying the liquidation rates to the current period past due balances (i.e., the 150-179 day balance is liquidated in the first projected month, the 120-149 day balance is liquidated in the second projected month, the 90-119 day balance is liquidated in the third projected month and the 60-89 day balance is liquidated in the fourth projected month). For the fifth month the conditional default rate is calculated using the average 30-59 day past due balances for the prior three months. An average of the third, fourth and fifth month conditional default rates is then used as the basis for the plateau period that follows the embedded five months of losses.

As of March 31, 2011, in the base scenario, the conditional default rate (the “plateau conditional default rate”) was held constant for one month. Once the plateau period has ended, the conditional default rate is assumed to gradually trend down in uniform increments to its final long-term steady state conditional default rate. In the base scenario, the time over which the conditional default rate trends down to its final conditional default rate is thirty months (compared to eighteen months at year-end 2010). Therefore, the total stress period for second lien transactions would be thirty-six months which is comprised of: five months of delinquent data, a one month plateau period and 30 months decrease to the steady state conditional default rate. This is twelve months longer than the 24 months of total stress period used at year-end 2010.The long-term steady state conditional default rates are calculated as the constant conditional default rates that would have yielded the amount of losses originally expected at underwriting. When a second lien loan defaults, there is generally very low recovery. Based on current expectations of future performance, the Company assumes that it will only recover 2% of the collateral.

The rate at which the principal amount of loans is prepaid may impact both the amount of losses projected (which is a function of the conditional default rate and the loan balance over time) as well as the amount of excess spread (which is the excess of the interest paid by the borrowers on the underlying loan over the amount of interest and expenses owed on the insured obligations). In the base case, the current conditional prepayment rate is assumed to continue until the end of the plateau before gradually increasing to the final conditional prepayment rate over the same period the conditional default rate decreases. For transactions where the initial conditional prepayment rate is higher than the final conditional prepayment rate, the initial conditional prepayment rate is held constant. The final conditional prepayment rate is assumed to be 10% for both HELOC and closed end second lien transactions. This level is much higher than current rates, but lower than the historical average, which reflects the Company’s continued uncertainty about performance of the borrowers in these transactions. This pattern is consistent with how the Company modeled the conditional prepayment rate at year-end 2010. To the extent that prepayments differ from projected levels it could materially change the Company’s projected excess spread.

The Company uses a number of other variables in its second lien loss projections, including the spread between relevant interest rate indices, and HELOC draw rates (the amount of new advances provided on existing HELOCs expressed as a percent of current outstanding advances). For HELOC transactions, the draw rate is assumed to decline from the current level to the final draw rate over a period of three months. The final draw rates were assumed to range from 0.0% to 2.6%.

In estimating expected losses, the Company modeled and probability weighted three possible conditional default rate curves applicable to the period preceding the return to the long-term steady state conditional default rate. Given that draw rates have been reduced to levels below the historical average and that loss severities in these products have been higher than anticipated at inception, the Company believes that the level of the elevated conditional default rate and the length of time it will persist is the primary driver behind the likely amount of losses the collateral will suffer (before considering the effects of repurchases of ineligible loans). The Company continues to evaluate the assumptions affecting its modeling results.

At March 31, 2011, the Company’s base case assumed a one month conditional default rate plateau and a 30 months ramp down (for a total stress period of 36 months). Increasing the conditional default rate plateau to 4 months and keeping the ramp down at 30 months (for a total stress period of 39 months) would increase the expected loss by approximately $88.3 million for HELOC transactions and $9.8 million for closed end second lien transactions. On the other hand, keeping the conditional default rate plateau at one month but decreasing the length of the conditional default rate ramp down to a 24 month assumption (for a total stress period of 30 months) would decrease the expected loss by approximately $80.1 million for HELOC transactions and $3.9 million for closed end second lien transactions.

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

First lien RMBS are generally categorized in accordance with the characteristics of the first lien mortgage loans on one to four family homes supporting the transactions. The collateral supporting “subprime” RMBS transactions is comprised of first-lien residential mortgage loans made to subprime borrowers. A “subprime borrower” is one considered to be a higher risk credit based on credit scores or other risk characteristics. Another type of RMBS transaction is generally referred to as “Alt-A first lien.” The collateral supporting such transactions is comprised of first-lien residential mortgage loans made to “prime” quality borrowers who lack certain ancillary characteristics that would make them prime. When more than 66% of the loans originally included in the pool are mortgage loans with an option to make a minimum payment that has the potential to negatively amortize the loan (i.e., increase the amount of principal owed), the transaction is referred to as an “Option ARM.” Finally, transactions may be primarily composed of loans made to prime borrowers. Both first lien RMBS and second lien RMBS sometimes include a portion of loan collateral with a different priority than the majority of the collateral.

The performance of the Company’s first lien RMBS exposures began to deteriorate in 2007 and such transactions, particularly those originated in the period from 2005 through 2007 continue to perform below the Company’s original underwriting expectations. The Company currently projects first lien collateral losses many times those expected at the time of underwriting. While insured securities benefitted from structural protections within the transactions designed to absorb some of the collateral losses, in many first lien RMBS transactions, projected losses exceed those structural protections.

The majority of projected losses in first lien RMBS transactions are expected to come from non-performing mortgage loans (those that are delinquent, in foreclosure or where the loan has been foreclosed and the RMBS issuer owns the underlying real estate). An increase in non-performing loans beyond that projected in the previous period is 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 delinquency categories. The Company arrived at its liquidation rates based on data in loan performance and assumptions about how delays in the foreclosure process may ultimately affect the rate at which loans are liquidated. The liquidation rate is a standard industry measure that is used to estimate the number of loans in a given aging category that will default within a specified time period. The Company projects these liquidations to occur over two years.

The following table shows the Company’s liquidation assumptions for various delinquency categories. There were no changes to the liquidation rates as of March 31, 2011, December 31, 2010 and March 31, 2010.

First Lien Liquidation Rates

30 - 59 Days Delinquent
Alt-A first lien	50	%
Option ARM	50
Subprime	45
60 - 89 Days Delinquent
Alt-A first lien	65
Option ARM	65
Subprime	65
90 - Bankruptcy
Alt-A first lien	75
Option ARM	75
Subprime	70
Foreclosure
Alt-A first lien	85
Option ARM	85
Subprime	85
Real Estate Owned
Alt-A first lien	100
Option ARM	100
Subprime	100

While the Company uses liquidation rates as described above to project defaults of non-performing loans, it projects defaults on presently current loans by applying a conditional default rate trend. The start of that conditional default rate trend is based on the defaults the Company projects will emerge from currently nonperforming loans. The total amount of expected defaults from the non-performing loans is translated into a constant conditional default rate (i.e., the conditional default rate plateau), which, if applied for each of the next 24 months, would be sufficient to produce approximately the amount of defaults that were calculated to emerge from the various delinquency categories. The conditional default rate thus calculated individually on the collateral pool for each RMBS is then used as the starting point for the conditional default rate curve used to project defaults of the presently performing loans.

In the base case, each transaction’s conditional default rate is projected to improve over 12 months to an intermediate conditional default rate (calculated as 15% of its conditional default rate plateau); that intermediate conditional default rate is held constant for 36 months and then trails off in steps to a final conditional default rate of 5% of the conditional default rate plateau. Under the Company’s methodology, defaults projected to occur in the first 24 months represent defaults that can be attributed to loans that are currently delinquent or in foreclosure, while the defaults projected to occur using the projected conditional default rate trend after the first 24 month period represent defaults attributable to borrowers that are currently performing.

Another important driver of loss projections is loss severity, which is the amount of loss the transaction incurs on a loan after the application of net proceeds from the disposal of the underlying property. Loss severities experienced in first lien transactions have reached historical high levels and the Company is assuming that these historical high levels will continue for another year. The Company determines its initial loss severity based on actual recent experience. The Company then assumes that loss severities begin returning to levels consistent with underwriting assumptions beginning in March 2012, and in the base scenario decline over two years to 40%.

The following table shows the Company’s key assumptions used in its calculation of expected losses for the Company’s direct vintage 2004 - 2008 first lien U.S. RMBS as of March 31, 2011, December 31, 2010 and March 31, 2010.

Key Assumptions in Base Case Expected Loss Estimates of First Lien RMBS Transactions

	As of March 31, 2011	As of December 31, 2010	As of March 31, 2010
Alt-A First Lien
Plateau conditional default rate	2.7% - 40.2%	2.6% - 42.2%	2.0% - 34.4%
Intermediate conditional default rate	0.4% - 6.0%	0.4% - 6.3%	0.3% - 5.2%
Final conditional default rate	0.1% - 2.0%	0.1% - 2.1%	0.1% - 1.7%
Initial loss severity	65%	60%	60%
Initial conditional prepayment rate	0.4% - 40.5%	0.0% - 36.5%	0.0% - 27.9%
Final conditional prepayment rate	10%	10%	10%
Option ARM
Plateau conditional default rate	12.3% - 33.2%	11.7% - 32.7%	15.1% - 27.4%
Intermediate conditional default rate	1.8% - 5.0%	1.8% - 4.9%	2.3% - 4.1%
Final conditional default rate	0.6% - 1.7%	0.6% - 1.6%	0.8 - 1.4%
Initial loss severity	65%	60%	60%
Initial conditional prepayment rate	0.0% - 24.5%	0.0% - 17.7%	0.0% - 12.3%
Final conditional prepayment rate	10%	10%	10%
Subprime
Plateau conditional default rate	8.0% - 34.3%	9.0% - 34.6%	7.8% - 30.4%
Intermediate conditional default rate	1.2% - 5.1%	1.3% - 5.2%	1.2% - 4.6%
Final conditional default rate	0.4% - 1.7%	0.4% - 1.7%	0.4% - 1.5%
Initial loss severity	80%	80%	75%
Initial conditional prepayment rate	0.0% - 13.3%	0.0% - 13.5%	0.0% - 12.5%
Final conditional prepayment rate	10%	10%	10%

The rate at which the principal amount of loans is prepaid may impact both the amount of losses projected (since that amount is a function of the conditional default rate and the loan balance over time) as well as the amount of excess spread (the amount by which the interest paid by the borrowers on the underlying loan exceeds the amount of interest owed on the insured obligations). The assumption for the conditional prepayment rate follows a similar pattern to that of the conditional default rate. The current level of voluntary prepayments is assumed to continue for the plateau period before gradually increasing over 12 months to the final conditional prepayment rate, which is assumed to be either 10% or 15% depending on the scenario run. For transactions where the initial conditional prepayment rate is higher than the final conditional prepayment rate, the initial conditional prepayment rate is held constant.

The ultimate performance of the Company’s first lien RMBS transactions remains highly uncertain and may be subject to considerable volatility due to the influence of many factors, including the level and timing of loan defaults, changes in housing prices and other variables. The Company will continue to monitor the performance of its RMBS exposures and will adjust the loss projections for those transactions based on actual performance and management’s estimates of future performance.

In estimating expected losses, the Company modeled and probability weighted sensitivities for first lien transactions by varying its assumptions of how fast recovery is expected to occur. The primary variable when modeling sensitivities was how quickly the conditional default rate returned to its modeled equilibrium, which was defined as 5% of the current conditional default rate. The Company also stressed conditional prepayment rates and the speed of recovery of loss severity rates. In a somewhat more stressful environment than that of the base case, where the conditional default rate recovery was more gradual and the final conditional prepayment rate was 15% rather than 10%, the Company’s expected losses would increase by approximately $8.3 million for Alt-A first liens, $57.3 million for Option ARMs, $25.7 million for subprime and $0.1 million for prime transactions. In an even more stressful scenario where the conditional default rate plateau was extended 3 months (to be 27 months long) before the same more gradual conditional default rate recovery and loss severities were assumed to recover over 4 rather than 2 years (and subprime loss severities were assumed to recover only to 60%), the Company’s expected losses would increase by approximately $40.6 million for Alt-A first liens, $142.3 million for Option ARMs, $170.8 million for subprime and $0.6 million for prime transactions. The Company also considered a scenario where the recovery was faster than in its base case. In this scenario, where the conditional default rate plateau was 3 months shorter (21 months, effectively assuming that liquidation rates would improve) and the conditional default rate recovery was more pronounced, the Company’s expected losses would decrease by approximately $22.5 million for Alt-A first liens, $76.7 million for Option ARMs, $30.7 million for subprime and $0.3 million for prime transactions.

Breaches of Representations and Warranties

The Company is pursuing reimbursements for breaches of R&W regarding loan characteristics. Performance of the collateral underlying certain first and second lien securitizations has substantially differed from the Company’s original expectations. The Company has employed several loan file diligence firms and law firms as well as devoted internal resources to review the mortgage files surrounding many of the defaulted loans. The Company’s success in these efforts resulted in two negotiated agreements, to date, in respect of the Company’s R&W claims, including on April 14, 2011 with Bank of America as described under “Bank of America Agreement” in Note 3. Additionally, for the counterparties with which the Company had not settled its claims for breaches of representations and warranties, the Company had performed a detailed review of approximately 13,500 second lien and 15,400 first lien defaulted loan files, representing approximately $940 million in second lien and $4.5 billion in first lien outstanding par of defaulted loans underlying insured transactions. The Company identified approximately 12,000 second lien transaction loan files and approximately 14,550 first lien transaction loan files that breached one or more R&W regarding the characteristics of the loans, such as misrepresentation of income or employment of the borrower, occupancy, undisclosed debt and non-compliance with underwriting guidelines at loan origination. The Company continues to review new files as new loans default and as new loan files are made available to it. The Company generally obtains the loan files from the originators or servicers (including master servicers). In some cases, the Company requests loan files via the trustee, which then requests the loan files from the originators and/or servicers. On second lien loans, the Company requests loan files for all charged-off loans. On first lien loans, the Company requests loan files for all severely (60+ days) delinquent loans and all liquidated loans. Recently, the Company started requesting loan files for all the loans (both performing and non-performing) in certain deals to limit the number of requests for additional loan files as the transactions season and loans charge-off, become 60+ days delinquent or are liquidated. The Company takes no repurchase credit for R&W breaches on loans that are expected to continue to perform. Following negotiations with the providers of the R&W, as of March 31, 2011, the Company had reached agreement for providers to repurchase $33 million of second lien and $42 million of first lien loans. The $33 million for second lien loans represents the calculated repurchase price for 123 loans and the $42 million for first lien loans represents the calculated repurchase price for 378 loans. The repurchase proceeds are paid to the RMBS transactions and distributed in accordance with the payment priorities set out in the transaction agreements, so the proceeds are not necessarily allocated to the Company on a dollar-for-dollar basis. Proceeds projected to be reimbursed to the Company on transactions where the Company has already paid claims are viewed as a recovery on paid losses. For transactions where the Company has not already paid claims, projected recoveries reduce projected loss estimates. In either case, projected recoveries have no effect on the amount of the Company’s exposure. These amounts reflect payments made pursuant to the negotiated transaction agreements and not payments made pursuant to legal settlements. See “Recovery Litigation” below for a description of the related legal proceedings the Company has commenced.

The Company has included in its net expected loss estimates as of March 31, 2011 an estimated benefit from loan repurchases related to breaches of R&W of $2.2 billion, which includes amounts with Bank of America. The amount of benefit recorded as a reduction of expected losses was calculated by extrapolating each transaction’s breach rate on defaulted loans to projected defaults and, in the case of transactions subject to the Bank of America Agreement, the estimated impact of that agreement on the relevant transactions. See “Bank of America Agreement” in Note 3. The Company did not incorporate any gain contingencies or damages paid from potential litigation in its estimated repurchases. The amount the Company will ultimately recover related to contractual R&W is uncertain and subject to a number of factors including the counterparty’s ability to pay, the number and loss amount of loans determined to have breached R&W and, potentially, negotiated settlements or litigation recoveries. As such, the Company’s estimate of recoveries is uncertain and actual amounts realized may differ significantly from these estimates. In arriving at the expected recovery from breaches of R&W, the Company considered the credit worthiness of the provider of the R&W, the number of breaches found on defaulted loans, the success rate in resolving these breaches with the provider of the R&W and the potential amount of time until the recovery is realized.

The calculation of expected recovery from breaches of R&W involved a variety of scenarios which ranged from the Company recovering substantially all of the losses it incurred due to violations of R&W to the Company realizing very limited recoveries. The Company did not include any recoveries related to breaches of R&W in amounts greater than the losses it expected to pay under any given cash flow scenario. These scenarios were probability weighted in order to determine the recovery incorporated into the Company’s reserve estimate. This approach was used for both loans that had already defaulted and those assumed to default in the future. In all cases, recoveries were limited to amounts paid or expected to be paid by the Company.

The following table represents the Company’s total estimated recoveries netted in expected loss to be paid, from defective mortgage loans included in certain first and second lien U.S. RMBS loan securitizations that it insures. The Company had $2.2 billion of estimated recoveries from ineligible loans as of March 31, 2011, of which $1.0 billion is reported in salvage and subrogation recoverable, $0.8 billion is netted in loss and LAE reserves and $0.4 billion is netted in the unearned premium reserve portion of its stand- ready obligation reported on the Company’s consolidated balance sheet. The Company had $1.6 billion of estimated recoveries from ineligible loans as of December 31, 2010, of which $0.9 billion is reported in salvage and subrogation recoverable, $0.5 billion is netted in loss and LAE reserves and $0.2 billion is netted in unearned premium reserve portion of its stand-ready obligation reported on the Company’s consolidated balance sheet.

Roll Forward of Estimated Benefit from Recoveries from Representation and Warranty Breaches,

Net of Reinsurance

	Future Net R&W Benefit at December 31, 2010		R&W Development and Accretion of Discount during 2011		Less: R&W Recovered During 2011(1)		Future Net R&W Benefit at March 31, 2011(2)
	(dollars in millions)
Prime first lien	$	1.1	$	1.2	$	—	$	2.3
Alt-A first lien	81.0		39.7		—		120.7
Option ARM	309.3		335.3		25.6		619.0
Subprime	26.8		54.3		—		81.1
Closed end second lien	178.2		95.0		—		273.2
HELOC	1,004.1		154.5		33.9		1,124.7
Total	$	1,600.5	$	680.0	$	59.5	$	2,221.0

	Future Net R&W Benefit at December 31, 2009		R&W Development and Accretion of Discount during 2010		Less: R&W Recovered During 2010(1)		Future Net R&W Benefit at March 31, 2010
	(dollars in millions)
Prime first lien	$	—	$	0.9	$	—	$	0.9
Alt-A first lien	64.2		11.6		—		75.8
Option ARM	203.7		40.0		7.7		236.0
Subprime	—		—		—		—
Closed end second lien	76.5		60.2		—		136.7
HELOC	828.7		43.3		22.7		849.3
Total	$	1,173.1	$	156.0	$	30.4	$	1,298.7

(1) Gross amount recovered are $64.2 million and $34.8 million in First Quarter 2011 and 2010, respectively.

(2) Includes R&W benefit of $1,324.3 million attributable to transactions covered by the Bank of America Agreement.

Financial Guaranty Insurance U.S. RMBS Policies with R&W Benefit

as of March 31, 2011 and December 31, 2010

	# of Insurance Policies with R&W Benefit Recorded as of		Outstanding Principal and Interest Policies with R&W Benefit Recorded as of
	March 31, 2011	December 31, 2010	March 31, 2011		December 31, 2010
	(dollars in millions)
Prime first lien	1	1	$	55.6	$	57.1
Alt-A first lien	21	17	1,909.9		1,882.8
Option ARM	12	11	2,099.7		1,909.8
Subprime	4	1	995.9		228.7
Closed end second lien	4	4	411.0		444.9
HELOC	16	13	3,909.7		2,969.8
Total	58	47	$	9,381.8	$	7,493.1

The following table provides a breakdown of the development and accretion amount in the roll forward of estimated recoveries associated with alleged breaches of R&W:

	First Quarter
	2011		2010
	(in millions)
Inclusion of new deals with breaches of R&W during period	$	107.1	$	62.4
Change in recovery assumptions as the result of additional file review and recovery success	198.4		29.8
Estimated increase in defaults that will result in additional breaches	39.8		63.7
Results of Bank of America Agreement	334.1		—
Accretion of discount on balance	0.6		0.1
Total	$	680.0	$	156.0

The $680.0 million R&W development and accretion of discount during First Quarter 2011 in the above table resulted in large part from the Bank of America Agreement the Company executed on April 14, 2011 with Bank of America related to the Company’s R&W claims and described under “Bank of America Agreement” in Note 3. The benefit of the Bank of America Agreement is included in the R&W credit for the transactions directly impacted by the agreement. In addition, the Bank of America Agreement caused the Company to increase the probability of successful pursuit of R&W claims against other providers where the Company believed those providers were breaching at a similar rate. Also, during First Quarter 2011, the Company added four transactions not subject to the Bank of America Agreement for which it expects R&W benefits, because it concluded it had the right to obtain loan files it had not previously concluded were accessible. The remainder of the development primarily relates to additional projected defaults. The accretion of discount was not a primary driver of the development. The Company assumes that recoveries on HELOC and closed end second lien loans that were not subject to the Bank of America Agreement will occur in two to four years from the balance sheet date depending on the scenarios and that recoveries on Alt-A first lien, Option ARM and Subprime loans will occur as claims are paid over the life of the transactions. Recoveries on second lien transactions subject to the Bank of America Agreement will be paid in full by March 31, 2012.

Student Loan Transactions

The Company has insured or reinsured $3.0 billion net par of student loan securitization transactions, $1.5 billion issued by private issuers and classified as asset-backed and $1.5 billion issued by public authorities and classified as public finance. Of these amounts, $243.7 million and $585.7 million, respectively, are rated BIG. The Company is projecting approximately $57.4 million and $13.6 million, respectively, of losses in these portfolios. In general the losses are due to: (i) the poor credit performance of private student loan collateral; (ii) high interest rates on auction rate securities with respect to which the auctions have failed or (iii) high interest rates on variable rate demand obligations that have been put to the liquidity provider by the holder and are therefore bearing high “bank bond” interest rates. The largest of these losses was approximately $31.8 million and related to a transaction backed by a pool of private student loans ceded to AG Re by another monoline insurer. The guaranteed bonds were issued as auction rate securities that now bear a high rate of interest due to the primary insurer’s downgrade. Further the underlying loan collateral has performed below expectations. The Company has estimated its losses based upon a weighting of potential outcomes.

XXX Life Insurance Transactions

The Company has insured $2.1 billion of net par in XXX life insurance reserve securitization transactions based on discrete blocks of individual life insurance business. In these transactions the monies raised by the sale of the bonds insured by the Company were used to capitalize a special purpose vehicle that provides reinsurance to a life insurer or reinsurer. The monies are invested at inception in accounts managed by third-party investment managers. In order for the Company to incur an ultimate net loss on these transactions, adverse experience on the underlying block of life insurance policies and/or credit losses in the investment portfolio would need to exceed the level of credit enhancement built into the transaction structures. In particular, such credit losses in the investment portfolio could be realized in the event that circumstances arise resulting in the early liquidation of assets at a time when their market value is less than their intrinsic value.

The Company’s $2.1 billion net par of XXX life insurance transactions includes, as of March 31, 2011, a total of $882.5 million rated BIG, comprising Class A-2 Floating Rate Notes issued by Ballantyne Re p.l.c and Series A-1 Floating Rate Notes issued by Orkney Re II p.l.c (“Orkney Re II”). The Ballantyne Re and Orkney Re II XXX transactions had material amounts of their assets invested in U.S. RMBS transactions. Based on its analysis of the information currently available, including estimates of future investment performance provided by the current investment manager, and projected credit impairments on the invested assets and performance of the blocks of life insurance business at March 31, 2011, the Company’s gross expected loss, prior to reinsurance or netting of unearned premium, for its two BIG XXX insurance transactions was $70.1 million. The Company’s net loss and LAE reserve was $59.6 million.

Other Notable Transactions

The preceding pages describe the sectors in the financial guaranty portfolio that encompass most of the Company’s projected losses. The Company also projects losses on a number of other transactions, the most significant of which are described in the following paragraphs.

The Company has projected estimated losses of $28.3 million on its total net par outstanding of $494.4 million on Jefferson County Alabama Sewer Authority exposure. This estimate is based primarily on the Company’s view of how much debt the Authority should be able to support under certain probability-weighted scenarios. See Note 17.

The Company has projected estimated losses of $8.8 million on a transaction backed by revenues generated by telephone directory “yellow pages” in various jurisdictions with a net par of $110.8 million and insured by Ambac Assurance Corporation (“Ambac”). This estimate is based primarily on the Company’s view of how quickly “yellow pages” revenues are likely to decline in the future.

The Company has projected expected loss to be paid of $14.3 million on one transaction from 2000 backed by manufactured housing loans with a net par of $69.0 million. The Company insures a total of $368.4 million net par of securities backed by manufactured housing loans, a total of $244.4 million rated BIG.

The Company has $164.8 million of net par exposure to the city of Harrisburg, Pennsylvania, of which $92.9 million is BIG. The Company has paid $3.3 million in net claims to date, and expects a full recovery.

Recovery Litigation

As of May 10, 2011, the Company had filed lawsuits with regard to six second lien U.S. RMBS transactions insured by AGM or AGC, alleging breaches of R&W both in respect of the underlying loans in the transactions and the accuracy of the information provided to AGM and AGC, and failure to cure or repurchase defective loans identified by AGM and AGC to such persons. These transactions consist of the ACE Securities Corp. Home Equity Loan Trust, Series 2006-GP1, the ACE Securities Corp. Home Equity Loan Trust, Series 2007-SL2 and the ACE Securities Corp. Home Equity Loan Trust, Series 2007-SL3 transactions (in each of which AGC or AGM has sued Deutsche Bank AG affiliates DB Structured Products, Inc. and ACE Securities Corp. in the Supreme Court of New York), the SACO I Trust 2005-GP1 transaction (in which AGC has sued JPMorgan Chase & Co.’s affiliate EMC Mortgage Corporation in the United States District Court for the Southern District of New York) and the Flagstar Home Equity Loan Trust, Series 2005-1 and Series 2006-2 transactions (in which AGM has sued Flagstar Bank, FSB, Flagstar Capital Markets Corporation and Flagstar ABS, LLC in the United States District Court for the Southern District of New York).

AGM has also filed a lawsuit in the Superior Court of the State of California, County of Los Angeles, against UBS Securities LLC and Deutsche Bank Securities, Inc., as underwriters, as well as several named and unnamed control persons of IndyMac Bank, FSB and related IndyMac entities, with regard to two U.S. RMBS transactions that AGM had insured, alleging violations of state securities laws and breach of contract, among other claims. One of these transactions (referred to as IndyMac Home Equity Loan Trust 2007-H1) is a second lien transaction and the other (referred to as IndyMac IMSC Mortgage Loan Trust 2007-HOA-1) is a first lien transaction.

In December 2008, Assured Guaranty (UK) Ltd. (“AGUK”) sued J.P. Morgan Investment Management Inc. (“JPMIM”), the investment manager in the Orkney Re II transaction, in the Supreme Court of the State of New York alleging that JPMIM engaged in breaches of fiduciary duty, gross negligence and breaches of contract based upon its handling of the investments of Orkney Re II. In January 2010, the court ruled against AGUK on a motion to dismiss filed by JPMIM, dismissing the AGUK’s claims for breaches of fiduciary duty and gross negligence on the ground that such claims are preempted by the Martin Act, which is New York’s blue sky law, such that only the New York Attorney General has the authority to sue JPMIM. AGUK appealed and, in November 2010, the Appellate Division (First Department) issued a ruling, ordering the court’s order to be modified to reinstate AGUK’s claims for breach of fiduciary duty and gross negligence and certain of its claims for breach of contract, in each case for claims accruing on or after June 26, 2007. In December 2010, JPMIM filed a motion for permission to appeal to the Court of Appeals on the Martin Act issue; that motion was granted in February 2011. Separately, at the trial court level, a preliminary conference order related to discovery was entered in February 2011 and discovery has commenced.  See Note 17.

In June 2010, AGM sued JPMorgan Chase Bank, N.A. and JPMorgan Securities, Inc. (together, “JPMorgan”), the underwriter of debt issued by Jefferson County, in the Supreme Court of the State of New York alleging that JPMorgan induced AGM to issue its insurance policies in respect of such debt through material and fraudulent misrepresentations and omissions, including concealing that it had secured its position as underwriter and swap provider through bribes to Jefferson County commissioners and others. In December 2010, the court denied JPMorgan’s motion to dismiss. AGM is continuing its risk remediation efforts for the Jefferson County exposure.

In September 2010, AGM, together with TD Bank, National Association and Manufacturers and Traders Trust Company, filed a complaint in the Court of Common Pleas in the Supreme Court of Pennsylvania against The Harrisburg Authority, The City of Harrisburg, Pennsylvania (the “City”), and the Treasurer of the City in connection with certain Resource Recovery Facility bonds and notes issued by the Harrisburg Authority, alleging, among other claims, breach of contract by both the Harrisburg Authority and the City, and seeking remedies including an order compelling the Harrisburg Authority to pay all unpaid and past due principal and interest and to charge and collect sufficient rates, rental and other charges adequate to carry out its pledge of revenues and receipts; an order compelling the City to budget for, impose and collect taxes and revenues sufficient to satisfy its obligations; and the appointment of a receiver for the Harrisburg Authority. See Note 17.

Net Loss Summary

The following table provides information on loss and LAE reserves net of reinsurance and salvage and subrogation recoverable on the consolidated balance sheets.

Loss and LAE Reserve, Net of Reinsurance and Salvage and Subrogation Recoverable

	As of March 31, 2011									As of December 31, 2010
	Loss and  LAE Reserve(1)			Salvage and Subrogation Recoverable(2)			Net			Loss and LAE  Reserve(1)			Salvage and Subrogation Recoverable(2)			Net
	(in millions)
	(restated)						(restated)			(restated)						(restated)
U.S. RMBS:
First lien:
Prime first lien	$	1.1		$	—		$	1.1		$	1.2		$	—		1.2
Alt-A first lien	39.0			4.6			34.4			39.2			2.6			36.6
Option ARM	112.8			76.2			36.6			223.3			63.0			160.3
Subprime	82.7			—			82.7			108.3			0.1			108.2
Total first lien	235.6			80.8			154.8			372.0			65.7			306.3
Second lien:
Closed end second lien	7.7			113.3			(105.6		)	7.7			50.3			(42.6		)
HELOC	7.5			849.1			(841.6		)	7.1			843.4			(836.3		)
Total second lien	15.2			962.4			(947.2		)	14.8			893.7			(878.9		)
Total U.S. RMBS	250.8			1,043.2			(792.4		)	386.8			959.4			(572.6		)
Other structured finance	151.2			1.8			149.4			131.1			1.4			129.7
Public finance	59.4			36.6			22.8			81.6			34.4			47.2
Total financial guaranty	461.4			1,081.6			(620.2		)	599.5			995.2			(395.7		)
Other	2.1			—			2.1			2.1			—			2.1
Subtotal	463.5			1,081.6			(618.1		)	601.6			995.2			(393.6		)
Effect of consolidating financial guaranty VIEs	(62.5		)	(153.5		)	91.0			(49.5		)	(92.2		)	42.7
Total(1)	$	401.0		$	928.1		$	(527.1	)	$	552.1		$	903.0		$	(350.9	)

(1) The March 31, 2011 loss and LAE consists of $419.6 million loss and LAE reserve net of $18.6 million of reinsurance recoverable on unpaid losses. The December 31, 2010 loss and LAE consists of $574.4 million loss and LAE reserve net of $22.3 million of reinsurance recoverable on unpaid losses.

(2) Salvage and subrogation recoverable is net of $128.9 million and $129.4 million in ceded salvaged and subrogation recorded in “reinsurance balances payable” at March 31, 2011 and December 31, 2010, respectively.

The following table presents the loss and LAE by sector for financial guaranty contracts accounted for as insurance that was recorded in the consolidated statements of operations. Amounts presented are net of reinsurance and net of the benefit for recoveries from breaches of R&W.

Loss and LAE Reported

on the Consolidated Statements of Operations

	First Quarter
	2011			2010
	(restated)
	(in millions)
Financial Guaranty:
U.S. RMBS:
First lien:
Prime first lien	$	(0.1	)	$	0.1
Alt-A first lien	8.2			5.4
Option ARM	(29.1		)	44.4
Subprime	(9.4		)	24.7
Total first lien	(30.4		)	74.6
Second lien:
Closed end second lien	(9.9		)	4.4
HELOC	61.0			17.9
Total second lien	51.1			22.3
Total U.S. RMBS	20.7			96.9
Other structured finance	20.3			10.5
Public finance	(15.8		)	27.7
Total financial guaranty	25.2			135.1
Other	—			—
Subtotal	25.2			135.1
Effect of consolidating financial guaranty VIEs	(50.7		)	(24.2		)
Total loss and LAE (recoveries)	$	(25.5	)	$	110.9

The following table provides information on financial guaranty insurance and reinsurance contracts categorized as BIG as of March 31, 2011 and December 31, 2010:

Financial Guaranty Insurance BIG Transaction Loss Summary

March 31, 2011

	BIG Categories
	BIG 1						BIG 2						BIG 3						Total BIG,			Effect of Consolidating
	Gross			Ceded			Gross			Ceded			Gross			Ceded			Net(1)			VIEs			Total
	(dollars in millions)
	(restated)			(restated)			(restated)			(restated)									(restated)						(restated)
Number of risks(2)	129			(41		)	96			(41		)	117			(44		)	342			—			342
Remaining weighted-average contract period (in years)	12.8			19.2			8.6			6.5			8.5			6.0			9.6			—			9.6
Outstanding exposure:
Principal	$	5,491.3		$	(570.0	)	$	5,822.5		$	(236.6	)	$	8,192.2		$	(702.4	)	$	17,997.0		$	—		$	17,997.0
Interest	3,493.5			(547.6		)	2,653.8			(78.4		)	2,344.8			(183.2		)	7,682.9			—			7,682.9
Total	$	8,984.8		$	(1,117.6	)	$	8,476.3		$	(315.0	)	$	10,537.0		$	(885.6	)	$	25,679.9		$	—		$	25,679.9
Expected cash outflows(inflows)	$	136.1		$	(6.5	)	$	1,582.0		$	(73.3	)	$	2,672.0		$	(148.2	)	$	4,162.1		$	(404.7	)	$	3,757.4
Potential recoveries(3)	(151.1		)	1.7			(677.2		)	25.5			(3,021.7		)	194.3			(3,628.5		)	395.9			(3,232.6		)
Subtotal	(15.0		)	(4.8		)	904.8			(47.8		)	(349.7		)	46.1			533.6			(8.8		)	524.8
Discount	(74.6		)	17.8			(437.6		)	29.3			(27.9		)	(8.4		)	(501.4		)	(16.1		)	(517.5		)
Present value of expected cash flows	$	(89.6	)	$	13.0		$	467.2		$	(18.5	)	$	(377.6	)	$	37.7		$	32.2		$	(24.9	)	$	7.3
Deferred premium revenue	$	121.5		$	(16.9	)	$	572.4		$	(30.3	)	$	995.9		$	(120.7	)	$	1,521.9		$	(274.0	)	$	1,247.9
Reserves (salvage)(4)	$	(102.0	)	$	15.1		$	247.8		$	(7.1	)	$	(877.9	)	$	103.9		$	(620.2	)	$	91.0		$	(529.2	)

Financial Guaranty Insurance BIG Transaction Loss Summary

December 31, 2010

	BIG Categories
	BIG 1						BIG 2						BIG 3						Total BIG,			Effect of Consolidating
	Gross			Ceded			Gross			Ceded			Gross			Ceded			Net(1)			VIEs			Total
	(dollars in millions)
	(restated)			(restated)			(restated)			(restated)									(restated)						(restated)
Number of risks(2)	119			(45		)	98			(42		)	115			(42		)	332			—			332
Remaining weighted-average contract period (in years)	11.7			16.0			8.4			7.9			8.8			6.0			9.6			—			9.6
Outstanding exposure:
Principal	$	6,173.0		$	(723.3	)	$	5,899.3		$	(182.8	)	$	7,954.5		$	(673.6	)	$	18,447.1		$	—		$	18,447.1
Interest	3,599.5			(580.4		)	2,601.6			(70.9		)	2,490.7			(186.3		)	7,854.2			—			7,854.2
Total	$	9,772.5		$	(1,303.7	)	$	8,500.9		$	(253.7	)	$	10,445.2		$	(859.9	)	$	26,301.3		$	—		$	26,301.3
Expected cash flows	$	303.9		$	(20.2	)	$	2,036.6		$	(68.9	)	$	2,256.6		$	(133.2	)	$	4,374.8		$	(384.2	)	$	3,990.6
Potential recoveries(3)	(375.2		)	37.4			(533.0		)	16.6			(2,543.6		)	197.5			(3,200.3		)	354.8			(2,845.5		)
Subtotal	(71.3		)	17.2			1,503.6			(52.3		)	(287.0		)	64.3			1,174.5			(29.4		)	1,145.1
Discount	(21.0		)	(5.5		)	(613.2		)	21.5			(139.6		)	(7.9		)	(765.7		)	(19.8		)	(785.5		)
Present value of expected cash flows	$	(92.3	)	$	11.7		$	890.4		$	(30.8	)	$	(426.6	)	$	56.4		$	408.8		$	(49.2	)	$	359.6
Deferred premium revenue	$	169.9		$	(16.9	)	$	572.4		$	(30.3	)	$	995.9		$	(120.7	)	$	1,570.3		$	(263.9	)	$	1,306.4
Reserves (salvage)(4)	$	(112.9	)	$	12.4		$	424.4		$	(9.5	)	$	(815.9	)	$	105.8		$	(395.7	)	$	42.7		$	(353.0	)

(1) Includes BIG amounts relating to VIEs that the Company consolidates.

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

(3) Includes estimated future recoveries for breaches of R&W as well as excess spread, and draws on HELOCs.

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

Components of Net Reserves (Salvage)

	March 31, 2011			December 31, 2010
	(in millions)
	(restated)
Loss and LAE reserve	$	419.6		$	574.4
Reinsurance recoverable on unpaid losses	(18.6		)	(22.3		)
Salvage and subrogation recoverable	(1,057.0		)	(1,032.4		)
Salvage and subrogation payable(1)	128.9			129.4
Total	(527.1		)	(350.9		)
Less: other	2.1			2.1
Financial guaranty reserves, net of salvage and subrogation	$	(529.2	)	$	(353.0	)

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

Ratings Impact on Financial Guaranty Business

A downgrade of one of the Company’s insurance subsidiaries may result in increased claims under financial guaranties issued by the Company. In particular, with respect to variable rate demand obligations for which a bank has agreed to provide a liquidity facility, a downgrade of the insurer may provide the bank with the right to give notice to bondholders that the bank will terminate the liquidity facility, causing the bondholders to tender their bonds to the bank. Bonds held by the bank accrue interest at a “bank bond rate” that is higher than the rate otherwise borne by the bond (typically the prime rate plus 2.00%-3.00%, often with a floor of 7%, and capped at the maximum legal limit). In the event that the bank holds such bonds for longer than a specified period of time, usually 90-180 days, the bank has the right additionally to demand accelerated repayment of bond principal, usually through payment of equal installments over a period of not less than five years. In the event that a municipal obligor is unable to pay interest accruing at the bank bond rate or to pay principal during the shortened amortization period, a claim could be submitted to the insurer under its financial guaranty policy. As of May 10, 2011, the Company had insured approximately $1.3 billion of par of variable rate demand obligations issued by municipal obligors rated BBB- or lower pursuant to the Company’s internal rating. For a number of such obligations, a downgrade of the insurer below A+, in the case of S&P, or below A1, in the case of Moody’s Investor Services, Inc. (“Moody’s”), triggers the ability of the bank to notify bondholders of the termination of the liquidity facility and to demand accelerated repayment of bond principal over a period of five to ten years. The specific terms relating to the rating levels that trigger the bank’s termination right, and whether it is triggered by a downgrade by one rating agency or a downgrade by all rating agencies then rating the insurer, vary depending on the transaction. See also Note 14 for a discussion of the impact of a downgrade in the financial strength rating on the Company’s insured leveraged lease transactions.