Audited Financial Stmt 2013 - ACA Financial Guaranty Corporation

45 Pages·2014·0.52 MB·English

ACA Financial
Guaranty Corporation

Statutory-Basis Financial Statements as of and
for the Years Ended December 31, 2013 and 2012,
Supplemental Schedules as of December 31, 2013,
and Independent Auditors’ Report
ACA FINANCIAL GUARANTY CORPORATION
TABLE OF CONTENTS
Page
INDEPENDENT AUDITORS’ REPORT 1–2
STATUTORY-BASIS FINANCIAL STATEMENTS AS OF AND FOR THE
YEARS ENDED DECEMBER 31, 2013 AND 2012:

Statements of Admitted Assets, Liabilities and Surplus 3

Statements of Income and Changes in Surplus 4

Statements of Cash flow 5

Notes to Statutory-Basis Financial Statements 6–34
SUPPLEMENTAL SCHEDULES: 35

Supplemental Summary of Investment Schedule as of December 31, 2013 36

Supplemental Schedule of Investment Risk Interrogatories as of December 31, 2013 38–41

Supplemental Schedule of Reinsurance Risk Interrogatories as of December 31, 2013 42–43
Deloitte & Touche LLP
30 Rockefeller Plaza
New York, NY 10112-0015
USA
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www.deloitte.com

INDEPENDENT AUDITORS’ REPORT
To the Board of Directors of
ACA Financial Guaranty Corporation:
We have audited the accompanying statutory-basis financial statements of ACA Financial Guaranty
Corporation (the “Company”), which comprise the statutory-basis statements of admitted assets, liabilities
and surplus as of December 31, 2013 and 2012, and the related statutory-basis statements of income and
changes in surplus, and cash flow for the years then ended, and the related notes to the statutory-basis
financial statements.
Management’s Responsibility for the Statutory-Basis Financial Statements
Management is responsible for the preparation and fair presentation of these statutory-basis financial
statements in accordance with the accounting practices prescribed or permitted by the Maryland Insurance
Administration. Management is also responsible for the design, implementation, and maintenance of
internal control relevant to the preparation and fair presentation of financial statements that are free from
material misstatement, whether due to fraud or error.
Auditors’ Responsibility
Our responsibility is to express an opinion on these statutory-basis financial statements based on our
audits. We conducted our audits in accordance with auditing standards generally accepted in the United
States of America. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the statutory-basis financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in
the statutory-basis financial statements. The procedures selected depend on the auditor’s judgment,
including the assessment of the risks of material misstatement of the statutory-basis financial statements,
whether due to fraud or error. In making those risk assessments, the auditor considers internal control
relevant to the Company’s preparation and fair presentation of the statutory-basis financial statements in
order to design audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control. Accordingly, we express no
such opinion. An audit also includes evaluating the appropriateness of the accounting policies used and
the reasonableness of significant accounting estimates made by management, as well as evaluating the
overall presentation of the statutory-basis financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for
our audit opinions.
Basis for Adverse Opinion on Accounting Principles Generally Accepted in the United
States of America
As described in Note 4 to the statutory-basis financial statements, the statutory-basis financial statements
are prepared by the Company using the accounting practices prescribed or permitted by the Maryland

Member of
Deloitte Touche Tohmatsu Limited
Insurance Administration, which is a basis of accounting other than accounting principles generally
accepted in the United States of America, to meet the requirements of the Maryland Insurance
Administration.
The effects on the statutory-basis financial statements of the variances between the statutory-basis of
accounting described in Note 5 to the statutory-basis financial statements and accounting principles
generally accepted in the United States of America, although not reasonably determinable, are presumed
to be material.
Adverse Opinion on Accounting Principles Generally Accepted in the United States of
America
In our opinion, because of the significance of the matter described in the Basis for Adverse Opinion on
Accounting Principles Generally Accepted in the United States of America paragraph, the statutory-basis
financial statements referred to above do not present fairly, in accordance with accounting principles
generally accepted in the United States of America, the financial position of the Company as of
December 31, 2013 and 2012, or the results of its operations or its cash flows for the years then ended.
Opinion on Statutory-Basis of Accounting
In our opinion, the statutory-basis financial statements referred to above present fairly, in all material
respects, the admitted assets, liabilities and surplus of the Company as of December 31, 2013 and 2012,
and the results of its operations and its cash flows for the years then ended, in accordance with the
accounting practices prescribed or permitted by the Maryland Insurance Administration as described in
Note 4 to the statutory-basis financial statements.
Report on Supplemental Schedules
Our 2013 audit was conducted for the purpose of forming an opinion on the 2013 statutory-basis financial
statements as a whole. The supplemental summary of investment schedule, the supplemental schedule of
investment risk interrogatories, and the supplemental schedule of reinsurance risk interrogatories as of
and for the year ended December 31, 2013 are presented for purposes of additional analysis and are not a
required part of the 2013 statutory–basis financial statements. These schedules are the responsibility of
the Company’s management and were derived from and relate directly to the underlying accounting and
other records used to prepare the statutory-basis financial statements. Such schedules have been subjected
to the auditing procedures applied in our audit of the 2013 statutory-basis financial statements and certain
additional procedures, including comparing and reconciling such schedules directly to the underlying
accounting and other records used to prepare the statutory-basis financial statements or to the statutory-
basis financial statements themselves, and other additional procedures in accordance with auditing
standards generally accepted in the United States of America. In our opinion, such schedules are fairly
stated in all material respects in relation to the 2013 statutory-basis financial statements as a whole.

June 6, 2014
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ACA FINANCIAL GUARANTY CORPORATION
STATUTORY-BASIS STATEMENTS OF ADMITTED ASSETS, LIABILITIES AND SURPLUS
AS OF DECEMBER 31, 2013 AND 2012
(Dollars in thousands)
2013 2012
ADMITTED ASSETS
BONDS — At NAIC carrying value $ 380,300 $ 397,472
CASH AND SHORT-TERM INVESTMENTS 8,150 24,241
RECEIVABLE FOR SECURITIES - 3
Total cash and investments 388,450 421,716
ACCRUED INVESTMENT INCOME 2,898 2,836
OTHER ASSETS 79 38
TOTAL ADMITTED ASSETS $ 391,427 $ 424,590
LIABILITIES AND SURPLUS
UNEARNED PREMIUMS $ 119,603 $ 146,732
LOSSES AND LOSS ADJUSTMENT EXPENSES 89,311 86,580
CONTINGENCY RESERVE 87,961 76,919
PAYABLE TO SUBSIDIARIES 84 83
PAYABLE FOR SECURITIES 292 -
ACCRUED EXPENSES AND OTHER LIABILITIES 5,129 5,082
Total liabilities 302,380 315,396
COMMON STOCK — 1,000,000 shares authorized, issued and
outstanding at December 31, 2013 and 2012; par value of $15 per share 15,000 15,000
GROSS PAID-IN AND CONTRIBUTED SURPLUS 363,974 363,974
UNASSIGNED DEFICIT (289,927) (269,780)
Surplus as regards policyholders 89,047 109,194
TOTAL LIABILITIES AND SURPLUS $ 391,427 $ 424,590
See notes to statutory-basis financial statements.

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ACA FINANCIAL GUARANTY CORPORATION
STATUTORY-BASIS STATEMENTS OF INCOME AND CHANGES IN SURPLUS
FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012
(Dollars in thousands)
2013 2012
PREMIUM EARNED $ 27,275 $ 27,755
LOSSES AND LOSS ADJUSTMENT EXPENSES 38,450 31,199
UNDERWRITING EXPENSES INCURRED 18,895 25,311
TOTAL UNDERWRITING DEDUCTIONS 57,345 56,510
NET UNDERWRITING LOSS (30,070) (28,755)
NET INVESTMENT INCOME 19,130 21,529
NET REALIZED CAPITAL GAINS 1,618 1,018
NET INVESTMENT GAIN 20,748 22,547
OTHER INCOME 141 255
LOSS BEFORE FEDERAL INCOME TAXES (9,181) (5,953)
FEDERAL INCOME TAXES - -
NET LOSS $ (9,181) $ (5,953)
SURPLUS AS REGARDS POLICYHOLDERS — Beginning of year $ 109,194 $ 117,315
Net loss (9,181) (5,953)
Change in net unrealized capital (losses) gains (38) 122
Change in contingency reserve (11,042) (3,000)
Change in deferred income tax 3,268 1,087
Change in non-admitted assets (3,154) (377)
Change in surplus as regards policyholders (20,147) (8,121)
SURPLUS AS REGARDS POLICYHOLDERS — End of year $ 89,047 $ 109,194
See notes to statutory-basis financial statements.

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ACA FINANCIAL GUARANTY CORPORATION
STATUTORY-BASIS STATEMENTS OF CASH FLOW
FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012
(Dollars in thousands)
2013 2012
CASH FLOWS FROM OPERATIONS:
Premiums collected net of reinsurance $ 146 $ 62
Net investment income 20,629 23,551
Other income 141 255
Losses and loss related payments (30,403) (16,415)
Commissions, expenses paid and aggregate write-ins for deductions (23,718) (30,874)
Net cash used in operations (33,205) (23,421)
CASH FLOWS FROM INVESTMENTS:
Proceeds from investments sold or matured 160,747 122,241
Cost of investments acquired (143,284) (87,755)
Net cash provided by investments 17,463 34,486
CASH FLOWS FROM FINANCING AND MISCELLANEOUS
SOURCES:
Other cash (applied) provided (349) 320
Net cash (applied) provided by financing and miscellaneous sources (349) 320
NET CHANGE IN CASH AND SHORT-TERM INVESTMENTS (16,091) 11,385
CASH AND SHORT-TERM INVESTMENTS — Beginning of year 24,241 12,856
CASH AND SHORT-TERM INVESTMENTS — End of year $ 8,150 $ 24,241
See notes to statutory-basis financial statements.

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ACA FINANCIAL GUARANTY CORPORATION
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS
AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012
1. GENERAL
ACA Financial Guaranty Corporation (the “Company” , “ACA FG”, or “ACA”) is organized and
domiciled in the State of Maryland and is a licensed, authorized and accredited insurance company in all
50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands and Guam. The Company is
authorized to provide financial guaranty insurance on tax-exempt and other debt obligations, as well as
on certain obligations related to asset-backed and corporate financings. As further discussed in Note 2,
since December 2007, the Company has not issued any new financial guaranty insurance policies and is
currently operating as a run-off insurance company.
Financial guaranty insurance provides an unconditional and irrevocable guaranty to the holder of a valid
debt obligation to full and timely payment of the guaranteed principal and interest thereon when due.
Financial guaranty insurance adds another potential source of repayment of principal and interest for an
investor, namely the credit quality of the financial guarantor. Generally, in the event of any default on an
insured debt obligation, payments made pursuant to the applicable insurance policy may not be
accelerated by the holder of the insured debt obligation without the approval of the insurer. While the
holder of such an insured debt obligation continues to receive guaranteed payments of principal and
interest on schedule, as if no default had occurred, and each subsequent purchaser of the obligation
generally receives the benefit of such guaranty, the insurer normally retains the option to pay the debt
obligation in full at any time. Also, the insurer generally has recourse against the issuer of the defaulted
obligation and/or any related collateral for amounts paid under the terms of the insurance policy as well
as pursuant to general rights of subrogation. The issuer of an insured debt obligation generally pays the
premium for financial guaranty insurance, either in full at the inception of the policy, as is the case in
most public finance transactions, or in periodic installments funded by the cash flow generated by
related pledged collateral, as is the case in most structured finance and international transactions.
Typically, premium rates paid by an issuer are stated as a percentage of the total principal (in the case of
structured finance and international transactions) or principal and interest (in the case of public finance
transactions) of the insured obligation. Premiums are almost always non-refundable and are invested
upon receipt.
The Company’s common stock is owned 76.6% by ACA Holding, L.L.C. (ACAH), a Delaware limited
liability company, and 23.4% by KPR Ltd, (KPR), a company with limited liability organized under the
laws of the Cayman Islands. KPR is a wholly owned subsidiary of ACAH and ACAH is a wholly owned
subsidiary of Manifold Capital Corp. (ACACH), formerly ACA Capital Holdings, Inc., a Delaware
corporation. Effective at the closing of the Restructuring Transaction discussed in Note 2, ACACH and
its wholly owned subsidiaries disclaimed control over the Company and voting control of the Company
became vested in the surplus notes issued in connection with the restructuring. This disclaimer of control
was approved by the Maryland Insurance Administration (MIA).
The Company through its subsidiaries, ACA Service, L.L.C. and ACA Management L.L.C., was
historically engaged in the business of providing asset management services within targeted sectors of
the fixed income capital markets. ACA FG’s affiliates participated in this market by structuring and
managing and investing in collateralized debt obligations (CDO) in collaboration with investment banks
which market the corresponding CDO securities to investors worldwide. The Company and its affiliates
are no longer engaged in the CDO asset management business, except for a limited number of
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pre-existing arrangements, and have not originated any CDOs since the third quarter of 2007. The
Company’s indirect wholly owned subsidiary, ACA Management, L.L.C., continues to receive fees
related to these contracts from third parties to whom they assigned rights and obligations to manage
these contracts and on a periodic basis pays dividends to ACA Service, L.L.C., its direct parent and
direct wholly owned subsidiary of the Company. ACA Service, L.L.C., in turn, passes on these funds to
the Company, also in the form of a dividend.
2. RESTRUCTURING TRANSACTION
As a result of adverse developments in the credit markets generally and the mortgage market specifically
that began in the second half of 2007 and continued to deepen in 2008 and thereafter, the Company
experienced material adverse effects on its business, results of operations, and financial condition, which
resulted in significant downgrades of the Company’s financial strength ratings by Standard & Poor’s
Ratings Services (S&P) and, ultimately, a restructuring of the Company to avoid a regulatory proceeding
(the “Restructuring Transaction”). The Restructuring Transaction, which was consummated on
August 8, 2008, was comprised of three main components.
The first component of the Restructuring Transaction consisted of a Global Settlement Agreement
whereby insured credit swap counterparties’ claims were settled in consideration for a cash payment of
approximately $209 million and surplus notes with a face value of approximately $950 million. In the
aggregate $1 billion face amount of surplus notes were issued in connection with the Restructuring
Transaction. Of such amount, the aforementioned insured credit swap counterparties received
$950 million and the balance of $50 million was issued to ACACH. While certain of the surplus notes
issued to the insured credit swap counterparties were issued to be non-voting at the request of certain of
such counterparties, the surplus notes issued to the counterparties, in the aggregate, represent a 100%
voting interest in the Company. The surplus notes issued to ACACH are all non-voting.
The second component of the Restructuring Transaction provided for the settlement of a $100 million
medium term note guaranteed by the Company. This obligation was settled with the noteholders in
exchange for a cash payment by the Company of approximately $48 million and the transfer by the
Company to the noteholders of investments in CDO equity with an estimated value of $2.5 million. Of
the total cash settlement, approximately $32 million was paid out of a cash collateral account supporting
the issued note while the remaining amount of approximately $16 million was funded by cash from the
Company and its other subsidiaries.
The third component of the Restructuring Transaction centered on the Intercompany Agreement which
treated ACACH and its non-ACA FG subsidiaries as one sub-group and ACA FG and its subsidiary as a
separate sub-group. By its terms, the Intercompany Agreement provided for the cancellation of a
previously issued intercompany surplus note as well as intercompany balances between the Company’s
sub-group and the ACACH sub-group. It also provided for a global release of liability among the two
sub-groups. In general, the release discharges the entities from any and all actions, cause of action, suits,
debts, liens, contracts, rights and other legal obligations against each other, except those provided for in
the Intercompany Agreement.
Subsequent to the closing of the Restructuring Transaction, the Company is required to and has operated
under an order issued by the MIA, Case No.: MIA: 2008-08-011 dated August 7, 2008 (the “Order”).
The Order provides, among other things, that the Company operate as a run-off company. In connection
with the Order, following the Restructuring Transaction, the Company wound down all subsidiaries no
longer necessary for the conduct of its ongoing business, including 73 special purpose entities created
for the insured credit swap and CDO asset management businesses.
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3. DESCRIPTION OF SIGNIFICANT RISKS AND UNCERTAINTIES AND THE COMPANY’S
ON-GOING STRATEGIC PLAN
Description of Significant Risks and Uncertainties
• As further discussed in Note 4, ACA FG recognizes losses and establishes related loss reserves
on bond obligations it has insured only upon the initial payment default by the issuer of such
bond obligations (under the Company’s accounting policy, the initial payment default is
generally considered the incident which gives rise to a claim and triggers loss recognition
relating to the incident). The loss recognized by ACA FG upon a payment default represents the
Company’s best estimate of its remaining unpaid ultimate loss over the life of the policy,
discounted to reflect the time value of money (not the amount of the claim under the policy
received upon the initial payment default which generally reflects the shortfall by the obligor of
the scheduled principal and/or interest payment then due under the terms of the bond indenture).
However, ACA FG has policies in-force upon which it expects that payment defaults will occur
in the future resulting in losses that will be incurred by the Company. Such expected future
losses are not recorded by the Company in the accompanying Statements of Admitted Assets,
Liabilities and Surplus at December 31, 2013 and 2012, because a payment default has not yet
occurred. With consideration of the inherent uncertainty of estimating losses discussed further
below, the Company’s estimate of the ultimate losses that it will incur in the future on such
policies (where payment defaults have not yet occurred but are expected) ranged from
$95 million to $115 million at December 31, 2013, on a discounted basis. Accordingly, the
Company believes it will incur material losses in the future which will materially adversely
affect its policyholders’ surplus. Notwithstanding the de-recognition of the Company’s
contingency reserves approved by the Maryland Insurance Commissioner discussed in Note 4
and any further de-recognition of contingency reserves that may be approved by the Maryland
Insurance Commissioner in the future, no assurance can be given that the recognition of such
losses in the future will not cause the Company to fail to comply with its regulatory required
minimum policyholders’ surplus requirement of $750,000. However, the Company believes that
its surplus will be in excess of the required minimum surplus over the twelve months succeeding
the date of the accompanying Statement of Admitted Assets, Liabilities and Surplus and, that it
has sufficient liquidity resources to satisfy its financial obligations as they come due for the
foreseeable future.
• The Company is materially exposed to risks associated with deterioration in the tax exempt
bond market through its insurance guaranties (see Note 10), as well as to the economy generally.
The extent and duration of any future deterioration in the tax exempt bond market is unknown,
as is the effect, if any, on potential claim payments and the ultimate amount of losses the
Company may incur on obligations it has guaranteed. As discussed in Note 19, the Company
classifies its insured in-force portfolio in one of four credit quality categories. As noted therein,
as of December 31, 2013, the Company had insured obligations with outstanding principal
totaling $375.8 million classified in category 4, which means that it either has paid claims on
such exposures or expects to pay claims on such exposures in the future. In addition, as of such
date, the Company had insured obligations with outstanding principal totaling $289.7 million
classified in category 3, which means those credits have materially violated financial and
operational covenants and require remedial action to avoid further performance deterioration. As
discussed in Note 10, the risk of loss under the Company’s guaranties extends to the full amount
of unpaid principal and interest on all debt obligations it has guaranteed. No assurance can be
provided that further deterioration in ACA FG’s insured guaranties will not occur resulting in a
further migration of insured exposure to categories 3 and/or 4 or that ACA FG will not incur
losses that may be materially in excess of what it currently estimates.
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