Assured Guaranty Ltd (AGO) 2004 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the First Quarter 2004 Assured Guaranty Earnings Conference Call.

My name is Louise (ph) and I will be your coordinator for today.

At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. If at any time during the call you require assistance, please press star, followed by zero and a coordinator will be happy to assist you.

I would now like to turn the presentation over to your host for today's call, Ms. Sabra Purtill, Senior Vice-President of Investor Relations. Please proceed ma'am.

Good morning. Thank you all for joining us for Assured Guaranty's first quarter 2004 Earnings Conference Call.

We released our earnings this morning and our press release and financial supplement are available on our web site and also via an 8K filing that we made with the SEC.

The speakers on our call today will be Dominic Frederico, Chief Executive Officer of Assured Guaranty and Bob Mills, our Chief Financial Officer. Other senior members of management are also available during the Q&A session.

Before turning the call over to Dominic, I'd like to remind you that our report today will contain forward-looking statements, such as statements relating to our financial outlook, business strategy, growth prospects, debt offering, rating agency and regulatory action, demand and other market conditions. Actual results may differ materially.

Please refer to our most recent SEC filings as well as our earning press release and financial supplement for more information on factors that could affect the forward-looking statements.

With that, I'll turn the call over to Dominic.

Thanks Sabra. Today I'm going to update you on some of our accomplishments for the first quarter of 2004, our last quarter before becoming a publicly traded company on April 22nd and touch on a few items related to new business production and market conditions.

I will then turn the call over to Bob Mills, our CFO, for a more detailed discussion of the financials. By any measure, we view the first quarter as a success. The accomplishments of the last four-and-a-half months are significant when you consider that we received a ratings upgrade, implemented a significant change in our business strategy, streamlined our operations to make ourselves more efficient, went public, and are about to execute a $200 million senior debt offering. In addition we added new management talent to the team with Bob Mills, Mike Schozer, Jim Michener, Pierre Samson and Sabra Purtill, joining Assured Guaranty.

While the accomplishments of the quarter were numerous, the financial activity from all the actions taken make the numbers somewhat of a challenge to analyze. We've tried to make these items as clear as possible in the press release, and in the financial supplement. Bob and Sabra are both available to help you work through the details of the results and of course, you can ask your questions after our commentary.

Now I'd like to touch on new business production and market conditions. One of the key strengths of our company was highlighted in this quarter. The value of our flexible operating platform. We have both a financial guaranty direct operation and a financial guaranty reinsurance operation. This quarter showed limited activity in our direct insurance operation due to the challenging market conditions, investor attention focused on the completion of the IPO and the previously announced potential of a ratings upgrade.

However, our market leading reinsurance operation had a tremendous quarter reflective of our position in the market. We benefited from our diversified client base as well as the reduction in competition in that market since 2003. Even though our financial direct business was modest, it was in line with our expectations. Our mortgage guarantee production was up as this valuable component of our structure contributes to future earnings stability.

Going forward we continue to believe that we can demonstrate solid results in a financial guaranty market that is expected to be flat this year. As we have emphasized on the IPO road show, our market share in financial guaranty is modest and with the IPO rating agency reviews almost completed, we expect to build on our first-quarter efforts in all of our ongoing segments over the balance of the year.

A key factor for our 2004 business plan was the Moody's upgrade, which happened last week. The financial strength ratings of our two key operating companies were upgraded. Assured Guaranty Corp., which was upgraded to Double A1, which is one notch behind Triple A and Assured Guaranty Re-International was upgraded to Double A2.

We anticipate hearing S&P's conclusion on our operating subsidiary soon. S&P announced an A+ rating with a stable outlook on our senior debt issue last week, and Moody's also announced an A1 rating on this debt as well.

As for overall market conditions, you have heard the other primaries talk about the impact of tight credit spreads on the market, particularly in the mortgage-backed securities and CDOs, which together have represented the majority of our direct business to date. Even in these difficult market conditions, we believe we have solid opportunities in many areas. With the IPO complete and the uncertainty it created in the minds of our customers resolved, we can now focus our attention on building our direct insurance franchise.

First our mortgage business continues to meet expectations and our ability to write business in either financial guaranty or mortgage insurance form has allowed us to write attractive risk remote business, consistent with our heightened concern about the state of the housing market. While the structure finance market continues to suffer from spread compression, our pipeline of new business is beginning to grow.

We expect demand for our secondary municipal financial guaranties to grow as well.

The international marketplace has a long time frame on deals, but we will be actively marketing in that arena once we receive our UK license. We are making progress on our license application and expect action by the FSA in the next 30 to 45 days.

In summary, we feel very comfortable that we have the people, capital, expertise and credit discipline to compete in the market. We have an operating platform and structure that allows us to adjust our focus where we see opportunity to expand our market presence. Even in the current soft market, given our low market share and investors' interest in financial guarantor diversification, we are seeing an increase in activity.

At the same time, our reinsurance franchise is strong and vibrant and our core reinsurance customers continue to demonstrate a need for our products.

Now I'd like to return the call over to Bob Mills to discuss our financial results.

Thanks Dominic and good morning. I have a couple of housekeeping items to open my discussion.

We expect to file our 10-Q for the first quarter just prior to the Memorial Day weekend. It's not actually due until June 6th. Although this is our first quarterly earnings release, we plan on conducting future earnings releases in a similar fashion with a press release followed by a call with analysts. A definitive date for the second quarter is probably a bit premature right now, but I have targeted the beginning of August for that release.

As Dominic mentioned there's a significant amount of financial noise in the first-quarter numbers, which makes analysis a challenge. We provided as much transparency as possible in the press release and financial supplement while conforming to the reporting rules.

I'll explain certain aspects of the first-quarter results more fully. The formation transactions discussed in the prospectus have by and large, been completed. Some require regulatory approvals that we expect to receive shortly. Although many of the formation transactions and much of the reshaping of the business was accomplished in the first quarter, there will still be noise in the second-quarter financials, because of IPO related transactions.

One of these transactions is the launch of our $200 million 30-year debt offering that will be completed shortly. Although interest rates have been rising recently, we hedged our debt issuance interest rate some weeks ago.

In addition, the conversion of Ace Equity Compensation Plans to Assured Guaranty is estimated at a charge of $9.5 million as disclosed in the IPO prospectus. There are other transactions and business transfers that primarily impact the asset and liability amounts with insignificant impact on the P&L in the second quarter.

As the press release notes, our net income for the quarter was $46.9 million, a result that's within the guidance range provided in the IPO prospectus. Excluding IPO related items and unrealized gains and losses on derivatives, the amount was $32.6 million, a 6% increase from the comparable amount in the first quarter of 2003.

Although many of the IPO related items are included in the other segment, certain transactions also impacted the direct segment. The company's ROE was 13.6% increased from 10.1% in the first quarter of 2003. Operating ROE for the quarter was 12.6%. Excluding IPO related transactions, and adding the impact of the increased leverage from the second-quarter debt offering, the operating ROE would be 10.1%. If all the IPO related transactions had occurred at March 31, 2004, the resulting book value per share and adjusted book value per share would have been $18.24 and $24.41 respectively.

We continue to maintain a target, operating ROE for 2004 of 11%.

Let's review the results for the quarter in a bit more detail now. First premiums look quite unusual as a result of the $97.8 million reduction reflecting the accounting for the unwinding of the equity CDOs, which was previously disclosed as part of our strategic restructuring.

We also closed out an index transaction structure, which is included in the direct segment. Although this was quite profitable, its nature and volatility did not fit the business strategy going forward. This transaction added $10.4 million to direct gross written premiums and $24 million to net premiums earned. The PVP or present value of gross financial guaranty premiums written grew by 93% this quarter. The PVP for the direct business was $7.9 million down 62%. This really was not unexpected at all as our focus and prospects for the quarter were limited by the IPO activities, the restructuring of the business and the ratings evaluations.

PVP for the reinsurance segment totaled $74.6 million, up 93% reflecting the strength in this well established business.

I want to highlight that PVP for reinsurance new business is reported on a one-quarter lag, calculated on the prior quarter's session. All other reinsurance segment reporting is for the current quarter as disclosed on our IPO prospectus.

Given the seasonality of financial guaranty premiums, our second-quarter PVP for reinsurance is usually below the first-quarter level.

The investment portfolio produced an appropriate return, commensurate to its short duration and high credit quality. Deals were down slightly from the 2003 levels reflecting the lower rate environment and some minor changes in the investment mix while the duration was maintained at less than five-and-a-half years.

Loss and loss adjustment expenses totaling $23.7 million also requires some explanation. This amount includes 7.5 million in the other segment, which is the net impact of multiple transactions. It also includes a loss in the direct segment of $12.3 million associated with our decision to liquidate one specific instrument in Argentina that did not meet our strategic direction going forward.

Lastly the total benefited by a credit of 2.9 million in the mortgage segment associated with the annual profit commission adjustment for that segment.

Taking all of these items into consideration, case loss activity for the quarter was modest. Absent unforeseen case losses we would expect our loss ratio to be in the mid teens for the remainder of the year, reflecting normal portfolio reserve activity and expenses.

Operating expenses were within our expectations and reflect a number of IPO related activities. Our cost reduction initiatives implemented in the fourth quarter of 2003, and the first quarter of 2004 resulted in control of or declines in a number of expense categories. At the same time, we incurred employee related expense for severance of $1.5 million.

Our expense run rate will decrease in the future by the reduction in employee-related costs due to reduced head count. But this will be largely offset by the cost of establishing the structure of an independent public company.

I fully agree with Dominic, we've really accomplished quite a bit this quarter and are ready to get down to business.

With that I will turn it over to the operator to poll for questions. In addition to Dominic and Sabra, we have with us Mike Schozer, the Head of the Direct Business, and Robbin Conner, the Head of the Reinsurance Segment to help field your questions.

Thank you. Ladies and gentlemen, if you wish to ask a question, please press star, followed by one on your touch-tone telephone. If your question has been answered or you wish to withdraw your question, press star, followed by two. Again, that is star-one to ask a question.

And your first question comes from Mark Lane from William Blair and Company. Please proceed, sir.

I didn't think I was that quick into the queue. Congratulations. First of all, on the reinsurance business, within the comments on AGP, you highlighted that part of the growth came from increasing your market share with certain cedents. Can you talk about which clients on a year-over-year basis in the fourth quarter where you increased market share, and has that changed since the first of the year?

Yes, Mark, this is Dominic Frederico. We typically do not, other than disclose in total, what we do in terms of receiving cessions from the various primary companies. So you know, I'd be uncomfortable to talk about individual companies and specific percentage of cessions. I think the take-away there is we have increased participation, as you would expect, because of the lack of competition, the reinsurance segment. As you know, that marketplace declined by about 50% of capacity since 2002.

And if we look at ourselves in terms of our ratings today and position in the marketplace, we're probably the only true high-cap dedicated reinsurance facility for the primary companies. Obviously, other people have strategies that kind of mix both their direct business and their reinsurance business. You know, we have decided to keep an absolute Chinese Wall between the two operations. So the reinsurance operation is strictly dedicated to the primary companies and as such, I think it has a pre-imminent position in that marketplace.

As you know we're executing more of that business offshore as well as part of our long-term corporate strategies in terms of maximizing the value of our structure.

Okay, but on a, so if we look, in other words, I believe there was one, you know, there's obviously not that many direct clients ...

And we do business with basically all of them.

Right, and so there's, I believe there was one that came up on maybe early this year. Has that changed at all since the fourth quarter? I mean has the level of cession gone up after one-one?

After one-one, no it has not. We've maintained. We've renewed the majority of the reinsurance business already into the '04 year with the changes made in terms of the participations, there's still a little bit of flexibility left, but by and large, they principally held with the '03 values.

Mark, remember, this is Bob Mills, remember that the comparison that you're looking at is first quarter to first quarter and there was a change after the first quarter of '03, which increased the amount of business that came to us, so on a comparative basis first quarter to first quarter, so there was an increase.

Only one of the primaries renews as of one-one.

Right, Okay, and then on the international side, is the license really the only obstacle to writing business. So if you got your license within 30 days, would you expect to actually write business in the second quarter or is there still some infrastructure et cetera that you need to – (multiple speakers)?

Remember we have an arranger's license today, so to the extent that we're able to go out and solicit opportunities and have them written by the direct company in the U.S. as a reinsurance company of Bermuda, that has existed and we've done that in the past.

In terms of the ability to really participate in the market, you're exactly right, it is contingent upon us receiving a license. We had the license pretty much received for the first of the year. We then announced the IPO, which in the FSA's mind did change you know, what some of the core principles were of things like internal audit et cetera, in terms of how those functions and governances were going to be carried out, because initially we went to them as an application as part of the ACE Group of companies. And now we had to go back to them and reapply as an independent company and it's just kind of working through those administrative issues that have been the cause for the delay, but we are confident in receiving the license in the short-term.

Once we establish the license, obviously we've done a lot of what I'll call marketing in the past without the ability to execute in continent, and now we'd have the ability to execute, but those deals still take a fairly long time, you know, from origination to ultimate binding and execution.

So we would anticipate that you would see production towards the end of the year.

And maybe just finishing up the direct segments. You mentioned the pipeline growing, is that a result of any changes in the market overall or is that just the result of the completion of the IPO and the upgrades by Moody's and maybe Mike wants to offer any additional comments on that, that'd be great.

Yes, I'll let Mike handle that one.

Michael?

I think what we clearly saw was you know, we, I was new in December. We had a lot of changes going on, I mean, an IPO, a change in management, and I can tell you from my perspective all of a sudden now we're starting to see the pipeline build, because we're focused now on you know, building the business. And you know, people are human and people look at a series of changes organizationally and you know, clients are human and they say well gee what's going to happen to the ratings and so forth like that.

So, you know, there was an understandable slowdown, both on the parts of you know, the people as well as the client who wanted to do business. And while it does take time to get deals through the pipeline, I will tell you that, you know, I'm quite pleased with the rate at which the pipeline is building.

Okay, thank you.

And your next question comes from A.J. Grewal from Smith Barney. Please proceed sir.

Yes, hi, I'm not sure if I missed this, but you did give some guidance on what you expect in the loss ratio for the rest of the year, could you give us some color on what you expect on expense ratio for the remainder of the year.

I mean, what I had said in my remarks was that you know, barring unforeseen case losses that I expected the loss ratio to be in the mid-teens. The expense ratio for the balance of the year I did not specifically address. I guess I would expect the expense run rate after consideration of the items that I had mentioned that impact expenses that were unusual as well as, you know, the items I mentioned for the second quarter and the continuing noise to probably be about – be a similar run rate to what we had in the first quarter.

In absolute terms, the dollar value, yes?

Right. Remember our expense ratio is heavily influenced by the reinsurance segment. As you know we pay a ceding commission in the reinsurance side, which in effect adds to an overall expense run rate, so the direct side has a benefit if you look at our competitors, of receiving the ceding commission, so it's kind of a contra-expense item. We have the detriment. That's always going to account for about a 10-15 point difference in expense ratio. Because today our reinsurance segment still dominates the overall, you know, total of business written, we're going to be trending or have a result that is going to be at the higher end. So, you know, if you think of a traditional expense ratio in the 40's, we'd hope to be at the low end of that, and then as we build the direct business, ultimately pull that down over the year as we get to recognize more of that, but also remember the expense ratio is based on earned premium.

So you know, the amount of how you recognize earned premium is this industry is extremely slow, it'll be a gradual pulling down. So you know, we hope to maintain the ratio in the current year, kind of in the low 40's if we get benefited from some extraordinary growth in the direct side with some contributing to the earned premium, you could see a better value than that, but that's kind of where we think it's going to be.

Thank you.

And once again, ladies and gentlemen, that is star-one to ask a question. There are no more questions at this time.

Thank you Louise. This is Sabra Purtill. I'm available to answer questions and do follow-ups with people to the extent they need. I apologize as my cell phone, which normally works well in Bermuda is not working this time, this trip for some reason. So please contact me at 441-296-4004 or via my email and I will get back to you in a timely basis.

With that, I'd like to thank you all for joining our call. A replay will be available on the Internet as well as in the dial-in number that was made available in the press release. And we look forward to talking to you again for our second-quarter earnings release. Thank you very much.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation; you may now disconnect. Good day.