Contracts Accounted for as Credit Derivatives

6 Months Ended

Jun. 30, 2022

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Contracts Accounted for as Credit Derivatives

The portfolio of outstanding exposures discussed in Note 3, Outstanding Exposure, and Note 4, Expected Loss to be Paid (Recovered), includes contracts that are accounted for as insurance contracts, derivatives, and FG VIEs. Amounts presented in this note relate only to contracts accounted for as derivatives. See Note 5, Contracts Accounted for as Insurance for amounts that relate to contracts accounted for as insurance and Note 8, Financial Guaranty Variable Interest Entities and Consolidated Investment Vehicles, for amounts that relate to contracts that are accounted for as FG VIEs. 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 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 credit derivative 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 transactions the Company also specifically agreed to pay if the obligor were to become bankrupt or if the reference obligation were restructured. Furthermore, 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 CDS contract; however, the Company on occasion has mutually agreed with various counterparties to terminate certain CDS transactions.

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 13.3 years and 13.2 years as of June 30, 2022 and December 31, 2021, respectively.

Credit Derivatives (1)


	As of June 30, 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	$	1,348	$	(80)	$	1,705	$	(72)
Non-U.S. public finance	1,476		(42)		1,800		(48)
U.S. structured finance	355		(22)		400		(32)
Non-U.S. structured finance	122		(3)		135		(2)
Total	$	3,301	$	(147)	$	4,040	$	(154)

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(1) Expected loss to be paid was $5 million as of both June 30, 2022 and December 31, 2021.

Distribution of Credit Derivative Net Par Outstanding by Internal Rating


	As of June 30, 2022				As of December 31, 2021
Rating Category	Net Par Outstanding		% of Total		Net Par Outstanding		% of Total
	(dollars in millions)
AAA	$	1,317	39.9	%	$	1,503	37.2	%
AA	1,116		33.8		1,283		31.8
A	329		10.0		514		12.7
BBB	480		14.5		677		16.7
BIG	59		1.8		63		1.6
Credit derivative net par outstanding	$	3,301	100.0	%	$	4,040	100.0	%

Fair Value Gains (Losses) on Credit Derivatives


	Second Quarter				Six Months
	2022		2021		2022		2021
	(in millions)
Realized gains (losses) and other settlements	$	—	$	2	$	(1)	$	3
Net unrealized gains (losses)	9		(35)		7		(55)
Fair value gains (losses) on credit derivatives	$	9	$	(33)	$	6	$	(52)

During second quarter 2022, unrealized gains were generated primarily as a result of the increased cost to buy protection on AGC, as the market cost of AGC’s credit protection increased during the period, and changes in discount rates. These gains were partially offset by an increase in the credit spread of certain underlying reference obligations. For those CDS transactions that were pricing at or above their floor levels, when the cost of purchasing CDS protection on AGC, which management refers to as the CDS spread on AGC, increased, the implied spreads that the Company (or another comparable entity) would expect to receive on these transactions decreased.

During second quarter 2021, unrealized losses were generated primarily as a result of the decreased cost to buy protection on AGC, as the market cost of AGC’s credit protection decreased during the period. These losses were partially offset by general price improvements of the underlying collateral.

During six months 2022, unrealized gains were generated primarily as a result of the increased cost to buy protection on AGC and changes in discount rates. These gains were partially offset by an increase in the credit spread of certain underlying reference obligations.

During six months 2021, unrealized losses were generated primarily as a result of wider implied net spreads driven by the decreased market cost to buy protection in AGC’s name during the period. These losses were partially offset by general asset price improvement of the underlying collateral.

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 June 30, 2022	As of December 31, 2021	As of June 30, 2021	As of December 31, 2020
Five-year CDS spread	103	49	62	132
One-year CDS spread	41	16	16	36

Fair Value of Credit Derivative Assets (Liabilities)

and Effect of AGC Credit Spread


	As of
	June 30, 2022		December 31, 2021
	(in millions)
Fair value of credit derivatives before effect of AGC credit spread	$	(223)	$	(225)
Plus: Effect of AGC credit spread	76		71
Net fair value of credit derivatives	$	(147)	$	(154)

The fair value of CDS contracts as of June 30, 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.