Contracts Accounted for as Credit Derivatives

12 Months Ended

Dec. 31, 2022

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Contracts Accounted for as Credit Derivatives

Contracts Accounted for as Credit Derivatives

Amounts presented in this note relate only to contracts accounted for as derivatives. The Company’s credit derivatives (financial guaranty contracts that meet the definition of a derivative in accordance with GAAP) are primarily CDS and also include interest rate swaps.

Credit derivative transactions, including CDS, are governed by International Swaps and Derivatives Association, Inc. documentation and have certain characteristics that differ from financial guaranty insurance contracts. For example, the Company’s control rights with respect to a reference obligation under a CDS may be more limited than when the Company issues a financial guaranty insurance contract. In addition, there are more circumstances under which the Company may be obligated to make payments. Similar to a financial guaranty insurance contract, the Company would be obligated to pay if the obligor failed to make a scheduled payment of principal or interest in full. In certain credit derivative transactions, the Company also specifically agreed to pay if the obligor were to become bankrupt or if the reference obligation were restructured. Furthermore, in certain credit derivative transactions, the Company may be required to make a payment due to an event that is unrelated to the performance of the obligation referenced in the credit derivative. If events of default or termination events

specified in the credit derivative documentation were to occur, the non-defaulting or the non-affected party, which may be either the Company or the counterparty, depending upon the circumstances, may decide to terminate a credit derivative prior to maturity. In that case, the Company may be required to make a termination payment to its swap counterparty upon such termination. Absent such an event of default or termination event, the Company may not unilaterally terminate a credit derivative contract; however, the Company on occasion has mutually agreed with various counterparties to terminate certain CDS transactions.

Accounting Policy

Credit derivatives are recorded at fair value. Changes in fair value are reported in “net change in fair value of credit derivatives” in the consolidated statement of operations. The fair value of credit derivatives is reflected as either net assets or net liabilities determined on a contract-by-contract basis in the Company’s consolidated balance sheets. See Note 9, Fair Value Measurement, for a discussion on the fair value methodology for credit derivatives.

Credit Derivative Net Par Outstanding and Fair Value

     The components of the Company’s credit derivative net par outstanding by sector are presented in the table below. The estimated remaining weighted average life of credit derivatives was 12.8 years and 13.2 years as of December 31, 2022 and December 31, 2021, respectively.

Credit Derivatives (1) 

	As of December 31, 2022				As of December 31, 2021
Sector	Net Par Outstanding		Net Fair Value Asset (Liability)		Net Par Outstanding		Net Fair Value Asset (Liability)
	(in millions)
U.S. public finance	$	1,175	$	(79)	$	1,705	$	(72)
Non-U.S. public finance	1,565		(58)		1,800		(48)
U.S. structured finance	342		(22)		400		(32)
Non-U.S. structured finance	121		(3)		135		(2)
Total	$	3,203	$	(162)	$	4,040	$	(154)

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(1)    Expected loss to be paid was $3 million as of December 31, 2022 and $5 million as of December 31, 2021.

Distribution of Credit Derivative Net Par Outstanding by Internal Rating 

	As of December 31, 2022				As of December 31, 2021
Rating Category	Net Par Outstanding		% of Total		Net Par Outstanding		% of Total
	(dollars in millions)
AAA	$	1,260	39.3	%	$	1,503	37.2	%
AA	1,064		33.2		1,283		31.8
A	232		7.2		514		12.7
BBB	590		18.5		677		16.7
BIG	57		1.8		63		1.6
Credit derivative net par outstanding	$	3,203	100.0	%	$	4,040	100.0	%

Fair Value Gains (Losses) on Credit Derivatives 

	Year Ended December 31,
	2022		2021		2020
	(in millions)
Realized gains (losses) and other settlements	$	(2)	$	(3)	$	(4)
Net unrealized gains (losses)	(9)		(55)		85
Fair value gains (losses) on credit derivatives	$	(11)	$	(58)	$	81

The impact of changes in credit spreads will vary based upon the volume, tenor, interest rates and other market conditions at the time these fair values are determined. In addition, since each transaction has unique collateral and structural terms, the change in fair value of each transaction may vary considerably. The fair value of credit derivative contracts also reflects the Company’s own credit cost based on the price to purchase credit protection on AGC. The Company determines its own credit risk primarily based on quoted CDS prices traded on AGC at each balance sheet date.

CDS Spread on AGC (in basis points) 

	As of
	December 31, 2022	December 31, 2021	December 31, 2020
Five-year CDS spread	63	49	132
One-year CDS spread	26	16	36

Fair Value of Credit Derivative Assets (Liabilities) and Effect of AGC Credit Spread

	As of
	December 31, 2022		December 31, 2021
	(in millions)
Fair value of credit derivatives before effect of AGC credit spread	$	(207)	$	(225)
Plus: Effect of AGC credit spread	45		71
Net fair value of credit derivatives	$	(162)	$	(154)

The fair value of CDS contracts as of December 31, 2022, before considering the benefit applicable to AGC’s credit spread, is a direct result of the relatively wider credit spreads under current market conditions compared to those at the time of underwriting for certain underlying credits with longer tenor.