Consolidation of Variable Interest Entities

6 Months Ended

Jun. 30, 2011

Consolidation of Variable Interest Entities

Consolidation of Variable Interest Entities

8. Consolidation of Variable Interest Entities

The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs. The Company has not originated any VIEs nor acted as the servicer or collateral manager for any VIE deals that it insures. The transaction structure generally provides certain financial protections to the Company. This financial protection can take several forms, the most common of which are overcollateralization, first-loss protection (or subordination) and excess spread. In the case of overcollateralization (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by the Company), the structure allows defaults of the securitized assets before a default is experienced on the structured finance obligation guaranteed by the Company. In the case of first loss, the financial guaranty insurance policy only covers a senior layer of losses experienced by multiple obligations issued by special purpose entities, including VIEs. The first-loss exposure with respect to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to special purpose entities, including VIEs, generate cash flows that are in excess of the interest payments on the debt issued by the special purpose entity. Such excess spread is typically distributed through the transaction’s cash flow waterfall and may be used to create additional credit enhancement, applied to redeem debt issued by the special purpose entities, including VIEs (thereby, creating additional overcollateralization), or distributed to equity or other investors in the transaction.

AGM and AGC are not primarily liable for the debt obligations issued by the FG VIEs it insures and would only be required to make payments on these debt obligations that it has insured in the event that the issuer of such debt obligations defaults on any principal or interest due. AGL’s and its Subsidiaries’ creditors do not have any rights with regard to the assets of the VIEs. Fair value gains and losses on FG VIEs are expected to reverse to zero at maturity of the VIE debt, except for claim payments paid by AGC or AGM under the financial guaranty insurance contract. The Company’s estimate of expected loss to be paid for FG VIEs is included in Note 5.

During Second Quarter 2011, the Company determined that, based on the assessment of its control rights over servicer or collateral manager replacement, given that servicing/managing collateral were deemed to be the FG VIEs’ most significant activities, eight additional VIEs required consolidation, bringing the total consolidated VIEs to 35 at June 30, 2011. This resulted in an increase in FG VIEs’ assets of $254.8 million, an increase in FG VIEs’ liabilities of $305.2 million and a net loss on consolidation of $95.3 million, which was included in “net change in fair value of FG VIEs” in the consolidated statement of operations. In addition, debt on two FG VIEs was fully paid off during Second Quarter 2011.

The total unpaid principal balance for the FG VIEs’ assets that were 90 days or more past due was approximately $1,245.4 million and $1,199.1 million as of June 30, 2011 and December 31, 2010, respectively. The change in the instrument-specific credit risk of the FG VIEs’ assets for the Second Quarter 2011 and 2010 and Six Months 2011 and 2010 were losses of $861.9 million, $44.1 million, $478.7 million and $95.4 million, respectively. The difference between the aggregate unpaid principal and aggregate fair value of the FG VIEs’ liabilities was approximately $2,663.8 million and $2,053.0 million at June 30, 2011 and December 31, 2010, respectively.

The financial reports of the consolidated FG VIEs are prepared by outside parties and are not available within the time constraints that the Company requires to ensure the financial accuracy of the operating results. As such, the financial results of the FG VIEs are consolidated on a one-quarter lag; however, the Company does adjust the financial statements for the effects of material events occurring from the lag period until the balance sheet date. The Company has elected the fair value option for assets and liabilities classified as FG VIEs’ assets and liabilities. Upon consolidation of FG VIEs, the Company elected the fair value option because the carrying amount transition method was not practical.

Consolidated FG VIEs

By Type of Collateral

	As of June 30, 2011				As of December 31, 2010
	Assets		Liabilities		Assets		Liabilities
	(in millions)
			(restated)				(restated)
HELOCs	$	780.4	$	1,092.1	$	857.1	$	1,126.1
First liens:
Alt-A	173.6		165.4		—		—
Subprime	466.2		555.6		528.7		616.5
Option ARM	651.1		850.9		626.6		909.4
Alt-A second liens	760.6		807.1		747.4		818.4
Automobile loans	333.3		333.3		486.8		486.8
Life insurance	327.0		327.0		304.8		304.8
Credit card loans	—		—		106.1		106.1
Total	$	3,492.2	$	4,131.4	$	3,657.5	$	4,368.1

The table below shows the income statement impact of the consolidated FG VIEs:

Effect of Consolidating FG VIEs on Net Income

and Shareholders’ Equity

	Second Quarter						Six Months
	2011			2010			2011			2010
	(in millions)
	(restated)			(restated)			(restated)			(restated)
Net earned premiums	$	(18.3	)	$	(10.7	)	$	(37.4	)	$	(21.6	)
Net investment income	(0.4		)	—			(0.7		)	—
Net realized investment gains (losses)	0.2			—			0.5			—
Net change in fair value of financial guaranty variable interest entities	(174.3		)	(27.4		)	(54.7		)	(36.3		)
Loss and loss adjustment expenses	16.9			10.1			67.6			34.2
Total pretax effect on net income	(175.9		)	(28.0		)	(24.7		)	(23.7		)
Less: tax provision (benefit)	(61.6		)	(9.8		)	(8.6		)	(8.3		)
Total effect on net income	(114.3		)	$	(18.2	)	(16.1		)	$	(15.4	)

	As of June 30, 2011			As of December 31, 2010
	(in millions)
	(restated)			(restated)
Total effect on shareholders’ equity	$	(342.6	)	$	(371.4	)

(1) Includes the effect of initially consolidating and/or deconsolidating VIEs based on changes in AGM’s and AGC’s assessment of its control rights over servicer or collateral manager replacement during the period.

The table below summarizes the contractual obligations, of the consolidated FG VIEs’ liabilities with recourse.

Contractual Maturity Schedule of FG VIE Liabilities with Recourse

Gross Par Outstanding

Contractual Maturity	As of June 30, 2011
	(in millions)
2012	$	15.8
2013	25.4
2014	199.6
2015	—
Thereafter	3,907.4
Total	$	4,148.2

Non-Consolidated VIEs

To date, the Company’s analyses have indicated that it does not have a controlling financial interest in any other VIEs and, as a result, they are not consolidated in the consolidated financial statements. The Company’s exposure provided through its financial guaranties with respect to debt obligations of special purpose entities is included within net par outstanding in Note 4.