Variable Interest Entities

The Company provides financial guaranties with respect to debt obligations of special purpose entities, including VIEs. Assured Guaranty does not act as the servicer or collateral manager for any VIE obligations insured by its companies. 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 interest income 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.

Assured Guaranty is not primarily liable for the debt obligations issued by the VIEs it insures and would only be required to make payments on those insured debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due and only for the amount of the shortfall. AGL’s and its subsidiaries’ creditors do not have any rights with regard to the collateral supporting the debt issued by the FG VIEs. Proceeds from sales, maturities, prepayments and interest from such underlying collateral may only be used to pay debt service on FG VIEs’ liabilities. Net fair value gains and losses on FG VIEs are expected to reverse to zero at maturity of the FG VIEs’ debt, except for net premiums received and net claims paid by Assured Guaranty under the financial guaranty insurance contract. The Company’s estimate of expected loss to be paid for FG VIEs is included in Note 5, Expected Loss to be Paid.

As part of the terms of its financial guaranty contracts, the Company, under its insurance contract, obtains certain protective rights with respect to the VIE that give the Company additional controls over a VIE. These protective rights are triggered by the occurrence of certain events, such as failure to be in compliance with a covenant due to poor deal performance or a deterioration in a servicer or collateral manager's financial condition. At deal inception, the Company typically is not deemed to control a VIE; however, once a trigger event occurs, the Company's control of the VIE typically increases. The Company continuously evaluates its power to direct the activities that most significantly impact the economic performance of VIEs that have debt obligations insured by the Company and, accordingly, where the Company is obligated to absorb VIE losses or receive benefits that could potentially be significant to the VIE. The Company is deemed to be the control party for certain VIEs under GAAP, typically when its protective rights give it the power to both terminate and replace the deal servicer, which are characteristics specific to the Company's financial guaranty contracts. If the protective rights that could make the Company the control party have not been triggered, then the VIE is not consolidated. If the Company is deemed no longer to have those protective rights, the VIE is deconsolidated.

Adoption of ASU 2016-01

Amendments under ASU 2016-01 apply to the Company's FG VIEs’ liabilities which the Company had historically elected to measure through the consolidated statements of operations in "fair value gains (losses) on FG VIEs" under the fair value option. For FG VIEs’ liabilities with recourse, the portion of the change in fair value caused by changes in ISCR must now be separately presented in OCI as opposed to the consolidated statements of operations.

The inception to date change in fair value of the FG VIEs’ liabilities with recourse attributable to the ISCR is calculated by holding all current period assumptions constant for each security and isolating the effect of the change in the Company’s CDS spread from the most recent date of consolidation to the current period. In general, if the Company’s CDS spread tightens, more value will be assigned to the Company’s credit; however, if the Company’s CDS widens, less value is assigned to the Company’s credit.

On adoption of ASU 2016-01, the Company reclassified a loss of approximately $33 million, net of tax, from retained earnings to AOCI. This amount represents the portion of the fair value of the FG VIEs’ liabilities with recourse that related to the change in the Company's own credit risk from the date of consolidation through January 1, 2018. The accounting and disclosure of the FG VIEs’ liabilities without recourse are unchanged.

Consolidated FG VIEs

Number of FG VIEs Consolidated



	Nine Months
	2018		2017

Beginning of year	32		32
Consolidated	—		1
Deconsolidated	(1	)	(2	)
September 30,	31		31

The total unpaid principal balance for the FG VIEs’ assets that were over 90 days or more past due was approximately $79 million at September 30, 2018 and $99 million at December 31, 2017. The aggregate unpaid principal of the FG VIEs’ assets was approximately $350 million greater than the aggregate fair value at September 30, 2018. The aggregate unpaid principal of the FG VIEs’ assets was approximately $361 million greater than the aggregate fair value at December 31, 2017.

The changes in the instrument-specific credit risk of the FG VIEs’ assets held as of September 30, 2018 that were recorded in the condensed consolidated statements of operations for Third Quarter 2018 and Nine Months 2018 were gains of $1 million and $4 million, respectively. The changes in the ISCR of the FG VIEs’ assets held as of September 30, 2017 that were recorded in the condensed consolidated statements of operations for Third Quarter 2017 and Nine Months 2017 were gains of $8 million and $32 million, respectively. To calculate the ISCR, the changes in the fair value of the FG VIEs’ assets are allocated between changes that are due to the ISCR and changes due to other factors, including interest rates. The ISCR amount is determined by using expected cash flows at the date of consolidation versus current expected cash flows discounted at original contractual rate. The net present value is calculated by discounting the expected cash flows of the underlying security, at the relevant effective interest rate.

The unpaid principal for FG VIEs’ liabilities with recourse, which represent obligations insured by AGC or AGM, was $590 million and $674 million as of September 30, 2018 and December 31, 2017, respectively. FG VIEs’ liabilities with recourse will mature at various dates ranging from 2018 to 2038. The aggregate unpaid principal balance of the FG VIEs’ liabilities with and without recourse was approximately $72 million greater than the aggregate fair value of the FG VIEs’ liabilities as of September 30, 2018. The aggregate unpaid principal balance was approximately $73 million greater than the aggregate fair value of the FG VIEs’ liabilities as of December 31, 2017. See Condensed Consolidated Statements of Comprehensive Income and Note 17, Shareholders' Equity, for information on changes in fair value of the FG VIEs’ liabilities with recourse that is attributable to changes in the Company's own credit risk.

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

Consolidated FG VIEs

By Type of Collateral



	As of September 30, 2018				As of December 31, 2017
	Assets		Liabilities		Assets		Liabilities
	(in millions)
With recourse:
U.S. RMBS first lien	$	315	$	341	$	362	$	385
U.S. RMBS second lien	122		147		144		177
Manufactured housing	55		57		64		65
Total with recourse	492		545		570		627
Without recourse	104		104		130		130
Total	$	596	$	649	$	700	$	757

The consolidation of FG VIEs affects net income and shareholders' equity due to (i) changes in fair value gains (losses) on FG VIEs’ assets and liabilities (effective January 1, 2018 the change in fair value of FG VIEs’ liabilities with recourse attributable to ISCR is recorded in OCI, instead of net income), (ii) the elimination of premiums and losses related to the AGC and AGM FG VIEs’ liabilities with recourse and (iii) the elimination of investment balances related to the Company’s purchase of AGC and AGM insured FG VIEs’ debt. Upon consolidation of a FG VIE, the related insurance and, if applicable, the related investment balances, are considered intercompany transactions and therefore eliminated. Such eliminations are included in the table below to present the full effect of consolidating FG VIEs.

Effect of Consolidating FG VIEs



	Third Quarter						Nine Months
	2018			2017			2018			2017
	(in millions)
Net earned premiums	$	(3	)	$	(3	)	$	(9	)	$	(11	)
Net investment income	(1		)	(2		)	(3		)	(4		)
Fair value gains (losses) on FG VIEs	5			3			11			25
Loss and LAE	(3		)	1			0			5
Effect on income before tax	(2		)	(1		)	(1		)	15
Less: tax provision (benefit)	0			0			0			5
Effect on net income (loss)	$	(2	)	$	(1	)	$	(1	)	$	10

Effect on OCI	$	(2	)	$	0		$	0		$	0

Effect on cash flows from operating activities	$	1		$	6		$	7		$	16



	As of September 30, 2018		As of December 31, 2017
	(in millions)
Effect on shareholders' equity (decrease) increase	$	1	$	2

Fair value gains (losses) on FG VIEs represent the net change in fair value of the consolidated FG VIEs’ assets and FG VIEs’ liabilities (effective January 1, 2018 the change in fair value of FG VIEs’ liabilities with recourse attributable to ISCR is recorded in OCI, instead of the condensed consolidated statements of operations). During Third Quarter 2018 and Nine Months 2018, the Company recorded pre-tax net fair value gains on consolidated FG VIEs of $5 million and $11 million, respectively, in the condensed consolidated statements of operations. The primary driver of the gain during Third Quarter and Nine Months 2018 in fair value of FG VIEs’ assets and liabilities was due to improvement in the underlying collateral on FG VIEs’ assets.

During Third Quarter and Nine Months 2017, the Company recorded a pre-tax net fair value gain on consolidated FG VIEs of $3 million and $25 million, respectively. During Third Quarter 2017, the primary driver of the gain was price depreciation on the FG VIEs’ recourse liabilities resulting from the Company's credit risk. During the Nine Months 2017, the primary driver of the gain is price appreciation on the FG VIEs’ assets resulting from improvements in the underlying collateral.

Other Consolidated VIEs

In certain instances where the Company consolidates a VIE that was established as part of a loss mitigation negotiated settlement that results in the termination of the original insured financial guaranty insurance or credit derivative contract, the Company classifies the assets and liabilities of those VIEs in the line items that most accurately reflect the nature of the items, as opposed to within the FG VIEs’ assets and FG VIEs’ liabilities. The largest of these VIEs had assets of $85 million and liabilities of $22 million as of September 30, 2018 and assets of $86 million and liabilities of $41 million as of December 31, 2017.

Non-Consolidated VIEs

As of September 30, 2018 and December 31, 2017, the Company had financial guaranty contracts outstanding for 514 and 510 VIEs, respectively, that it monitored and did not consolidate based on the Company’s analyses which indicate that it is not the primary beneficiary of these VIEs. The Company’s exposure provided through its financial guaranties with respect to debt obligations of special purpose entities (or VIEs) is included within net par outstanding in Note 4, Outstanding Exposure.