The following discussion and analysis contains forward-looking statements which involve inherent risks and uncertainties. All statements other than statements of historical fact are forward-looking statements. These statements are based on our current assessment of risks and uncertainties. Actual results may differ materially from those expressed or implied in these statements and, therefore, undue reliance should not be placed on them. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed in this report, including the section entitled “Risk Factors.”
2046, both of which are fully and unconditionally guaranteed by ACGL. We were formed for the sole purpose of issuing the senior notes and have no business activities.
On December 22, 2016, we loaned $950.0 million, comprising the net proceeds from the issuance of the Senior Notes and the proceeds from a capital contribution, to U.S. MI Holdings in exchange for (i) a promissory note receivable for $500.0 million principal amount bearing interest at 4.011% due December 1, 2026 and (ii) a promissory note receivable for $450.0 million principal amount bearing interest at 5.031% due December 1, 2046. U.S. MI Holdings used the proceeds in connection with its acquisition of UGC from AIG on December 31, 2016.
For the period from November 3, 2016 to December 31, 2016, our expenses consisted of interest expense of $2.6 million on the Senior Notes. In future periods, we expect that substantially all of our expenses will consist of interest due on the Senior Notes.
We review our securities measured at fair value and discuss the proper classification of such investments with investment advisors and others. See note 5, “Fair Value,” of the notes accompanying our financial statements for a summary of our financial assets and liabilities measured at fair value at December 31, 2016 by valuation hierarchy.
See note 2(d), “Significant Accounting Policies-Recent Accounting Pronouncements,” of the notes accompanying our financial statements.
$500.0 million principal amount of 4.011% senior notes due December 15, 2026 (2026 notes), fully and unconditionally guaranteed by ACGL. The 2026 notes are unsecured and unsubordinated obligations of us and ACGL, respectively, and rank equally and ratably with the other unsecured and unsubordinated indebtedness of us and ACGL, respectively. Interest payments on the 2026 notes are due on June 15th and December 15th of each year. We may redeem the 2026 notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price;
$450.0 million principal amount of 5.031% senior notes due December 15, 2046 (2046 notes), fully and unconditionally guaranteed by ACGL. The 2046 notes are unsecured and unsubordinated obligations of us and ACGL, respectively, and rank equally and ratably with the other unsecured and unsubordinated indebtedness of us and ACGL, respectively. Interest payments on the 2046 notes are due on June 15th and December 15th of each year. We may redeem the 2046 notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price.
The indenture under which the 2026 notes, 2046 notes and the related note guarantees were issued contain various covenants, including, with respect to ACGL, limitations on mergers, amalgamations and consolidations, restrictions as to the disposition of the stock of designated subsidiaries and limitations on liens on the stock of designated subsidiaries. The indenture, the notes and the note guarantees are governed by the laws of the State of New York. As of December 31, 2016, we were in compliance with all of the covenants related to the 2026 notes and 2046 notes.
On December 22, 2016, we loaned $950 million to U.S. MI Holdings in exchange for:
a promissory note receivable of $500.0 million principal amount bearing interest at 4.011% due December 1, 2026 (“2026 promissory note”). Interest payments on the 2026 promissory note are due on June 1st and December 1st of each year. U.S. MI Holdings may redeem the 2026 promissory note at any time and from time to time, in whole or in part, at a price equal to 100% of the principal amount to be paid;
a promissory note receivable of $450.0 million principal amount bearing interest at 5.031% due December 15, 2046 (“2046 promissory note”). Interest payments on the 2046 promissory note are due on June 1st and December 1st of each year. U.S. MI Holdings may redeem the 2046 promissory note at any time and from time to time, in whole or in part, at a price equal to 100% of the principal amount to be paid.
Our contractual obligations consist of payments related to the 2026 notes and 2046 notes and related interest. We are also a subsidiary guarantor under ACGL’s credit agreement. The following table provides an analysis of our contractual commitments at December 31, 2016:
We have audited the accompanying balance sheet of Arch Capital Finance LLC as of December 31, 2016, and the related statement of income, changes in member’s interest and cash flows for the period then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
On December 22, 2016, the Company loaned $950.0 million, comprising the net proceeds from the issuance of the Senior Notes and the proceeds from a capital contribution, to U.S. MI Holdings in exchange for $950.0 million of promissory notes receivable. U.S. MI Holdings used the proceeds in connection with its acquisition of United Guaranty Corporation, a North Carolina corporation (“UGC”), from American International Group, Inc. on December 31, 2016.
The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of the Company. There are no other comprehensive income items for 2016 and, as such, the Company’s comprehensive income (loss) is equal to net income (loss) for 2016. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions.
No income tax expense or benefit is recognized in the accompanying financial statements for 2016 as the Company is treated as a disregarded entity for income tax purposes. No formal tax-sharing arrangement exists between the Company and U.S. MI Holdings. Accordingly, the Company’s taxable income or loss is included in the income tax return of U.S. MI Holdings.
The Company adopted ASU 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40),” effective for annual periods ending after December 15, 2016. This ASU provides guidance to address the diversity in practice in determining when there is substantial doubt about an entity's ability to continue as a going concern and when an entity must disclose certain relevant conditions and events. The amendments in this ASU require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. The adoption of this ASU did not have any effect on the Company's results of operations, financial position or liquidity.
ASU 2016-01, “Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities,” was issued in the 2016 first quarter to enhance the reporting model for financial instruments and to provide improved financial information to readers of the financial statements. The ASU is effective in the 2018 first quarter and, aside from limited situations, cannot be early adopted. The Company is currently assessing the impact the implementation of this ASU will have on its consolidated financial statements.
On December 8, 2016, the Company completed a public offering of:
$500.0 million principal amount of 4.011% senior notes due December 15, 2026 (2026 notes), fully and unconditionally guaranteed by ACGL. The 2026 notes are unsecured and unsubordinated obligations of the Company and ACGL, respectively, and rank equally and ratably with the other unsecured and unsubordinated indebtedness of the Company and ACGL, respectively. Interest payments on the 2026 notes are due on June 15th and December 15th of each year. The Company may redeem the 2026 notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. The fair value of the 2026 notes at December 31, 2016 was $509.3 million;
$450.0 million principal amount of 5.031% senior notes due December 15, 2046 (2046 notes), fully and unconditionally guaranteed by ACGL. The 2046 notes are unsecured and unsubordinated obligations of the Company and ACGL, respectively, and rank equally and ratably with the other unsecured and unsubordinated indebtedness of the Company and ACGL, respectively. Interest payments on the 2046 notes are due on June 15th and December 15th of each year. The Company may redeem the 2046 notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. The fair value of the 2046 notes at December 31, 2016 was $476.0 million.
The indenture under which the 2026 notes, 2046 notes and the related note guarantees were issued contain various covenants, including, with respect to ACGL, limitations on mergers, amalgamations and consolidations, restrictions as to the disposition of the stock of designated subsidiaries and limitations on liens on the stock of designated subsidiaries. The indenture, the notes and the note guarantees are governed by the laws of the State of New York.
On December 22, 2016, the Company loaned $950 million, comprising the net proceeds from the issuance of the Senior Notes and the proceeds from a capital contribution, to its sole member, U.S. MI Holdings, in exchange for:
The promissory notes receivable contain customary terms and conditions regarding the application of payments, defaults and remedies in the event of default and transfer. The promissory notes receivable may not be assigned by U.S. MI Holdings and are governed by the laws of the State of New York.
At December 31, 2016, the 2026 notes were carried at their cost, net of debt issuance costs, of $495.7 million and had a fair value of $509.3 million, while the 2046 notes were carried at their cost, net of debt issuance costs, of $445.1 million and had a fair value of $476.0 million. The fair values of the senior notes were obtained from a third party pricing service and are based on observable market inputs. As such, the fair value of the notes is classified within Level 2. There is no market for the promissory notes receivable held by the Company. As such, the Company classifies the promissory notes within Level 3. The Company believes that the fair value of the promissory notes receivable would approximate the fair value of the related senior notes.