Additionally, management reviews our performance using a measure known as net economic income. Management believes that analyzing net economic income enhances the understanding of our results of operations by highlighting income attributable to our ongoing operating performance. See “-Net Economic Income.”
Premiums Earned-Premiums on financial guaranty insurance products in the form of traditional insurance policies are typically received on an up front basis, although certain policies pay premium in periodic installments. The vast majority of our Public Finance business is conducted through the issuance of traditional policies. Traditional policies are those that meet the scope exception of the guidance of FAS 133, paragraph 10d, as amended by FAS 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“FAS 149”). The scope exception provides that financial guaranty contracts are
Investment Portfolio. The primary components of our investment portfolio are the fixed maturity securities of ACA Financial Guaranty, our CDO investments and the investments in the Credit Fund. As per FAS 115, “Accounting for Certain Investments in Debt and Equity Securities” (“FAS 115”) management determines the appropriate classification of these securities at the time of purchase. As of December 31, 2006, all investments in fixed maturity securities except for those related to the Credit Fund were designated as available for sale and were carried at fair value. Unrealized gains and losses for available for sales securities are the difference between fair value and amortized cost included in the accumulated other comprehensive income component of stockholders’ equity, net of applicable deferred income tax. As of December 31, 2006, the investments of the Credit Fund were designated as trading securities and were also carried at fair value. Unrealized gains and losses for trading securities are included in net income. The fair values of our securities are based on independent market quotations or, when such quotations are not readily available because the securities are infrequently traded in the public market, from internal valuation models. The valuation results from these models could differ materially from amounts realizable in an open market sale or exchange.
Beginning in 2005, we have retained a lesser share of the equity position of our newly issued CDOs. Based on analyses under FIN 46(R), we are not deemed to be the primary beneficiary of these VIEs. As a result, these CDOs are not consolidated in our financial statements. Rather, our non-majority investment is recorded as an investment in a single fixed maturity security under the provisions of FAS 115 and Emerging Issues Task Force Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets” (“EITT 99-20”). During 2006, we closed eight CDOs and purchased an equity interest in four. During 2005, we closed five CDOs and purchased equity interests in four of the five CDOs. We were not determined to be the primary beneficiary in any of these CDOs and therefore do not consolidate them.
The accounting policies of our lines of business are the same as those described in the summary of “Critical Accounting Policies and Estimates” above. Our two financial guaranty insurance lines of business, Structured Credit and Public Finance, are presented as separate lines of business. Items not directly
The Company’s consolidated net income for 2006 was $58.7 million, or $1.89 per diluted share, as compared to $28.8 million, or $0.96 per diluted share, in 2005, an increase of $29.9 million. The Company’s consolidated net income for 2005 of $28.8 million, or $0.96 per diluted share, was an increase of $32.6 million compared to the Company’s net loss of $(3.8) million, or $(0.61) per diluted share, in 2004.
Depreciation and Amortization. Allocated depreciation and amortization expense is related to furniture and computer equipment, leasehold improvements and any costs deferred in connection with the raising of corporate debt. Such expenses are allocated to line of business similarly to other operating expenses.
Net Insured Credit Swap Revenue. Net insured credit swap revenue grew to $53.0 million in 2006 from $20.5 million in 2005 and $5.6 million in 2004. As set forth in the table below, insured credit swap revenue is the sum of premiums earned on our insured credit swap transactions, net realized gains (losses) which may result from time to time result from any termination or credit events related to such transactions and unrealized gains (losses) resulting from the changes in fair value of these transactions. Premiums earned from our insured credit swap transactions increased to $46.2 million in 2006 from $23.1 million in 2005 which was a significant increase from $6.4 million in 2004. The primary reason for the increases was the higher volume of transactions completed resulting from increases in available credit from existing counterparties and the addition of new counterparties, and the annual revenues from business written in 2006 compared to 2005 and in 2005 compared to 2004. Notional credit exposure increased to $39.4 billion at December 31, 2006 from $14.6 billion and $4.7 billion as of December 31, 2005 and 2004, respectively.
Interest Expense. Interest expense results from debt costs at the Credit Fund as well as allocated interest costs associated with corporate debt at our holding company. The Credit Fund finances its asset purchases in part through the use of security repurchase agreements. Total interest expense related to the
Net Realized and Unrealized Gains (Losses) on Derivative Instruments. The following table illustrates the type of derivative instruments reported in this line item:
Net Investment Income. Net investment income was $3.8 million in 2006, $3.3 million in 2005 and $2.1 million in 2004. Net investment income is derived from the allocation of income from ACA Financial Guaranty’s investment portfolio. A portion of our capital is allocated to this line of business because we have outstanding exposure, principally related to our exposure to insured manufactured housing securitizations. Notwithstanding the run-off or expiration of our exposure overall in our Other line of business, allocated investment income increased due to the increase in the size of the ACA Financial Guaranty investment portfolio from 2004 to 2005 and again from 2005 to 2006.
If S&P was to reduce ACA Financial Guaranty’s financial strength rating to below the “A” category, we would be severely limited in our ability to insure additional municipal bonds or insure additional Structured Credit transactions. In addition, if the financial strength rating was reduced below “A-”, we could be required to provide collateral in the form of cash or securities to back certain of our Structured Credit transactions. In the case of certain insured credit swaps, if the underlying portfolio deteriorates
On November 9, 2006, the Company priced its initial public offering of 6,875,000 shares of newly issued common stock and 23,541 shares of existing common stock. The Company realized gross proceeds
Fixed maturity securities having an amortized cost of $4.9 million and $5.2 million were on deposit with various regulatory authorities as required by law at December 31, 2006 and 2005, respectively.
Accrued Investment Income-The fair value of accrued investment income is assumed to approximate carrying value.
On November 23, 2004, the Company (i) issued 13,501 shares of series C senior convertible preferred stock for $0.8 million to ACA’s senior management and to one of its directors, and (ii) an additional 4,705 shares of series B senior convertible preferred stock for $0.3 million to one of its existing stockholders. An additional 5,000 shares of series C senior convertible preferred were issued to one of the Company’s directors on June 17, 2005. Each share of series C senior convertible preferred automatically converted into one share of series B senior convertible preferred on November 30, 2005.
The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately since each business requires different marketing strategies, personnel skill sets and technology.