Consolidation of Variable Interest Entities

9 Months Ended

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

A VIE is consolidated when the Company is deemed to be the control party. Under GAAP, the Company is deemed to be the control party typically when its protective rights give it power to both terminate and replace the deal servicer.

AGM and AGC are not primarily liable for the debt obligations issued by the FG VIEs they insure and would only be required to make payments on the debt obligations that they have 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. Proceeds from sales, maturities, prepayments and interest from VIE assets may only be used to pay debt service on VIE liabilities. Net fair value gains and losses on FG VIEs are expected to reverse to zero at maturity of the VIE debt, except for 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 Third 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, 34 VIEs required consolidation, compared to 35 VIEs consolidated at June 30, 2011. Debt of one FG VIE was fully paid off during Third Quarter 2011.

The total unpaid principal balance for the FG VIEs’ assets that were 90 days or more past due was approximately $1,161.4 million and $1,199.1 million as of September 30, 2011 and December 31, 2010, respectively. The change in the instrument-specific credit risk of the FG VIEs’ assets for the Third Quarter and Nine Months ended September 30, 2011 were losses of $178.1 million, $656.8 million, and gains of $152.3 million and $47.2 million, for 2010, respectively. The difference between the aggregate unpaid principal and aggregate fair value of the FG VIEs’ liabilities was approximately $2,721.9 million and $2,053.0 million at September 30, 2011 and December 31, 2010, respectively.

The trustee 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 lag; however, the Company adjusts 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.

The table below shows the carrying value of the consolidated FG VIEs’ assets and liabilities in the consolidated financial statements, segregated by the types of assets held by VIEs that collateralize their respective debt obligations.

Consolidated FG VIEs

By Type of Collateral

	As of September 30, 2011					As of December 31, 2010(restated)
	Numbers of VIEs	Assets		Liabilities		Number of VIEs	Assets		Liabilities
	(in millions)
HELOCs	8	$	651.6	$	1,027.1	8	$	857.1	$	1,126.1
First liens:
Alt-A	3	155.1		145.4			—		—
Subprime	5	429.4		512.1		5	528.7		616.5
Option ARM	2	556.8		766.7		2	626.6		909.4
Alt-A second liens	10	639.9		684.7		5	747.4		818.4
Automobile loans	5	278.5		278.5		7	486.8		486.8
Life insurance	1	294.1		294.1		1	304.8		304.8
Credit card loans	—	—		—		1	106.1		106.1
Total	34	$	3,005.4	$	3,708.6	29	$	3,657.5	$	4,368.1

Gross Par Outstanding for FG VIEs’ Liabilities

With Recourse

	As of September 30, 2011		As ofDecember 31, 2010
	(in millions)
Gross par outstanding for FG VIEs’ liabilities with recourse	$	3,966.5	$	3,630.5

FG VIEs’ liabilities insured by the Company are considered to be with recourse, since the Company guarantees the payment of principal and interest regardless of the performance of the related FG VIEs’ assets. FG VIEs’ liabilities not insured by the Company are considered to be non-recourse, since the payment of principal and interest of these liabilities is wholly dependent on the performance of the FG VIEs’ assets.

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

Contractual Maturity Schedule of FG VIE Liabilities with Recourse

Contractual Maturity	As of September 30, 2011
	(in millions)
2012	$	8.0
2013	20.1
2014	166.4
2015	—
Thereafter	3,772.0
Total	$	3,966.5

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

Effect of Consolidating FG VIEs on Net Income

and Shareholders’ Equity

	Third Quarter						Nine Months
	2011			2010			2011			2010
				(restated)						(restated)
	(in millions)
Net earned premiums	$	(19.4	)	$	(12.8	)	$	(56.8	)	$	(34.4	)
Net investment income	(4.0		)	—			(4.7		)	—
Net realized investment gains (losses)	6.7			—			7.2			—
Net change in fair value of financial guaranty variable interest entities	(99.2		)	171.3			(153.9		)	135.0
Loss and loss adjustment expenses	37.9			10.2			105.5			44.4
Total pretax effect on net income	(78.0		)	168.7			(102.7		)	145.0
Less: tax provision (benefit)	(27.3		)	59.1			(35.9		)	50.8
Total effect on net income	$	(50.7	)	$	109.6		$	(66.8	)	$	94.2

	As of September 30, 2011			As of December 31, 2010(restated)
	(in millions)
Total effect on shareholders’ equity	$	(393.4	)	$	(371.4	)

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.