Assured Guaranty Ltd (AGO) 2004 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to the fourth quarter 2004 Assured Guaranty Earnings Conference Call. My name is Andrea and I'll be your coordinator for today. (Operator Instructions)

I would now like to turn the presentation over to the host of today's call, Miss Sabra Purtill, Senior Vice President of Investor Relations. Please proceed.

Good morning. Thank you all for joining us for Assured Guaranty's Fourth Quarter 2004 Earnings Conference Call. We released our earnings yesterday evening. Our press release and financial supplement are available on our web site at www.assuredguaranty.com.

The speakers on our call today will be Dominic Frederico, President and Chief Executive Officer of Assured Guaranty Ltd. and Bob Mills, Chief Financial Officer. Following their prepared remarks, they and other members of senior management including Mike Schozer, who runs our financial guaranty-direct business, and Pierre Samson, who's in charge of our financial guaranty-reinsurance business, will be available to address your questions.

A replay of this call will also be available on our web site and by telephone at 1-888-286-8010 in the U.S. and at 617-801-6888 for international callers. The passcode is 30864145.

Before turning the call over to Dominic, I'd like to remind you that our commentary today may contain forward-looking statements, such as statements relating to our financial outlook, business strategy, growth prospects, ratings goals, personnel, demand and other market conditions. Actual results may differ materially. Please refer to our most recent SEC filings as well as our earnings press release and financial supplement, which are available on our website, for more information on factors that could affect our forward-looking statements.

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

Thank you, Sabra. And thanks to all of you on the call and webcast for your interest in Assured Guaranty.

Our fourth quarter results reflect the tangible results of the many initiatives that we have undertaken since our IPO process began in late 2003. This is only our second full quarter as a publicly traded company and I'm very pleased that our financial results reported last night demonstrate the progress we are making to build a leading financial guaranty insurance and reinsurance franchise.

While market conditions remain challenging industry wide, our financial guaranty and mortgage guaranty new business results were the best we've seen all year, a testament to the market traction we are building in the direct business.

In the reinsurance segment, 2004 represents the best year in the company's history in the production of new business. Our facultative business grew during the year and we maintained our industry leadership in this area by any measure - premium, par or capital.

Bob will review our financial results in detail in a few minutes, but first I'd like to touch on a few transactions in the quarter that stand out as achievements for our company.

In the fourth quarter, we insured our largest cash collaterized loan obligation deal. This transaction was upsized from $1 billion to $1.25 billion due to strong investor demand and was one of the largest wrap CLOs of 2004. In addition, while the collateral was from the U.S., about half the deal was placed offshore, our first major placement of paper to international fixed income investors.

Our public finance team successfully launched our first series of wrapped primary deals in the quarter and is building a good pipeline for 2005. The rating agencies are keenly interested in our success in this market and we expect to produce a solid track record in the first half of 2005, when the agencies undertake their annual review of our operations.

Our mortgage team successfully closed over $4 billion of public residential mortgage-backed security transactions.

Turning to reinsurance, we had several significant accomplishments. First, we centralized the reinsurance operations in Bermuda and now the substantial majority of new reinsurance business is written by Assured Guaranty Re.

Second, we previously announced the January renewal of our reinsurance treaties with FSA, our largest reinsurance client. Negotiations with our second largest treaty client have begun and that treaty renews in April.

Third, our reinsurance facultative volume continues to build and we continue to expand the number of master facultative agreements in place. During the quarter, we signed a master facultative agreement with FGIC and wrote 6 deals for them. Facultative business accounted for 36% of fourth quarter reinsurance PVP, a significant increase compared to 12% for the first 9 months of 2004.

For the full year 2004, the fac PVP was up 27% over 2003. At mid year, we anticipated this facultative opportunity and we were able to execute when presented with submission requests.

In addition to these deals, other achievements in the quarter include receiving our California license, which allows us to actively solicit both public and structured finance business in one of the largest issuance states in the country. In total, we received 6 new state licenses during 2004 for a total of 47 and hope to get 3 more, including New Jersey and Puerto Rico by the end of 2005. We also received passport approvals for the European Union and can now write business throughout Europe.

Now I'd like to turn the call over to Bob Mills, our CFO, to cover the financial highlights for the quarter. And we look forward to taking your questions later in the call. Bob.

Thanks, Dominic and good morning to everyone. Before I begin, I'd like to remind everyone to refer to our press release and financial supplement for segment level details and further explanations of our financial position and results of operations.

From a financial performance standpoint, I'm really quite satisfied with our results for the quarter. Net income for the quarter was $0.64 a share compared to $0.59 a share for the third quarter of 2004 and a $1.30 a share for the fourth quarter of 2003. Our operating income per share, which we calculate as net income, excluding realized gains and losses on investments. and unrealized gains and losses on derivative financial instruments was $0.48 per share compared to $0.45 per share for the third quarter of 2004 and $0.45 per share for the fourth quarter of 2003. Earnings from municipal bond refundings contributed $0.03 per share in the third and fourth quarters of 2004 and approximately $0.01 per share for the fourth quarter of 2003.

Let's review the results for the quarter in a bit more detail. PVP, or the present value of written premiums, totaled $82.2 million for the quarter, an increase of 71% versus the third quarter of 2004 and an increase of 44% compared to the fourth quarter of 2003.

PVP for the direct business was $39.6 million, and increase of 401% from the third quarter of 2004 and an increase of 82% from the fourth quarter of 2003.

PVP for the reinsurance segment totaled $35.7 million, a decline of 8% from the third quarter 2004. Although a decline in PVP this quarter was expected, because of a change in the second quarter of our reinsurance relationships with two of our clients, the decline was softened by increases in facultative business. You should keep in mind that reinsurance PVP volume overall will probably decline in 2005 unless market conditions improve enough to offset an otherwise 30% decline in PVP due to the non-renewal of 2 quota share treaties that occurred in mid 2004.

You will recall that this segment reports PVP on installment business and par written on a one quarter lag basis due to a delay in receiving new business information from the primary companies.

PVP for the mortgage segment totaled $6.9 million, a significant increase over the $1.1 million in the third quarter of 2004. PVP for the mortgage segment for the full year 2004 was $27.1 million compared to $0.6 million for the full year of 2003.

Net earned premium for the quarter totaled $57.1 million, up 7% from the third quarter of 2004, but down 34% from the fourth quarter of 2003. If we exclude the other segments, net earned premiums of $40.7 million in the fourth quarter of 2003, the direct, reinsurance and mortgage net earned premiums increased by 23% in 2004.

For the Direct segment, net earned premium totaled $15.5 million for the quarter, down 6% from the third quarter of 2004 and down 4% from the fourth quarter of 2003. This reflects the run-off of prior years' business and was only partially offset by new business volume, the majority of which was written in the fourth quarter.

Net earned premiums for the reinsurance segment were $36.5 million, up 14% from the third quarter of 2004 and up 49% from the fourth quarter of 2003. This reflects continued growth in the segment's book of business and unearned premiums during 2004.

Net earned premiums for the mortgage segment were $5.2 million, substantially flat with the third quarter of 2004 and down 9% from the fourth quarter of 2003.

Loss and loss adjustment expenses incurred totaled $0.2 million for the quarter compared to $4.2 million for the third quarter of 2004 and $52.7 million for the fourth quarter of 2003, which included a loss provision of $35.9 million in the other segment.

Losses for the quarter are comprised of a couple of components. In the aggregate and at the segment level, there were no material changes in case or portfolio reserves. Case reserve and loss adjustment expenses incurred for the quarter totaled $1.5 million. Direct segment case losses and loss adjustment expenses incurred totaled $0.3 million, while reinsurance case losses and loss adjustment expenses incurred totaled $1.2 million consisting largely of loss adjustment expenses related to older cases.

Portfolio reserve activity was the net addition of $1.2 million for the quarter, reflecting additions to the reserve for normal portfolio activity including new business, changes in previously existing business and the run-off of CDOs and the single name book. Portfolio reserve additions for the direct, reinsurance and mortgage segments were $ 0.6 million, $0.4 million and $0.2 million respectively for those segments. In the mortgage segment, there was also a decrease in IBNR of $2.1 million, as it's actual loss experience was less than expectations. This was offset by a similar amount in profit commissions. During the quarter there were no changes in the reserving process that took place.

Turning to the investment portfolio, the portfolio grew slightly from the beginning of the quarter. Yields were up slightly from the third quarter of 2004 and were relatively flat compared with the fourth quarter of 2003, reflecting the rate environment and changes in the investment mix. The current pre-tax book yield is 4.8% and the duration has shortened to approximately 5.0 years from 5.4 years in the fourth quarter of 2003, in line with our objectives and the current environment.

Operating expenses increased 3% from the third quarter of 2004. Compared to the fourth quarter 2003, operating expenses were up 51%, the result of expenses related to the establishment of a holding company infrastructure and increased staff in the direct business.

Our book value per share was $20.19. Our accumulated comprehensive other income account was relatively unchanged compared to the end of the third quarter. Adjusted book value, which is used by management and investors to evaluate growth in the company's equity and enforce booked business, was $27.67 per share at quarter end.

The Company's operating ROE in the quarter, which is calculated by dividing annualized quarterly operating income by average shareholders' equity, was 10.0%. The year to date operating ROE unadjusted was 10.1%. This is slightly below our target of 10.2% and is largely a function of continued growth in the market value of our derivatives book, which I had not anticipated. Unrealized derivative gains are excluded from our operating income but are included in equity, impacting the calculation. As I've said previously, a number of variables will impact our earnings and ROE going forward. These variables include our split ratings from the rating agencies and uncertainty regarding the timing of a potential upgrade, as well as market conditions and credit spreads. We also continued to have a significant amount of excess capital that will be utilized more efficiently as we grow the business and continue to implement our business plans. While it is clearly our goal to continue improving ROE in 2005 and beyond, immediate improvement will be a challenge as our equity continues to increase.

All in all, we're making good progress. We expect to release our first quarter 2005 earnings during the first week or the second week of May and will update you as the time gets closer.

With that I'd like to turn the call over to the operator to poll for questions.

(Operator instructions)

And our first question comes from A.J. Grewal from Smith Barney. Please proceed.

Could you give us an idea of where you expect your expense ratios to go going forward? There's been quite a bit of movement from quarter to quarter and I'm just trying to get an idea of what to expect in the coming quarters.

I mean if you look at the operating expenses and if you focus on that, I think that probably what you're looking for is a baseline to work with, and operating expenses for the third quarter were $14 million and operating expenses for the fourth quarter were $14.5 million. I think that presents a reasonable base line, the $14.5 million. We have been adding some staff and clearly we continue. We have plans to add additional staff on the business side during 2005. But I think from a baseline operating expense number, the $14.5 number is probably not unreasonable.

If you annualize that you get to around $58 million. What kind of growth do you expect on top of that?

I think as Bob said, we're not really considering anything additional in terms of major expense items other than continued additions to staff, but they would not be significant relative to total staff in the company. So we add selectively and strategically where we see continued opportunities. For instance, in the last month we've added 2 more people to our public finance staff in the United States, but once again that would not be significant. And the second thing is that earned premium will start to also ramp up based on the level of new writings. So from a percentage calculation it should remain fairly consistent.

We did have huge bump in expenses year-over-year because under the old Ace structure there was no push down of the holding company expenses for things like public entity, D&O etc. Now we absorb all of that internally within the financials and that was the largest amount of the operation. But as Bob said, going forward we expect that to be a fairly consistent number offset slightly by some growth in staff, but that should also be absorbed by growth in our earned premium.

Just in regards to the growth in the pipeline. Could you give us an idea of the size of the pipeline by segments?

We don't look at size-we don't disclose size. I mean as we talked about last quarter on the earnings call, we were very pleased with the pipeline that we had at that point in time and obviously it led to a fairly strong fourth quarter.

As we look to the first quarter pipeline, once again, it's very strong as we've now continued to add transactors to our staff with a real market focus. We've been out in the market and receiving a good number of opportunities, really across all asset classes, so it's not like I can differentiate that one is lagging behind the other. We've got pretty good submission activity, which we do track obviously across all aspects of our business.

Thank you.

And our next question comes from Geoffrey Dunn from KBW. Please proceed.

Thank you, good morning. Dominic, last quarter you gave us a fair amount of detail on the first public finance transaction you did. Can you give us a little color on some of the other transactions that occurred in the fourth quarter? What the pricing might have looked like against others that were on those deals? And also what is the rating agency's reaction to the traction that you're demonstrating in that market?

Well, to give you color, we did roughly on the direct side about 6 deals. We did some other secondary market deals. They were totally spread across the gamut of municipal type of exposure. Some power utility, one healthcare, a couple of GOs and a couple of revenue bonds.

In terms of pricing, as we talked about, on the asset backed side we trade about 5 to 7 back of the other FG companies. On the muni side and especially in the long dated area, we're probably in the 10 to 15 range back. So obviously we have to focus on those credits that would have enough spread differential to allow us to in effect consider that pricing, especially in the fixed rate market it's probably 15 to 20 back.

And as we look at those deals, and we do allocate capital to every deal and calculate a ROE. And understanding the importance of doing the municipal primary issuance is a real key rating agency component. We were still very pleased with the ROEs we were able to get on those deals. I mean they are principally around our target ROE of 15%. Some a little south, some a little north.

Okay, and then second. In the direct segment, can you possibly give some guidance on where the provision rate will probably be going forward? Are we going to be looking at around mid to upper single digits? Or are we going to probably normalize out at a double-digit run rate?

Losses are a factor of new business generated during a period as well as run-off of old business and changes in credit conditions during a period. When you look at the new business, I think we would clearly expect the losses in the public finance area to be in the, what you would call the normalized trend of 5 to 10%. And the structured finance area to be in the area of 10 to 15%. But certainly the losses paid have been at a much lower level than that. So I'm not sure if that answers your question or not.

Trying to get to a normalized loss ratio for us is still very difficult, because we've got books running off that were really not in the market today that are very different in terms of loss content than we're currently booking. And the amount of reserve takedowns, as we continue to run a quarterly analysis of losses, which is a principle numeric type exercise based on rating and obviously based on other credit facts that we know.

The single name book has continued to pressurize down. The quota share mortgage book is pressurizing the losses down as well as some of the CDO run off. So though we are putting up what I'll call normal provisions on the new business. The run off books are really having an effect on what the ultimate net-net losses incurred are. And that will still continue into '05.

Okay and I wanted to circle back on the rating agency's reaction to the public finance traction.

As I said last quarter, I'm kind of retiring from predicting rating agency reaction, because I haven't done a very good job. Obviously, they've made it a special point to look at public finance issuance. We've obviously heard that significantly. We continue to add resources and pay a lot of attention. We had some good activity in the fourth quarter.

As I stated in my comments, we expect continued good activity. We see a good flow of opportunity in the target class that we're looking at, which is very different than the other monolines to a certain extent. And therefore we expect to be able to continue to hit some pretty good numbers in terms of direct primary issuance. And we think that is part of the rating agency requirements. So we hope that we're meeting that need.

Okay. Thank you.

Your next question comes from Mike Grasher from Piper Jaffray. Please proceed.

Good morning. Just to follow up on Jeff's comment. You broke out the structured and the public finance in terms of the pricing and that. Is there any way to sort of quantify how that might change as you look at deal sizes? As the deal sizes changes, how much the pricing environment changes as well or the competition?

Thanks Mike for the comment. The deal size-we're literally, because of how we're rated, we have a very focused strategy and very direct or defined market place in the public finance. And therefore the size deal that we're able to really go out and take a look at is somewhere in the $15 to $50 million range. That will continue based on our current ratings.

Obviously, we're looking at smaller issuances. We're looking at higher ed, some small healthcare, small utilities and general obligations. That's not going to change in the short term, so I don't really anticipate kind of a pricing movement change as well.

Okay. Thanks very much. And then also the California license. How soon will that or might we see an impact on California in the mortgage business?

Well, the day we got the license, I think we had two planeloads of people heading out to California that began the details specific marketing effort. Obviously, we're looking in two general areas out there, municipal and asset backed. And asset backed ,principally mortgage, cause that's where a lot of origination takes place.

And we've had a pretty good flow of that business to date. We now expect greater flow. It's hard for me to quantify when the first deal will come up. As you know that that's a business where everyone has kind of a target allocation for any given year.

So the typical beginning of the year, there's a lot of competition, which we obviously think will be taken by the large monolines. And then as they begin to fill up, we'll start to see more opportunities for us as well as we get on other rotations that are currently available in the California market. So it's probably a mid-to-late year opportunity for us.

Okay. Thanks very much. And then just in terms that you were in the market buying back shares in the quarter. I expect we'll continue to see that. Is that the case?

Bob you want---

Yeah, I'll take that.

Opportunistically.

The program itself is a modest program. As we had disclosed last quarter, it's a $25 million program. The purpose of which is largely to offset the compensation plans. We did buy back shares, as you note, some 300,000 shares. We will be in the market on a reasonably consistent basis. Naturally, we are somewhat confined by blackout periods and things like that. And we will be looking to buy back shares while the price is under the book value.

Thanks Bob.

And our next question comes from Rob Ryan from Merrill Lynch. Please proceed.

Good morning.

Hi Rob.

Good morning Rob.

Could you give us an update on the European efforts?

Sure. Europe, we're actually starting to see and we were hoping to announce our first international European deal, but it kind of slipped from closing. So stay tuned, there'll be an announcement maybe next quarter when we finish the quarter.

We see good activity in the asset backed and mortgage area. We're obviously beginning to enter our bids on the public finance side of the PFI business, but as you know that has a very long gestation period in terms of when bids are solicited before actually getting the deal finalized, done and out to the market.

So we're beginning to quote on those at a very active basis. As I said we expect to see European activity this year in the asset backed area and mortgage area and begin the process on the PFI and PPP business.

Okay. Great. Also could you give us an update on what you see as the prospects for new Bermuda based competition in financial guaranty reinsurance?

Sure. As you know, Blue Point began operation. They've got the ratings and they're down here as a new competitor. Obviously, we think it's probably good. Putting another reinsurance company in Bermuda for us continues to then increase the status of Bermuda as a financial guaranty reinsurance market. And our view is because we think we maintain the preeminent position in that marketplace with the largest capital capacity and obviously confidence of execution, we welcome the opportunity to bring new sources of business to a marketplace that we think we dominate.

The other companies - there alway is rumors for other participants, but in most cases those don't come fruition. Obviously to start a new reinsurance company, one of our views is that you have to have a portfolio and therefore having more portfolios that are out there to be acquired.

But we still think that the reinsurance market is a good opportunity for us. There still is a lack of real capacity in competition in the area. Obviously, as we talk about our reinsurance company, we had our best year ever. And that's in spite of ramping up the direct operation at the same time. Because I think there is a need for quality reinsurance highly rated, consistent, committed capacity.

And if you go back 2 or 3 years the capacity today is still significantly less than what was available at that point in time. And yet markets are continuing to build. The direct monolines are still running a lot of business with very high tags to them, but they still need to manage their portfolio risks. So we kind of welcome the competition. We think there's still plenty of space in the reinsurance area.

Great. Thank you.

Thank you.

(Operator Instructions)

And our next question comes from Mark Lane from William Blair and Company. Please proceed.

Good morning everyone.

Good morning, Mark.

Hi Mark.

Just a couple quick ones. Can you just share with us on the U.S. structured finance business, the mortgage deals that you wrote in the fourth quarter? And maybe use like an AmeriQuest as an example. In terms of competition, why did you write the business? Was it relationship based? Was it rotationally based? Can you just give a little bit more insight relative to existing competitors?

Sure, Mark. I would say it's all the above. It is rotation based. It is relationship based. We have a very kind of defined niche. We've got some of the best people in the industry in that area. Typically, we write at the AAA attachment. So these are very nice deals from the standpoint of an ultimate ROE, because although they're not heavily priced from the standpoint of a basis point, they track very little capital allocation, because of the AAA attachment.

About half of them are done in derivative formand the other half are really done as FG or financial guaranty. And they're the typical portfolio mortgages. Fairly large subordination, so the attachment is the AAA level. And obviously we've had very good experience in that area. Of course, it's sub-prime mortgages as you know, non-qualifying. And it's been a great line of business for us. And we do get on rotations even in our current situation. It's less price sensitive.

Okay. And what about paid losses in direct and reinsurance in the fourth quarter? Do you have those numbers?

Paid losses in direct during the fourth quarter was $1 million. And on the reinsurance businesses $1.6 million.

Principally, that was loss adjusted expenses coming through a set of treaties with one of the monolines as opposed to case paid reserves.

So very benign activity in the loss area for the fourth quarter.

And what about new hiring for 2005? First of all, in January, you added two people. Are those transaction people? And then what other areas will you add people and at what level?

We continue to add principally transactors, because obviously that's where we are continuing to build opportunity. We've got a good submission flow. We want to make sure we can provide timely service and response.

What we expect in 2005 is to continue to build out our structure finance area. We've made some significant additions, but that's an area that we see good opportunity, steady flow of business and we still need to have more people involved. Public finance, we will always add to as that's a critic component of the company and it's growth direction. We've added 5 in the last say 2 or 3 months and we will continue to look to hire probably about 4 more in the first half of '05.

Lastly, we've got to build out the international capability. We've got some strong people there in the PFI and the ABS markets, but they're kind of one-man bands. We really need to compliment fully their staff, so you're going to see probably about 6 people hired in London as well at the same time.

In structured finance, you're talking like 3 or 4 people in existing areas or new areas, would you say?

Well structured finance is kind of catch-all for a lot of opportunities, very unique transactions in some cases. So there we tend to look at people with a very strong base either in technical applications potentially actuaries or at least strong asset backed skills demonstrated either through rating agencies or other companies. And so it's hard to say there's a specific type as you can appreciate. When you look at our asset classes done this quarter, it's pretty well spread across many.

Alright. And this closely monitored credit disclosure that I think was included in the supplement, which I don't think was in the last quarter. Any changes in that sequentially?

We had very little activity in the closely monitored. We had a credit go from a category 1 to a category 2, which was a manufactured housing deal. And we had probably two small additions to the category 1, which is obviously where we just start to watch the activity. But in terms of major dollars, no real significant activity or no real additional losses to be expected. The actual net par outstanding on the closely monitored list dropped as well, $500 million in the quarter. So actually it was an add and subtracts coming in and out of the list.

Okay. Thank you very much.

Thank you.

Our next question comes from James Shanahan from Wachovia. Please proceed.

Thank you good morning everyone. Just a quick question. Could you discuss your exposure to the airline industry - particularly on the structured finance side of your business, EETCs for example?

We can if you like. We monitor that activity as close as everyone else. Today, we have about $350 million of net EETC exposure. With a kind of company wide average LTV of 75% and an average rating of BBB minus.

So far so good, we don't have any losses out of that list to date. Obviously, we've paid some in the past. So we're still fairly confident and comfortable with where we are. Our EETC position is not as significant. And as I said the average rating is BBB minus and the average LTV is 75%.

And I have one more follow-up. Thank you for that-one more follow up please. Can you talk about your attachment points and the CDO deals you did in the fourth quarter? Is it a similar sort of structure and attachment point that you see in your sub-prime and home equity?

I guess I can give you the easier side, is what it's rated in terms of our attachment point. A strong number of them are rated AAA. And there's I'd say the majority, 66% or so, are AAA and then the rest are A plus or A, so fairly high attachment points across the board.

Thank you.

And we have a follow up question from A.J. Grewal from Smith Barney. Please proceed.

Could you give any ideas if you have any updates on what your expectations are for an operating ROE number? It was slightly below your expectations. And I realize that the denominator had derivative gains in that. But going forward, do you have any color on what to expect from returns?

As we've said in the last quarter and I think as I said in my comments before, we're not really providing guidance at this time relative to ROE expectations. We certainly hope to increase the ROE in '05 and beyond. Earnings-I expect operating earnings to increase, but we're not going to provide specific guidance at this point.

Thank you.

Ladies and gentlemen this concludes the question and answer portion of today's presentation. I will turn it back to Sabra Purtill for closing remarks.

Thank you. Thank you to you all for listening today or to the replay after this call. We certainly appreciate your interest in Assured Guaranty. And if you have any additional questions or information needs, please feel free to contact me at 441-278-6665 or via e-mail at spurtill@assuredguaranty.com. Thank you again and have a good day.

(Operator instructions)