Arch Capital Group Ltd (ACGLN) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Arch Capital Group Q4 2016 earnings conference call. (Operator Instructions) As a reminder, this conference call is being recorded. Before the Company get started with its update, management wants to first remind everyone that certain statements in today's press release and discussed on the call may constitute forward-looking statements under the federal securities laws.

These statements are based upon management's current assessments and assumptions and are subject to a number of risks and uncertainties. Consequently, actual results may differ materially from those expressed or implied. For more information on the risks and other factors that may affect future performance, investors should review periodic reports that are filed by the Company with the SEC from time to time.

Additionally, certain statements contained in the call that are not based on historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company intends the forward-looking statements in the call are subject to the Safe Harbor created thereby. Management will also make reference to some non-GAAP measures on the financial performance.

The reconciliation to GAAP and definition of the operating income can be found in the Company's current reports on the Form 8-K furnished to the SEC yesterday, which contains the Company's earnings press release and is available on the Company's website. I would now like to introduce your host for today's conference call, Mr. Dinos Iordanou, Mr. Marc Grandisson and Mr. Mark Lyons. Sirs, you may begin.

Thank you, Kevin. Good morning, everyone, and thank you for joining us today for our fourth quarter and year-end 2016 earnings call. We have a lot to talk about today so let's begin with our completing the purchase of United Guaranty Corporation at the end of 2016. The combination of Arch MI and United Guaranty Corporation not only creates the world's largest mortgage insurer but equally important, brings a culture of both leadership and innovation to the mortgage insurance industry that we believe will benefit our shareholders and customers for years to come.

Merging two companies is no small task, but I'm pleased to say that the integration of Arch MI and United Guaranty Corporation is progressing smoothly. Across our companies, our employees are working hard to ensure that there will be no disruption to our customer base in both the bank and credit union channels.

Now let me turn to year end results. We had a good quarter despite noise from acquisition related expenses and a few other items which we will discuss in a few minutes. The reported combined ratio on the core basis, Mark Lyons will define in a moment what core means -- increased by two points over the fourth quarter of 2015 to 88.8% as cat losses added four points to our accident year results for the quarter.

For the year ended 2016, our combined ratio was essentially flat at 88.2% compared to 88% for the full year in 2015. The full 2016 accident year, excluding cats, improved to 93.4% on a core basis versus 94.4% for the 2015 accident year. Accident year results were roughly flat in both our insurance and reinsurance segments despite a softening market where our mortgage segment improved its accident year combined ratio year-over-year to 64% from an 84.2% in 2015 year, due primarily to improving profitability at Arch MI.

Even before considering the acquisition, the mortgage segment went from representing 6.4% of net earned premiums on a core basis in full year 2015 to 8.4% for full year 2016. In the future, these will continue to increase based on our own growth in the business and the acquisition of United Guaranty Corporation. Loss reserve development remained favorable in each of our segments which, in the aggregate, reduce our combined ratio by 6.4 points for the fourth quarter and 7.7 points for the year ending 2016.

There were no significant changes that we see in the property-casualty operating environment for the quarter. Marc Grandisson will elaborate on what we see in each of the markets in a few minutes. On an operating basis, we produce a return on equity of 9.4% while on a net income basis, we earn a return on equity of nearly 11% for the full year 2016. Net investment income per share for the fourth quarter was $0.56 per share, up $0.03 sequentially from the third quarter of 2016.

On a local currency basis, the total return on our investment portfolio for the quarter was a negative 166 basis points, primarily due to the significant increase in interest rates on our very large bond portfolio. For the full year 2016, again, on a local currency basis, our total return was a positive 235 basis points. Our core operating cash flow was $279 million in the fourth quarter as compared to $99 million in the fourth quarter of 2015.

Our book value per common share at December 31, 2016 stands at $55.19 per share, a 3.5% increase sequentially from the third quarter of 2016 and 15.8% increase from the fourth quarter of 2015. Mark Lyons will give more details on the components of the change in book value per share in just a few minutes. Before I turn the call over to Marc Grandisson, I would like to discuss our PMLs, which are essentially unchanged from October 1 of 2016.

As usual, I would like to point out that our cat PML aggregates reflect business bound through January 1, while the premium numbers included in our financial statements are through December 31, and that the PML's also are reflected net of all reinsurance and retrocessions we purchased. As of January 1, 2017, our largest 250 year PML for a single event remains the Northeast at $492 million or 6.6% of common shareholders' equity. Our Gulf of Mexico PML stands at $427 million and our Florida Tri-County PML decreased slightly to $394 million.

I will now turn the call over to Marc Grandisson to comment on our operating units and make some remarks on market conditions. Marc?

Thank you, Dinos. Good morning to all. First, on this 14th day of February, I would like to wish my wife and daughters a happy Valentine's Day.

You are such a great father and a great husband.

Thank you. As Dinos mentioned, the integration of UG into Arch is going very well. Culturally, we are finding that the UG team as basically cut from the same cloth as the Arch team. They have been created with capital solutions and we share a pricing philosophy based on risk assessment, and also a dedication to analytics and technology development. The combined entities' abilities provide us with a strong and, we believe, sustainable platform in the US private mortgage insurance space.

For the fourth quarter of 2016, Arch US MI, including UG, had new insurance written, or NIW, of $8.8 billion, about the same level as the third quarter's. On a combined basis, we estimate our primary US market share at approximately 25% to 26% for the fourth quarter including UG, which is in line with the third quarter of 2016. In addition, we continued to lead in the USGS risk sharing transactions with approximately $2.2 billion of risk-in-force at year end 2016.

Our Australian Mortgage Insurance relationship continues to generate good volume. However, we've increased the level of our Australian quota share retrocession to 37.5% from 25% for those of you keeping track, which explains the healthy amount of premiums ceded in the segment this quarter. With the acquisition of UG we have multiplied our US primary risk-in-force by more than five times with over 87% of the exposure written after 2008, a period in which the underwriting quality of the insurance written has been at its peak.

The MI data contained in the quarterly supplement reflects the quality of the combined primary portfolios with average FICO scores of 743 and a low 90s loan to value ratio. We continue to see favorable reserve development from both legacy MI portfolios and at the end of the first quarter, we will provide you with more clarity on the progress we're making with the integration process and fully combined US MI statistics.

Switching over to the P&C insurance world, the level of rate decrease has slowed somewhat but it is still broadly negative. This is especially true for the larger accounts. For that reason, both our insurance and reinsurance groups continue to move towards less competitive, smaller accounts and more specialized areas of the market. We continue to move away from lines such as excess liability, E&S property and property cat, while focusing our efforts in less volatile and specialized lines such as travel, differentiated programs or reinsurance of agricultural business.

In our primary US P&C Insurance operations, we had margin erosion of 40 basis points for all lines in the fourth quarter and about 100 bps for the full year 2016. For the full year 2016, our controlling and low volatility segments, which represents about 70% of our primary insurance portfolio had rate increases of 210 bps while our cycle managed business, the remaining 30%, experienced 410% -- 410 basis points of rate decrease.

Our UK insurance operation has experienced similar pressures from a rate level perspective. Rate decreases across all our product lines were 7.6% this quarter and, just as we have discussed in the US, we continue to shift to smaller accounts. On a group-wide basis, we had modest growth in the quarter in our insurance segments, construction, national accounts, travel and alternative markets lines. Our executive assurance, E&S property and casualty businesses are areas where current rate levels lead us to a more defensive strategy.

Turning over to reinsurance, it's a similar story to our insurance group in that we continue to focus on opportunities with a relative rate strength and more favorable returns such as facultative, agriculture and motor, while the more commoditized segments, such as property cat, excess liability and marine continue to experience rate decreases and we accordingly are shrinking in those lines. Overall, we estimate single-digit rate decreases across our reinsurance portfolio.

At the heart of Arch's long-term success are two factors. First, we focus on seeking favorable returns across industry cycles and then we practice prudent capital and risk management towards maximizing risk-adjusted returns. As we enter into 2017, we continue to do just that. Within our P&C units we are defensive and shifting our risk exposures to relatively more attractive areas. With MI we have made a strong commitment to one of the best return opportunities available in the specialty area and we have also improved the diversification of our risk portfolio.

Our corporate culture and platform specialty businesses, we believe, allow us to pivot or to move towards markets where we can earn appropriate returns while shying away from markets or business lines where the volatility around expected returns requires a more cautious approach. And with that, I hand this over to Mark Lyons.

Great, thank you, Marc. And as Dinos alluded to, there is a lot of ground to cover this quarter, so on today's call I'm going to depart from the usual commentary structure and focus more on the unusual accounting impacts driven largely by the UGC transaction.

First, though, I'll highlight just a few items about this quarter, but as a reminder, the usual quarterly topics that we usually talk about and comment on can be found in the earnings release and the associated Financial Supplement. Okay, so now for some summary comments on the fourth quarter, all on a core basis. As a refresher, as Dinos alluded to earlier, the term core corresponds to Arch's financial results excluding the Other segment which is Watford Re, whereas the term consolidated includes Watford Re.

Okay. losses recorded in the fourth quarter from 2016 catastrophic events net of reinsurance recoverables and reinstatement premiums was $34.1 million or 4 loss ratio points compared to 1.9 loss ratio points in the fourth quarter of 2015 on the same basis. The activity was primarily driven by Hurricane Matthew, the New Zealand earthquake, and the Tennessee wildfire. We believe this continues to highlight our property cat underwriting discipline as actual reported losses on cat events continue to correlate with the exposure reductions that have been implemented over the last several years.

As for prior period development, approximately $55 million of favorable development, or 6.5 loss ratio points, was reported in the fourth quarter, led by the reinsurance segment with approximately $42 million of favorable development, reinsurance segment with about $8 million and the mortgage segment providing nearly $5 million of favorable development.

The calendar quarter combined ratio on a core basis was 88.8%, and when adjusting for cats in prior period development, the core accident quarter combined ratio was 91.2% compared with 93.5% in the fourth quarter of 2015. The reinsurance segment accident quarter combined ratio, again excluding cats, of 91.2% showed modest deterioration of 110 basis points compared to the fourth quarter 2015, while the insurance segment's accident quarter combined ratio, excluding cats, remained flat at 96.3%, but saw an accident quarter loss ratio increase of 90 basis points offset by a corresponding expense ratio reduction of 90 basis points.

These competitive conditions were more than offset by the continued improving profitability of the mortgage segment, amplified with their net earned premium being a larger proportion of the total. The mortgage segment's accident quarter combined ratio improved to 59.5% from 83.1% in the fourth quarter of last year and their net earned premiums represented nearly 10% of the total core net earned premium compared to only 6.9% in the corresponding quarter of 2015.

Now, moving on to some of the unusual financial statement impacts this quarter. I'd like to focus on the UGC transaction as it affected, among other things, reported corporate expenses, financing expense, book value and our capital structure. The transaction closed at 11:59 PM on December 31, so UGC is reflected in our year-end balance sheet but not our income statement.

As for nonrecurring expenses, the Company incurred $25.2 million of such expenses related to the UGC transaction in the quarter, arising primarily from investment banking, bridge financing and credit facility fees along with the usual legal rating agency accounting and consulting fees with such banks. Given the nonrecurring nature of these expenses, we have excluded them from operating income as they are not relevant to our true underlying performance. However, I would like to provide some alternative insight into our operating income per share by providing results on three basis, which we feel is important to distinguish. The official reported operating income per share and then two alternative pro forma views, which I will define now.

First, we view the official reporting of operating income per share as, and in the earnings release as being a hybrid and by that we mean it excludes the nonrecurring UGC transaction expenses but includes the UGC financing costs since we did raise that additional capital and are obligated to incur interest expense and pay additional preferred dividends per the terms of those instruments. The first alternative pro forma view of earnings that I'll get into is as if the UGC transaction did not occur. This view provides a clear comparative picture to last year's fourth-quarter and the third quarter of 2016 and is likely most representative of views from the Street.

This first alternative pro forma view excludes the UGC transaction expense and excludes the debt and preferred stock financing expenses and excludes the incremental investment income gained as a result of raising that additional capital. The second alternative view provides for this quarter's operating income. It would include all recurrent -- or sorry, all nonrecurring expenses and the financing costs and the additional investment income associated with the transaction.

So, the official operating earnings per share to common shareholders, as reported in our earnings release, is $1.13 per share. The first alternative pro forma view, which completely excludes the UGC transaction as respects transactional expenses, financing costs and additional investment income, is $1.16 per share. The second pro forma alternative view, which reflects, as discussed above, all UGC transactional expenses, finding costs and investment income is $0.96 per share. Hopefully these three views will provide useful information for your analyses of this busy quarter on the different basis as defined.

Okay. So, rather than going through the mind numbing annual and incremental fourth quarter tax rates on a pretax operating income for each of the three views discussed, I will instead provide a 2017 forward-looking tax rate since the fourth quarter reflects so many unusual impacts and is not indicative of what could be expected on a run rate basis. As we have previously discussed, 2017 should provide, on an expected basis, higher mortgage segment income and a different taxable income mix by jurisdiction.

As a result, we anticipate that the expected tax rate for pretax operating income in 2017 to be in the low to mid teens range without giving any consideration to evolving tax changes potentially emanating from the Trump administration. This preliminary range is primarily driven by varying jurisdictional profit assumptions, cat loss assumptions and varying loss ratios.

Having said all this, the annual tax rate on pretax operating income for 2016 as reflected in our official earnings of $1.13 per share, was 5.2% which caused a fourth-quarter incremental tax rate of pretax operating income of 2.1%. This reflects an approximate $5 million true-up tax benefit for the first three quarters of the year, or nearly $0.04 per share to achieve this 5.2% annual tax rate.

Since the 2016 fourth-quarter results only partially reflect the additional effects of UGC financing transactions, it makes sense to provide a run rate for interest expense as well as for preferred dividends. Total interest expense for 2017 is expected to be $24.9 million per quarter. This reflects new and prior debt issuances as well as borrowings under our credit facility. Similarly, the run rate for quarterly preferred dividends also from new and prior issuances, is expected to be $11.4 million per quarter. This does not contemplate any potential action being taken on our $325 million of Series C preferred that becomes redeemable beginning in April 2017.

Lastly, as a result of the UGC acquisition, we took the opportunity to conform accounting standards between the segments as respects deferred acquisition expenses. As a result, book value was negatively impacted by $0.31 per share due to the charging off of previously capitalized deferred underwriting related expenses, largely through shareholders' equity with a small portion through the income statement.

As respects our capital structure, in connection with the UGC transaction, we raised capital in 2016, as reported on last quarter, by issuing 450 million of 5.25% noncumulative perpetual preferred and in December we raised $950 million of debt by issuing 10-year and 30-year vintages. We also tapped our credit facility for $400 million and utilized roughly $384 million of internal cash resources. We also issued Series D convertible preferred common equivalent shares to AIG at a fair market value of approximately $1.1 billion.

Before I get into our updated capital structure ratios, it's important to understand how we've accounted for the new equity issuance. There are no restrictions to ownership of these shares by AIG except for the passage of time as respects certain lockup provisions and these shares rank equally in all material respects to our existing common shares.

The Series C convertible preferred common equivalent shares are being treated in our calculation of book value as if they are common shares. Therefore, the approximate 12.8 million common equivalent shares issued to AIG are added into our common share count to determine book value per share now totaling 135.6 million shares. GAAP common equity at 12/31/2016 is approximately $7.5 billion and total GAAP capital is approximately $10.5 billion.

On a GAAP basis, our total debt to total capital ratio was 21.3% and total debt plus preferred to total capital is 28.7%. Accordingly, December 31, 2016 book value, as Dinos has mentioned, per share is $55.19 which represents 3.5% increase over the prior quarter and nearly 16% over year-end 2015. Book value per share primarily grew as a result of the $1.1 billion of Series D common equivalent shares issued to AIG, as mentioned earlier.

We issued those shares at a price to book multiple of approximately 1.61x and, accordingly, our book value gains an immediate accretive benefit of approximately $417 million at issuance. Now, since we made commentary today about operating income per share, excluding the impact of the UGC transaction, it is only fitting to provide the corresponding impact on book value per share as well. That excludes the Series D common equivalent issuance to AIG, eliminates the debt and preferred financing costs, the UGC nonrecurrent transactions, investment income differences and other conforming adjustments. So basically, as if UGC hadn't occurred.

Book value per share, excluding the UGC transaction, would have followed by 2.1% or $1.12 per share. We did not repurchase any shares during the fourth quarter of 2016 and don't anticipate repurchasing any during 2017. Our remaining authorization, which was due to expire on this December 31, has been extended to 12/31/2019, but the amount remains the same at $446.5 million.

Additionally, as respects the acquisition, we recorded approximately $189 million of goodwill on the books, or $1.39 per share, and have established an additional $507 million of intangible assets as of December 31, 2016. $480 million of which are subject to amortization. We anticipate that this associated amortization to be the highest in calendar year 2017 at approximately $110 million and then decline thereafter, such that approximately 75% of the amortization will be recognized within five years. I refer you to page 7 of the earnings release to see more information about these intangible assets.

So, with these exhausting introductory comments out of the way, we are now prepared to take your questions.

(Operator Instructions) Sarah DeWitt, JPMorgan.

Hi, good morning. Now that the United Guaranty acquisition is closed, I wanted to get your thoughts on the potential for any additional expense savings or upside on the earnings accretion. I know the accretion of over 35% included some expense savings, but if you could provide any more exact numbers on that, that would be very helpful.

Well, we -- first and foremost, let me remind everybody that we didn't make the acquisition on the basis of expense savings. As you probably will know that with any merger of two companies, there is significant redundancies, which we are going to experience over the next two years as we put the companies together. Our focus is mostly on making sure that our customers don't get disturbed. So we continue to provide the service together, bringing the two companies together with an eye that if we can improve the expense ratio by saving, we will do it. And we will continue reporting to you on a quarterly basis what those savings are.

You know, it's -- I don't like to make projections because sometimes when you make projections, you might make your predictions come true and make the wrong management decisions. I'd rather have our people free to make the right decisions as we bring the companies together on a week by week basis and that's the basis we're going to run the integration. Mark, do you want to add to it, or --?

No, all set.

Okay.

Okay, that's fair. Thank you. And then also, how should we be thinking about the size of the combined premium base for the Company thinking -- for United Guaranty and AIG's mortgage business, taking into account how much will be non-renewed as well as the AIG quota share?

Well, there is two points here, one, there will be some actions on our part, mostly what we said in the past that I think probably a participation in singles will probably get reduced a bit over time. Having said that, there might be some action by our customers because they might feel that the combination of the two companies might create some overlay in significant exposure.

Based on our analysis, the latter doesn't seem to be a problem. It seems that there wasn't a lot of overlap between us and United Guaranty. So I don't expect that to be much, and then I believe that long-term, as we said before, we expect our market share to come down in the low 20s. It can be anywhere from 22% to 24%. We're at maybe 25%, 26% today. I don't see significant change in that that it would be dramatic quarter over quarter.

It's implementing our pricing strategies that we're going through now in combining the risk-based pricing of the two companies together. And, don't forget, our mortgage business is more global in nature. You're only focusing on the MI in the US, so we take what -- how much we're going to write a mortgage from a global point of view, including the book -- both transactions, our Australian business and our European business.

So, Marc, you want to elaborate a little bit further?

I think I would echo on this is also the 2016 was a bit higher in the last half of the year because of the refinancing (inaudible) that we got. So the market overall, expect a slower market in 2017; so that's something you need to keep in mind. So, generally, the way we look -- the high level look at the premium that can be generated by the portfolio, you take the insurance in force which we provide in our supplement, and you can ascribe 50 bps roughly rate to it and you could -- that sort of gives you the run rate as to what kind of premium you get per, year. And you could put some persistency around it, which you've heard on other calls as well, 75%, 76%, and this is how you get to the runoff of the portfolio and then you ascribe some new written for this year based on your view of the market, which really at this point in time is very, very difficult to see to have any clarity on.

Okay, great. Thank you. That's very helpful.

Quentin McMillan, KBW.

Hi. Good morning, guys. Thanks very much. I just wanted to talk about the mortgage business and the Australian contract that you have ceded. It looks like the net to gross in that portfolio dropped down the last two quarters in the 60% to almost 70% range, and I'm kind of just curious whether that was one-off because of the Australian contract or do you expect to retain a little bit less of that business as UGC earns in? And, potentially, would you look to maybe retain a little bit more of the Australian when it comes back up for renewal if the terms look attractive again next year?

Well, I mean the terms, they are attractive in our Australian business, otherwise we wouldn't be there, but our attitude is, we look at all of our business; I don't care if it's insurance, reinsurance, mortgage insurance, and we have a risk management perspective about aggregations, how much we want to have either in a particular territory, etc., etc. The -- our desire or our ability to reinsure part of the book, it comes out of that process.

When we sit down internally at the senior management level with our Chief Risk Officer and his team and we look at all of our aggregations, we make those determinations. So we purchase, as Marc said, 37.5% quota share going back to inception for our Australian book and that was a judgment that we made. That judgment might change in the future, but it's a decision we make on a lot of stuff here including how much retrocession we buy in our reinsurance book, on our cat book, etc. It's part of our risk management methodology. So, Marc, elaborate a little further.

Yes, the quota share goes back to May of 2015, and it's on for three years. So the panel has been set and the reason we had more accession this quarter was because of the catch up. We went from 25% accession to 37.5%; that 12.5% additional premium ceded has to be retroactively ceded back to our partners and this is exactly what we did this quarter. We have also good partners with us (inaudible) bring some value in terms of knowledge of the market and capital, helping us, as Dinos said, just to rightsizing the overall risk on balance sheet.

At this point in time, there is no plan to change. If somebody else would want to take more of it or help us provide some structure, we are, as usual, always interested in entertaining such things. But right now, there is no plan to change.

And Quentin, let me just -- just for clarity given what Dinos and Marc have said, neither the third nor the fourth quarter of this year are indicative in a run rate basis. Both of them had the retroactive cumulative catch up, as Marc alluded to. So on a go forward basis, assuming there is no changes to that in the multiyear nature, any new premiums arising in 2017's first-quarter, you should expect a 62.5% net arising from those out of Australia and a 37.5% ceded.

That's very helpful, thanks. And then moving to the investment portfolio, I asked this last quarter as well, but you guys last quarter had about a 2% yield and expecting the UGC portfolio to earn in at about a 3.5% yield. Is the assumption similar now and how much impact might that have and what are your expectations of what you'll do with the portfolio over the next couple of quarters as that higher-yielding book earns in?

Well, I think a couple things. First off is the composition of that portfolio is markedly different than what Arch had natively. It was longer duration in nature; it was made up much more heavily of municipals and corporate credits and lower rated corporate credits and that will be changed over time. It's going to be a little bit -- in fact, some of that has already occurred in the beginning of this year, and that will take a little while to do because a lot of it is onshore. So there is tax consequences to everything, so you've got to be mindful on how it's done. But I think over time, it will conform a lot more closely to the Arch portfolio in that regard. Dinos?

Yes, the only thing I will add it is, there is a tax component that we have to be mindful with, especially having more income emanating from the US, which is taxable at a very high rate, depending what happens with the tax law. And we might not change the municipal component, which is giving us some tax relief, so all that is being considered.

We have our teams in the investment department and our finance and tax people looking at restructuring the portfolio. But over time, it's going to look more like the Arch portfolio. High credit quality, probably shorter duration. But having said that, we've got to take also into consideration the tax considerations.

Thanks, guys. If I could just fit one more modeling thing in. Just -- you gave a lot of guidance there. In terms of integration costs, do you have any updated estimate of what that might be for 2017?

Let me reiterate what I just said before. Integration costs -- you have costs upfront and then you have significant savings later on. We didn't do this transaction because we had some spreadsheet that says this is going to be wonderful and you're going to have all these kind of savings. We did it because it's make a lot of sense going forward, buying a business that has a tremendous potential for earnings. It fits the -- it's a specialized product that I think we can create value with it.

Having said that, our teams, they are going to look at maximizing synergies. Like I said, without affecting customers and volume as we go, so depending how much we do, we will have the expense up front and then the savings that come commensurate to that. But I want our teams to have freedom to make the right management decisions and we'll let the accounting take care of itself.

At a high level, though, it's a timing issue really. As you -- as Dinos pointed out, we will have some synergies that we will be able to extract some costs from. But I think the best thing I can tell you is, depending on the glide path that you think we'll be able to execute on, the long-term rate, ratio rate of expense of a typical MI company is 25% to 30%. So that's probably what I would use as an endpoint, depending what that endpoint is for -- in your mind as to how well and how quickly we can execute. But again, the speed of execution is not going at a cost of losing customer and losing culture and losing the spirit of our Company.

Perfect. Thanks very much, guys.

Kai Pan, Morgan Stanley.

Good morning and thank you. Thank you so much for providing these two alternative operating EPS estimates. I would add another one or ask for the third one is actually what would be your pro forma earnings would be if you included both the financing costs as well as UGC earnings in the quarter?

I don't have that because we did not have UGC's earnings in the quarter, so that's something I don't have readily available, Kai.

Okay, all right.

It didn't report to us. I mean we don't have the United Guaranty numbers.

Okay, I just wanted to give a try to see what's ongoing going forward run rate to earnings for you guys.

Be patient. First-quarter will give you a lot of disclosure. We'll try to make your jobs as easy as possible and -- be patient, another three months and we will be there.

Okay, thanks. And then on capital management, you said no buyback in 2017, so I'm assuming the priority would pay down some of the debt and also what's your comfort level in terms of debt to capital ratio as well as if you're going to 2018 when the buybacks come, would you prefer to do the buyback in sort of like a common preferred or more in the open market?

Well, let me start with 2017. 2017, we did say to the market and to the rating agencies we will not buy back shares. So 2017, it will be a year for us -- we're going to take the earnings, we're going to retain those earnings and basically we're going to start rebuilding some firepower on our balance sheet. Having said that, I don't know where 2018 is going to be. When I see the yearend 2017 numbers, we'll make some decisions. We want to maintain very good relationships with the rating agencies; they've been very fair with us in analyzing not only the transaction with us but the future plans or what we would need to do over the next three years.

From our past history, you will know that we try to maintain a conservative balance sheet without a lot of debt on it so we can have firepower in case markets change, so we can take advantage of it. So that's the overall strategy. Now with that, I'll turn you over to Mark Lyons who has more of the details. He does that analysis for all of us on a day-to-day basis, so Mark?

Sure. I think, Kai, on an overall basis -- we've said this publicly -- is that over three-year period we expect to be south of 20% Moody's adjusted leverage ratios which, as you may recall, our preferreds get basket seed treatment of 50% equity credit so when you go back and noodle it you can see how we're thinking. But that's going to be accomplished by a shrinking numerator and an increasing denominator. So both of those are going to go and, because we pulled 400 out of the credit facility, which is more flexibility, that's likely the target area that if we're going to differ and have the ability to pay back sooner than planned, it will go to that area.

Okay, great. Lastly, if I may, is on the US tax reform and just wanted to get your guys' perspective on that in both the lower corporate tax rate and Board adjustability and also the new bills in Congress. What -- how would that impact your business going forward?

Well, I mean it's -- first and foremost -- let me start with the first one. The lower tax rate, it's good for business. We -- at the end of the day, I'm in the minority but I strongly believe that corporations should pay zero tax and let their shareholders pay the tax when eventually Corporation has to distribute through dividends or through shares, funds to their shareholders and they are all full taxpayers, so let them collect the tax on that basis.

But put that aside, a reduction in the corporate tax rate is positive, especially with the United Guaranty Corporation acquisition, which is going to increase our domestic or U.S. earned income, so that's a positive. The other two that are hypothetical, the border adjustment tax, I don't know what's going to happen and if it will influence transactions between reinsurers. To me, reinsurance transactions across border is more exporting risk rather than importing capital, so at the end of the day -- without knowing the details very, very, very hard to project as to what the effect is going to be. But the wheel has been around for a long time.

I don't know what's going to happen, but we have alternatives to that. We are multifaceted and we are global in nature, so at the end of the day, I -- depending on this hypothetical, we'll react to it if it happens.

Great. Thank you so much.

Charles Sebaski, BMO Capital Markets.

Good morning. Hey, so it just like some thoughts on -- you talked about risk management and I think in the past you guys have talked about mortgage now really filling out three legs of a stool, but mortgage has got a different risk profile than us P&C people are used to thinking about with PML and maybe greater exposure to economic risk.

As we think about the mortgage business here, what's your -- how you think about it from a risk perspective and what's the ability to grow, be it globally, be it from GSE transactions? Is there still capacity to expand it or do the other legs of the stool need to expand further? Just how the relativeness between the three divisions and the relative size on a risk basis how you guys are thinking about that.

Well, let me start with the premise that our brains work in a fashion that -- I don't care what you do, you have to understand what your PML is and you've got to be comfortable on the basis of the balance sheet you have and are you comfortable with the setting of how much PML you can take within the balance sheet. The fact that historically MI companies might have not looked at it from that perspective is not relevant to us. We -- so the task that I have assigned all of our teams, and I personally work with them because that's a significant bet we're making in another line of business.

We would should have a methodology of calculating PML and we do -- we're in the third iteration of a model that calculates the aggregation of risk, including both underwriting risk within our mortgage business and also macroeconomic risk, changing unemployment, housing prices, etc., etc. And we stress test that to see as to what kind of outcomes we have and how much of that we are willing to take within our balance sheet.

Now we have also brought other tools that they were not traditional and some of the other of my companies are starting to use them as well. You don't have to retain all the risk on your balance sheet; there is reinsurance transactions you can bring, there is capital markets transactions you can bring to bear to manage the risk. So, that's the concept that we have. We use it with our cat business. We use it with our P&C and our reinsurance business. We pay retro in different segments; it could be marine, it could be aviation, it could be -- so we use the same approach because that's our DNA. Our DNA is bring in the rest, understand how much you are taking. Risk manage it to the point of comfort and see if you have more than what you want then either reinsure it out or use capital market transactions to bring it down to an acceptable level.

It's the old saying -- I use the expression my father taught me. He said, son, I don't care how good the meal is, don't eat too much because you get indigestion. So, we're not a Company that is going to overline on risk to the point that I can't sleep at night or Marc and Mark cannot sleep at night. We sleep like babies.

Will you guys be willing to provide -- so in your traditional P&C businesses you talk about Tri-County, you talk about Northeast. We think about wind exposure and PML's on 1 in 250 or 1 in 100. Will there be some kind of basis for you to explain to us how these metrics are if it's on unemployment or on GDP or on interest rates so that we can have some comparability on risk?

Yes, we might do that in the future. The reason I'm hesitant is not because we don't like to disclose to you guys a lot of stuff. We do but we don't want to wake up our competitors to understand what we're doing either. And to tell you the truth, we're still in the process of -- with the rating agencies of going back and forth and them understanding all of our methodologies and all the good work we've done. So -- and we haven't come to a complete agreement with them as of yet in those discussions. So we're hoping this year maybe sooner than later we'll get to some understandings in sharing our thoughts and our methodologies and some of the methodologies actually we're using we've taking from them. We look at how they look at mortgage risk and we try to bring it in.

But, the basis of our PML analysis, it goes to both. One, things that we can control, meaning underwriting quality of the mortgages we ensure and the pricing we apply to that and what those potential outcomes are. And second, macroeconomic factors that, what if the unemployment rate goes to 15%? What if housing prices collapsed by 25%? By 30%? And how rapidly they collapsed, and we model all that and then we come up and there is a lot of other factors.

We might share with you maybe some of our methodologies at an investor conference. This way you know our deep thinking into these issues, but I'm not ready yet to be -- start putting our PMLs out for our competition to know.

That's fair. I guess just a follow-up on the mortgage. Any thoughts on new Treasury Secretary, commentary about getting Fannie and Freddie out of government ownership? Would the expectation for you guys be that the speed of GSE de-risking would accelerate for those companies to come out? Is that how you guys think about that, or --?

Well, there is two constants that I think in our thinking is. First and foremost, there is pressure by Congress to put mortgage risk to the private markets, so that's a constant. The other constant is I think there is a recognition by our elected officials that securitization without the ultimate guarantee of the federal government is not possible. So, those things we don't believe they are going to change.

Now, are the GSEs privately owned and/or controlled by -- I don't think those two factors they are going to change. So at the end of the day, for everybody who is involved in the mortgage guarantee business, it's positive; because there is, independent if you are Republican or Democrat, there is a movement to put more risk into the private hands and eliminate the tax payer who has been the guarantor of these mortgages. The exception to that is the FHA who still, I want to remind you guys, has probably between the FHA and the VA, they got more than, what, 55%, 57% of the market.

So in essence we do have the taxpayer funded facilities competing in to private market, so that to me is more of a concern than what we do on the private side. But, I think the future is pretty bright. Marc?

Yes, the indication that we get, Charles, from talking to both the GSEs and certainly the various projects and various products that you've heard were initiated this year, and there is more on the horizon. Clearly the mandate from the GSEs is to be utilizing more of the private market absent -- we've heard that the new world order and the GSEs for five or six years now, I guess we'll get to a landing at some point. But I echo what Dinos just said, there is clearly no stopping them trying to leverage their positioning and use -- utilizing the third-party and the private capital to help make that a vibrant market. It's clearly pointing in that direction.

And, Chuck, I would just add on the GSE, because you were asking a pretty broad question, on the GSE credit risk transfer side, when you look at the balance scorecards that are out there and what Congress expects of the GSEs, there's no dropping off of that; it's a good signal of a continued transfer.

Thank you very much for the answers, guys.

Jay Cohen, Bank of America.

Good morning, everybody. Two questions. The first is, on the tax rate, that was very helpful to give the 2017 number. I know you're not giving a 2018 number but directionally -- and let's assume for a second that the corporate tax rate doesn't change, so kind of an as if basis, as you get into 2018 in 2019, would you expect the tax rate to come down because of things you would be doing internally?

Wow, that's loaded. If I could forecast the P&C underwriting cycle, I'd be a gazillionaire. But keeping everything constant, if there is no change at all, there should be minor drift in the aggregate effective tax rate because there should be incrementally more mortgage income associated with it. But that is a very rough and lack of confidence number.

To the extent that there is changes in any submarket, we're going to allocate and put capital there and that will change our effective tax rate. And if it's cat, for example, it's going to be Bermuda centric, which is going to drive it down. So, that's the best I can tell you.

No, that's helpful. I just didn't know if there were things you would be doing internally to affect that tax rate just structurally. Internal reinsurance or something?

-- there might be a few things we do on the investment side. It's all -- it's part of the restructuring of the portfolio. Maybe there is a little more municipal exposure on the investment side because it eliminates some of US tax. But -- that doesn't move the needle that much. You probably are talking about a point or so. It's the difference between 11 and 12 or 12 or 13, so --.

Got it. And the other question was -- one of the things the new administration did was they suspended the price cut on the FHA premium. This wasn't a big deal when they were proposing cutting it, but how you see that affecting you?

Well, it affects the market in general, right? The FHA is -- and the VA is competing with the private markets, and don't forget, they have a tremendous advantage. Their capital requirement is 2%, so in essence they are writing 50-to-1, where we're at 15-to-1 or less. So it's very, very tough sometimes to compete with Uncle Sam, but to us, that's positive because that reduction, in our view, we would have put more pressure on eventually the taxpayer by -- yes, reducing the cost to the consumer, but also -- I'm not so sure that those rates with those kind of risks it was sufficient to cover the exposure.

There is some movement, Jay, right now that the GSEs are sort of -- the FHA's purpose is really to get home ownership to people that otherwise wouldn't have access to it. There is clearly a response on the GSE with Home Possible. There is a couple of programs that they are putting in place and are starting to implement that will, hopefully, try and attract and address that specific segment. So a little bit away from the FHA, try to get into that segment as well, which is, again, good news for us, because it would be -- most of it would be conforming and needing private MI attached to it.

So overall, that, to echo again what Dinos just said, that move was seen positively by us, but again, we want to caution everyone that we're always one decision away from one of these directors to yet again put some other rate decrease, but that's the nature of the business that we're in.

Yes, good stuff, guys. Thanks.

Ian Gutterman, Balyasny.

It must be lunchtime.

It must be.

Ian, Today on the menu is pasticchio, so you can Google it. I'm not going to tell you what it is, but you can Google it.

I think I've had it before, so --.

Yes, my mother made it for our Investor Day.

I remember, I remember. So, my first question for Mark is as much of a comment, actually is, I think you need to come up with a better term than alternative income because I worry -- if you stick with that word, Melissa McCarthy is going to be reading your script next quarter.

As long as you are an English major, Ian, I'll listen to you.

(laughter) So, first just a couple number ones. The other underwriting income was higher than normal this quarter, mostly in reinsurance. What was driving that?

Yes, as we kind of talked about in the past with Watford Re, underwriting and investment fees are put together into a pot and they are shared equally and it was just a reflection of better performance.

Okay, so is that like a yearend true-up or is that just a good quarter?

No, it was a quarter --.

No, it's a quarter performance.

Got it. Okay. And then the amortization -- you said $110 million for this year, grading down. Can you just give us some sort of sense for the slope of that?

Well, I did give you two data points.

You did, you did and I tried. It's just that -- can I linearly do it or is there -- or is it a parabolic?

A reverse exponential.

Yes, just do a down slope exponential and you'll be good. I think you've got 480, 480 of it at the beginning that is amortizable, right? I told you 110 in the first year. 75% of that at year five.

You can figure it out, you're a math major.

I can get my junior high school daughter to do it.

I took a shot but I just want to make sure there wasn't some curvature to it rather than a slope, but the --.

There is some curvature; there is some curvature. Think of it as it's -- actually it varies by which intangible asset goes before distribution versus the other. But, as I said, after five years out, it becomes insignificant. I'll give you one more data point. At year six is pushing $20 million area, so that gives you your degree of fall off.

It's becoming a math exam for you.

That's okay. I can handle it. I'll compare notes with you next time I see you and see how good my guess is. You can grade me on it. I do sit in the back of the room, but I take good notes.

Just on that topic as we are talking about disclosures for UG. Would it be possible to give us some time before next quarter's earnings say a four quarter trailing pro forma mortgage insurance segment? I know it's possible. I guess I'm asking you is it realistic? We could discuss off-line, if you like, but that's a request (multiple speakers) --.

Why don't we, as a starting point because of the debt and the preferred that we had to issue for the prospectus has the actual UGC information in it that you can use as a baseline. Because as you know, the segment on the prior owner reporting was beyond UGC; it took the take back by quota share, so that, I think, is a useful starting point.

And then just lastly on the comment on the tax of low to mid teens, should I assume that -- does that assume that you will have a 50% quota share on the entire US MI business including UG?

It does.

It does.

Okay, and so, it --.

Forward.

Right, okay, and I guess this isn't an issue for 2017, but if you want to go out to 2018 or 2019, whatever, if there were a change in US tax rules, where something like the Neal Bill happened, any sort of sense of what the sensitivity of that tax rate is?

Well, without knowing what the bill is going to say, I can't model it for you, but tell me what the bill is going to say and then I'll model.

Fair enough, fair enough. Okay. I guess I wondered are there the same opportunities that I think you've hinted at with the P&C business. Could they be applied to the MI business as well or was that really something that only would work on the P&C business?

I don't totally understand the question. What do you mean? Sessions from P&C versus MI?

Right. I mean are there other places you can send stuff to, I guess? Other balance sheets you could use, things like that.

Believe me, believe me, my door is breaking down by people that want to get a piece of our MI business as reinsurance. Depends how -- what kind of terms you negotiate. Do you share on the profit or not. It's a lot of alternatives, so without me knowing exactly -- we react to what the actual law is and we abide by the law. And then we maximize for our shareholders the potential outcome, so not knowing that is so very hard. But there is alternatives, yes.

Got it. Okay. I think that's what I have. Enjoy lunch.

Elyse Greenspan, Wells Fargo.

Hi, yes, thank you. Just a couple quick questions. First off, the intangibles that we were just talking about, the $110 million, are those going into net or operating earnings?

Well, since that's a 2017 item, in all honesty, we are debating the alternatives. But I believe you can count on us being more transparent as more likely having it itemized in a way that lets you flip it however you choose to look at it.

So when you guys talked about the deal, I guess the accretion, 35%, was that including or excluding the amortization?

It was including.

Okay, and then in terms of the PMLs, I know, Dinos, you had mentioned how you guys are talking about calculating the aggregate risk including the mortgage exposure, so as we think about potentially a harder market on the cat side, obviously it doesn't seem like that's anything you guys are expecting. I guess the right assumption would be that we would never really see 25% of your capital going to cat business because now we have this greater mortgage exposure that you are also counterbalancing against your capital. How are you guys thinking about how that all comes together?

Well, my authority as -- and the senior management authority from the Board is -- we can't expose more than 25% of our equity capital on any line of business; that would include MI. So, that's the maximum we can take on a PML basis. If we want to take more, we have the opportunity, but it will be, I bet you, a very, very long discussion with our Board. And then jointly we will make a decision and if we make a decision to be something different, we will tell the market about it. So, right now that's what we are operating under.

Okay, and then one last question on I guess the pricing side. As we think about higher inflation just overall for the industry, where you guys pointed to it seems like still kind of deteriorating on the primary insurance side. Do you see people starting to think about pushing for more prices as we think about higher inflationary levels? Or you're thinking it will be like what we've seen in prior cycles where as we get companies pushing for price after inflation shows up within margins?

Yes, unfortunately, we don't see price increases. I'll give it to Mark for more color, but I think there is a time delay and basically I think it's the other metrics that usually cause us to -- the industry -- I'm not talking us specifically, but the industry to change is when loss cost inflation, which is not always call rate with the economic inflation, starts showing up in the numbers, how well the reserves are behaving. Those are the kind of things that cause adjustment to pricing. For now, I'm not sensing any adjustments to pricing. So we reported that for some of our business, we're getting some price increases, but for a lot of them, we get decreases, so -- and in the aggregate, we're negative, not positive. So Marc?

I think that the difficulty that we're running right now is most people are looking at a portfolio, and we've had a very benign trend for the last five or six years and a lot of your projections or the way you were price your business going forward is dependent on the historical, not only forward-looking. It's very, very hard to predict what the future inflation will be. There is a tendency for an underwriting unit or an underwriting company to assume the same old trend will carry on for a little while.

That explains why there is a delay and a lag in recognizing trends and it's especially acute if you are on the excess of loss, if you're excess of a certain threshold, say $3 million, $4 million, $5 million or $10 million is what we further delay. So unfortunately, we're seeing -- we're not seeing big reactions to this. I would also add a lot of people are expecting yields to pick up and interest rates to increase and more -- possibly more investment income in the future. So they are sort of buttressing a little bit that rate deterioration that we're seeing in the moment.

And Elyse, I'll just throw something in as well. We're more concerned with loss cost trends -- sometimes that's frequency driven, sometimes that severity driven. Your question was more severity driven. To the extent that a class-rated business primary frequency tends to drive it and you can sharpen your pencil a lot more and so do the competitors. When it's long tail, long duration excess and market example, rationalization takes over and it's not necessarily correlated as much.

Okay, thanks again.

And don't forget, don't forget -- traditionally the markets don't turn on these technical analysis and evaluation. The market turns when you have more fear than greed. It's the two emotions that determine the market. We have excess capital, there is a lot of people accepting mid single-digit returns, they view that as acceptable for the risk business, which I think is insanity, in my view. And at the end of the day, I don't see fear in the market yet. When you start seeing fear in the market, that's when you're going to see rates moving up and we don't see it yet.

Okay, great and thanks for the answers and congrats on getting the deal done at 11:59. (laughter)

We appreciate that. I had a glass of champagne celebrating the New Year and the closing, so it was very economical. I pay for one glass and I celebrated two things.

Thank you very much.

And I'm not showing any further questions at this time. I'd like to turn the call back over to Dinos Iordanou for closing remarks.

Well, thank you all. We're looking forward to the next quarter. Have a good afternoon.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect.